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Written and copyright © 2008-2009 by Thomas N. Bulkowski. All rights reserved.
Summary
In a rising price trend, price moves up in a rise -- fall pattern, often retracing a
portion of the prior climb. The median retrace is 59%. The most frequent retrace values
are, in order, 61%, 56%, 50% and 55%. On a cumulative basis, a third (33%) of the samples
stopped declining on or before retracing
half (50%) of the prior up move. Two thirds retraced less than 67%.
The numbers suggest that a stop placed no closer than 67% of the prior up move will
protect your position in two out of every three trades.
New research suggests that Fibonacci retracements offer no benefit in swing trading and that probably holds
true for stop placement.
Background
I found usable patterns in 766 stocks (but additional stocks were not used
because they trended downward) and found 1,956 samples. About a quarter (535
samples) came from 1994 to 2003, which includes the 2000 to 2002 bear market. The
rest came from 471 stocks from July 2005 to August 2006
(a bull market).
In the test, I used about 525 samples from inverted and ascending scallop chart patterns
along with 471 stocks that gave additional patterns found manually.
I measured the decline from B to C as a percentage of the rise from A to B (see
the above figure). Point A is the start of the uptrend, B is the uptrend peak, and
C is the retrace low.
Results
The top five most frequently occurring percentage retraces are:
- 61%
- 56%
- 50%
- 55%
- 44% and 59% (tied)
You will notice that the first (61%) and third (50%), are also found in the
Fibonacci retrace list of 38.2%, 50% and 61.8%. There was no spike at the 38%
retrace value in my data.
The median retrace is 59%. That means half the samples retraced less than 59%
and half retraced more.
On a cumulative basis, the following list shows how often a retrace occurs.
| Frequency | Retrace amount |
| 33% | 50% |
| 40% | 54% |
| 45% | 56% |
| 50% | 59% |
| 55% | 61% |
| 60% | 64% |
| 66% | 67% |
| 70% | 69% |
| 75% | 72% |
| 80% | 75% |
| 90% | 81% |
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In words, a third of the samples (33%) will decline less than half (50%) the
distance from B
to A (see above chart). Two thirds will retrace less than 67%. Nearly all, 90%,
will retrace less than 81% of the B to A move.
Stops
Measure the recent swing move from A to B. Take 67% of that move and subtract it
from B. Place a stop no closer than the result. That should prevent you from being
stopped out in two out of every three trades. For example, if point A is at 20, B
is 25, then place a stop below 21.65. The move from A to B is 5 points and 67% of
this is 3.35. Subtracted from B gives the stop price of 21.65.
As a sanity check, a 3.35 point drop from 25 represents a decline of 13.4%,
which is quite high. You might want to narrow your stop, but the risk of being
stopped will rise if you do.
-- Thomas Bulkowski
Copyright © 2008-2009 by Thomas N. Bulkowski. All rights reserved. Washing your car to make it rain doesn’t work.
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