Bulkowski’s Busted Patterns

Written and copyright © 2009-2010 by Thomas N. Bulkowski. All rights reserved.

Busted chart patterns occur when the breakout is in one direction, but price does not travel far before reversing and breaking out in the new direction. The new direction often marks a powerful move. Symmetrical triangles have a tendency to double bust: breakout, reverse (bust 1), breakout, reverse (bust 2).

Let's take a closer look at one variety of busted chart patterns: the Adam & Adam double top

The Adam & Adam Double Top

I show a chart of American Superconductor on the daily scale.

Pictured is an Adam & Adam double top. One of these days, I'll explain the differences between the variations of double tops, but for now, that's not important. What is important is that a double top is just squiggles on a screen until price closes below the low posted between the two peaks. I show that as point B. When that happens, called confirmation, it turns the squiggles into a valid double top. And that means price is going down.

Or does it?

In this example, price does drop but not far. In fact, it moves horizontally for about a week and then begins rising. When price closes above the top of the chart pattern at A, it busts the double top. And that often means price is going to make a strong move up, which we see happening now.

In this example, the stock gapped higher after the release of quarterly earnings. Don't get too excited about this stock because it could round over in a another week or so. Why? See the event pattern cleverly called good earnings surprise.

Busted Double Top

This chart is an example of a busted double top. I define a busted pattern as one that breaks out in the expected direction, moves no more than 10% in that direction before reversing. Then, price shoots out the other side of the pattern. When that occurs, it busts the pattern, often setting up for a strong move.

The 10% number is arbitrary. You can use anything you wish, but for testing purposes, I limited the original breakout move to 10% with no time limit.

The breakout can be either up or down, but downward breakouts that bust are the ones to trade. Why? Because price has unlimited room to move to the upside, so you can make an infinite amount of money. After an upward breakout, when price busts the pattern downward, you can only lose 100% of your money and no more. Thus, the downside is limited in comparison.

You won't find busted patterns on my website, so don't bother looking for them. They are just one topic I haven't gotten around to writing about yet. I have researched them, but not exhaustively. My paperback book, Getting Started in Chart Patterns, pictured on the right, devotes a chapter to busted chart patterns (beginning on page 215, in case you have a copy laying around). I include a few performance statistics, but what you'll find is that the performance is slightly better than the move posted by non-busted chart patterns.

Performance

Let me retract that statement because the comparison isn't fair. Why? Because an Adam & Adam double top has an average drop of 19% in a bull market. If you wait for the trend to change and then buy the stock, price rises by an average of 54% (this is the so-called "Change after the trend ends" number list in my Encyclopedia of chart patterns book). However, if you trade a busted double top, the average rise is a tasty 74%. Thus, the comparison between 74% and 19% isn't fair, but 54% versus 74% is.

Before you roll your eyes in disbelief, let me say that all of the numbers just mentioned were from perfect trades. You buy in at the breakout price and sell the day price makes the ultimate high or ultimate low, which are the highest high or lowest low before a trend change. And you do that not just once, but dozens of times. Your chances of replicating that performance is zero. Use the numbers like I have here, for comparison shopping only.

Anyway, look for busted patterns not just from double tops, but head-and-shoulders, broadening patterns, triangles, and so on. And if you should come across a busted symmetrical triangle, be sure to say "Hello," and then run the other way. Symmetricals have a tendency to double bust (breakout, reverse and reverse again).

-- Thomas Bulkowski

Other Examples

• This is an example of a busted descending triangle in QLGC.
• Example of a busted symmetrical triangle in CLR.
• Example of a busted head-and-shoulders top in ADTN.

Written and copyright © 2009-2010 by Thomas N. Bulkowski. All rights reserved. Experience is what you get when you were expecting something else.