AB=CD pattern can be a wonderful tool to help predict when price will turn and then make a substantial decline. Once you know the first three turns, you can determine when and at what price the fourth turn will appear. And when turn D appears, the stock will drop. Does it really work like that? Let's find out.
Table 2.3 shows how price behaves after point D.
How often does price reach or exceed D? I checked how often price climbed far enough to reach the calculated price of D. The table shows that nearly all of the patterns reached the target turn.
Table 2.3 Price Move after Pattern End
| Description | Bull Market | Bear Market |
|---|---|---|
| How often does price reach or exceed D? | 95% | 98% |
| How often does price turn at D? | 32% | 38% |
| How often does D appear within a week of calculated time? | 43% | 45% |
| How many drop to point A? | 24% | 36% |
| How many drop to point B? | 76% | 87% |
| How many drop to point C? | 35% | 46% |
That's terrific! Swing traders can use this to predict how far price will rise. They can even trade it by buying at the low at C and riding price higher, to D.
How often does price turn at D? I checked each pattern to see if a minor high formed at the calculated point D. I found that only about a third of the time will you see price turn lower at the calculated price of D. Because we know price rises to D nearly all of the time, we can assume that price continues beyond D instead of turning lower when it should.
This finding is not a deal breaker. Now that we know price will likely continue rising, we can just stay in our trade (when we bought after turn C) and ride the stock upward until it does turn.
How often does D appear within a week of calculated time? The pattern can work as a predictor of when point D will occur (as well as the price of the turn). I found the dates of the ABC turns and found the ratio of CB to BA. Then point D followed the equation: D = (C – B)/Ratio + C using dates instead of price.
I found that between 43% and 45% of the time point D appeared within (plus or minus a 2‐week window) a week of when it was supposed to. Because the numbers fall well short of the expected time, I don't think this measure is helpful.
How many drop to…? If price reaches D and turns down, we know that the average decline measures between 12% and 22% from Table 2.2. Let's measure how far price drops in terms of turns A, B, and C.
Point B is closest to turn D, so we would expect the stock to drop that far most often. Indeed, the table shows that price reaches turn B between 76% and 87% of the time. Price will drop to C less often (35% to 46% of the time) and reach the bottom of the pattern (point A) even less often.
Using these values, we can get a sense of how far price might decline. It could be less or more, depending on the situation, of course. But at least we have a roadmap.
Sample Trade
Figure 2.4 shows a sample trade using the AB=CD pattern.
Jacob poked me in the ribs, then pointed to the screen to discuss his trade. “See that? It's a double bottom.”
His fingers traced the twin bottoms at EA with a nice peak (F) between them. “I can make money trading that.”
He placed a buy stop a penny above F. That order triggered at G, putting him into the stock near the breakout price. Immediately, he placed a stop a penny below the lower of the two bottoms, which in this case, was A, at 37.12. If the trade went bad, he'd lose about 10%.
“That's bigger than the 8% I like to see, but you have to be flexible,” he told me.
Figure 2.4 Jacob used the bearish AB=CD pattern to exit a trade.
For about a week, the stock cooperated and climbed to B before starting to retrace.
“The throwback and drop to C made me nervous. I started sweating bullets because I thought I'd be stopped out. Don't believe me? The sweat started pouring off me, and the furniture started floating. I'm not kidding. You can see the watermark.” He pointed to a smudge on the wall. His wide grin made the Grand Canyon look like a small ditch by comparison.
“I thought of selling, but I invariably sell a week or two before the stock bottoms. It's annoying. What helped me this time was when I noticed the bearish AB=CD pattern.”
His software helped by providing the location for him. Let's run through the numbers. The low at point A was 37.13, the high at B was 43.14, and the low of price bar C was 38.42. Crunching the numbers said that the ratio of BC to BA was (43.14 – 38.42)/(43.14 – 37.13) or 78.5%. That was close to the 78.6% Fibonacci number, so the turn matched the identification guidelines (Table 2.1).
If the pattern worked as he hoped, the CD leg would equal or exceed the AB leg and make for a tasty profit.
The height of the AB move was 43.14 – 37.13 or 6.01. Added to the low at C (38.42) gave a target for turn D of 44.43.
“I doubled my position right there,” he said and poked the screen, leaving a fingerprint behind. The second buy was near C, and he set a target to sell both positions at 44.43. “I raised my stop, too, to a penny below C. Just in case…”
The stock took off in a straight‐line run up to D. The stock sold at the exact high at D, 44.43, cashing him out of the AB=CD trade and also out of the double bottom trade.
“Let's do lunch,” he said. “I'll let you buy.”
3 AB=CD®, Bullish
RESULTS SNAPSHOT
Appearance: A zigzag pattern that has four turns, two of which are governed by Fibonacci ratios.
Upward Moves
| Bull Market | Bear Market | |
|
|
