measure rule numbers to help determine the probability of a stock dropping to half, one, two, or three times the pattern's height below the breakout. Just remember that anything can happen. Look for underlying support where the stock might turn and decide if it's worth selling now before it drops that far.
Table 6.10 Trading Tactics
| Trading Tactic | Explanation | |
|---|---|---|
| Measure rule | Measure the height of the pattern from the price of the low between the two peaks to the higher of the two peaks. Subtract the height from the low between the two peaks. The result is the target price. Ignore results at or below zero. Larger percentage moves will be unlikely. The bottom portion of the table shows how often the measure rule works. | |
| Stop location | Place a stop at the location of your choice, using the results in Table 6.7 as guidance. | |
| Pullback trade | Look for underlying support below the bottom of the pattern. Price may reach support and return to the breakout price in a pullback. Will that dip be deep enough to make money trading the pullback? | |
| Busted trade | If you find a busted big M, then consider buying the stock and riding the recovery. | |
| Tips | See text. | |
| Description | Bull Market | Bear Market |
| Percentage reaching half height target | 80% | 82% |
| Percentage reaching full height target | 55% | 58% |
| Percentage reaching 2× height | 26% | 27% |
| Percentage reaching 3× height | 13% | 15% |
| Return to launch price | 52% | 59% |
Another way to trade a big M is to wait for price to find support after the breakout. Consider buying then and riding the recovery. Don't be fooled into buying the stock during a pullback. After a pullback completes, the stock resumes the plunge 55% to 60% of the time (see Table 6.4).
Return to launch price. I also computed the percentage of time that price, at the ultimate low, met or dropped below the launch price. The last line in the table shows that it reached the launch price just over half the time in bull markets.
One challenge of using this method is to figure out where the launch price is. Often it's the same as the trend start (see the Glossary). The launch price is the location where price begins rising into the big M in earnest. In the first three figures of this chapter, the launch price is point A. In Figure 6.4, it's point B.
After you determine a measure rule target, convert the potential decline into a percentage of the current price. For example, if the height is $10 and the stock is trading at 50, that's a potential 20% loss (10/50 × 100). Table 6.3 says that in bull markets, big Ms fail to see a stock drop more than 20% about two‐thirds (68%) of the time. That suggests a large decline probably won't happen but your trade may be the exception. Visit with Table 6.3 and make the check.
Stop location. Use Table 6.7 to help determine where a stop loss‐order should be located. If you're planning to short the stock, then do use a stop.
After you locate the stop, determine if the potential loss is big enough that you might need to reconsider the stop location. If you can't find a reasonable loss value (like 8% or less), then abandon the trade. Another big M will come along shortly. I saw the schedule.
Pullback trade. This setup idea should be used only by experienced traders. You can place an order to short the stock a penny below the bottom of the big M and cover at the bottom of the pullback. Table 6.4 can help determine your chance of making money using this technique.
In more than two out of every three trades (67% in bull markets, from Table 6.4) a big M will show a pullback within a month of the breakout, often in the first week.
Price drops for an average of 6 days and returns to the breakout price (or near it), in a roundtrip total of 12 days. The drop from the breakout to the low at the bottom of the pullback attempt measures 7% to 10% (for bull and bear markets, respectively). If you short the stock a penny below the breakout and place an order to cover the short 5% to 7% lower than the breakout, you might be able to catch the drop and make a profit.
The median decline is 6% (bull market) to 8% (bear market) in 5 days (for both markets).
Busted trade. Another way to trade a big M is to buy the stock long if the big M busts. After busting a downward breakout, price soars an average of 55% for a single busted pattern. Even if you only capture half of that, it's still a big gain. See Table 6.9 for details. The trick is to pick single busted trades, so look for overhead resistance within 10% of the breakout price, which might send the stock scurrying for cover.
Tips. I don't have any trades in big Ms to share with you because I don't like to short stocks. However, I do have some tips I want to pass on from what I've learned studying them in the bush.
Look at Figure 6.4 with a big M at CE. Notice the knot of support circled at I. If I was shorting this stock, this knot of support would be my first choice for where the stock will turn.
The knots need not be midway up from the launch price (but they do tend to be about midway). That is, it's about midway up the move from B to C.
What you want to look for is 3 days (or more) of horizontal price movement. Not a loose meandering of price, but a tight sideways move with lots of overlap. H is a good example of what to look for, but it's often shorter than what's shown. I is a good example. The two weeks to the left of B shows a third example of what to look for (not the placement in the BC run, but the type of horizontal move you're looking for). Sometimes it's only 3 or 4 days wide, but it's enough to support price.
The knot of support should be the first one below the confirmation price. In this example, D is the confirmation price of the big M. Notice that price drops to F and finds support at I. As a price target, pick the highest price in the knot. Chapter 1 gives a good tutorial on knots, so reread that if you need a refresher.
