As of 12/04/2020
  Indus: 30,218 +248.74 +0.8%  
  Trans: 12,742 +155.26 +1.2%  
  Utils: 856 -10.76 -1.2%  
  Nasdaq: 12,464 +87.05 +0.7%  
  S&P 500: 3,699 +32.40 +0.9%  
YTD
 +5.9%  
 +16.9%  
-2.6%  
 +38.9%  
 +14.5%  
  Targets    Overview: 11/30/2020  
  Up arrow30,700 or 28,250 by 12/15/2020
  Up arrow13,500 or 11,700 by 12/15/2020
  Down arrow830 or 925 by 12/15/2020
  Up arrow12,500 or 11,400 by 12/15/2020
  Up arrow3,750 or 3,400 by 12/15/2020
CPI (updated daily): Arrows on 11/2/20
As of 12/04/2020
  Indus: 30,218 +248.74 +0.8%  
  Trans: 12,742 +155.26 +1.2%  
  Utils: 856 -10.76 -1.2%  
  Nasdaq: 12,464 +87.05 +0.7%  
  S&P 500: 3,699 +32.40 +0.9%  
YTD
 +5.9%  
 +16.9%  
-2.6%  
 +38.9%  
 +14.5%  
  Targets    Overview: 11/30/2020  
  Up arrow30,700 or 28,250 by 12/15/2020
  Up arrow13,500 or 11,700 by 12/15/2020
  Down arrow830 or 925 by 12/15/2020
  Up arrow12,500 or 11,400 by 12/15/2020
  Up arrow3,750 or 3,400 by 12/15/2020
CPI (updated daily): Arrows on 11/2/20

Bulkowski on Bearish Reversals

 

Initial release 10/30/2020.

Bearish Reversals: Summary

I ran a test to see which of ten types of short-term reversal patterns resulted in the biggest average decline. The answer is what I call the Below 3 pattern. In that pattern, I looked for a high price above the following 3 days. If those three days remained below the peak of the first bar, then I entered the trade at the open the following price bar.

Here's the list of patterns tested, ranked from best to worst by the percentage profit.

RankTest
 1 (Best)  Below 3 
2 Open-close reversal, uptrend 
3 Inverted 3L-R 
4 Pivot point reversal, uptrend 
5 Closing price reversal, uptrend 
6 Hook reversal, uptrend 
7 Below 2 
8 Key reversal, uptrend 
9 Pivot 
 10 (worst)   Below 1 

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Bearish Reversals: Methodology

Here are the rules I followed to test these patterns.

  1. I searched 476 stocks with a low price at or above $5 per share.
  2. I logged trades only in bull markets.
  3. Dates tested ranged from the late 1980s to October 29, 2020. Not all stocks covered the entire range.
  4. If the opening price was 0, the trade wasn't logged (this was a problem with old data).
  5. Price needed to trend higher for at least 10 days before the pattern started. I used the slope of the line found using linear regression over 10 days ending the day before the pattern's start and then I checked the high-low average at the start of the uptrend (one price bar) to the high-low average of the day before the pattern starts (one price bar). The second average must be above the first one. This is needed on some turns when price drops in a U-shape. Linear regression may say price is rising but it's not clear from the chart.
  6. After the reversal pattern, price drops and reaches a low. If price didn't recover far enough to reach or exceed the high price in the pattern then the trade wasn't logged. I did this because I was trying to find how far down price dropped, and if I ran out of data before a recovery, I chose to ignore the trade.

Some of these rules are made clearer below.

The Inverted 3L-R pattern

Consider the chart on the right.

The three red bars form an inverted 3L-R pattern. That's two higher peaks followed by a drop (C) with a low below the first red price bar.

The day before the first red price bar, A, I checked the slope of the linear regression line found using the ten black price bars (starting from F) leading to and including A. In this example, the line slopes upward, confirmed with the high-low average of the first black bar (F) compared to the high-low average of the last price bar in the ten (A).

The inverted 3L-R appears and makes a high at B followed by the end of the pattern at C. Price at E recovered and posted a high above the high price at B. If E remained below B until the end of data, then I didn't include the trade in the results.

I measured the largest drop between bar C and E using the low at C and D, and divided the difference by the low at C to get the percentage drop.

