Encyclopedia of Chart Patterns. Thomas N. Bulkowski

      RESULTS SNAPSHOT

      Appearance: A three‐leg zigzag pattern with two turns located by Fibonacci ratios.

       Downward Moves

      You'll need a computer to find this pattern unless you're incredibly fast with a calculator and have lots of time to waste searching for the thing. If you have access to a computer with pattern recognition software, then this pattern is as plentiful as hair on a gorilla. If your software is better than mine or you have special sauce that you can add to the ingredients, then your pattern may behave differently than the ones I studied.

      I measured performance of Fibonacci‐based patterns differently than I do other chart pattern types. That's because we're looking for a reversal at the end of the pattern and not an up or down breakout. Therefore, the layout of this chapter is different from most other chapters in this book.

The bearish AB=CD performs in two ways. First, if you know the first three turns (ABC), then you can anticipate at what price the last turn (D) will appear. This works well, with price reaching D nearly all of the time (95% of the time or more). Second, once price reaches D, it's supposed to turn lower. My tests show this doesn't work well (only 32% to 38% of the time). As I mentioned, this could be a flaw with the model I used. Your software may perform differently.

      Let's run through the rest of the Results Snapshot for the bull market (you can compare the results with the bear market). I measured the drop from the peak at turn D (the last in the pattern) to the ultimate low. Of the five bearish Fibonacci‐based patterns I studied, this one performs worst in the bull market when price drops just 12.7%. The breakeven failure rate is 26.3%, which is high. That means price fails to drop more than 5% over a quarter of the time. Volume trends downward, but it's close to random.

      Let's take a closer look at this pattern to discover what this mysterious point D is and what the pattern looks like.

Tour

      The bearish AB=CD is a Fibonacci based pattern, meaning Fibonacci ratios determine the turning points.

Figure 2.1 shows an example of a bearish AB=CD pattern. The pattern appears as turns ABCD on the chart. In this example, leg AB's height is similar to the height of CD, hence the name of the pattern. In the ideal case, you'll see leg CD equal AB. Often, however, the CD leg may be a Fibonacci extension away (meaning point D can be far away from the other three turns). That's not a flaw. Rather, that's just the way the pattern is constructed.

Figure 2.1 A bearish AB=CD pattern correctly predicts a downward move in the stock after turn D.

      The duration (days) of AB should also equal the CD duration in the ideal case. Here we see leg AB lasting 6 calendar days and CD lasting 8. That's quite close, isn't it? Most of the time, like I described for price, point D's date can be far removed from the other points.

      In well‐behaved patterns of this type, the slope of the AB line should be similar to the CD slope, with a retrace in between. That's almost what you see in Figure 2.1, but it's seldom that pretty. In fact, you can see some bizarre‐looking AB=CD patterns even though they qualify as valid Fibonacci patterns.

      Volume trends downward in this example, shown on the chart as E.

      This ABCD is a good performer. Price completes a tidy and compact‐looking pattern and then price falls, making an extended decline into December. That's how the pattern is supposed to behave.

      Let's go through the guidelines for identifying these patterns.

Identification Guidelines

      Table 2.1 shows identification guidelines for the chart pattern, and Figure 2.2 shows a typical example. The pattern appears in the figure as ABCD.

Appearance. As I mentioned, the shape of the bearish AB=CD can look weird when point D is far from the ABC turns. The figure is an example of that asymmetry, but not an extreme one. Leg AB is 36 days long, so you might expect (or hope) the CD move to also be that long. It's not. CD is 66 days long or almost twice the AB duration. It'll be rare that leg CD matches the length of AB. Just because CD is almost twice as far away as AB doesn't mean the pattern is invalid. Rather, the turn is determined by the Fibonacci number used to located it.

Table 2.1 Identification Guidelines

Characteristic	Discussion
Appearance	A three‐leg zigzag pattern with two turns located by Fibonacci ratios.
BC/BA retrace	The ratio of BC/BA is one of .382, .5, .618, .707, .786, or .886.
DC/BC extension	The extension of leg DC to BC is one of the Fibonacci numbers: 1.13, 1.27, 1.41, 1.618, 2, 2.24, 2.618, or 3.14.
Hills and valleys	From A to B, there should be no valley lower than A and no peak higher than B. From B to C, there should be peak higher than B and no valley lower than C. From C to D, there should be no valley lower than C and no peak higher than D.
Volume	Trends downward most often. Don't ignore a pattern because of an unusual volume trend.
Duration	I limited patterns to 6 months, but this is an arbitrary limit I use for most chart patterns.

Figure 2.2 This bearish AB=CD pattern breaks out upward.

      Let's talk about the Fibonacci ratios.

      BC/AB

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