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Thomas Bulkowski’s successful investment activities allowed him to retire at age 36. He is an internationally known author and trader with 30+ years of stock market experience and widely regarded as a leading expert on chart patterns. He may be reached at

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Bearish AB=CD®

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Market
Industrials (^DJI):
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Nasdaq (^IXIC):
S&P500 (^GSPC):
As of 11/15/2018
25,289 208.77 0.8%
10,615 158.69 1.5%
715 -9.55 -1.3%
7,259 122.64 1.7%
2,730 28.62 1.1%
YTD
2.3%
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-1.2%
5.2%
2.1%
Tom's Targets    Overview: 11/14/2018
26,800 or 24,500 by 12/01/2018
11,000 or 10,100 by 12/01/2018
710 or 750 by 12/01/2018
6,900 or 7,700 by 12/01/2018
2,650 or 2,800 by 12/01/2018

Written by and copyright © 2005-2018 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Some pattern names are the registered trademarks of their respective owners.

Initial release: 6/20/2018

Overview

This article describes my analysis of the bearish AB=CD pattern as described by publicly available information and common sense rules to determine valid patterns. Additional rules may or may not improve performance. I tested the pattern using only the below identification guidelines.

The bearish AB=CD is a measured move up chart pattern except that the turns are located using Fibonacci ratios. By using three different measures, I found that the pattern isn't bearish at all. It's bullish between 61% and 77% of the time.

However, the pattern correctly predicts point D 69% of the time. By using the next higher Fibonacci ratio in the measure rule, you can boost the accuracy somewhat, to 74%. I'll explain this in Trading Tips.

The AB=CD pattern
Bearish AB=CD

 

Important Bull Market Results

Overall performance rank (1 is best): Not ranked
Break even failure rate: *29%
Average decline: *14%
Pullback rate: 66%
Percentage meeting price target: 69%

The above numbers are based on 5,645 perfect trades. See the glossary for definitions.

* As measured from the peak at point D, regardless of the breakout direction.

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Identification Guidelines

 Characteristic Discussion
Peaks/ValleysThe peaks and valleys in the pattern need not be consecutive. This is not a guideline, but an observation.
ABCPrice climbs from valley A to peak B then retraces to valley C. Retrace BC as a percentage of BA should be one of the following Fibonacci ratios: 38.2%, 50%, 61.8%, 70.7%, 78.6% or 88.6%.
BCDAfter peaking at B, price drops to C followed by an extension to D. The DC/BC extension measures one of 113%, 127%, 141%, 161.8%, 200%, 224%, 261.8%, or 314%.

Find four turns where the ratio of one leg to another is close to the Fibonacci numbers listed in the prior table.

What does "close" mean? In my tests, I used 1% because this pattern occurs so frequently, a larger percentage is not necessary. See Trading Tips for an explanation of this.

ab=cd retraces
Bearish AB=CD Ratios

In my tests, I used a reciprocal of the Fibonacci retrace to predict D. That excluded some of the ratios listed in the table, BCD row, because they are not reciprocals of the ABC retrace (meaning I excluded 314% and 224%).

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Trading Tips

The following explains how to use the measure rule to predict point D.

Why is this important? Because if you can identify a valid ABC turn, you can determine how far price will rise (to D). This method works 69% of the time, according to my tests but you can increase this to 74%.

Find the ABC retrace which obeys one of the Fibonacci ratios listed in the previous table. Because the CD leg is supposed to equal the length of the AB leg, if we know the length of AB, we can compute point D.

For example, if point A is at 25, B is at 35 and C is at 28.82. Point C retraces 61.8% of the AB move. The length of AB is 10. Add this to the low at C gives a target of 38.82.

This method works 69% of the time.

Boosting Measure Rule Accuracy

A more complicated approach is to use Fibonacci ratios to determine D. Refer to the chart on the right.

Take the reciprocal of this ratio and multiply it by the length of the BC leg. Add the result to the low price at C. The measure rule target provided by the calculation, if the pattern works, will be point D.

For example, say that the low at point A is 10, the high at B is 12, and the low at C is 10.98. Is point C close enough to a 50% retrace (that is, the closest Fibonacci number listed in the ABC row of the Identification Guidelines table)? A 50% retrace of the 10 to 12 move would be 11.