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Bearish Reversals: Results

The following table shows how the reversals performed. Note that this is for perfect trades. It measures the drop from the opening price the day after the pattern ends to the lowest low before price begins its recovery.

As you scan down the list, notice that the percentage profit (6% to 8%) and the range between the two is small. Failures are high, too, usually in the 60s. Profit per share ranges from a low of $2.45 to a high of $4.18.

In other words, there's not a big difference in performance.

 Test  Profit  Samples  % Profit  5% Failures (Rank)  Profit/share (Rank) 
 Below 3  $95,885.63  31,330  8%  62% (1 best) $3.06 (4) 
 Open-close reversal, uptrend  $851.51  348  8%  71% (10 worst) $2.45 (10 worst) 
 Inverted 3L-R  $11,625.22  2,783  7%  63% (2) $4.18 (1 best) 
 Pivot point reversal, uptrend  $63,188.99  20,969  7%  63% (2) $3.01 (5) 
 Closing price reversal, uptrend  $35,537.59  12,953  7%  64% (4) $2.74 (7) 
 Hook reversal, uptrend  $2,900.05  1,136  7%  65% (5) $2.55 (8) 
 Below 2  $106,943.00  37,722  7%  65% (5) $2.84 (6) 
 Key reversal, uptrend  $5,175.99  1,605  7%  66% (7) $3.22 (3) 
 Pivot  $16,056.64  4,874  7%  66% (7) $3.29 (2) 
 Below 1  $126,000.30  50,120  6%  69% (9) $2.51 (9) 

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Here are the 10 patterns I tested, in order of performance, from best to worst.

1 (best). Below 3

The below 3 pattern

This is a pattern I use to find peaks and valleys, using various number of price bars (usually 3, 5 or 10, but I tested only 1, 2, or 3) after a peak or valley.

For the Below 3 pattern, find the tallest peak followed by three price bars which don't exceed the first bar's high price. Thus, the first price bar is the highest of the four. Enter at the open a day after the last bar.

In the figure, bar A is higher than 1, 2, and 3. I don't care about the low price or anything else except the high price of each bar.

In this test (Below 3 pattern), I found 31,330 of them. Price dropped an average of 8% which ties for first place and 62% of the patterns failed to drop more than 5%. That high failure rate is not startling for short patterns. Even so, the failure rate places the pattern first (best). The trades made an average of $3.06 a share.

With this pattern, you're entering the trade on day 5 which probably means price is already heading lower. That keeps failures low but also hurts profit per share.

For the Below 2 pattern, it's the same pattern except I'm only looking at bars 1 and 2 compared to A. Bars 1 and 2 must have a high below bar A.

For Below 1, it's the same except I'm comparing price bar A with 1. Bar 1 must have a lower high price than A.

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2. Open-Close Reversal, Uptrend

The open-close reversal pattern

In this pattern, price opens near the high price for the day and closes near the low for the day but above the prior close.

It's easier to explain it with formulas.

  1. Compute the height of what might be an open-close reversal day: Height = HighToday - lowToday.
  2. High Target = HighToday - (25% x Height). Price has to open above the High Target.
  3. Low Target = LowToday + (25% x Height). Price has to close below the Low Target.
  4. CloseToday > CloseYesterday. Price must also close above the prior close.

The chart on the right shows an example. The open-close reversal occurs in an uptrend. Price opens near the high (red bar), closes near the low (brown bar), and closes above the prior close (green bar).

In my tests, I found only 348 of them but they performed well in terms of percentage profit (8%, tied for first place). However, 71% failed to see price drop more than 5%. That's the worst failure rate of the tests. Each share gained an average of $2.45, which is also the worst performance.

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Inverted 3L-R

The Inverted 3L-R pattern

The figure on the right shows the inverted 3L-R.

I found out about the inverted 3L-R 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.

3L-R stand for 3 lows and a reversal. In this case, however, we're looking for 2 higher highs and a reversal with a low below the first price bar in the pattern.

  1. Begin finding bar 1, which is any price bar.
  2. Bar 2 has a high above the peak of bar 1. Ignore the low price.
  3. Bar 3 has a high above the peak of bar 2. Ignore the low price.
  4. Bar 4 is the reversal bar. Price must make a low below the low of bar 1. Ignore the high price.

In my test, I found 2,783 of them which made an average of 7% with 63% failing to see price drop at least 5% (tied for second place). Each share made on average $4.18, the highest profit per share of the tests. This is a rare pattern but you enter a trade close to the high, which boosts per-share profit.

