As of 10/03/2024   Indus: 42,012 -184.93 -0.4%     Trans: 15,745 -226.81 -1.4%     Utils: 1,058 -6.74 -0.6%     Nasdaq: 17,918 -6.64 0.0%     S&P 500: 5,700 -9.60 -0.2%	YTD  +11.5%   -1.0%    +20.0%    +19.4%    +19.5%	Targets    Overview: 09/30/2024     43,500 or 41,600 by 10/15/2024   16,800 or 15,700 by 10/15/2024   1,125 or 1,025 by 10/15/2024   19,000 or 17,600 by 10/15/2024   5,900 or 5,600 by 10/15/2024
Chart Pattern Indicator: on 10/2/24

As of 10/03/2024   Indus: 42,012 -184.93 -0.4%     Trans: 15,745 -226.81 -1.4%     Utils: 1,058 -6.74 -0.6%     Nasdaq: 17,918 -6.64 0.0%     S&P 500: 5,700 -9.60 -0.2%	YTD  +11.5%   -1.0%    +20.0%    +19.4%    +19.5%
Targets    Overview: 09/30/2024     43,500 or 41,600 by 10/15/2024   16,800 or 15,700 by 10/15/2024   1,125 or 1,025 by 10/15/2024   19,000 or 17,600 by 10/15/2024   5,900 or 5,600 by 10/15/2024
Chart Pattern Indicator: on 10/2/24

Bulkowski's cloud bank Trading Setup

Updated on 8/3/2018.

My book, Fundamental Analysis and Position Trading, has a section that discusses cloud banks, including "The cloud bank Setup" and "Investing in cloud banks."

I show the book on the left and you can read more about cloud banks starting on page 172.

If you click on the above link and then buy the book (or anything) while at Amazon.com, the referral will help support this site. Thanks.

$ $ $

This article discusses a trading setup using the cloud bank chart pattern. If you don't know what a cloud bank chart pattern is, click on the link for more information.

• The Setup Rules
• Bad Setup 1
• Bad Setup 2
• The Winning Setup
• Drawdown
• Recovery Shape
• That's a Wrap
• See Also.

Cloud Bank: Setup Rules

The cloud bank setup has these rules. Reference the ideal cloud bank setup on the right (not drawn to scale) as I discuss the rules.

1. Find a cloud bank. Look for a cloud bank chart pattern on the weekly or monthly scale. The cloud should be long, often years in length, with a flat base that touches a horizontal or nearly horizontal trendline multiple times. The base of the cloud bank represents the fair value of the stock. It's where the stock would be trading if the economy or other factors didn't pull it down. By the length of the cloud bank, it should be clear to all that the cloud is where price should be trading and the drop after the cloud bank ends is just an anomaly.
2. Steep drop. Look for price to tumble, preferably in a straight-line decline but that is optional. The stock has to make a significant decline (at least 40%, but 50% or more is better) such that it represents not only a good value, but a steal. The decline is often the result of a bear market with problems common to many companies and not just this one. In fact, when selecting a cloud bank, look for a company that maintains its price until near the end of the bear market.
3. 30-week SMA crossover. Wait for price to touch or rise above the 30-week simple moving average (or 5 month). I have found that the simple moving average hugs price better than the exponential, so use the simple moving average. The 30-week is the same as the 150-day moving average. Other moving average values might work better, but I tested it with the 4, 5, 7 and 10-month moving averages, both in and out of sample tests. The 5-month worked best. I show the crossover on the picture as Buy.
4. Profit potential. Measure from the base of the cloud (A) to the crossover price (the price where the stock closes above the 30-week moving average, shown as Buy on the chart). If the drop is less than 40% (such as the cloud bank at 10 and the crossover at 7), consider looking elsewhere for a more promising situation. Often if you wait, the stock will drop to a lower price, so sit back and wait if the profit potential is not high enough. In the 2007 to 2009 bear market, many stocks dropped more than 50%. The next bear market may not show such declines, so be flexible. This rule is to help minimize the paper loss when price resumes dropping if you buy too close to the cloud bank.
5. Sell. When the stock rises to the bottom of the cloud bank (A), sell. Why? Because once price enters the cloud, the rise slows. The rise from the lowest low (B) to the cloud base (A) will take a median of 1.1 years, but the move from the bottom of the cloud (A) to the top (C) will take 1.8 years (median) despite the cloud thickness being slightly thinner than the move from the lowest low to the cloud base (median dollar move, only). Thus, momentum drops once price enters the cloud. If you can find another cloud bank forming, you'll have the opportunity to make more money quicker than holding while the stock traverses the cloud.

More

Cloud Bank: Bad Setup 1

Let's discuss what not to do, first.

Pictured is a small cloud bank in Continental Air on the weekly chart. During the terrorist attack on September 11, 2001, the stock plummeted but then recovered to A. Point A is where price rises above the 30-week simple moving average. It's normally the buy point, but not in this case. Why? Because there just isn't enough profit potential to justify a trade. Wait for price to drop further or go shopping for another cloud bank.

At D, price reaches the lowest low, the turning point in the stock. You know it's the lowest valley because price at E makes a higher bottom and price rises above the green line at B, confirming the turn. Higher highs and higher lows mean a rising price trend. The turn DE is also an ugly double bottom chart pattern. In a traditional ugly double bottom, buy when price closes above the highest peak (B) between the two bottoms (D and E). I show that as a horizontal green line.

In this setup, the buy signal occurs at F when price crosses above the 30-week moving average. Price at this point is about 7, well below the cloud bank low of 38. It represents a wonderful profit opportunity if you like airline stocks. Wait for price to climb back to the cloud bank before selling. If price never rises that high, then don't buy the stock.

