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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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Bulkowski's Best Entry

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Written by and copyright © 2005-2019 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 12/21/2018.

This article discusses where is the best location to buy, before or after confirmation, when trading a chart pattern in a stock.

 

Best Entry: Summary

Tests of twin bottom patterns shows that buying as soon after a twin bottom appears is a recipe for a losing trade. Forty-eight percent of unconfirmed double bottoms close below the bottom of the second bottom, resulting in a loss. And that's in a bull market.

Waiting for confirmation, buying at the open the day after price closes above the top of the double bottom, doubles the median rise while cutting the failure rate in half.

However, the best entry is to place a buy stop a penny above the top of the double bottom. That cuts the failure rate and marginally boosts the median rise, too.

Best Entry: Background

Confirmation means waiting for squiggles on a price chart to become a valid chart pattern. Often that means waiting for price to close above the top of the pattern (for upward breakouts) or below the bottom of one (for downward breakouts).

When I catalog patterns for research (that is, for my books and website), I wait for price to confirm the pattern in the manner just described and buy at the open the next day. That cuts down on false breakouts, but is it the best entry method?

I conducted a series of tests to find out.

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Best Entry: Methodology

In these tests, I used only bull market data from January 1990 to December 2018 on 502 stocks. I programmed my computer to find all twin bottoms and bought at various locations, measuring how the stock performed from the buy point to the ultimate high.

The ultimate high is the highest peak before price drops at least 20% or before it closes below the second bottom of the twin bottom pattern.

I won't go into the details of the algorithm I used to find the patterns, but suffice it to say that it does a good job of finding potential double bottoms.

The number of trades were more than 2,200, so I had plenty of samples.

Best Entry: Results

I programmed my computer to count how many twin bottoms see price rise far enough to confirm the pattern, that is, close above the highest peak in the pattern.

I found that 52% of patterns confirmed. In other words, if you buy before confirmation, you will see price close below the second bottom 48% of the time. Wow. That's a huge failure rate. It suggests waiting for confirmation has benefits.

I logged 5,467 trades in the test.

Table 1 shows results of other tests.

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Table 1: Test Results
Test DescriptionMedian
Rise
5%
Failures
Trades
1. Buy as soon as possible10%37.4%4,438
2. Wait for confirmation, a close above double bottom's peak22%17.9%1,913
3. Best: Buy false breakouts23%17.7%2,703
4. Buy 50% down from peak15%30.4%3,448
5. Buy 25% down from peak21%22.4%2,776
6. Buy 12.5% down from peak23%18.2%2,483

Best Entry: Test 1

The first test buys as soon as the twin bottom is recognized. My computer can find the second bottom five days after it appears. So entry occurs the next day at the opening price.

The average rise from the buy price to the ultimate high is 31%, the median is 10% and the 5% failure rate is 37.4%. In other words, more than a third of twin bottoms will see price rise less than 5%. Ouch!

Best Entry: Test 2

In this test, I waited until the twin bottom confirmed as a valid double bottom. Confirmation means a close above the top of the highest peak between the two bottoms. When that occurs, buy at the open the next day, and sell at the ultimate high.

I found that the average rise was 43%, the median was 22% and the 5% failure rate was 17.9%. I show two of these results in the table. Notice that the median rise has more than doubled the result found in Test 1 and the failure rate has dropped by more than half.

In short, waiting for confirmation helps improve profitability, but is it the best entry location? No.

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Best Entry: Test 3

This is the best performing entry that I found. Place a buy order a penny above the top of the twin bottom.

The order gets you in sooner than waiting for confirmation and yet there's a good chance the pattern will confirm. The risk is that it won't confirm.

The average rise is 44% and the other metrics are in the table. You can see that this test shows the best median rise with the lowest failure rate of any row in the table.

I explored this test further and found that of the patterns which later confirmed, 41% showed a buy signal trigger before confirmation. In other words, price made a high above the top of the chart pattern but closed below the pattern's peak (closing above it would have confirmed the pattern). These are false breakouts.

Also, I found that only 6% of the trades did not confirm, meaning the buy stop triggered but the pattern never confirmed. It eventually closed below the second bottom, resulting in a loss.

Best Entry: Tests 4-6

Tests 4 to 6 are wreck checks. Does performance continue to improve as the buy price drops closer to the second bottom? No.

I raised the buy price from midways up the pattern, to 25% below the peak and half that, or 12.5%. In each test, the closer the buy price came to confirmation, the better the results.

The average rise for test 4 was 36%, test 5 was 40% and test 6 was 43%. The other numbers are in the table.

-- Thomas Bulkowski

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See Also

Written by and copyright © 2005-2019 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. If you're happy, you're successful.