Copyright © 2008-2013 by Charles Kirk. All rights reserved.
The following is a question and answer session conducted with Thomas Bulkowski in mid February 2008 by Charles Kirk of TheKirkReport.com. It is posted here with the gracious permission of Charles Kirk.
Since the interview is lengthy, I have split it into multiple parts for your reading pleasure.
Kirk: I'm very excited to bring you a Q&A with technical analysis expert Thomas Bulkowski.
Last year I provided Tom with an open invitation to speak with us concerning his life's work and research concerning the application of technical analysis. Many members have sent in questions and I have quite a few of my own. I think you'll find it helpful.
Tom is no stranger to this website. Over the years, I've recommend his excellent website and he is the only author that currently has three books -
Encyclopedia of Chart Patterns,
Getting Started in Chart Patterns, and
Trading Classic Chart Patterns -
on my list of recommended readings. I have also linked to numerous of his articles over the years which have appeared in various well known and highly respected publications like SFO and Stocks & Commodities.
I have benefited tremendously from Tom's research, books, and website and I implement many of his methods. If you are serious about improving upon your knowledge about technical analysis, Tom is a great resource as you'll soon discover in the following Q&A. We hope you enjoy it!
* This is a lengthy Q&A and I recommend that you print this post and read it offline on the first pass. Then, I would reread it and visit and study many of the links Tom has provided that will help you with your own analysis.
Technical Analysis With Thomas Bulkowski
Kirk: First off, for those who may not know you already, please tell us a little about yourself and your background.
Bulkowski: This is one of those questions that's difficult to answer. How do I condense a lifetime into a few sentences? I graduated from Syracuse University
with a degree in computer engineering and went to work at Raytheon in Boston on the Patriot air defense system. Bored to tears since the program was winding down and freezing my butt
off, I opted for warmer climes and moved south. I managed a team of people at a small company before the recession of 1982 claimed some of our jobs (including mine).
I chose Tandy to work for next and spent over a decade there as a senior software engineer. Then they sold their manufacturing operations, of which research and development - where I worked - was a
part, and I lost my job. About two months later, my old boss had an operation from which he died, and they asked me to come back as a consultant to fill in. I remained there for five
months before more
rounds of layoffs eventually claimed the jobs of everyone I worked with.
After that, I was tired of being laid off so I opened my wallet and found that if I ate sawdust for food and turned off the heat and air conditioning, I could survive to age 65, whereupon I'd be dead broke.
I quit working. And no, I didn't inherit large sums of money, didn't win the lottery, nor marry rich (I'm single). I just decided to retire at 36. Best move I ever made, but I'm not 65 yet, so
I'll have to let you know how it turns out.
Kirk: When did your interest in the stock market begin?
Bulkowski: It was a Friday. I remember thinking that there are two ways to make money in this world: drugs or stocks. I've never been into drugs (thank goodness) and don't engage in illegal activities anyway, so I focused on stocks.
Kirk: In the early years, how did you learn and transform yourself into such a successful investor?
Bulkowski: When at Raytheon, I charted about two dozen of my best stock picks on a piece of graph paper taped to the wall. My officemate, Bob Kelly, closed his eyes,
twirled his hand around, and repeatedly dropped it into the pages of the Wall Street Journal. Those were his picks. After six months of tracking my carefully chosen stocks and his
random picks, I found that he was beating me. That was the first of many surprises. I paper traded for four years before I bought my first stock, but it was time well spent. I
started with the fundamentals and eventually graduated to the technicals.
Kirk: Was there ever a time that you harbored serious doubts that you could do well in the market or were you successful right from the start?
Bulkowski: I wrote about my trading success in an SFO article (October 2006, Developing a trading style). I got lucky and made money on my first stock, 88% including
dividends, in Essex Chemical. During my trading career, on 27 trades I at least doubled my money and six of those I made over 1,000 percent. My best trade made about 5,000%
(a rise from 88 cents to 44). I've never used leverage, and I don't trade options. These are just pure stock picks, usually held for the long term.
Of course, I've lost money, too. That 5,000% winner did a dead-cat bounce ten times. That means I lost between 15% and 75% in one trading session ten times along the way (it was Michael's Stores, a stock taken private in 2006).
Kirk: What is your average hold time? How many positions do you typically hold? How many trades do you make in a typical year?
Bulkowski: My trading stats are on my website from 2000 until 2006. I stopped
after that so I could keep my focus. However, in those seven years which include a bear market, I've average +17.5% gain compared
to the S&P 500's gain of +1.7% and a decline of -3.2% in the Nasdaq, traded an average
of 28 round trips (buy and sell) annually with an average hold time of 51 days. For every buck I've lost, I've made $4.88 with a win/loss percentage of 56%. Those gains
allowed me to upgrade my diet from sawdust to vegetables. I may still be broke at 65, though. Please stay tuned.
Kirk: How often would you say that you trade a stock without even knowing what the company does or its fundamentals? Do you try not to know those things because they can influence and bias your decision making?
Bulkowski: I almost always check the fundamentals unless it's a day trade. Fundamentals keep me from getting excited about a flat base or rectangle top because I'll find out there's a reason for it: The stock is being taken over.
The stock will trade in a narrow range and it looks like a perfect technical setup, but it's a trap.
Checking the fundamentals can lead to disaster, too. Take Savient Pharmaceuticals (SVNT) as an example. If you guys and
gals want to make money then look at my study on Dutch auction tender offers. SVNT prompted this study, I think. I wanted to know if you can profit from Dutch auctions, and how you should trade them if the company you own via stock offers one.
The stock moved horizontally from A to B, forming a tall rectangle top or ascending triangle chart pattern.
Toward the end of the rectangle, the company offered to buy 10 million shares between 5.80 and 6.80 per share. On September 18, they announced that they would buy the 10 million paying
the full 6.80. I saw this as a buying opportunity because it represented a buyback of over 16% of shares outstanding, which is large. With fewer shares out, earnings per share would
explode, along with the stock price. Then I researched the fundamentals.
At the time, Barr Pharmaceuticals was trying to market a generic version of Savient's Oxandrin. That one drug represented 52% of sales in 2005. Some of the patents protecting the drug had already expired and if the company lost the patent fight (Savient sued Barr over it), the revenue steam would quickly dry up and the stock would likely dead-cat bounce. My notes say that I was most worried about the litigation sapping cash.
I decided not the buy the stock because of the fundamentals. The stock climbed from the 6.80 tender price to 15.75 in less than 5 months and recently neared 25. Fundamentals are nice elevator music, but they are not the tunes you should be dancing to. Why? Because by the time you see the numbers in a quarterly report, the information is weeks or months old.
Kirk: Do you trade anything other than equities? Options, futures, ETFs, currencies, etc.?
Bulkowski: I've used covered calls several years ago and ETFs recently. That's it. If I trade futures or currencies, it would be a sure bet that I'd be flat broke well before 65. Maybe I can still do that if I can marry someone filthy rich while my net worth plummets. She can pay for my playing.
Kirk: What are your thoughts on applying technical analysis to ETFs and, is the rate of success similar to those of individual stocks in your research?
Bulkowski: When the Dow was falling, I bought the ProShares UltraShort Dow30 ETF (DXD). That ETF moves up at
twice the rate as the Dow falls. I made almost 6% in two days (annualized, that's almost 700%. Yippee!). The only other ETF trade was in the ProShares UltraShort QQQ ETF
(QID). I sold it a day later for a 2% profit. Neither of these was based on chart patterns. I just saw the Dow going down so I thought
the market should pay for the privilege of trying to wipe me out.
Kirk: A substantial part of the edge you create for yourself is through the amazing amount of performance statistics that you've collected and analyzed. Can you tell us a little more about your approach?
Bulkowski: My first book (second edition pictured),
Encyclopedia of Chart Patterns Second Edition
started not from a desire to become rich or famous, but to determine how often chart patterns work. I decided to find as many chart patterns as I could and test them. The results I published, and it has become a best selling book because no one had ever done that before.
My interest in candles grew and one day I was emailing a friend and told her, "Tomorrow the price is likely to drop because a bearish harami is, well, bearish." The problem was, the stock moved up. I discovered that candles didn't work as predicted. So, I decided to find out and tested them. That's why you'll see my
Encyclopedia of Candlestick Charts
on the shelves late next month (it's available now). Both books are about a thousand pages long, and they contain information that no one else has. They give any trader an edge if they know what the numbers mean and how to apply them.
Since I don't do anything for a living, I can sit and do the million plus mouse clicks that it took to catalog the 15,000+ chart patterns for my first encyclopedia. Few have that kind of patience and time.
How many times have you read that markets trend only 10% of the time? Maybe it's really 20% or just 5%. Why do trends begin? What is the process that changes a stock from moving sideways to trending up in a straight-line run to the sun? Those are the types of questions you can ask when you retire at 36. After all, you have to do something with your time. My approach is to figure out a way to answer those questions and then do the work to find the answer, even if the pain of doing so becomes excruciating (well, up to a point anyway).
