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BROADENING PATTERNS: Clues to breakout direction

A partial rise or decline can predict the direction of a breakout.

Learn to use these signals to increase profits when trading broadening patterns.

BY THOMAS N. BULKOWSKI

Trying to determine when a breakout will occur in broadening chart patterns, which are expanding rather than contracting price   formations, can be difficult. However, partial rises (PRs) or partial declines (PDs) con improve the odds of making a correct decision. These   signals predict immediate breakouts and indicate their direction. too, allowing you to increase your profits

and reduce your losses. However, because a PR or PD often slows overall momentum, the size of the eventual breakout is not as large as when a   PR or PD does not appear.

Broadening tops and

bottoms

Figure 1 (left) shows two broadening bottom patterns. These are different from broadening tops because price enters the pattern from the top. In   both patterns, price touches each trendline at least two times and swings in a progressively wider range. That is, the minor highs get higher and the minor lows get lower.

The July pattern shows a PR, which occurs after the pattern is established – that is, there were at least two touches of   each trendline before the PR. Price makes a partial rise when it leaves the bottom trendline and works its way higher but fails to touch or come   too close to the top trendline before turning away.

How close is "close"? Use the figures in this article and your common sense as guides. For example, the July broadening bottom has three   top trendline "touches," not two or four: The second minor high (point 2) comes close enough to call it a touch, but the third (point 3) does not.

Analysis of 77 broadening bottoms on 500 slocks from mid-1991 to mid-1996, a bull market, showed that a PR correctly predicted a   downward breakout 67 percent of the time. The accuracy rale of PDs predicting upside breakouts was even better - 80 percent (see Table   1, lop right, for more statistics).

Notice how the July pattern is midway between the price at the start of the downtrend (around 32) and its low (around 14). The middle of   the pattern is around 23, the center of the 32-14 range. Although broadening patterns sometimes act as "half-suff patterns" that form in   the middle of moves, broadening bottoms usually function as reversals in a downtrend, not as continuation patterns within those trends, as   they do in Figure 1.

Figure 2 (right) includes two broadening tops with PDs. In a partial decline, price leaves the top trendline and descends but does not come close to or touch the bottom trendline. An upward breakout usually follows immediately. Again, the broadening top pattern must touch   each trendline at least two times before a PD signal can occur.

Table 1 shows PDs in broadening lops correctly predicted an upward breakout 65 percent of the time, while partial rises were 86- percent accurate in predicting downside breakouts. In a larger combined study of broadening tops and bottoms, PDs worked 77 percent of the time. When a PD occurred, the post-breakout up move was 32 percent; without a PD, the rise measured 36 percent. Thus, the PD   affected momentum by reducing the eventual rally. PDs not resulting in breakouts occurred just nine percent of the time, which means   false signals are comparatively rare.

For PRs, the post-breakout decline measured 15 percent; without a PR, the declines averaged 17 percent, indicating a partial rise steals   energy from the resulting down move.

False breakout signals for PRs (i.e., when a partial rise occurred inside a broadening top pattern after price touched each trendline twice

without triggering a breakout) occurred just 11 percent of the time in the 350 patterns examined.

A broadening top usually acts as a continuation pattern   within the prevailing price trend, as shown in Figure 2.