More

Cloud Bank: Bad Setup 2

Shown is Gap (GPS) on the weekly chart and it has the same problems as the prior chart. The cloud bank is several years long with the bottom relatively flat. It represents overhead resistance to an upward move. In late 2008, during the ending stage of the bear market, the stock plummeted, piercing the base of the cloud at A, at about 16.

Price formed what looks like an Adam & Adam double bottom chart pattern at C and D. Confirmation is at E. That's when the chart pattern becomes valid, and that occurs when price closes above the peak between the two bottoms (E, shown as a green line).

The cloud bank buy signal occurs at B when price climbs above the 30-week simple moving average. Why isn't this a buy? Because the price difference between B and A is minimal: 3 points. Yes, the stock continued to move up and climbs above the top of the cloud, but what if price reversed at the cloud base? Most investors would wait before selling and those three points of profit would disappear like water in a desert. Wait for a more profitable opportunity.

More

Cloud Bank: The Winning Setup

Here's what I consider a perfect setup, or nearly so. Pictured is Celanese Corp (CE) on the weekly scale. The cloud bank is irregular in appearance on both the bottom and the top. The stock pokes through the horizontal trendline at the base of the cloud, but that's ok. What you're looking for is a solid wall of overhead resistance and that's what this chart shows.

Price drops to C in a straight-line run then makes a higher low at D. This is the start of an ugly double bottom. Confirmation of the ugly double bottom occurs at A when price climbs above the peak between the two bottoms. If you were trading the ugly double bottom, confirmation (A) is when you'd buy. However, the ugly double bottom is irrelevant to this trade because we use the 30-week moving average crossover as the entry signal. Nevertheless, the ugly double bottom serves as an indication that the trend has changed.

A is also the point where price rises above the 30-week simple moving average. It's the buy signal providing there is enough profit potential. A is at 15 and the cloud bank low is at 33. If you ride this up to the cloud bank base before selling, you will double your money.

In this case, the stock cooperates by making a curved recovery from D to B. B is the base of the cloud extended into the future. It represents the time to sell since momentum is clearly declining (meaning the D to B arc is not a straight line but a curved one, resembling a rounding top chart pattern).

More

Cloud Bank: Drawdown

That's all there is to investing in cloud banks. Of course the ride upward can be bumpy, so let's discuss drawdowns.

The above table shows how far price drops below the buy price on the way to the cloud bank. The buy price is the opening price of the stock the month after you get a buy signal (where price crosses the 5-month simple moving average. If you use the weekly scale, the numbers might change, but the idea would remain the same).

For example, I found that 31% of the stocks decline below the purchase price less than 5%. Another 14% decline between 5% and 10%. The cumulative row says that over half (57%) will decline less than 15%, and 84% will drop less than 30%. At the far right edge of the table, it shows that 6% will lose more than half their value. Ouch!

No one wants to lose money, so you might consider using some type of stop loss order or other method to protect the investment. However, my guess is that should you use a stop, it will likely take you out before the stock returns to the cloud bank. For buy-and-hold investments, not using a stop is often an acceptable alternative, but you decide. Monitor the stock and if it looks as if the fundamentals are going bad, then sell. Otherwise, stick to the weekly or monthly scales and don't worry about the daily gyrations.

More

Cloud Bank: Recovery Shape

Let's talk about the shape of the recovery. I used the monthly scale to look at the shape of the recovery -- that is, the shape as price hits the lowest low and bounces. The figure on the right shows four types of bounce patterns. I did not search for head-and-shoulders bottoms or any other complex variety.

Double Bottom

The first shape is a double bottom. You'll see two spikes separated by a month but usually more (like 5 months). Both spikes bottom near the same price but this need not be exact. Double bottoms appear 17% of the time.

Ugly Double Bottom

To the right of the double bottom is its cousin, the ugly double bottom. This occurs when the second spike is well above the first, so it's an ugly version of a normal double bottom. The second bottom should not be too far away in price. It should look as if the second bottom tried to reach the price of the first bottom but didn't make it. The difference between the two is at least 5% when viewed on the daily chart, but I did not apply the percentage in this case. I just eyeballed it. The two bottoms looked near the same price (as in a double bottom) or they didn't (ugly double bottom). Ugly double bottoms happen 12% of the time.

V-Shape

The V-shaped recovery happens the most: 63% of the time. It occurs when price makes a strong move down, reverses and powers upward. I'm looking at the turn around the lowest low, here, not what happens a year later. However, in many cases, the stock continues its straight-line run back up to the cloud bank. That happens most often when the distance between the cloud bank and the lowest low is small. With longer distances, you'll often see price consolidate (move sideways) for several months. Sometimes the V-shaped bottom has an extension, but I did not look for that either.

Horizontal

The last variety describing the shape of the stock as it hits the lowest low is the horizontal turn. Often you'll see a short spike downward that is below the others, but then price recovers and moves horizontally for 5 months or longer before starting the journey upward. This type of turn is the rarest of them all, occurring just 8% of the time.

Cloud Bank: That's a Wrap

Be sure to read the discussion on the cloud bank chart pattern. The article fills in the details and provides additional performance numbers that you'll want to consider.

-- Thomas Bulkowski

More

See Also

• Cloud banks. Read more about the cloud bank chart pattern.
• Double bottom. Use shallow throwbacks as an entry condition.
• Ugly double bottom. I studied these bad boys. Check it out.
• V-shaped turns. You don't see these on every street corner!
• V bottom with extension. This is a horizontal move after a V-bottom.
• Busted pattern. After the breakout reverses, trade the new direction.
• Flat base (buy-and-hold). Here are the rules for trading a flat base pattern.
• Monthly symmetrical triangles. The monthly charts can yield some profitable setups.

Kiss me twice: I'm schizophrenic.