Kirk: No doubt, the research you do takes a tremendous amount of time and dedication and thank you for sharing your findings. That said, I'm sure you are asked this quite a lot. What would you say to someone who doesn't believe in Technical Analysis (i.e. that charts show what has already happened, not what will happen)?
Bulkowski: I would say use whatever tools you want to make money in the markets. If fundamentals work for you, then use them. If technicals float your boat, then use those.
For example, noted retired Fidelity Magellan fund skipper writes, "I've always detested 'stop orders.' Show me a portfolio with 10 percent stops, and I'll show you a portfolio that's destined to lose exactly that amount." That's a quote from
One Up On Wall Street,
Peter Lynch doesn't use stops? My jaw dropped when I read that. But he didn't actually say that he doesn't use stops (please forgive the double negative). I thought he did somewhere
in his book, but I can't find it. The thing is, he's right...for his method. How do you think I made 5,000% in Michael's Stores? I didn't use a stop either. Please don't
misunderstand: I do use stops, but not in core holdings (stuff I don't want to sell, like utility stocks and those I want to see move up by 10x).
Kirk: Do you believe that technical analysis is helpful to part-time, long-term focused investors? If so, how would a long-term investor incorporate pattern analysis versus a short-term trader?
Bulkowski: My growing belief, meaning I'm not certain of this, is that technical analysis is best for market timing. Use it to buy a stock. Use it to sell a stock. Base your shopping list on the long term approach: fundamentals, market trends, new discoveries or gizmos, and so on. That's the method I used to score a 30% rise in Georgia Gulf in just 3 days (a value play). I'll talk more about that trade later.
The problem with the buy and hold approach, is that all stocks tumble, sooner or later. That's the main reason I got fed up with fundamentals. I would buy a stock and hold it. It would double in price and then drop. I'd give back a significant portion of my gain and I was tired of that happening. The easy cure is to use a stop. But like Peter Lynch says, once you use that approach then forget about catching any 10 baggers.
A trader I know puts his stop 1% or 2% away from the stock and he's continually getting stopped out for a very small gain or loss. He can't make any money. He knows what the problem is, but he's unwilling to change. Fear of loss has crippled him. I think that's sad and I wish I could help him, but I can't force a horse to drink the water. I can only show him the pond, try to push him toward it, and hope I don't get my teeth kicked in when he bucks.
How would investors use technical analysis versus traders? If you think that the trend is going to change or is in the process of changing then sell the stock. How do you detect a trend change? I could say that I'll leave that as an exercise for the reader. Instead, I'll say that I've been searching for 25+ years and I haven't found a good answer yet. Maybe when I reach 65.
Kirk: As your research continues, have you noticed any significant changes - i.e. patterns no longer working as well as previous or patterns now that work better than they have in the past?
Bulkowski: Doing pattern research is such a pain in the @$$, so time consuming and so Carpal tunnel inducing that I don't do it. By that I mean I haven't
gone in recently and tested any chart pattern to see how it works now versus x years ago. I did that when I came out with the second edition of my book, Encyclopedia of Chart
Patterns, but I also changed the method a bit, so you really can't make any valid comparisons. For example, the 2nd edition splits the markets into bull and bear. The 1st
edition only had bull market results because I couldn't find any bear market data of recent origin.
My feeling is that patterns work less often than they did in the past. For example, if everyone sees an ascending triangle, they will place a buy order a penny or two above the top of the chart pattern. When price moves up, it triggers those buy orders and price shoots upward, causing more buy orders to trigger. But then what happens? Everyone that wanted to buy the stock has bought. Now, selling pressure takes over and down she goes. You get a throwback.
If you do the analysis, you'll find that a throwback or pullback will occur more often after a
high volume breakout than a low volume one. If price does not throwback, then you know you're into a good trade, one that stands to do quite well (but no guarantee, of course). That's
what the numbers say, though. Throwbacks and pullbacks suck the momentum out of the stock (See these two studies:
one and two). Those patterns that do not have throws or pulls tend to move farther. Again, that's what the numbers say. And that information is what you can discover when you read my books.
It's all there, and that gives an astute trader the edge. That's how you make your first million.
Kirk: How often do you update the performance statistics you have concerning the patterns you use?
Bulkowski: I've done it once, when I came out with the second edition of my Encyclopedia of Chart Patterns book, as I've discussed. I increased the sample count from 15,000+ to 38,500+ patterns. Make no mistake, I'm logging the patterns each day (meaning I add them to my database, but I don't do the mouse clicks to find every telling detail like where the apex is, pullbacks or throwbacks, prior dips or overshoots, quick rises and declines, partial rises and declines, premature breakouts, and so on, that are necessary to completely define a pattern). I dread when my publisher asks me to do a third edition.
Kirk: Please tell us a little about your chart pattern indicator (page one and two)?
Bulkowski: Bullish chart patterns appear in large numbers at market bottoms and they signal an upturn in the market. Bearish patterns appear near market tops and they signal a
downturn. I used this idea to create an indicator, called the chart pattern indicator (creative name, huh?), to detect those market turns. After spending months testing over 170 price patterns along
with various combinations, I settled on the Nr7 - narrow range 7. That price pattern signals a large price move if
today's high-low price range is narrower than the prior six days (for a total of 7 days). I wait for price to either close above or close below the top/bottom of the 7 days before I call it a
bullish or bearish pattern. Then I just count how many of those bull/bear readings I get in hundreds of stocks. The ratio of bullish readings to the sum of bullish and bearish readings gives the CPI,
expressed as a percentage.
In other words, I'm just counting the number of bullish patterns I find compared to all Nr7 patterns. I plot the results against a major index, such as the S&P 500. Here's the latest chart (as of early February 2008):
I use 35 and 65 as the thresholds for bearish and bullish readings. For example, if the indicator drops below 35, then that's bearish. The blue line is the indicator, and the red (sell)
and green (buy) vertical lines highlight potential market turning points (it shows the FIRST signal, meaning that you'd see a sea of green bars followed by a sea of red bars if I colored
each signal, each day). My free pattern recognition program, Patternz, displays the indicator, but
you have to throw a bunch of stocks at it.
Notice how well the indicator detects the market turning points! But there's a problem. The indicator is not like MACD, RSI or a moving average crossover. Since it's based on breakouts from Nr7s, it can take up to a week for the numbers to stabilize. Most times within two or three days you get a valid signal. In other words, the indicator will say, "You should have sold two days ago." So, the indicator is best used as a longer-term filter, not a day-to-day trading vehicle (but play with it to see how timely it is for your markets). The accuracy is uncanny, though.
If you want more details about the CPI, you can find it on my website here.
Kirk: One of most popular questions I receive now is whether we are in a bear market. In your view, 1) Is this the right question to ask (why or why not) and 2) what does your analysis currently suggest?
Bulkowski: To me, a bear market has a strict definition. It's the close-to-close drop in the Dow (or index of choice) of at least 20%. We're at 15% from the highest close on October 9, so we're not in a bear market.
Does it matter? No. It's just a label, so it doesn't mean anything. The real question is, how do you make money in this market? And the answer to that one is easy: Anyway you can!
I'm excited by this market. Why? Because I see good stocks on sale at prices we haven't seen in years. Great value plays abound. I think the market has bottomed. That occurs when I see
a bunch of bullish chart patterns. Last month I started to find pipe bottom after pipe bottom in the
550+ stocks I look at daily. Pipes were so numerous that they stuck out (and I had to take the time to log them in, so the pain of doing that is fresh in my mind). But I also know
that the first time they appear is NOT the time to buy. It predicts a sucker's rally, which we've seen. Only when the market drops a second time and you begin to see more bullish
chart patterns appear will it be safe to start loading up on those value plays. That hasn't happened yet.
In short, look for the market to create a double bottom or ugly double bottom and buy close to the second bottom. Just be careful because it could be a bumpy ride.
Kirk: What's your overall game plan when dealing with this market? Do you see any specific chart patterns unfolding in the major indexes?
Bulkowski: The utilities show an Eve & Adam double top in December-January
followed by a weak pipe bottom in late January (meaning the twin bottoms are not well defined). Transports show an
Adam & Adam double bottom in January. The Dow shows a symmetrical triangle from October 31 to
December and it might be forming a (ugly?) double bottom now. Nasdaq shows an Adam & Adam double top in December and a potential (ugly?) double bottom now.
Chart patterns work best when price breaks out of congestion (which the chart pattern highlights) and trends in a straight-line run. Two examples appear in the Nasdaq composite. An Adam & Adam double bottom (AADB) occurs in March 2007 and price trends upward to the July peak. The head-and-shoulders bottom (LS=left shoulder, RS=right shoulder) leads to a faster rise in September. The two throwbacks gave traders and investors the opportunity to add to their positions or establish new ones. These are the types of moves that traders love to see in individual stocks.
With the markets so volatile, I've changed my strategy to look for short-term trend changes. I do this by listening to a voice that whispers "This is going down. It's time to sell." Listening to that voice is usually correct. The accuracy of that voice and the ability to hear it and obey it is what separates novice traders that lose from experienced ones that win.
