| Description | Bull Market, Up Breakout | Bear Market, Up Breakout | Bull Market, Down Breakout | Bear Market, Down Breakout |
|---|---|---|---|---|
| Percentage reaching half height target | 83% | 73% | 70% | 73% |
| Percentage reaching full height target | 66% | 52% | 42% | 46% |
| Percentage reaching 2× height | 48% | 26% | 19% | 24% |
| Percentage reaching 3× height | 37% | 18% | 9% | 13% |
The bottom portion of the table shows how often price reaches the measure rule target. For the full height (as in our example above, bull markets, upward breakouts), price will reach the target 66% of the time. You can adjust the height to get different targets that may be easier or harder for price to reach.
Once you know the target, read the text associated with Table 11.3 to see if the potential move is reasonable.
How do you make use of the measure rule? Imagine that you are considering purchasing the stock. Try the following tips:
Go long at the bottom. Since a broadening formation should have five touches (three on one trendline, two on the other) before it becomes valid, point A in Figure 11.5 shows one likely investment location. Before placing the buy order, compute the target price using the measure rule. The target price will help you determine if the potential gain is worth the risk.
In the example shown in Figure 11.5, the purchase price is about 10.38 (at A) and the target price is 14.25, a 37% move. The stop‐loss should be 9.85 (15 cents below the low at A), for a potential loss of 5%, which gives a reward‐to‐risk ratio of 7 to 1, more than enough to risk a trade.
Long stop. Buy the stock soon after it touches the lower trendline and moves higher (after the pattern has fully developed following the identification guidelines). Place a stop‐loss order 15 cents below the lowest low (0.15 below point A). Should price drop, your position will likely be sold before a large loss occurs.
Price climbs across the pattern. Be ready to sell once price reaches the prior minor high. Confused? Look at Figure 11.3. On the way to point 5, be prepared to sell as the stock climbs to the price of point 3. Price may pause for a bit before moving higher and tagging the top trendline, or it may reverse at this point (which it does in Figure 11.3, at point 5). Make sure your stops have been raised to protect your profits.
Go short at the top, short stop. For short positions in broadening tops, open the short after price touches point B (Figure 11.5) and begins heading down. Place a stop 15 cents above the highest high (12.28 in this case) to limit losses. Lower your stop to the next minor high or apex of the broadening top (either 11.88 or 11.13 in Figure 11.5) once the stock nears point A. Sometimes the stock will not make it down to the trendline before beginning to move up. At other times, there is a lengthy pause before price turns around or continues down. A lower stop‐loss point helps you achieve at least some measure of profit.
Partial rise and decline. Partial rises and declines are like deer in mating season when you're driving: Look out for them. See the Glossary (“Partial rise” or “Partial decline”) for details on spotting the pesky critters. When you see a partial rise or decline, place a trade once the stock reverses course. If a breakout happens, then consider adding to your position.
Using a partial rise or decline to enter a trade before the breakout is a reliable trading technique. You get in at a better price, and they accurately predict the breakout direction.
Stop location. Use Table 11.7 for guidance on stop placement.
Busted trade. Consult Table 11.9 for tips on trading busted patterns. If you are lucky enough to trade a single busted pattern, you can make a lot of money.
Experience
Let me tell you about what I found in my trade review.
Advanced Micro Devices Inc.
Advanced Micro Devices Inc. (AMD) formed a broadening top in the first half of 2001. Here's my notebook for the trade entry: “2 August 2001. I bought at the market, filled at 19.64. The stock has bounced off the bottom of a broadening top. I hope prices will race across the pattern, but expect them to stall at 22, with eventual push to 25. Downside is old low at 16, or lower [trendline] boundary. Upside is 25, with possibilities of a climb into the high 30s. Resistance at 22, 25, 30. I expect a climb to 25 where it may be time to sell. Book
