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Identifying Bearish Chart Patterns

Bearish chart patterns form at the top of abear market. What do they look like?

by Thomas N. Bulkowski

Since March 2003, the market has been trending upward. As I write this in August 2003, I'm starting to see bearish chart patterns dotting the stock market landscape like storm clouds brewing. What should you know about bearish chart patterns? This two-part

article takes a close look at them.

BROADENING FORMATION, RIGHT-ANGLED AND ASCENDING

Figure 1 shows a right-angled and ascending broadening formation. Prices along the bottom of the pattern follow a horizontal trendline; along the top, a trendline connects higher highs. Thus, the pattern broadens out, but only on the topside. The pattern portends a bearish price reversal. In this example, prices started climbing in late March, entered the pattern, then tumbled after the   breakout, reversing the short-term uptrend.

A key to this pattern and other broadening patterns is the partial rise. If prices touch the bottom trendline and climb but don't touch   the upper trendline, then there is a good chance that prices will break out downward. I call that hump a partial rise because prices   partially make their way across the pattern. Look for partial rises after four touches of the trendlines occur (at least two on each   side). Only then is a partial rise valid. As a bearish chart pattern, the right-angled and ascending broadening formation isn't very   bearish. Although prices can tumble, as shown in Figure 1, the average decline measures 18% for the 181 patterns I looked at.   That's shy of the average 21% decline for other bearish chart patterns.

BROADENING TOP

Figure 2 shows what a broadening top looks like. It sports higher highs and lower lows bounded by two trendlines that widen over   time. The price broadens out. A top means that prices enter the pattern from the bottom. The direction they exit is unknown until   the breakout occurs.

In this example, prices tumbled despite the partial decline predicting an upward breakout. A partial decline is similar to a partial   rise flipped upside down. You need at least two touches of each trendline before you start looking for partial declines. A partial   decline occurs when prices touch the top trendline, then dip but don't touch the bottom trendline before reversing. When prices   touch the top trendline, expect an upward breakout. Partial declines work 86% of the time, and partial rises work 65% of the time   for broadening tops, according to the 189 patterns I looked at. If the breakout is downward, expect a decline averaging 23%, but   your results will vary.

Figure 2 also shows other bearish patterns. A head & shoulders top appears just as prices peak. Prices break through the neckline,   then pull back before continuing down. A descending scallop with its characteristic rounded bowl appears in August and suggests a continued decline.

BROADENING WEDGE, ASCENDING

Figure 3 shows an ascending, broadening wedge. It appears on the chart as a megaphone tilted up, hence the "ascending" part of   the name. Higher highs and higher lows, each bounded by an upsloping trendline, form this pattern; thus, prices broaden over time.

I uncovered 157 of these in the stocks I looked at. Of those showing a partial rise, 84% successfully broke out downward. That's   key. Look for a partial rise sometime after two touches of each trendline. Once prices break out downward, the average decline measured 20% for the patterns I examined