Kirk: For those of us looking to time the bottom, what are some things we should be looking for beyond what you've already said? Likewise, what are some signs (other than lower prices) that will indicate that we remain in a bear market?
Bulkowski: I've mentioned how I think this bottom will occur. We've seen the first half, a burst of bullish patterns. Then they went away as price climbed. Now the
market is coming down again. When the bullish patterns appear again, that will be the time to buy. They may NOT appear, so that's an indication of more downside ahead. Or the market
may turn up sooner than I expect. On a time scale, I'm looking for this to occur within the next month, perhaps as the indices make a double bottom. That's just a guess but have your
ammo ready. Don't buy too soon. If I'm correct, price may throwback, so you'll have another opportunity to invest (see the prior chart of the market. If you waited, you would have
had another buying opportunity).
Kirk: In your +25 year experience, you've seen a variety of different types of markets, far more than the average investor. However, it seems like many people are trying to formulate bear market playbooks that have been successful in the past. Do you have a bear market playbook, and if so, what are some methods you've been able to use in the past to do well even in downtrending markets? (For example, do you use any watch list filters concerning relative strength that you've found helpful during these times?)
Bulkowski: During the last bear market, March 2000 to October 2002 in the S&P 500 index, I picked stocks that climbed during that time, so I made a cumulative +42.5% over those 3 years while the S&P dropped -46.5%. By cumulative, I mean the sum of returns (14.8% + 18.7% + 9% = 42.5% versus -10.1% -13.0% -23.4% = -46.5%).
If you know or suspect that price is going to drop, then park your money in cash and wait it out. With ETFs, you can buy those that short the indices or you can buy puts on the market or individual stocks. I do not recommend shorting stocks because you're just feeding your broker (the cost of borrowing money even if you have enough cash, and you have to pass on any dividends).
Industry relative strength is one technique for weeding out the also-rans from the performers. Pick industries that are doing well over the past 6 months (close today vs the close 6 months ago) on a price basis. I have a spreadsheet, updated weekly, that shows the industries I follow and the industry relative strength link describes a study on how to trade on that information.
You can trade Dutch auction tender offers as I've previously described. You can use stock relative strength (see pages one and two) but that doesn't work as well as industry RS.
Avoid stocks that are known for dead-cat bounces, such as the Internet, semiconductors, specialty retailers, and so on. Instead, concentrate on the homebuilders (ok, so that's not a good choice now...or is it? You decide) and metals & mining.
Market cap. Small cap stocks get killed in a falling market but large caps hold their value better (but they go down, too). I learned that when writing my book,
Trading Classic Chart Patterns.
The details are in that book, in the numbers. You can also find additional information here.
In fact, spend some time reading over the 28 studies I have on my website and then don't believe a
word of it. Do your own research. Use my work as a springboard for your own results. Make the techniques fit your trading style. Backtest them and then paper trade in real time. Five
years from now, when you're finished, you'll be better prepared when the next bear market comes along and chops your legs off. It will hurt just as bad, but at least you'll know how to
Kirk: Do you ever sit out of the market (i.e. hold cash) at any time based on overall market conditions? Why or why not?
Bulkowski: All the time. If I can't find anything worth buying, then I wait for the next buying opportunity to come along. It's rare that I'm fully in the market.
And I'm very selective. I can wait for the perfect setup. I reported results of two studies that
describe what influences stock movements. The market accounts for 31% of the price fluctuation of stocks, according to Brealey. The economy, industry, company, and other factors share
a different pie, 30 to 35% for the first two, each, and 15% to 20% for each of the last two.
I do keep my long-term holdings, my core group. These are the stocks that I don't have stops on and will have long-term capital gains. These are usually utility stocks that I hold for the tasty dividends or long-term plays that I expect to double, triple, or move up by 10x...if they don't go bankrupt first.
Kirk: How does the overall market condition affect your approach? For example, will you still put on a trade if the overall market and sector showing a pattern counter to that particular stock?
Bulkowski: I'll lie and say that I never buy a stock in a falling market in an industry that ranks poorly for price relative strength, but the truth is, I do it all
the time. This morning (Monday, Feb 11), I placed a day order to buy a stock that will be hit only if price rises even though I know the market is going down, or at least I think it will
drop. Technically, the setup is a good one and I want to be ready if I'm right. I found that if I can't buy into a stock within 5% of the breakout price, then the chances increase
substantially that the trade will be a loser.
On the longer scale, I change my trading style as the market changes. In the good old 1980s, I followed the long-term up trend and a buy and hold approach worked very well. I switched to position trading to eliminate the large giveback of profits when the trend reversed. That lead to swing trading and even some day trading in these volatile markets. It's difficult to make money when you ride the tide upward one day only to be sucked into a whirlpool of down days over the coming week because the markets are dropping by hundreds of points daily.
Kirk: What are your thoughts regarding portfolio diversification?
Bulkowski: Nothing feels better than owning a stock that goes up while the market goes down by 300 points. That's diversification with negative correlation. I have put all of my eggs in one basket at times and concentrated bets can pay off. But the downside is the single stock risk of watching your one holding drop by 30% to 70% when the CEO says he's been backdating options and using company funds to remodel his bathroom and pay for his jet.
I have a tendency to load up on utility stocks when I don't have anything else to buy (collecting the dividend). Other than that, I usually buy no more than two stocks in any industry. It's also rare that I will take multiple positions in the same stock, but I give myself the option of buying more if price behaves like I expect. Right now, I'm only buying in quarter size lots because the market is so risky. When things resume trending, I'll go back to a full position size.
Kirk: You have shared quite a few studies that I've found incredibly helpful in the past. Among all of those that you have completed, what conclusion was the most surprising to you and why?
Bulkowski: Probably the one on industry relative strength. I call it the holy
grail of investing. Everyone is looking for the one technique that will turn iron into gold. Industry relative strength is it. I still have more work to do on this, but you rank the
price performance over the prior 6 months (which is the best out of the periods I studied: daily, weekly, monthly, 3, and 6 months) for each stock in an industry. I used 512 stocks,
sorted into 44 industries. Here's what I found.
If you want to make money, then select stocks from the top performing industry and this works for holdings as short as a month to as long as 2 years, and perhaps longer. On average, the stocks in the top tier climbed 8% in one month, 57% in 6 months and 98% in two years. Those dead last for relative strength dropped 6% in the first month, -28% after six months, and were 25% lower after two years.
All I'm doing is taking a snapshot of the best and worst performing industry on day one and seeing how that industry performs over time, close to close. You can read the methodology and complete results on my website.
The story doesn't end there. I still want to see if you buy a lower ranked industry stock, ride it upward until it drops and test performance. There are several variations that I used on stock relative strength that I want to try on the industry (see both pages one and two).
Kirk: Can you give us some idea of what tools you use to monitor the markets and trade (i.e. details on your trading platform, charting software, broker, websites, etc?)
Bulkowski: I wrote my own software, so that's what I use for charting. I have two machines, one online and the other not (for antivirus protection). The one that's online is connected via fiber optic line (broadband) to the Internet, and I have a Dell Dimension 2400 computer with 768 megabytes of RAM, running at 2.19 gigahertz. That's plenty for end-of-day trading. I have two monitors, a flat panel 22" beauty and a 15" CRT that I rarely use, connected to the computer.
Kirk: If we sat next to you on a typical trading day, can you tell us how you go about finding the stocks you trade?
Bulkowski: To describe the day trading setups would take too much room and some of
them are on my website anyway. For non-day trading, I begin by reviewing the industry relative strength. I focus on the top 10 but look at them all to see which ones are moving
most (the largest percentage change). Then I review my holdings, filtering them through Wilder's relative strength index (RSI), commodity channel index (CCI), and Bollinger bands (BB). I'm
looking for anything that's alarming since I already own the stocks (like divergence or opportunities to buy more). Then I click a button and see how well they did over the prior day.
Following that, I review my holdings to see what I can see using a 15-month sized chart (that's how much I can pack into my chart without scroll bars appearing).
I use the same pattern recognition code as the released version of Patternz and I review the charts of all of my stocks. Either my eyeballs or the program finds chart patterns in development as I scan them. If I see a chart pattern of interest, I may put it into another folder for a closer look after I complete my review of all 598 securities (stocks, ETFs, indices) that I review on a daily basis.
I may score the chart pattern to determine whether it's worth buying or not, based on the probabilities discussed in my Trading Classic Chart Patterns book. Scoring is also
available at my website. Each chart pattern is just a buy or sell signal. All I do is decide which
ones to buy and which ones to sell. For selling, sometimes it's just that voice saying this is going down. And if it's already down and approaching my stop, then I'll just sell it now
instead of hoping it will recover before it hits the stop. It won't recover, and you'll just lose more money by waiting.
Kirk: I know from running similar scans using your Patternz software that a tremendous number of patterns show up. Can you discuss how you go about narrowing your focus to a specific set of stocks?
