the top trendline once again at a new high of 55.50.
The steepness of the ascent in the latter stages was unsustainable. The peak looked like a one‐day reversal, with a close near the low of the day and a tall daily price swing. However, volume was unconvincing. It was higher that day than during the prior week, but it certainly was not of the caliber of the late November spike.
In any case, the stock tumbled and soon reached a new low of 43.50, stopping right at the bottom trendline. Once the stock began moving higher, the momentum players jumped on board and volume increased along with price. Buying enthusiasm and rising momentum pushed the stock higher, climbing through the top trendline. An upward breakout occurred.
Throughout the various peaks and troughs as this chart pattern unfolded, there was a struggle between buyers and sellers. Near the lows, the buyers believed the stock was oversold, and they eagerly bought it. At the top, they and others sold their shares and pocketed handsome profits. This selling pressure, of course, sent the stock back down.
Some investors—seeing the stock decline below their purchase price and still believing that the stock had value—bought more. That behavior also helped turn the stock around at the lows and probably explained their heightened nervousness at the top. They wanted to keep their gains this time instead of watching them evaporate should the stock decline again.
The broadening top shown in the figure also makes evident that identifying the ultimate breakout is difficult. It appears that each new high or new low may be the final push to freedom. Only when price moves in the opposite direction is it clear that price will not break out. We explore ways to profit from that behavior in the Trading Tactics section.
Identification Guidelines
Table 11.1 shows the identification guidelines for the broadening top.
Appearance. The pattern looks like a megaphone with price peaks and valleys bounded by two diverging trendlines. The top trendline slopes upward, and the bottom one slopes downward.
Price trend. The price trend leading to the start of the pattern is what differentiates a broadening top from a broadening bottom. For broadening tops, the price trend should be upward, leading to the chart pattern, not downward as in the broadening bottom. This is just an arbitrary designation I have chosen to distinguish tops from bottoms (in all chart pattern types).
Trendlines. Trendlines drawn across the peaks and valleys resemble a megaphone. Higher highs and lower lows make the formation obvious to those versed in spotting chart patterns. The slope of the trendlines is what distinguishes this chart pattern from others. The top trendline must slope up and the bottom one must slope down. When one of the two trendlines is horizontal or nearly so, the formation becomes a right‐angled ascending or descending broadening formation. When the two trendlines slope in the same direction, the formation is a broadening wedge.
Table 11.1 Identification Guidelines
| Characteristic | Discussion |
|---|---|
| Appearance | Megaphone shape with higher highs and lower lows. Five‐point reversals have three peaks and two troughs. |
| Price trend | The price trend leading to the formation should be up. Ignore any overshoot or undershoot within 2 weeks of the pattern's start. |
| Trendlines | Price is bounded by two trendlines: The top one slopes upward, and the bottom one slopes downward. |
| Touches | Should have at least five touches, three on one trendline and two on the other, but not necessarily alternating touches. Price passing through a trendline doesn't count as a touch. |
| Volume | Trends upward most often. Do not discard a pattern because of an adverse volume trend. |
| Breakout direction | The breakout can occur in either direction and, in several cases, price moves horizontally for several months before staging a definitive breakout. |
Touches. There should be at least five touches of the trendlines: two on one trendline and three on the other, but be flexible. Five (or more) minor high or minor low touches makes for a well‐formed pattern. Fewer touches than five often leads to incorrectly identified patterns.
Avoid counting it as a touch when price slices through a trendline (no minor high or low involved). That's common at the start and end of the broadening pattern. Figure 11.3 shows an example of this on both ends of the bottom trendline. The trendline cuts through price and does not rest on a minor low, so it doesn't count as a touch.
Page back to Figure 11.1. It shows three minor highs touching the top trendline and four minor lows either nearing or touching the bottom trendline. The minor highs and minor lows need not alternate as price crisscrosses the broadening pattern (but usually do).
Volume. Linear regression on volume shows it trending up most often. Many times, the volume pattern mimics the price pattern: rising and falling along with price, but the overall trend will be upward. Many times, you can tell the volume trend by dividing the pattern in half and estimating which half has higher volume.
Breakout direction. A breakout happens when price closes outside one of the trendline boundaries or follows a trendline for an extended time. In the figure, if you extend the top trendline upward, it will intersect price at about 58. That's a long time to wait for a breakout.
When a breakout occurs, I consider the actual breakout price to be the value of the highest peak in the pattern. In the figure, for example, the breakout price is 55.50, or the high at the one‐day reversal. Determining the breakout price is one of the challenges of trading a broadening top.
For an example of how to apply the various guidelines, consider the broadening top shown in Figure 11.2. At first glance, it looks like a large megaphone with price trends that generally follow two sloping trendlines. The top trendline slopes upward and the bottom one slopes downward, each intersecting the minor highs or lows at least twice, totaling at least five touches.
Price forms higher highs and lower lows until it breaks out of the chart pattern, closing beyond the line of trend or below turn 5.
The volume pattern generally rises as price moves up and recedes as price moves down. The figure shows this quite clearly. During the rise in mid‐November, for example, volume jumped upward as price peaked, then just as quickly receded as price declined.
Figure 11.3 shows a U‐shaped volume trend. Volume is higher in September and December, and lower in the intervening months.
Orthodox broadening tops and five‐point reversals describe the same type of pattern. They are simply broadening tops that have three minor highs and two minor lows. Figure 11.3, for example, falls into this category. Other than the name, I found no substantial difference between broadening tops, orthodox broadening tops, and five‐point reversals.
Some analysts say five‐point reversals are bearish indicators, and that the formation predicts a downward breakout. A study of the pattern, admittedly using