Missing this by one percentage point (for a retrace of 49% to 51%) would give a range of 10.98 to 11.02, so C would qualify as "close" to the 50% retrace value. I programmed my computer to use this 1% window to qualify the turns. A larger window was unnecessary because too many patterns already met the guidelines.

the measure rule for the bearish ab=cd
The Measure Rule

Once you know that the stock retraced 50% of the AB move, take the reciprocal of this (1/0.5 or 2) and multiply the BC leg by this value and add it to the low at C.

In this case, the BC leg is 12-10.98 or 1.02. Multiplying this by 2 gives 2.04 and adding it to the low at C gives 13.02. That value becomes the D target.

This method works the same as the prior one, 69% of the time.

You can increase the accuracy of the measure rule by using the next higher Fibonacci number in the formula to find point D.

In this example, instead of using 50%, use 61.8%. The multiplication number would change from 2 (1/0.5) to 1.618 (1/0.618). So we have 1.02 * 1.618 or 1.65. Add that value to the low at C (10.98) gives 12.63, closer than the prior method's 13.02. This projection method works 74% of the time.

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Is the Bearish AB=CD Really Bearish?

The AB=CD pattern

The traditional measure I use to determine whether a chart patterns is bullish or bearish is to determine the breakout direction. A close above the top of the pattern (above point D, refer to the image on the right) means an upward breakout. A close below the bottom of the pattern (below point A) means a downward breakout. Using this measure, I found that 61% of bearish AB=CD patterns breakout upward, not downward. That means the pattern is bullish, not bearish.

However, this measure is misleading for this pattern. Why? Because price ends the pattern at D, the high of the pattern, a close above D is much easier to achieve than a drop all the way down to close below A.

Method 2

Another measure is to look at patterns which meet the measure rule target (that is, they climbed up to the predicted turning point at D). I used a 5% window to gauge whether the stock turned when it was supposed to (within 5% of D). If it did, then I concluded a bearish reversal had occurred.

How many actually turned within 5% of point D? Just 23%. In other words, it's more accurate to say that price will continue rising 77% of the time.

Perhaps the 5% window is too small. I opened it to 10%. How many bearish AB=CD patterns turned within 10% of the target (for those that reached the target)? Answer: 36%. That's still less than half (meaning the pattern is bullish, not bearish).

Method 3

In the third method, I visually inspected 125 patterns with upward breakouts only (that is, price met or exceeded the measure rule target) to see if price turned down at D or continued rising (that is, made a meaningful drop or not). It's a very subjective analysis, so results tend to vary. I found that 81 or 65% showed price continuing higher. In other words, the pattern is bullish 65% of the time.

You can find your own bearish AB=CD patterns and gauge this for yourself. And as I said, additional identification rules might improve performance.

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Example

An example AB=CD pattern

Consider a trade in AES corporation, the chart of which is shown on the right.

Point A has a low price of 10.23. B has a high of 11.32. And C has a low of 10.65. Does this qualify as a potential bearish AB=CD pattern?

Let's find out. The BC/BA retrace is (11.32-10.65)/(11.32-10.23) or 61.5%, which is close (within one percentage point) to the target ratio of 61.8%

So it's a valid pattern. What is the predicted price of D, which is to say, how far will price rise?

If the pattern works as it's supposed to, the stock will peak at 11.73. How do I know? Let's go through the calculation.

The reciprocal of the ABC retrace is 1/0.618 or 1.618. Multiply this by the BC leg and add it to the low at C. We get (11.32-10.65)*1.618 + 10.65 = 11.73

A simpler approach is to compute the length of the AB leg and add it to the low at C. We have 11.32-10.23 = 1.09. Add 1.09 to the low at C gives 1.09+10.65=11.74. The differences between the two methods are because of round off.

The stock closed at D at 11.74.

In this case, the stock reached the target but look what happened. Price kept rising. Oops. As I mentioned, my tests showed price continuing rising past D the vast majority of the time, and this is an example.

-- Thomas Bulkowski

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See Also

AB=CD is a registered trademark of Scott Carney.

Written by and copyright © 2005-2018 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Some pattern names are the registered trademarks of their respective owners. Diplomacy -- the art of letting someone have your way.