Bulkowski: My own program (not Patternz) remembers patterns that I've already looked at and evaluated (logged into my system). I have notes of where earnings or other
events may have occurred on my charts. My trading notebook, which I'll discuss later, describes my buying checklist. Of the charts I look at, few new patterns will appear. As I log them
into my system, I may decide to take a closer look. The border color of my charts tells me the relative strength (green is good, red is bad), and I also have both industry and stock
relative strength values listed. I usually want to pick stocks in a top ranked industry, as I've discussed.
When I pick a stock or see a pattern that I want to trade, I will go up and down the time scale (I trade daily, so I go up to weekly or even monthly and then drill down to intraday) just to see what I can see. Where is overhead resistance and underlying support? Will the stock run up against a down-sloping trendline soon? What other patterns appear in the stocks in the same industry? How are they behaving (the stocks, not the patterns)? I ask all sorts of questions to help me determine whether the stock is worth buying or not.
If I like the stock, then I go online and fill in any missing information like when is the next earnings release? Maybe I'll listen to the prior conference call. I'll see what S&P and Ford have to say about the stocks (fundamentals). I'll look at insider trading to see what the big boys are doing. If I like what I read then I'll either place a buy stop, market order at the open, or day trade the entry.
As for patternz, the best way to use that program is to select patterns that you want to trade.
For example, select the triangles: ascending, descending, and symmetrical. Then go to the List form and let the program search for them. When it finishes thinking, click the Sort button
so it sorts them according to date (or using the option buttons to filter them for volume and any other quirks listed, such as pattern width, height, volume trend, gaps, volatility and so on).
Look at the stocks with the most recent dates (listed first) and see if you like the patterns that appear. Since each is charted individually, when the patterns drift too far from the
current date, then you can stop. Or you can just highlight the stocks that you want to look at and chart those. Again, sorting is the key.
Kirk: Above all of the other things you do (writing books, blog, etc.) approximately how much time do you personally spend in scanning and looking for trading setups?
Bulkowski: In the last two weeks, I've spent both entire weekends looking for stocks (about 25 hours over 4 days). That's the first time I've ever done that. Usually, though, it's a quick 30 minutes each day, and I'm done because there's nothing new that interests me, especially if the market is down that day. I'm just not that juiced about buying a stock today that will be cheaper tomorrow.
Kirk: Can you now take us through one of your best trades recently? Please start from the beginning (how you found the stock) to the exit. If you can share the chart, we would appreciate it!
Bulkowski: Let me tell you about Georgia Gulf (GGC). I've also put this on my blog, so maybe you've already read about it. In my normal daily stock reviews, I saw one that started from the upper left and ended on the lower right, a huge decline, so I decided to take a closer look. When I checked the price scale, I gasped at the magnitude. It was Georgia Gulf, a company I've owned before.
As I recall, I spotted this stock at A, on the first spike down. "I should buy this," and "It's a steal!" I remember saying, but I didn't follow up on that. The stock was tending down and you don't want to catch a falling knife.
The next day, price zipped up by 25%, so I blew the stock off. I'm not going to chase it upward. In a few days, price sank lower, but I missed the double bottom that formed at A and B.
Price confirmed the pattern at C, and that is the first good buy signal. I started to take an active interest then. I looked at the fundamentals to discover why it was so cheap (the
chemical company makes, among other things, plastic pipe for the housing industry). I listened to the most recent conference call and decided that management knew what it was talking about.
Here's an edited portion of my notebook for the trade:
- Today's date: 01/29/2008
- Date bought: 1/29
- Stop: 3.77 -36.9%. Stop used: 3.77
- Upside target: 14, bottom of descending triangle in August.
- SAR: None until 12
- Elliott wave #:
- Nearest phi extension: about 9.50
- Next earnings: 2/15
- Weekly scale (industry, too): Nothing worth seeing.
- Indicators: RSI: bullish divergence from the Nov low, upward, cci: buy 3 days ago.
- Buy reason: Closed above down-sloping trendline, combined with fundamentals (co is worth $11/share) and double bottom. This is a very risky bet that the company will recover. It may go bankrupt but it's worth $11 per share and selling at half that.
The stop, based on volatility, was a massive 36.9% away from the current close. Wow! With a low price comes increased volatility. SAR is support and resistance. I didn't fill in the Elliott wave number because only Elliott himself can figure that one out. From my buy reason, I can still detect some hesitancy about buying the stock because it was so risky. But I did and received a fill at 5.80.
With the markets as turbulent as these are, I let the stock climb for two days. Then, with 15 minutes before the close, I decided to sell. Here's the sell portion of my notebook.
- Date placed: 1/31/08
- Date sold: 01/31/2008
- Order details: I sold all about 15 mins before market close
- Sell reason: Market was up 207 points today, so it may retrace tomorrow. Most importantly, the profit in 3 days is 33% and I don't want to give that back at the Feb 14 earnings release. I will buy more if it drops.
I received a fill at 7.67 and the stock closed a bit high in the last minute or so, at 7.80. The next day, price continued to a new high but closed at the same price. It has eased lower since. After commissions, I scored a gain of just under 32% in about 3 days.
Kirk: Can you share one of your recent losers with us and a good example of how a very attractive setup did not work (please share the chart as well)?
Bulkowski: This is one of those trades that comes along much too often. Questar showed much promise when it formed a symmetrical triangle. One of the problems with the triangles, especially the symmetricals, is that price can waffle up and down, around the triangle apex. Here's the chart and my notebook entry below:
- Today's date: 01/09/2008
- Order details: Buy at 56.03, GTC
- Date bought:
- Stop: 52.34 -6.5%. Stop used: 53.13, below prior minor low by a smidgen.
- Upside target: 71.89 according to scoring system (+3 score)
- SAR: none overhead once it passed the sym triangle humps. Below is 52.62, support
- Elliott wave #: 3
- Nearest phi extension: 56.40
- Next earnings: 1/24
- Weekly scale (industry, too): ok relative strength (12/47). Many are below the 30 wk moving avg, but not this one.
- Indicators: CCI: Buy today. BB: at top band, pushing through. RSI mid range.
- Buy reason: Upward breakout from sym triangle with upward 30 wk MA. This is showing strength in a decent industry.
The stop was good, at 5.2% down from the buy price. Since the stock was near a new high, overhead resistance was minimal. The scoring system said it was a +3 and that meant the probabilities suggested that this would rise more than the median stock, which suggested a target of 71.89 (see my book Trading Classic Chart Patterns for scoring or visit my website.
The phi extension of 56.40 was a minor worry. Price sometimes reverses at those locations, so I check for them and then usually ignore it, which I did this time (go figure). I checked the
other stocks in the industry and found nothing exciting except for this one looked to be doing better than the others. This industry ranked 12 out of 47 for relative strength. I've been
toying with moving averages recently, so that's why I reference the 30 week EMA. CCI is commodity channel index. BB is Bollinger bands and RSI is Wilder's relative strength index, all with
default parameters. I bought when price broke out upward from the symmetrical triangle.
Here's how the trade progressed, from my notebook.
1/10/08 Stop placed at 52.87, vol stop
1/14/07 Stop raised to 54.42, vol stop
1/16/08 Stop hit as it plummeted. Another loss...
(Vol stop is a volatility stop, discussed later)
The stock climbed to the phi extension (peaked at 57.48) and then reversed. I received a fill at 54.44 for a loss of slightly less than 3%. Notice that the original stop was over 5% away, so I was able to cut that. I bought the stock the day it pierced the top trendline and sold it when it pierced the lower one. Notice how price continued lower.
Failed trades happen. They are the cost of doing business.
Kirk: Thank you for going through both of these trades. It is always interesting to see how other traders organize their thoughts and trades and I'm sure others will find this fascinating.
Generally speaking, what are your views on how to manage your risk?
Bulkowski: I'm not going to get fancy on you. If you want to manage risk, then read, The Handbook of Portfolio Mathematics,
by Ralph Vince. The book discusses position sizing and provides equations to maximize returns for a chosen level of risk. You will find it advisable to have a degree in math but with work, you can probably muddle through most of it without an advanced degree.
I manage risk by using stops, diversification, and varying the position size. For non-core holdings, I always use a stop. I diversify across industries, and I usually allocate $20,000 per
trade. I started buying lots of $2,000 (100 shares of a $20 stock), so I've made some progress. In these volatile times, I've cut the size to $5k in the last few weeks, but today I placed
a trade for double that. I take the price of the stock, divide it into 20k and then increase the shares to the nearest round lot. The result is that the cost is usually between $20,000 and
$25,000 per trade. It's rare that I will buy a stock over $50 and certainly won't touch one over $100, like Google or Apple. That's just a personal preference. The lower priced stocks are
where you get your big moves anyway. I think I have a study on that and you can find details in my Trading Classic Chart Patterns book. Writing that is when I discovered it.
Kirk: Everyone wants to know about how better to incorporate stops in their approach. Do you have some suggestions or rules of thumb to share? I think you use Fibonacci retracements, correct?
