Table 10.9 Busted Patterns
| Description | Up Breakout | Down Breakout |
|---|---|---|
| Busted patterns count | 175 or 29% | 144 or 43% |
| Single bust count | 85 or 49% | 100 or 69% |
| Double bust count | 54 or 31% | 5 or 3% |
| Triple+ bust count | 36 or 21% | 39 or 27% |
| Performance for all busted patterns | –13% | 43% |
| Single busted performance | –22% | 60% |
| Non‐busted performance | –15% | 43% |
Busted patterns count. I'm always surprised at how many patterns fail to move more than 10% away from the pattern, then reverse and shoot out the other side of the pattern. Here, we have over a quarter (29%) to nearly half (43%) bust the up or down breakout, respectively.
Busted occurrence. I sorted the number of busts into one, two, or more than two busts (triple+). Single busts happen most often. Notice that triple+ busts place second after a downward breakout. I've seen this in other patterns, too.
Busted and non‐busted performance. Look at the performance after a single busted downward breakout: Broadening patterns see price rise an average of 60%. When I read that, my jaw swung open, my dentures fell out, and I had to pick them up off the carpet. Single busts also outperformed after a busted upward breakout.
The 60% number is so startling that if you can find a busted downward breakout, then do consider trading the pattern.
Non‐busted patterns seem to have the edge (and it's slight) on performance if you disregard the single busted patterns and downward breakouts.
Trading Tactics
Table 10.10 outlines trading tactics for descending broadening formations.
Measure rule. Figure 10.7 illustrates the use of the measure rule. Compute the broadening pattern's height by first taking the difference between the highest high (A, 49.50) and the lowest low (B, 43.50). Add the result (6) to the value of the horizontal trendline to get a target price of 55.50 (for an upward breakout). Price reaches this target during mid‐March 1996 as the stock climbs on its way to 60.
If the stock breaks out downward, the measure rule computation is nearly the same. Subtract the pattern's height from the lowest low, giving a target price of 37.50. Be aware that upward breakouts in bull markets are more likely to reach their targets (65%) than other combinations.
The lower portion of the table shows how often price will reach the target based on various heights. For example, if you slice the height of the pattern in half and use that in the measure rule computation, you'll find price will reach the target 82% of the time if your pattern behaves like the average pattern.
Once you've computed a target, change the difference between the target and the current price into a percentage of the current price. Then use Table 10.3 to see how often the stock will fail to exceed the move.
Using our example, the target is 6 points away from the top of the pattern (49.50, which we assume is the current price), or 12% above A (or 100 × 6/49.50). Table 10.3 shows that 32% will fail to see price rise more than 10%, so the failure rate would be higher for a 12% target. That also means 68% of the trades will see price exceed a 10% rise. That sounds like a reasonable number.
Table 10.10 Trading Tactics
| Trading Tactic | Explanation |
|---|---|
| Measure rule | Compute the formation height by taking the difference between the horizontal top and the lowest low in the pattern. For upward breakouts, add the height to the value of the horizontal trendline. For downward breakouts, subtract the height from the lowest low in the pattern. The result is the target price. The bottom portion of this table shows how often the measure rule works. |
| Wait for breakout | It is unclear which way price will break out (upward breakouts happen most often), so it is best to wait for price to close outside the trendlines. Once they do, expect price to continue moving in the direction of the breakout. |
| Stop location | Once a breakout occurs, consider the opposite side of the formation as the stop‐loss point. However, in many cases you will want something closer to your purchase price, so look for nearer support or resistance zones or use a volatility stop. |
| Intraformation trading | For aggressive and experienced traders, consider placing a trade as price reverses course at the pattern's lower trendline boundary. Go long at the bottom (which hopes for an upward breakout), but be sure to use stops. |
| Partial decline | Short a stock if you see a partial decline once price curls around and begins heading back up. A partial decline correctly predicts an upward breakout 75% of the time. |
| Busted trade | If you see a busted downward breakout, then consider buying the stock. See Table 10.9 for details. |
| Description | Up Breakout | Down Breakout |
|---|---|---|
| Percentage reaching half height target | 82% | 76% |
| Percentage reaching full height target | 65% | 51% |
| Percentage reaching 2× height | 49% | 23% |
| Percentage reaching 3× height | 38% |
13%
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