than two) and found that single busts happen most often. In second place for downward breakouts is triple (or more) busts.
Busted and non‐busted performance. I compared the performance of all busts (one, two, and triple+) with single busted and patterns that don't bust (non‐busted). Busted patterns outperform when the busted breakout direction matches the market trend (upward breakout in bull markets and downward breakout in bear markets).
Table 11.9 Busted Patterns
| Description | Bull Market, Up Breakout | Bear Market, Up Breakout | Bull Market, Down Breakout | Bear Market, Down Breakout |
|---|---|---|---|---|
| Busted patterns count | 351 or 29% | 57 or 29% | 379 or 47% | 30 or 15% |
| Single bust count | 176 or 50% | 42 or 74% | 252 or 66% | 21 or 70% |
| Double bust count | 115 or 33% | 11 or 19% | 12 or 3% | 4 or 13% |
| Triple+ bust count | 60 or 17% | 4 or 7% | 115 or 30% | 5 or 17% |
| Performance for all busted patterns | –14% | –20% | 38% | 38% |
| Single busted performance | –22% | –25% | 55% | 53% |
| Non‐busted performance | –13% | –22% | 42% | 25% |
Recall that after upward breakouts in bull markets, the stock will bust by dropping. So the stock is heading down (and showing better performance, too!), even as the general market is rising. The same applies to busted downward breakouts (price rises) in bear markets (many stocks drop).
Why does this happen? My only guess is that stockholders know a good or bad situation when they see it and trade with enthusiasm, in spite of what's happening in the general market.
Trading Tactics
Table 11.10 outlines trading tactics for broadening tops.
Measure rule. The first thing to consider about trading tactics is the measure rule. The measure rule predicts the price to which the stock will move (in theory). For many chart patterns, one simply computes the height of the chart pattern and adds or subtracts the height from the breakout price. Apply the same method to broadening tops.
Consider Figure 11.5 as an example. The height of the broadening top is the difference between the highest high (B, 12.13) and the lowest low (A, 10), or 2.13. For upward breakouts, add the height to the highest high in the chart pattern, giving a target of 14.26, as shown in the figure.
For downward breakouts, subtract the height from the bottom of the pattern, giving a target of 7.87. If the computation gives a target below zero, then don't use the measure rule. If the target is too far away (21% in this case), there's a good chance price won't drop that far. Use common sense.
Table 11.10 Trading Tactics
| Trading Tactic | Explanation |
|---|---|
| Measure rule | Compute the height between the highest high and the lowest low in the pattern. Add the height to or subtract it from the highest high or lowest low, respectively. The result is the target price for upward and downward breakouts. The bottom portion of the table shows how often the measure rule works. |
| Go long at the bottom | Once a broadening top appears, buy after the stock makes its turn at the bottom trendline. |
| Long stop | Place a stop‐loss order 15 cents below a nearby minor low. Should the stock reverse course, you will be protected. |
| Go short at the top | Sell short after price starts heading down at the top. |
| Short stop | Place a stop 15 cents above a nearby minor high to protect against an adverse breakout. Cover the short when it turns at the bottom trendline and starts moving up. For a downward breakout, cover as it nears the target price or any support level. |
| Partial rise and decline | Go long if a broadening top shows a partial decline. Consider adding to your position once it makes an upward breakout. Partial declines work 72% of the time in bull markets. Partial rises (downward breakout, bull markets) work 52% of the time. |
| Stop location | See Table 11.7 for stop location guidance. |
| Busted trade | Table 11.9 can help with busted patterns. |
| Description | Bull Market, Up Breakout | Bear Market, Up Breakout | Bull Market, Down Breakout | Bear Market, Down Breakout |
|---|---|---|---|---|
| Percentage reaching half height target | 83% | 73% | 70% | 73% |
| Percentage reaching full height target | 66% | 52% | 42% | 46% |
| Percentage reaching 2× height | 48% | 26% | 19% | 24% |
| Percentage reaching 3× height | 37% | 18% | 9% | 13% |
The bottom portion of the table shows how often price reaches the measure rule target. For the full height (as in our example above, bull markets, upward breakouts), price will reach the target 66% of the time. You can adjust the height to get different targets that may be easier or harder for price to reach.
Once you know the target, read the text associated with Table 11.3 to see if the potential move is reasonable.
How do you make use of the measure rule? Imagine that you are considering purchasing the stock. Try the following tips: