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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 Busted Rectangles

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Busted
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Market
Industrials (^DJI):
Transports (^DJT):
Utilities (^DJU):
Nasdaq (^IXIC):
S&P500 (^GSPC):
As of 04/27/2017
20,981 6.24 0.0%
9,194 26.25 0.3%
708 2.41 0.3%
6,049 23.71 0.4%
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1.7%
7.3%
12.4%
6.7%
Tom's Targets    Overview: 04/17/2017
20,100 or 21,150 by 05/01/2017
8,500 or 9,500 by 05/01/2017
725 or 685 by 05/01/2017
6,150 or 5,900 by 05/15/2017
2,275 or 2,425 by 05/01/2017
Mutt Winners: None YTD

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Information on busted chart patterns is discussed in my book, Visual Guide to Chart PatternsVisual Guide to Chart Patterns book.. You can find information in the book in Chapter 22: "Busted Pattern Buy Setups" (starting on page 229) and in Chapter 25, "Busted Pattern Sell Signals" starting on page 271.

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Busted Rectangle Summary

Price can breakout of a rectangle in any direction. When price moves less than 10%, reverses direction, and closes beyond the side opposite the breakout, it busts the chart pattern.

Busted rectangles with upward breakouts see price drop an average of 10%. Downward breakouts rise an average of 34%. That's for all types of busted rectangles (single, double, triple and more).

If you are lucky enough to ride a single busted rectangle, then the average drop is 18% (upward breakouts) and the average rise is 61% (yes, 61% for downward breakouts).

Single Busted Rectangles

Picture of Bemis (BMS) on the daily scale.

I show a chart of a single busted rectangle in Bemis (BMS) on the daily scale. The rectangle is highlighted by red trendlines and price crosses the chart pattern from side to side, filling the white space and touching each trendline at least twice.

Price breaks out of the rectangle at A and rises to B. That move is less than 10% before price crosses the rectangle and closes below the bottom of the rectangle at C. When that happens, it busts the rectangle. Price continues down at least 10% (not shown), completing the single busted rectangle.

For a single bust, look for:

  1. Price breaks out either upward or downward from an rectangle by closing outside of the trendline border. This occurs at A in the figure.
  2. Price must move less than 10% before reversing (the rise from the top red line to B).
  3. For upward breakouts, price then closes below the bottom of the rectangle (C). For downward breakouts, price closes above the top of the rectangle.
  4. Price continues moving in the new direction by at least 10% (the move below C).

For the last point, 4, if price fails to move more than 10%, then it could be forming a double busted rectangle.

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Double Busted Rectangles

Picture of Gilead Sciences (GILD) on the weekly scale.

The figure to the right shows an example of a double busted rectangle in Gilead Sciences (GILD) on the weekly scale.

The rectangle appears between the red lines in mid January and extending into February. Price pokes its head out the top of the rectangle at A and rises to B. That move is less than 10%.

Price then closes below the bottom of the rectangle at the candle shown at C. This busts the rectangle for the first time.

Price rebounds and moves up, closing above the top blue line, busting the rectangle for the second time at D. The stock could drop and cross the rectangle again, busting it for a third time, but so far, that hasn't happened.

For a double bust, look for these elements.

  1. Price busts a rectangle for the first time (point C in this figure).
  2. Price must move less than 10% before reversing (the drop from the bottom blue line to the low at candle C).
  3. Price reverses direction again, closing either above the top or below the bottom of the rectangle (The move from C to a close above the top trendline, at D).
  4. Price moves at least 10% in the new direction.

If price fails to move at least 10% in the new direction, then it could be a triple busted rectangle.

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Rectangle, Triple Busts

Picture of Loews (L) on the daily scale.

Loews (L) on the daily scale, pictured on the right, is an example of a triple busted rectangle.

The rectangle is outlined in red on the far left of the chart. Price closes below the bottom trendline at A, making a downward breakout. Price drifts down to B, but that move is less than 10% from the bottom of the rectangle. Then the stock rises to C, busting the rectangle for the first time. The rise above the top blue line (the top of the rectangle) is less than 10%.

Price moves down to D where it closes below the bottom blue line (below the bottom of the rectangle). This busts the rectangle for the second time.

The move from the blue line to the low after D is less than 10% before price reverses.

Price climbs to E where it closes above the top of the rectangle, busting it for the third time. At this point, for testing purposes, I stop counting. However, this stock busts the rectangle a fourth time and heads lower, completing the busting cycle at four when price moves more than 10% in the new direction.

Notice that the two green lines highlight a double busted rectangle. Price breaks out downward, rises to G where it busts the rectangle for the first time and then drops to H where it closes below the bottom of the rectangle. This busts it for the second time. Price then drops more than 10% below the bottom of the rectangle, completing the busted count process.

For a triple (or more) busted rectangle, look for the following:

  1. Find a double busted rectangle except that price fails to move more than 10% after the second bust (the up and down moves to D in this example).
  2. Price reverses direction again and closes below the bottom or above the top of the chart pattern, busting it for a third time (E).
  3. If price fails to move by 10% or more before reversing and closing on the opposite side of the rectangle, additional up and down busted cycles may continue.
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Methodology for Testing Busted Rectangles

I found 1,681 rectangles in 760 stocks dating back as far as July 1991 to October 2011. Few stocks covered the entire period. All of the rectangles I found manually either using a historical search or real time (looking at my stocks each day). The real time additions prevented any look-ahead bias since I am not privy to future price movements.

I then used software to measure performance and flag busted chart patterns.

Gauging performance uses the same method as I used to catalog non-busted chart patterns. That is, the search for the new ultimate high or low proceeded as described in the glossary. Thus, the numbers reported in Busted Rectangles Results (next section) should be considered perfect trades. Do not expect to duplicate the results in actual trading. The numbers should be used only for comparison purposes to other chart patterns.

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Busted Rectangle Results

The following numbers are the results from perfect trades in bull markets, unless otherwise noted. Do not expect actual trading results to match those discussed below. Use the numbers only for comparison purposes with other chart patterns.

How often do rectangles bust?

Upward Breakouts

  • Single busts: 10% of the time.
  • Double busts: 6% of the time.
  • Three or more busts: 7% of the time.
  • All busted rectangles: 22% of the time.

Downward Breakouts

  • Single busts: 28% of the time.
  • Double busts: 5% of the time.
  • Three or more busts: 9% of the time.
  • All busted rectangles: 42% of the time.

Of busted rectangles, what is the frequency distribution?

Upward Breakouts

  • Single busts: 43% of busted rectangles bust only once.
  • Double busts: 27% of them bust twice.
  • Three or more busts: 31% of them bust at least three times.

For upward breakouts, 43% of them will bust just once, meaning that 57% will fail to drop more than 10% below the bottom of the rectangle.

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Downward Breakouts

  • Single busts: 66% of busted rectangles bust only once.
  • Double busts: 13% of them bust twice.
  • Three or more busts: 21% of them bust at least three times.

If you trade busted rectangles with downward breakouts, there is a 66% probability that it will bust just once. Thus, 34% fail to show price rising by more than 10% above the top of the rectangle.

What is the average move for single busted rectangles? As measured from the bottom (the lowest valley) or the top (the highest peak) of the chart pattern to the ultimate low or high, respectively, the move averaged:

Upward Breakouts

  • The average drop: 18% (that is, price breaks out upward and busts the rectangle, moving lower)
  • Median (mid range) drop: 18%
  • By comparison, all rectangles* (both busted and non-busted) with downward breakouts saw price drop: 12% (average), 12% (median)

Downward Breakouts

  • The average rise: 61%
  • Median (mid range) rise: 30%
  • By comparison, all rectangles* (both busted and non-busted) with upward breakouts saw price rise 36% (average), 29% (median)
* I decided to include busted rectangles in the mix because a trader cannot know ahead of the breakout that the rectangle will bust. To remove all of those that did bust is to remove most losing trades, which is unfair.
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What is the move for perfect trades after all busted rectangles?

  • Upward breakout, the average drop: 10%
  • Upward breakout, median (mid range) drop: 7%
  • Downward breakout, the average rise: 34%
  • Downward breakout, median rise: 16%

What is the failure rate of all busted rectangles in bull markets? The answer appears in the below table.

Failure Rate for Busted Rectangles, Upward Breakouts
Failure rate:  5%  10%  15%  20%  25%  30%  35%  50%  75%  >75% 
Number of rectangles:6644171581110410
Percentage:38%25%10%9%5%6%6%2%1%0%
Cumulative:38%63%72%81%85%91%97%99%100%100%

For example, there were 66 rectangles with upward breakouts that failed to show price dropping at least 5% below the bottom of the rectangle. Those represent 38% of all bull market, busted rectangles. On a cumulative basis (a running total), they also represent 38% of all busted rectangles with upward breakouts.

The median drop of all busted rectangles is 7%. You can see that by interpolating between the 5% and 10% columns. Thus, half of all busted rectangles will see price drop 7% in a bull market, providing they are traded perfectly.

Failure Rate for Busted Rectangles, Downward Breakouts
Failure rate:  5%  10%  15%  20%  25%  30%  35%  50%  75%  >75% 
Number of rectangles:4024201911104161822
Percentage:22%13%11%10%6%5%2%9%10%12%
Cumulative:22%35%46%56%62%67%70%78%88%100%

Read the table just as you did the prior one. Let's begin with the 10% column. Twenty-four rectangles saw gains from over 5% to less than or equal to 10%. They represented 13% of busted rectangles. On a cumulative basis, 35% of rectangles saw price climb up to 10% after busting a downward breakout (as measured from the top of the pattern to the ultimate high).

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Trading Busted Rectangles

Picture of Zebra Technologies (ZBRA) on the daily scale.

How could you trade a busted rectangle? The figure on the right gives an example.

A small rectangle appears in June 2011 in Zebra Technologies (ZBRA). Price breaks out upward from this pattern. Price does not rise by much (less than 10%) before reversing.

Price busts the rectangle at A when it closes below the bottom of the rectangle. Price continues dropping to B, bounces, and completes its drop to C (so far).

If you placed an order to short the stock a penny below the bottom of the rectangle, that would have gotten you into the stock at 39.67.

Once the down trend got going and you recognized a straight-line run down, then placing a stop a penny above the prior candle would work well. That would take you out of the trade when price moved above the top of candle B. The low at B is 30.03 and the exit price is 32.38.

Thus this trade could have made 18% (39.67 to 32.38).

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Additional Trading Tips for Busted Rectangles

All of these tips apply to bull markets only!

For a definition of the trend start, visit the glossary.

For downward breakouts, when the time between the trend start and the start of the rectangle is less than or equal to the median 69 days, the stock rises an average of 48% (90 samples). When the time is more than the median, the rise averages 29% (87 samples). Thus, for busted rectangles with downward breakouts (price rises after busting), look for a trend start less than 69 days before the start of the rectangle.

For upward breakouts, the numbers flip: 9% average gain (88 samples) versus 11% (85 samples) for times of less than or equal to 76 days (the median for upward breakouts) versus longer periods, respectively. The best performance comes when the trend start is more than 76 days before the start of the rectangle.

When the trend start price is above the top of the busted rectangle by less than or equal to the median 9% and the rectangle breaks out downward, the busted pattern sees the stock rise by 55% (44 samples). If the trend start is above the busted rectangle by more than 9%, the rise averages 31% (44 samples). These measures exclude trend starts below the top of the rectangle. Look for the top of a busted rectangle with a downward breakout to be within 9% of the trend start.

The performance difference for upward breakouts is 8% (less than or equal to the median) to 12% (more than the median) for a median measure of 11% above the top of the rectangle. For the best performance, look for a trend start more than 11% above the top of the rectangle.

Comparing the trend start to above or below the top of the rectangle (a different measure than the previous), we find the following.

If the high price at the trend start is below the top of the rectangle and price breaks out downward, then busted patterns see price climb an average of 29% (89 samples). When the trend start is above the rectangle, the rise averages 48% (88 samples). Look for the trend start to be above the start of the rectangle after a downward breakout.

Upward breakouts show no performance difference.

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Entry Setup for Busted Rectangles

Picture of a lizard.

As an entry setup, here are the rules for trading busted rectangles.

For upward breakouts...

  1. Price must confirm a rectangle by closing above the top trendline (an upward breakout).
  2. Price rises less than 10% before reversing and closing below the bottom of the rectangle. This busts the pattern.
  3. Measure the time between the trend start and the start of the rectangle. If it is less than or equal to 76 days, skip the trade.
  4. Place an order to short the stock if price closes a penny below the bottom of the rectangle.
  5. Place a stop a penny above the top of the rectangle. If the stop location is too far away, adjust the stop accordingly, but recognize that you stand a greater chance of failure since price can retrace back into the pattern.
  6. Cover the short when the trend changes.

For downward breakouts...

  1. Price must confirm a rectangle by closing below the pattern (that is, a downward breakout).
  2. Price drops less than 10% before reversing and closing above the top of the rectangle. This busts the pattern.
  3. Locate the trend start leading to the rectangle. If the time between the trend start and the rectangle is more than 69 days, skip the trade.
  4. If the trend start is below the top of the rectangle skip the trade.
  5. Place a buy stop a penny above the top of the rectangle.
  6. Once in the trade, place a stop a penny below the bottom of the rectangle. If the stop location is too far away, adjust the stop accordingly, but recognize that you stand a greater chance of failure with closer stops.
  7. Sell when the trend changes.

-- Thomas Bulkowski

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See Also

Written by and copyright © 2005-2017 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Moderate: A guy who makes enemies left and right.