Bulkowski: I have a page or two on stop placement. My current method of choice is to use a volatility stop. Back in the '90s I refined a stop based on beta (BATS: beta adjusted trailing stop). Beta compares the volatility of a security with the general market. Given beta and price for a stock, you would use a table to look up the stop loss value. That method was flawed because beta is the wrong tool to use for volatility.
I read Kaufman's book, A Short Course In
Technical Trading, where he discusses a volatility stop. I tested it and found that it works.
For a volatility stop, measure the high-low price range each day for the prior month, average the result, and multiply by 2 (and yes, ATR - average true range - works, as does standard deviation, just not as well). Then subtract that value from the current low price. That tells you to place a stop no closer than that value. In the above link, you'll see an example that makes the process clear.
It works great for stocks in straight-line runs where there is no minor high or low to hide underneath.
Fibonacci is great for determining how far price is likely to drop before reversing. You can also use it to buy a stock (use the 62% retrace value and buy there when the stock rebounds off that level). If a stock you own drops below the 62% retrace of the prior move then sell it. It's probably changed trend and going down.
Kirk: Great stuff Tom. I think I may have to read the book you suggested and tweak my own approach in this regard. Thank you for sharing your thoughts.
Volatile markets chew up all traders. Stops are hit, only to rebound quickly, and then falter once again. Do you have any recommendations for trading and investing in more volatile environment?
Bulkowski: Stay in cash until things begin trending again. You can always paper trade to hone your skills. You can cut your position size as I have or monitor the trades more closely. That's why I got out of GGC after 3 days instead of waiting for it to hit 14. I had 30% in the bag, so why risk giving that back?
For a buy and hold or even shorter-term traders, switch to the weekly scale and reevaluate. If the shorter scale is driving you up the walls, then the weekly scale should cure that. That will require you to keep your stop farther away, but it won't get hit as often and the potential for larger gains increases.
For day traders, it's the difference between the 1-minute scale and the 5-minute. If, on the 1-minute scale, you grip the table so tight that your knuckles are white, then switch to the 5-minute scale. You can play a video game, read a magazine, or have sex. At least it will feel as if you could walk away. When you come back, only a few more bars have printed. It's much more relaxing. The downside is that you can lose more money, but you also stand to make substantially more, too.
Kirk: Which chart patterns are you finding to have the greatest probability of success in the present market environment for long traders? For short traders?
Bulkowski: As I said, each chart pattern is nothing more than a buy or sell signal. How you trade that signal is up to you. For long traders, I would focus on descending triangles that breakout downward, reverse, and bust out the top. Those tend to continue moving upward. That's a busted ascending triangle, by the way. I cover busted chart patterns in [my book] Getting Started In Chart Patterns.
There's also a lot of interest in high and tight flags. You can make 69% on these patterns (but maybe not recently). That's the average I found when I studied them. Just buy the stock
when price closes above the flag or flagpole high, and not before. In too many cases, buying when the stock climbs above a down-sloping trendline forming the top of the flag results in
a losing trade. Wait for price to clear the top of the chart pattern before taking a position. And be aware that price may rise 10% to 15% before tumbling in these markets. I see lots of
HTFs forming in cheap stocks right now, by the way. That's another reason why I'm excited about these markets. Maybe we should have the threat of a recession more often.
For shorts, there's lots to chose from. Head-and-shoulders tops abound aplenty. Diamond tops are also good providing they have a quick rise (a sharp move up in a straight-line run leading to the diamond). A quick decline often follows a quick rise, regardless of the chart pattern involved, but you see that scenario often in diamonds.
Kirk: Which patterns typically are more unreliable?
Bulkowski: I dislike cup with handles because price rises by 10% to 15% and then dies (drops). Maybe that only happens in the ones I pick. I also avoid broadening patterns. It's hard to judge when to buy those. Where's the breakout? Who knows? Ascending triangles also don't work well. Price will climb and then reverse just like cups.
Kirk: Hard to believe, but 37 members wanted me to ask you one simple question: What is your favorite pattern among all of those you monitor and why?
Bulkowski: I like symmetrical triangles and descending triangles. Symmetricals happen often so you can find one at any flea market. Descenders are more rare, but when
they bust, it's a fun ride. On the weekly scale, you can make some bank on rounding turns, but catch them as they bottom. Watch out for the jump in price that often happens just after the
midpoint (maybe sell then and buy back in later?). You may think you've struck gold but wait two weeks and price will have returned to near, but slightly above, the launch point.
Big Ws are also a good ride but they are more risky. That's just a double bottom (or any reversal pattern,
really) with tall sides. Expect price to return to the top of the left side, but in this market, that's probably wishful thinking. There's lots of Big Ws now that are really pint-sized
failures. By that I mean price on the right side of the W climbed but didn't come close to the left side.
Kirk: If you surveyed the top 100 traders in the world and ask them to rank order the various indicators by the best short, medium, and long-term strategies for entries and exits, which ones do you think would probably come out near the top?
Bulkowski: Vanna, I'd like to buy a vowel, because I don't have a clue. Strike that. I'll let you in on a very special secret that few traders recognize. There is one indicator that I know of that has never failed. Ever. It's a dream machine. Very tubular. It's not my chart pattern indicator either. Give up? No, it's not volume, but you're close.
Why use a moving average when you can look at price and see if it's going down? Why use RSI when you can look at price and see that it's making new yearly lows (over sold). Why use rate of change when you can look at a chart and see price climbing away from a trendline (increasing momentum) or moving toward it (decreasing momentum)?
If you're good, I mean really good, you can look at price and describe what your indicator of choice should be saying. That takes practice and knowledge of your tools.
I ignored indicators with Michaels Stores. I didn't have to look at RSI to know it was oversold. I just bought more. Besides, the top 100 traders probably use fundamental analysis anyway!
But even I cheat and use RSI, CCI, or BBs.
Kirk: I was asked for you to answer the following hypothetical (please don't feel that you must respond unless you want to). Here it goes - if someone paid you a handsome sum of money to learn technical analysis so they would become a better trader or investor AND you only could teach them to learn and use five chart patterns, what would those patterns be and why would you start there?
Bulkowski: This question raises my shackles. Call me altruistic, call me an idiot, but first, I'd give them back their money because I consider sharing my knowledge as a gift, an opportunity for me, and not a reason to try to profit from someone else. That's why Patternz is free on my site along with nearly 250 pages of technical analysis. And I'm not kidding. Making money is not that important to me anymore and it's not because I'm Bill Gates rich. I'm not. Not even close. Like I said, I could be broke at 65.
Second, this is probably an impossible question. Why? Because you, the trader, must find a trading style that works for you. I can't do that for you. I'm watching another trader wannabe take up day trading. She's spent a total of four figures for one-on-one sessions with seasoned professionals three times. Now, she's making noises now about changing her hardware setup. She's learning all of this good information from people that know the ropes, have been there, and she's not doing anything with it. It's a shame.
I keep telling her, "wait for a powerful move up (minor overlap between 3 candles in a row as price begins a straight-line move up) then all you have to do is place a mental stop two cents below the prior candle low. Maybe switch to the 5-minute chart and relax. As each new candle appears, raise the stop to the prior candle low. You can change your 5-cent gains into 20-cent moves. You can change your short trades into ones lasting 30 minutes. You can clean up. Hello? Are you listening?"
And that paragraph above about the prior candle low also works for longer term trades but it has to be in a strong uptrend.
Back to your question. I'll cheat and give you this longer list because it's probably all you need. 2B pattern along with double tops and bottoms. 2Bs and doubles are really the same thing
but used differently. Rectangles and I'll include flat bases in there. Again, those are synonyms. Head-and-shoulders because everyone knows about those and you should, too, just so they
won't point fingers at you and laugh. Pipes, including those on the daily scale so you can point at them [other people] and laugh. Finally, triangles: symmetrical, descending, and ascending,
in that order.
I'm not sure the 2B pattern is on my site. Think of a double top in which the second top either fails to meet the height of the first top or rises just above it and then reverses. Use that to detect trend changes and get out before disaster strikes.
Kirk: So true - everyone must find their own path and I can't tell you how much I respect the fact that you share your research and knowledge the way you have. You serve as great inspiration!
Here's another question. Stay with the trend is common sense advice, but knowing when a new trend has begun, has ended, or is just a fake out is the more challenging part. Do you have any rules of thumb when approaching trend analysis in your approach?
Bulkowski: The trend is your friend until it ends. Yeah. I heard that. How do you detect a trend change? I wish I knew the answer to that, but if I did, then probably everyone else would know it too and it would be useless.
Victor Sperandeo, in his book Trader Vic -- Methods of a Wall Street Master
discusses a technique to find market turns that I call the 1-2-3 trend change. It's based on three rules: 1) Draw a down-sloping trendline from the highest high to lowest low on the chart such that price does not cross the trendline until after the lowest low. 2) Price must retest the low and 3) A trend change has occurred when price closes above the high between the lowest low and retest. Flip the rules for up-sloping trendlines. See my website for examples and an explanation of the rules.
