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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 Inverted Gap2H

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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.

I found out about the Gap2H pattern from an article in Traders.com (a printed magazine, not the website) and according to the author Paolo Pezzutti, it's based on the work of Michael Harris. I flipped it upside down and called a new version the inverted Gap2H. That's what I test here.

The Inverted Gap2H pattern
Inverted Gap2H

 

Important Bull Market Results for Inverted Gap2H

Overall performance rank (1 is best)**: 17/23
Break even failure rate*: 39% (down breakouts)
Average drop*: 8%
Percentage meeting price target*: 44%
 
The above numbers are based on hundreds of perfect trades as of 2/11/2013. See the glossary for definitions.
* Based on the trend high, not the ultimate high. See text.
** Based on the average drop compared to other small patterns with downward breakouts in a bull market

Inverted Gap2H Identification Guidelines

CharacteristicDiscussion
3 barsThe pattern is composed of three bars, a gap followed by two lower highs and two lower lows.
Down gapLook for price to gap lower. Yesterday's high price is below the prior days low, forming a gap.
Lower high and lowThe third bar in the pattern makes a lower high and lower low.

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Inverted Gap2H Trading Tips

Trading TacticExplanation
ContinuationThe pattern acts as a continuation pattern 69% of the time (bull market, down breakout). This high value is probably due to its height.
BreakoutA breakout occurs when the stock closes either above the top of the pattern or below the bottom of it.
Trade with the trendSince Inverted Gap2Hs act as continuation patterns most often, expect the breakout to be downward.
Wait for breakoutWait for price to either close above the top or below the bottom of the pattern before taking a position.
Measure ruleThe Inverted Gap2H fulfills the measure rule 44% of the time (bull market, down breakout). That is, measure the height of the pattern and add it to the high price to get an upward breakout target or subtract the height from the low price to get a downward price target.

Inverted Gap2H Performance Statistics

For the following statistics, I used 1,205 stocks, starting from January 1990 to February 2013, but few stocks covered the entire range. All stocks had a minimum price of $5. Since samples were so numerous, I chose every other pattern. There were two bear markets in the 2000s (as determined by the S&P 500 index), from 3/24/2000 to 10/10/2002 and 10/12/2007 to 3/6/2009. Everything outside of those dates represents a bull market.

For each Inverted Gap2H, I found where the trend started and when it ended. To find the trend peak or valley, I found the lowest valley and highest peak within plus or minus 10 days (21 days total) each, before the inverted gap2H and the same peak/valley test after the inverted gap2H. The closest valley or peak before the inverted gap2H is where the trend began. The closest peak or valley after the inverted gap2H is where the trend ended.

The 10-bar peak or valley number tends to find major turning points on the daily charts.

I measured performance from the breakout price (the highest high or lowest low in the pattern, depending on the breakout direction) to the nearest trend peak or trend valley after the breakout.

Inverted Gap2H Performance and Failure Rates

Table 1: Performance and Failure Rates
  5% Failure  Average 
 Rise/Drop 
Bull market, up breakout34%10%
Bull market, down breakout39%-8%
Bear market, up breakout28%11%
Bear market, down breakout19%-18%

Table 1 lists the failure rates, sorted by market condition and breakout direction along with the average rise or decline after the breakout.

A failure occurs when the stock fails to move more than 5% in the direction of the breakout.

The failure rates may appear high, but that's typical for short-term patterns like the inverted gap2H. The highest failures occur after a downward breakout in a bull market 39% fail to drop at least 5%). The average drop is just 8%.

The best performance occurs in a bear market. They have the fewest failures, 28% and 19%. Those also have the highest average rise or drop, 11% and -18%, respectively.

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Inverted Gap2H Measure Rule

Table 2: Measure Rule Performance
  Success 
Bull market, up breakout57%
Bull market, down breakout44%
Bear market, up breakout48%
Bear market, down breakout50%

Table 2 shows how often the measure rule works. Use the measure rule to find an estimate of how far price is likely to move.

To do this, measure from the highest high to the lowest low in the pattern to get the height. Add the height to the highest high to get the target for an upward breakout.

For downward breakouts, subtract the height from the lowest low in the pattern. Ignore price predictions below 0 and those that represent a large percentage move.

The best performance of the measure rule occurs after an upward breakout in a bull market, with 57% of patterns reaching their target. Those patterns that trade with the trend (upward breakouts in bull markets or downward breakouts in bear markets) reach the target slightly more often than the counter-trend moves.

Inverted Gap2H Trading Performance

Table 3: Testing the Inverted Gap2H
Market/Breakout direction Bull/Up  Bull/Down  Bear/Up  Bear/down 
Net profit/loss$65.44$(84.45)$(42.30)$66.82
Wins56%43%48%53%
Winning trades2,4984,7943891,648
Average gain of winners$701.05$745.70$719.79$797.70
Losses44%57%52%47%
Losing trades1,9536.3974211,479
Average loss($747.55)($706.57)($746.45)($747.59)
Average hold time (calendar days)29241711

Table 3 shows the performance based on 19,579 trades using $10 commissions per trade ($20 round trip), starting with $10,000 per trade. No adjustments were made for interest, fees, slippage and so on.

The results are sorted by bull or bear market, up or down breakouts. The trades used the same setup as listed in Inverted Gap2H Performance Statistics.

Here's the setup.

  • Find a inverted gap2H
  • If price closes above the pattern's high, buy at the open the next day.
  • If price closes below the pattern's low, short at the open the next day.
  • Sell/cover when price moves 7% in the direction of the breakout.
  • If price moves 7% in the direction opposite the breakout, close out the trade for a loss.

For example, in a bull market after an upward breakout from an inverted gap2H, the net gain was $65.44 for all trades. The method won 56% of the time and there were 2,498 winning trades. The average gain of winning trades was $701.05.

Forty-four percent, or 1,953 trades were losers. They lost an average of $747.55.

The average hold time was 29 days.

Notice that gains and losses hovered around 7%, which is how the test was structured.

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Inverted Gap2H Trading Performance With Pattern Stop

Table 4: Testing the Inverted Gap2H with Pattern Stop
Market/Breakout direction Bull/Up  Bull/Down  Bear/Up  Bear/down 
Net profit/loss$78.67$(112.41)$(71.62)$61.81
Wins60%49%59%69%
Winning trades2,6515,5024772,159
Average gain of winners$703.71$751.32$717.10$789.76
Losses40%51%41%31%
Losing trades1,8005,671336975
Average loss($841.88)($950.40)($1,191.33)($1,550.12)
Average hold time (calendar days)30282419

Table 4 shows the results of 19,571 trades, but this time, a penny below the bottom of the inverted gap2H pattern (upward breakout) or a penny above the top of the inverted gap2H pattern (downward breakout) was used as a stop instead of a 7% stop.

The net profit/loss deteriorated in 3 of 4 variations, but the win/loss ratio improved.

 

 

Inverted Gap2H Trading Example

Inverted Gap2H in 3M

I show an example inverted gap2H trade in 3M (MMM) on the daily chart.

The inverted gap2H begins at A and extends two bars later.

An order to short the stock triggers when the stock closes below the bottom of the pattern. Entry occurs at the open the next day, as shown.

Once in the trade, the target is calculated as 7% below the buy price. The approximate price is shown as the target price.

This trade completed successfully (made a profit), just as the stock turned upward.

-- Thomas Bulkowski

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See Also

Below are other short patterns...

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. Q: How can you tell if a man is aroused? A: He's breathing.