TRADING PARTIAL DECLINES and RISES by Thomas N

Techniques TRADING PARTIAL DECLINES AND RISES by Thomas N. Bulkowski his article discusses two formations, partial Tdeclines and partial rises, and how they can be used to predict the breakout direction from a chart pattern. 1. Partial declines a) Broadening bottoms Consider Figure 1, a chart of a broadening bottom. (That's my term for what's usually called a broadening top, but I have found performance differences between tops and bottoms). In a broadening bottom, prices enter the pattern Figure 1. Broadening bottom. A partial decline sees prices tumble from the top (that is, after a downward price trend), but they but they do not come close to the lower trendline. Point A is a can exit in either direction. The pattern sports two trendlines small partial decline that doesn't work out. that broaden out over time, one trendline slopes up, the other slopes down. The trendlines should touch at least b) Broadening wedges, descending two minor highs on the top and two minor lows on the bottom with little white space in between (good side-to-side Figure 2 shows another partial decline, this time in a price crossings). descending broadening wedge. The chart pattern has the same megaphone appearance as the broadening bottom, Once you have a valid pattern (at least two touches of each only this time the megaphone tilts down. Prices still broad- trendline), then look for a partial decline like that shown. A en out and there are at least two minor high and two minor partial decline is just as it sounds: Prices drop but do not low touches of the associated trendline. Volume usually touch or come near to the bottom trendline. trends upward over time. A partial decline suggests an upward breakout on the next price crossing. The time to buy is when you are sure prices have started rebounding, completing the turn at the bottom of the partial decline. I have not found a guaranteed way to do this, so it's a judgment call. Use stops to limit an adverse move, say $0.15 below the partial decline low in the example shown in Figure 1. Consider point A in Figure 1. Prices drop then begin mov- ing up, and it looks like the stock will stage an upward breakout. Instead, prices drop quickly a few days later and form a new minor low, completing the real partial decline. A recent study has shown that a partial decline correctly predicts an upward breakout in broadening tops 77% (68/88) of the time (using data from mid-1991 to mid-2001). If a partial decline does occur, expect the rise after the Figure 2. Descending broadening wedge. This megaphone breakout to be less than usual (32% rise versus 36% with- shaped formation tilts down and a partial decline suggests an out a partial decline). It's as if a partial decline sucks ener- immediate upward breakout. Point A is a partial decline that does- gy from the upward momentum. n't result in a breakout. 38 THE TECHNICAL ANALYST February 2004 Techniques Partial declines correctly predict an upward breakout from Again, performance after the breakout is less (34%) when descending broadening wedges 76% (35/46) of the time. To a partial decline occurs than when it doesn't occur (a 37% prevent investing in what appears to be a valid partial rise). Intra-formation partial declines occur 29% of the time decline (point A), consider a rule like "at the widest point in in rectangles. That's a lot. An intra-formation partial decline the chart pattern, prices must travel at least halfway across is a partial decline that does not result in an immediate the pattern before turning around". Such a rule would pre- upward breakout. For example, prices touch the top trend- vent you from investing at point A in both Figures 1 and 2. line, drop (but do not fall close to the bottom trendline), recover, and touch the top trendline a second time then zip c) Rectangles across to the bottom trendline. The dip between the two top trendline touches appears like a partial decline, but prices tumble instead of staging an upward breakout. One way to guard against intra-formation partial rises (PRs) and declines (PDs) is to wait for a valid chart pattern. You must have at least two minor highs touching the top trendline and two minor lows touching the bottom trendline, with prices that fill the structure (that is, not a lot of white space), before you have a valid pattern. Only then should you look for intra-formation PRs and PDs. For reference, broadening tops had intra-formation PDs 9% of the time, and PRs 11% of the time. I didn't measure them in broadening wedges. 2. Partial rises a) Broadening formation, right-angled and descending Figure 3. Rectangles. A partial decline in this rectangle correctly In the last paragraph, I mentioned partial rises. If you own a predicts the upward breakout direction. stock, wouldn't it be wonderful if you knew when your stock was about to drop? That's what a partial rise does: It warns Figure 3 shows a partial decline in a rectangle top. I call you of an impending, immediate downward breakout. Look this a rectangle top because prices trend upward leading to at Figure 4, a picture of a right-angled, descending, broad- the pattern. The breakout can be in any direction, including ening formation. The top trendline is horizontal, the bottom horizontal, but usually follows the price trend leading to the one slopes downward, and both highlight a broadening pattern (up, in this case). As such, rectangles usually act as price pattern. The chart pattern usually acts as a reversal of consolidations of the prevailing price trend, not reversals. the price trend, and that's what happens here. The volume Volume typically recedes until the breakout. pattern typically appears irregular, but recedes in this example. Admittedly, this rectangle isn't perfect, but they rarely are. There are at least two minor high touches on the top trend- A partial rise is similar to a partial decline only flipped line and two minor low touches on the bottom trendline, as upside down. Once you have a valid chart pattern (at least you would expect. Prices drop down out of the pattern early two touches of each trendline), look for prices to climb but on, forming three touches of the lower trendline of a small not touch, or come close to, the top trendline before plung- right-angled, descending broadening pattern. It also shows ing. A downward breakout usually occurs immediately (that a partial decline (the day before prices close above the top is, without prices crossing the pattern again, but they may trendline). slide along the bottom trendline before pushing through). How often do partial declines predict an upward breakout Partial rises were correct a paltry 58% of the time (so be from rectangles? They were correct in 80 of 113 patterns I cautious) and partial declines were right 78% of the time. looked at from 1991 to 2001, for a success rate of 71%. These numbers may reflect the bull market data I used from February 2004 THE TECHNICAL ANALYST 39 Techniques 1991 to 1996. It may be that partial rises correctly predict a However, the minor low shown as point 6 also appears to downward breakout more often in bear markets. If you own be a partial decline that ends badly. Prices tumble from a stock and prices cross more than halfway up the pattern point 5 to more than halfway across the chart pattern, make then round over, consider selling immediately. If you want to a good try at breaking out upward, but get sucked down short a stock, that's the time to do so. along with the general market in July. Do prices come close to the bottom trendline so that it looks like a trendline touch and not a partial decline? I'll let you decide. The figure highlights a very important lesson. If a chart pattern you invest in doesn't work as expected, exit immediately. If you bought assuming the partial decline at point 6 was valid, the time to sell was when prices closed below point 6, the low of the partial decline (or a point closer to your buy point). Figure 4. Right-angled, descending broadening pattern. A partial rise occurs after the broadening chart pattern is established. Prices touch the lower trendline, bounce - but do not come close to the top trendline-before staging a downward breakout. b) Broadening formation, right-angled and ascending Figure 5 shows a partial rise in a right-angled, ascending Figure 5. Right-angled, ascending broadening pattern. This is broadening formation. The bottom trendline is horizontal, or another example of a partial rise in the Dow Jones Utility Average. nearly so, and the top trendline slopes upward. Volume (not shown) has no consistent pattern. Again, look for at least two touches of each trendline before searching for a partial decline or partial rise. Thomas Bulkowski is an author and private investor. This partial rise accurately predicts a downward breakout in Copyright © 2003 by Thomas N. Bulkowski. the Dow Jones Utility Average. The figure also shows an example of an intra-formation partial decline. The chart pattern becomes valid after two touches of the top trendline and two touches of the bottom one. This appears as points 1 through 4. After the fourth touch (point 4), prices decline then touch the top trendline again at point 5.

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