Additional hints to finding a trend change would be to watch other stocks in the same industry. Are they making turns, too? Is the relative strength dropping? What's the market doing? Do you see many bullish or bearish patterns in the stocks that you follow?
All of these questions can give you a sense of how the market is behaving. For your stock, look back through time and see if you can find the same pattern before. How did it act then? If you are seeing a quick rise followed by a horizontal price movement, then look for another example of that. If you can't find it, then look for the same pattern in another stock in the same industry. Just remember that price can tell you everything about a stock. Just listen and let it speak to you.
Kirk: One of the things I remember from reading your book is that you believe tall patterns outperform short ones. Can you explain this and provide a recent sample (if possible)?
Bulkowski: If there's one performance tip that towers above all others, it's that tall chart patterns and candlesticks do much better than short ones. That's based on tens of thousands of samples of chart patterns and a sampling of nearly 5 million candle lines for my new book,
Encyclopedia of Candlestick Charts.
Tall patterns work better than short ones.
I could show you two graphs, but why bother? The meaning is clear. Let me tell you via example. A head-and-shoulders top, which you can visualize is just like it sounds, has a median height to breakout price of 17.27%. Patterns taller than this show declines of 24%. Patterns shorter than that drop just 20% in a bull market. In a bear market (median: 20.45%), the declines are 31% for tall ones and 26% for short ones.
Another example: Adam & Adam double bottoms have a median height to breakout price of 17.54%. Patterns taller than that rise 39% in a bull market but short ones climb just 33% before the trend changes.
Not all patterns will do this, of course. Eve & Eve double bottoms show just the reverse. The median height is 16.5% and tall patterns rise 39% but short ones see price rise 41% after the breakout in a bull market.
You have to compare the height to the median for this to work, and that varies from pattern to pattern. See my study on this at here and here. Tall patterns work better 86% of the time for upward breakouts and 97% of the time for downward breakouts.
Kirk: One of the concepts that I found useful in reading your books is the value of trading failed or "busted" patterns. Can you briefly explain this method and provide a sample?
Bulkowski: See the chart of the symmetrical triangle in Questar below. I define a busted chart pattern as one in which price breaks out in one direction, moves no more than 10% before reversing and busting out in the direction opposite the original breakout. This happens often in symmetrical triangles and they sometimes double bust.
Once price finally decides on a new direction, it tends to follow that direction. Thus, you get good moves and trades that tend to work well. That's not always the case, but busted patterns might be an interesting alternative if you can't get regular ones to work.
Kirk: Do you use any overlay analysis like Bollinger bands, moving average crossovers, Fibonacci retracements, Williams %R, on balance volume, money flow, RVI, stochastics, MACD, etc. in your approach? Why or why not? Do you have any favorites among these?
Bulkowski: I use RSI, CCI, BB, and I've already mentioned them. Wilder's relative strength is decent. Years ago I tested it and found that you can make 19% if you buy
when price rises above the oversold line (30) and sell when it hits the overbought line (70). The problem is, the more data I threw at it, the worse performance became, so that's a warning.
Thus, it's not as reliable as I had hoped, plus, you should not use the crossovers as I did. By that, I mean you should not sell when price touches the over bought line, but sell when
it rises above and then drops below 70. Same with the buy side only reversed.
Anyway, I use it most often for divergence. CCI is the commodity channel index. This I use for the buy and sell signals that it issues almost ever day but mostly for divergence. BB is Bollinger bands. I look for price to reverse when it approaches a flat band. Price often bounces from the outer band to the opposite outer band.
I don't give indicators like these much weight because I can't get them to work reliably for me. They seem to signal every few minutes: buy now! No, sell now! No, sorry, I mean BUY! Is price trending or in a trading range? That makes a difference. Have you adjusted the parameters - tuned it - for this stock? How do you know a 200-day moving average will work better than a 190 or a 210 for this stock, today? Next month, the 250 might work better.
Imagine how happy you would be if you had a car that every time you drove it you had to tune the carburetor. That's how I think of moving averages. If you don't tune the car, it might run just fine, but halfway to the grocery store you'll find it running out of gas. Why? Because instead of getting 26 miles per gallon, you haven't tuned it, so it's getting 26 gallons per mile. It gets the same mileage as an M-1 tank stuck in mud.
Do you really want to use an indicator with such high maintenance? Switch to a different stock and guess what, another tune-up job. Are markets trending? Another tune-up. So you buy a
new car with a dynamic moving average. Does that work any better or are the tune-up requirements more subtle? I think it's like a vacuum cleaner salesman coming to your door and saying
"Buy my vac!" "But I already have a round vacuum cleaner," you reply. "Yes, but this one is circular!" Is it any better? Test it and find out and maybe the answer is yes, it is. Or
maybe not. One study I read about is that they show worse performance. The more complicated the indicator the worse it performs. Read
Way of the Turtle, by Curtis Faith.
I remember receiving an email from a novice trader that had over a dozen indicator rules to help him decide when to buy or sell. "If price is above the 200-day EMA and below the 10 day
SMA, and MACD is trending upward, and RSI is overbought then you should panic." That type of thing. It was so complicated as to be useless. Simple is best. Find one indicator that
works for you and know it intimately. Like I said, if you really know your indicator, then you don't need it anymore. You should be able to look at price and say, "There's a buy/sell
signal" and be right when you check the indicator for a reading.
Kirk: I received a number of questions by members on how to utilize moving average crossovers. Do you have any research that may prove helpful in this area especially relating to use these for entries and exits?
Bulkowski: My only work with indicators is taking the time to program them into my computer, trying them, and then throwing them away in disgust. As I mentioned, I did test RSI and wrote a Stocks & Commodities article on it. I've recently began looking at the 30 week/150 day EMA - not a crossover - according to Stan Weinstein. His book, Stan Weinstein's
Secrets For Profiting
In Bull And Bear Markets
makes a wonderful case based mostly on his reputation and the numerous chart examples he gives. But there's no numbers to back it up. Years ago when I read the book, I tried to implement
his strategy and found I couldn't get it to work. Recently, I've tried again without success. I'm also trying to test it, with numbers, but the results are dismal and it's not easy
to tell your computer "find a region of consolidation," according to his method.
My only advice on trying to get moving average crossovers to work is to try something else! If you can't get a technique to work for you then keep looking. It's like chart patterns.
They don't work for everyone. Sometimes they work and sometimes not. Indicators are the same way. They do add value, but you have to understand how and why they work and when they don't.
If MA crossovers are giving you fits, then understand why. There's a limitation that you don't understand. Or maybe it requires too much tuning each day, for each stock, for
each situation, such that you have over optimized.
Kirk: Very good advice Tom! A number of members also wanted me to ask how important it is to find both positive and negative divergences using a number of indicators. How important is this to you and how do you suggest traders learn how to spot these divergences?
Bulkowski: Every time I look for divergence, I have to ask myself, "Should I look for divergence against the highs or the lows?" Think of a symmetrical
triangle where the price highs are getting lower and the lows are getting higher (two converging trendlines). Do you look for divergence against the highs or the lows? I have a page that describes the answer. If price is trending up, look for divergence against the highs; if trending
down, look for it against the lows.
Since I only use RSI and CCI for divergence, they usually agree. One may show divergence and the other not. I can't recall one showing bullish divergence and the other showing bearish. But it probably wouldn't matter because I don't give it much weight anyway.
The only time I find divergence useful is when entering or exiting a trade. It's background information that might be the final item to push the scale into buy or sell mode.
I've seen price diverge from an indicator for months. It's like when RSI becomes overbought. It can remain overbought for four to six months as price continues climbing. Divergence is the same.
What I've found is that the best signals come when divergence has peaks/valleys about a month apart, two month's max. Failure swings are also helpful. Those are little M or W shaped signal changes - mini divergences in the indicator that signal brief turning points. I don't think failure swings get much air time, but they are actually quite good. Have I studied how they behave? No. I've no numbers to report.
Kirk: A member wanted me to ask you how to screen for "high and tight flag" patterns as he hasn't been able to find a tool that makes this possible. Any suggestions?
Bulkowski: Try Patternz. It finds over 170 price patterns and even some of them
are right! :) HTFs are one of them. The program finds the flagpole only, so that alerts you that the flag portion is coming. It gives you time to prepare for a possible trade, to place
the stock on your shopping list. Version 4.1h has a bug in it that allows HTFs in a downtrend to appear when price drops massively. This has happened in the Indian market. I have a new
version (unreleased) that prevents a HTF from appearing in one day to help correct for this. It's a minor issue and one of these days, I'll release it.
Kirk: Do you utilize any variant of oversold/overbought analysis in your approach?
Bulkowski: As I said, I use RSI, but I usually ignore what it tells me. It's background information only. Mostly, I just shop for chart patterns, and when I see a buy signal that I like, I buy.