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4. Pivot Point Reversal, Uptrend

The pivot point reversal, uptrend pattern

This pattern is simple enough and I show a picture of it on the right.

In an uptrend, price closes below yesterday's low. I also added a rule that today's high price must be below yesterday's high. The rule I added isn't part of the pattern, according to my web page describing the pattern.

Testing shows this to be a plentiful pattern. I found almost 21,000 of them. They made an average of 7%, failed 63% of the time (tied for second), and made $3.01 a share.

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5. Closing Price Reversal, Uptrend

The closing price reversal, uptrend pattern

This looks like a variation of the open-close reversal, uptrend pattern.

See the chart to the right.

Look for the opening price to be near the intraday high. The close must be near the intraday low and below the prior close.

In the figure, the horizontal red bar is the prior close. The pink bar is today's open, which must be near the intraday high (within 25% of the price bar's height, below the top), and the cyan bar is today's close. It must be below the red bar (the prior day's close).

Tests found 12,953, creating a gain of 7% (average), with a 64% failure rate, and making $2.74 per share.

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6. Hook Reversal, Uptrend

The hook reversal, uptrend pattern

The figure on the right shows a hook reversal in an uptrend.

The pattern forms an inside day (price today has a lower high and higher low than yesterday). I added a rule that today's high can't equal today's low. You see that in four price doji (a pattern where the open=high=low=close. You see them often in thinly traded stocks).

After that, the open must be near the high and the close must be near the low.

In the figure, I show the colored price bar inside the trading range of the prior price bar. Today's open (in red) must be near the intraday high (within 25% of the candle's height, as measured down from the high price) and must be 25% of the candle's height below the intraday low. I show that in the figure with a horizontal cyan bar.

This just in! This is a rare pattern. I found 1,136 of them and they saw price drop an average of 7%, with 65% of them failing to see price drop more than 5%, and each share made an average of $2.55.

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7. Below 2

See the Below 3 pattern.

Look for price to make a high followed by the next two price bars staying below the first bar's high.

The average percentage profit tied for second place, failures at 65% were in the middle of the pack, and so was the profit per share, at $2.84.

8. Key Reversal, Uptrend

The hey reversal uptrend pattern

This is one of the more complicated patterns. I show it in the figure to the right. Find two price bars in an uptrend which satisfy these rules.

  1. Today's open must be above yesterday's close;
  2. A high today above yesterday's high;
  3. A close today below yesterday's low.

In short, look for an outside day with the open above the prior close and a close below the prior low.

Tests show it's rare, with only 1,605 of them found in this test. They averaged a 7% gain, with 66% of them failing and making $3.22 a share (third).

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9. Pivot

The pivot pattern

This pattern, along with the Below 1, 2, and 3 patterns, doesn't have a formal name. I just call it a pivot because that's what Carl Vanhaesendonck calls it.

The figure on the right shows an example of a pivot.

Price makes a higher high and higher low (A) than the prior day (B) followed by price dropping below the first day (D below B). The drop at D need not occur in one day. However, for these tests, I did look for a low on price bar D to be below the low of B. Also, the high at A must be above the high at D.

When price drops below the low at B, that's the entry signal. Enter the trade at the open the next price bar.

Tests show the pattern is rare, giving traders an average of 7% with 66% failing to see price drop more than 5%, but the profit per share is high, at $3.29, placing second.

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10 (worst). Below 1

See the Below 3 pattern.

I tested this one just to see how it would compare with the Below 2 and Below 3 patterns.

Look for price to make a high and the following day to make a lower high. That's it.

Performance is last. It's plentiful (50,120 found) with each pattern averaging a drop of 6% (worst), with 69% failing (almost last), and making $2.51 per share (placing 9th).

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See Also

 

Support this site! Clicking any of the books (below) takes you to Amazon.com. If you buy ANYTHING while there, they pay for the referral.

My novels:  Bumper's Story Head's Law

Chart Patterns: After the Buy Getting Started in Chart Patterns, Second Edition Trading Basics Fundamental Analysis and Position Trading Swing and Day Trading Visual Guide to Chart Patterns Encyclopedia of Candlestick Charts Encyclopedia of Chart Patterns 2nd Edition Trading Classic Chart Patterns

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