Kirk: Do you ever use P&F patterns as indicators?
Bulkowski: Gack! I don't use P&F charts because they are like moving averages: they suffer from lag. If you have a $1 box size and require three boxes before you get a signal, that's $3 of profit you're throwing away. With 1,000 shares, that's $3,000. Even my health insurance company doesn't charge that kind of premium.
Here's an example. I won't tell you the author but he's a big name in the P&F world. In his book, he says that when price makes a massive drop, you should buy when you get a three box bullish reversal. What this means is that he's looking for a dead-cat bounce and then going long at the top of the bounce phase. A DCB is when price drops 15% to 70% or more in one or a few sessions, then bounces and continues down.
He complained in his book that recently he was having trouble getting this to work. No kidding! His system was telling you to buy right as price was about to reverse and head down. I couldn't believe it! You go short at the top of the bounce, not long. You go long when price stops dropping, before the bounce phase begins. See my page on DCBs for more information.
There's such bad information out there, folks, especially from authors that don't trade or don't test. They just read book after book, and then repeat what they've read in other books
instead of doing new research. That's why you have to make your own tests. I try to prove my case with numbers, and not hieroglyphics either, but numbers everyone can understand. But
you still need to test it out yourself. The numbers are just probabilities and with those, anything can happen. It just means that if you trade the technique long enough, the system
will win, and you'll make money if it hasn't bankrupted you first.
Kirk: Amen. I know when I've tried to duplicate many of the studies I've read in these books that I run into serious trouble.
One thing we haven't really discussed yet is how important volume is to you. Are there are any measurable formulas that can be applied to volume/price action that can lead to predictable price patterns?
Bulkowski: I hate volume. People have a tendency to say that price is rising because there are more people buying, and price is dropping because more people are selling the stock. That's just wrong. For every share bought there's a share sold. It may or may not be the case that more people are involved, depending on how much shares they want to trade. I can have 100,000 shares waiting to unload to 1,000 traders waiting to buy 100 shares each.
What volume is showing you is buying demand versus selling pressure. My studies of volume (see one and two) do indicate that if you are lucky enough to find a rising price trend with rising volume, then expect a better than average ride.
Time after time, I've read of authors saying buy a breakout on high volume. Have they tested it? Maybe so, but they don't say that in their book. I have tested it (see this
study) and found that 1) they are right, and 2) a high volume breakout is more susceptible
to a throwback. If a throwback does occur then the average rise is likely to suffer (over the same situation in which price does not throwback). I proved this. See the links for
throwbacks and pullbacks I mentioned earlier.
Many patterns will have a volume trend associated with them. For example, a symmetrical triangle will tend to see volume collapse a day or two before the breakout. Not always, but it's like saying "Lock and load, boys!" Volume trends downward throughout the typical pattern.
Then there's volume shapes. I explored this in the second edition of my Encyclopedia Of Chart Patterns book. For a brief tour, click on this link. Volume shape is not as effective as pattern height, for example, but it's a tool that if you studied hard, you might find value (or might discover that it's useless). Hint: I don't pay much attention to it, but I'm not a fan of volume anyway. It's just something I noticed and decided to test. You might find another Holy Grail within the U, V, up-sloping, down-sloping, or random (flat) volume shapes.
Kirk: Interesting stuff! I know you also have a new book coming out soon on Candlestick charting which I look forward to reading. Can you share something unique that this book will bring to the table versus so many other books on this kind of analysis?
Bulkowski: The difference is manifold. I cover over 100 candlesticks using almost 5 million samples in the tests. I prove the results with numbers, which I share. Each chapter has the same format and it's the same format as my Encyclopedia of Chart Patterns book, so once you understand one chapter, you understand them all. And if you have a question, flip to the back where I explain each table entry in clear language and have a visual index so you can locate candlesticks quickly.
At the start, I give you the important information on what I found, including behavior (reversal or continuation), performance rank, and frequency rank (what good is a well-performing candle if it never appears?). Following that is a brief introduction to the pattern including the psychology behind it. Then comes identification guidelines, statistics, trading tactics, sample trade, and the "For best performance" section (which are the Cliff-notes to pattern idiosyncrasies).
Statistics include general stats like performance over time, 10-day performance rank, number found, and type (reversal, continuation). Then height stats, including a measure rule and shadow height. Another table shows three types of volume stats.
Trading tactics look at more stats, such as reversal rates for three varieties of confirmation techniques, and another table of performance indicators, such as moving averages, confirmation performance (which is different from confirmation technique), and so on. That's five easy to understand tables that do not fill pages of the book with hieroglyphics, but they cover both bull and bear markets, up and down breakouts. You will learn more about candles from one source than you ever have before.
If you want a small taste, I have the important stuff here. The pages show behavior, frequency rank, and overall performance rank.
Kirk: I look forward to reading it Tom. Something I've admitted in the past is that I have found mixed success with rigid candlestick analysis. Is this typical?
Bulkowski: I think I've told you the story about trying to use candlesticks to predict tomorrow's price. A close read of another candlestick book author, in his quiz section, tells you what has happened, not what will occur. Fat lot of good that does. I don't care what happened yesterday. I want to know what will happen tomorrow.
I discovered that the traditional view of how candles are supposed to work is wrong. In several candles, but not all, they will have a label such as bearish xxx when it should read bullish xxx. For example, a bearish harami is supposed to act as a bearish reversal. Instead if acts as a bullish continuation pattern 53% of the time in a bull market. That's really about random.
In my opening chapter, I discuss the major findings in the book. I discovered that 31% of candles do not work according to traditional theory. In other words, if they were suppose to act as reversal patterns they didn't. Price continued moving in the same direction more than half the time.
That kind of knowledge is power. That kind of knowledge makes you money. If candle lovers look at candle x and see a reversal, but testing shows that it's really a continuation pattern, that's almost money in your pocket when you can remain in a trade while others are fleeing. It certainly gives you a trading edge. When the masses discover that they traded wrong, they have to unwind their positions quickly, and up moves the stock.
Kirk: That help explains quite a lot and it validates something I have also discovered.
On another topic, I believe there is value in evaluating charts through multiple time frames and I think you share that view. Can you explain the time frames you use and why you use them?
Bulkowski: For position or swing trades, I use the daily charts. When I contemplate a buy, I'll look at the weekly and, to a lesser extent, the monthly charts and then I'll drill down to the 1-minute scale. For the longer-term trends, I'm looking for support and resistance areas. I'm looking for trendlines, round numbers, and other chart patterns. Some patterns like horns and pipes do their dirty work on the weekly charts, but they also hide on the dailies.
On the 1-minute scale, I want to look for the same thing: support and resistance areas. Is price moving down? If I remember, I may look at the RSI because I have a day trading setup that works well using that indicator. I will want to look and see if it's overbought or oversold and the indicator's trend. If the indicator is saying the stock is going down, then I can wait for several minutes before expecting it to bottom.
Kirk: In your research and experience, are there sectors that tend to send out more false positives than others?
Bulkowski: You bet. Dead-cat bounces are the ones to look for. Which industries tend to have more DCBs than others? I've touched on them already. See this research.
Other than that, have I searched for false positives? I haven't thought of looking for premature breakouts by industry. Maybe lower priced stocks suffer more false breakouts because they are more volatile? I haven't checked but that's an interesting thought.
Kirk: Do chart patterns found in certain types of stocks tend to be more successful? For example, my own research indicates that patterns found in stocks not widely followed by investors tend to pan out more than those in stocks that are on everyone's radar. Does your research confirm or deny this?
Bulkowski: I haven't tested that, but you might be right. What I think is a trend is that pretty - near perfectly shaped - chart patterns tend to fail more than
ugly ones. For example, I remember telling a friend about a near perfect head and shoulders bottom in Gencorp (GY) during August
to November 2006. It had a tall left side so it looked like a Big W type reversal at the bottom. The stock broke out upward at 13.52 and climbed to a high of 15.25 before dropping.
It recently touched 9.50. The perfect pattern failed. It also didn't help that the company has a real estate sideline. They make missiles for a living and are very successful at that.
What in blazes are they doing in real estate? Answer: losing money. Full disclosure: I own this dog...
If everyone knows that a double bottom is forming, they jump on that pattern and buy. That's why double bottoms with valleys spaced closer together perform better than do those spaced widely apart. Traders see the two close bottoms and trade them. Those bottoms a year apart go unnoticed. Again, this behavior is identified in my Encyclopedia Of Chart Patterns book, but you have to look at the numbers.
Let me give you an example: Eve & Eve double bottoms. The median width from bottom to bottom is 50 days in a bull market. Those bottoms closer together than 50 days showed average gains of 44%. Those spaced more widely apart showed gains of 37%. And the same trend (but the numbers change) appears for the four Adam and Eve combinations of double bottoms. Again, that's an edge I give to traders that buy my books.
Kirk: A number of members was to know how you manage your record keeping and trading journal.
Bulkowski: I have a button on my remarks form (in the software that I wrote) that pastes a template into a document, automatically saved when I quit. It fills in some of the information, such as the stop loss level (based on a volatility stop) so I won't have to. Here's the format for a buy order.
- Today's date:
- Order details:
- Date bought:
- Stop: 31.37 -10.0%. Stop used:
- Upside target:
- Elliott wave #:
- Nearest phi extension:
- Next earnings:
- Weekly scale (industry, too):
- Buy reason:
It serves as a checklist of things to look at, but there's more to buying a stock than just this (like scoring it, reading the broker reports, and so on). I've already discussed the entries or they are self-explanatory. For day trades, I don't have the time to fill this in.
My software also shows where I have bought and sold in the past (on the chart), so they are easy to locate.
Kirk: As the level of sophistication improves in trading programs and software, how do you think technical analysis will be fundamentally impacted? For example, do you think that as improved software and sophisticated program trading takes an ever greater hold over the market, that traditional pattern recognition will be as valuable? Why or why not?
Bulkowski: That's what I wonder about Patternz. It finds over 60 chart patterns. Now that everyone can find them, are they more susceptible to failure? Maybe so.
It might be like trying to scalp a trade. That was easy before decimalization came along. Now, scalping has almost disappeared. Or like the open outcry system. I know traders that
only day trade the Nasdaq stocks because it's entirely computer driven. They want speed at the best price. Waiting for a market maker to set down his coffee cup and push buttons is
soooo yesterday. One trader I spoke with complained that he tried trading New York stocks but kept getting bad fills. So he switched to trading Nasdaq stocks and cured that problem.
Kirk: I suspect like all good traders you are working on improving your performance in some manner. Can you share what you're specifically working on right now?
Bulkowski: That reminds me of the joke, "I'd like to meet the person that invented sex to find out what they are working on now." I, of course, don't pretend to put myself in that category. I'm just a self-taught private trader that writes about his discoveries, his successes and his failures. I'm trying to make a difference in this world.
Anyway, I'm working on a new book (but don't tell my publisher yet, because I haven't) that discusses the four phases of a trader's life. I can't get specific because ideas are precious. It will include an analysis of fundamentals to see what works and what doesn't. It will include lots of trading setups. Those are the bread and butter of traders. I want to test them and report on it. Writing such a book helps me focus on techniques that work. That will help me improve my performance.
Kirk: Sounds again, like another interest read along with the rest of your impressive books. And, no doubt about that, you are making a difference in the world!
Looking back through the learning curve (which none us really escape since we're always learning), what were some key lessons that made a significant influence on your trading?
Bulkowski: Use stops on every trade. Period. Just remember that this applies to trades, not core holdings. When I started using stops, my average loss decreased and my
profits increased. Sure, I expected to cut my losses because that's what stops are for, but I didn't expect my profits to increase. What I found is that when you use a stop and move it
up, it narrows the loss (a trailing stop). When the trade swings into a profit, you get to keep more of it. Thus, you don't see a stock double and then lose all of the gains because
you didn't sell. You have a stop in place and it allows you to capture those profits that, with buy and hold, you would have given back.
Kirk: By virtue of all of your online endeavors, I'm sure you run across traders at all levels of experience and skills. With that experience, what are some common elements you find in those who are the most successful in trading?
Bulkowski: I don't know the answer to that question because I often receive emails from new traders trying to figure out how to make money. Those that are making money don't have a need to contact me and, if they do, I usually don't pry into their trading behavior or performance. Some traders are reluctant to share their winning setups they've worked to hard to find the answer and want to keep it quiet.
Me? I'm the first to shout at the start of the Internet pipe that I've found the perfect chart pattern! I'm no longer that focused on money so I can share my findings with others in the hopes that they will adapt it to their own trading to become more profitable. If doing so makes the pattern less profitable, then that's a pity. It's also expected. If you can find the perfect setup then others can, too. And if it's as good as you think, then it will spread fast and probably stop working.
Based on my experience helping traders, I would say that lack of patience is a major flaw. People need to wait for the perfect setup to come along before trading (unless they are using a mechanical approach, in which case, you trade everything that comes along). Traders cut their profits short, like I did in GGC, but guess what? I was right to do so because price has dropped since.
When you trade long enough and review your trades, you'll see more perfect ones. I bought and sold Exxon perfectly and wrote an article about it for Active Trader magazine. That was a breakout from an ascending triangle. Price formed a straight line run up and when it peaked, I sold. Price plummeted after that. That is just one of many perfect trades where you buy in right at the breakout price and sell right at or very near the peak. I'm shocked at how often that happens because it's supposed to be rare. But it all comes with experience.
Of course there's the duds like GY that I keep quiet about. :)
Kirk: Do you see any common ingredients in those who have difficulty finding their potential?
Bulkowski: Trading takes a certain mentality. Maybe that's why so many engineers are also traders. They don't mind taking things apart, putting them back together again
just to see how they work, just to see if they can improve it. I told you about the trader that places his stops too close. Another trader reads book after book but doesn't apply the
knowledge. Both are afraid to lose money. Another is too stubborn to change his ways, to adapt and is wondering why he can't make money. Another trader says, "Yes, Tom. you're absolutely
right," and then does nothing to change his behavior.
To trade successfully is to understand how things work. You have to want to test different variables. You have to take the time to understand what you are doing wrong and how to fix it. It requires patience. You can't throw big bucks and try to buy experience. A trader I know is trying to do just that, and she's frustrated because her trading is not working for her. She's too impatient and will likely never succeed. But maybe she'll surprise me.
Kirk: In your opinion, do you think trading is getting more difficult or easier for the average individual investor? Why or why not?
Bulkowski: I think it's getting harder for everyone, and that's probably a function of the volatility we are seeing. If I buy a stock after an upward breakout from a chart pattern, a few days later, the Dow drops a hundred points and then continues lower. It kills the trade. You can't expect trends to develop in this market when it's up 100 and down 100. And trends are what traders (trend followers) like me depend on. So, you have to adapt or die.
I know a trader that spent years developing a trading system and in her first year, she made six figures. In her second year, the system stopped working. But by that time, she had quit her job and had six figures of annual living expenses to feed. In her first year, she broke even despite having what many would classify as an exceptional year. The last I heard from her, she was trying to sell her house to cut those expenses, but she continues to trade. She's too old to go back to work at her day job, too. She's probably visiting church a lot and praying for divine intervention.
Kirk: In addition to your own books, are there any other books or sources you typically refer to as "must-reads" for the person who desires to learn more about technical analysis?
Bulkowski: I have a page on my website of financial books that I consider
to be a cut above the others. I like books that describe new methods in clear prose that are easy to read and prove what they say. That combination is rare. I like books that create new
ideas in my mind, such as "I can do that!" What good are equivolume, renko charts, or kagi charts when you can't draw them because your software doesn't support them?
Kirk: If someone approached you who had no knowledge of technical analysis before and desired to really gain a solid understanding and skill, how would you recommend they go about learning the technical analysis?
Bulkowski: I would probably say, read in the morning (magazines or books) and practice what you read in the afternoon. That way you'll learn and retain the information.
If you read about trendlines, then go find some. See how they work. Test them. If you really want to understand how double bottoms work, try to program a computer to find them. How
close should the tops be to each other in price and in time? How tall is a minimum for the pattern? What looks good? What happens when they appear in a stock trading at $2 versus
12,000 for the Dow? Of course, about three people on the planet would take that approach.
If you want an accelerated program then try day trading. You can test approaches out in one day that would otherwise take months of waiting on the daily scale (real time). I'm not talking about spending money. I'm talking about paper trading. If you can't make money on paper then trading for real won't fix that. And diving in with real money before knowing how to trade is almost criminal. But it's your money. You can burn it however you want.
Kirk: Who do you look up to for inspiration and guidance?
Bulkowski: No one. For some reason, I've always gone my own way. As I child, I was the one in my room with the door closed, seemingly ignored by my parents, while my brothers were beating each other up. I was there building machines with my erector set and tinkering with my Tinker toys. The world was one of exploration and my parents were tolerant enough to step over my pulley system in the hallway.
I saved my 60-cent allowance and bought a crystal radio and then listened to it for hours. And my eyes filled with wonder when my dad said that in Poland he used to build them with potatoes for power (with lemons?) and a rock (crystal). I'll bet his worked better than mine. Of course, he's the same fella that told me all they had to eat were potatoes, and he used to walk barefoot to school, uphill and against the wind, both ways.
And I believed it. I guess I'll have to test that and get back to you.
Kirk: Thank you for taking so much time to answer all of these questions and in the manner you answered them, complete with detailed research and analysis. On behalf of everyone here, we look forward to reading your new book and visiting your website!
* To say the least, Tom raised the bar significantly in this monthly feature. I hope you enjoyed it as much as I did and that you can utilize of his research to help you achieve your goals.
-- Thomas Bulkowski
Copyright © 2008-2013 by Charles Kirk. All rights reserved. Welcome to psychiatric voice mail. If you are manic depressive, it doesn't matter which button you press. No one will answer.