As of 12/24/2024   Indus: 43,297 +390.08 +0.9%     Trans: 16,063 +127.24 +0.8%     Utils: 993 +4.93 +0.5%     Nasdaq: 20,031 +266.24 +1.3%     S&P 500: 6,040 +65.97 +1.1%	YTD  +14.9%    +1.0%    +12.7%    +33.4%    +26.6%	Targets    Overview: 12/12/2024     44,200 or 41,750 by 01/01/2025   16,700 or 15,500 by 01/15/2025   1,050 or 975 by 01/01/2025   20,500 or 19,300 by 01/01/2025   6,100 or 5,775 by 01/01/2025
Chart Pattern Indicator: on 12/5/24

As of 12/24/2024   Indus: 43,297 +390.08 +0.9%     Trans: 16,063 +127.24 +0.8%     Utils: 993 +4.93 +0.5%     Nasdaq: 20,031 +266.24 +1.3%     S&P 500: 6,040 +65.97 +1.1%	YTD  +14.9%    +1.0%    +12.7%    +33.4%    +26.6%
Targets    Overview: 12/12/2024     44,200 or 41,750 by 01/01/2025   16,700 or 15,500 by 01/15/2025   1,050 or 975 by 01/01/2025   20,500 or 19,300 by 01/01/2025   6,100 or 5,775 by 01/01/2025
Chart Pattern Indicator: on 12/5/24

Bulkowski on Pothole Patterns

Initial release on 1/20/2021.

Pothole Pattern: Overview

I discovered the pothole pattern in early January 2021 when I was looking at topping patterns in the stock market on the daily charts. I was hoping to figure out how to predict a significant decline.

Pothole patterns are rare but they work quite well, ranking 4th out of 40 pattern where a rank of 1 is best for performance. They do fail (9% of them do), so you still have to be careful trading them, but they are especially valuable to swing traders. They point the way higher.

The pothole pattern represents a study in dashed hopes. In an uptrend, traders see the stock moving sideways (forming the "road"), and then dropping into a pothole. The move looks like a downward breakout, and it is, but the stock soon recovers. In fact, price continues higher, shooting out the top of the pattern and soaring (ideally).

The pothole pattern is a refined version of the diving board pattern except that potholes appear on the daily charts while diving boards appear on the weekly or monthly scales.

Pothole Pattern: Bull Market Results

Overall performance rank (1 is best): not ranked, but it if were, the rank would be 4 out of 40 Break even failure rate: 9% Average rise: 51% Throwback rate: 66% Percentage meeting price target: 86% The above numbers are based on 755 perfect trades. See the glossary for definitions.

Pothole Pattern

Pothole Pattern: Identification Guidelines

Pothole Pattern: Trading Tips

Trading Tactic	Explanation	Measure Rule
Measure rule	Reference the figure on the right. Measure the height of the pattern from the highest peak in the pothole pattern (A) to the bottom of the pothole plunge, B. Add the height to the price of A to get a target, C.
Stop	The bottom of the flat base (roadway) portion of the pothole pattern serves as a good stop location.
Entry	The pattern becomes valid when price closes above the top of the pothole pattern. However, in trading, I'd place a buy stop a penny above the top of the highest peak in the pattern. In this example, place a buy stop a penny above A.

Pothole Pattern: Two Examples

The first example of a pothole pattern appears on the right.

Price forms an uptrend, easing higher from the October low to the start of the pothole. The uptrend is important. You don't want to trade a pothole pattern in a downtrend.

Pothole patterns are bullish, not bearish. As I mentioned in the Identification Guidelines, you will occasionally see pothole patterns as part of a downward retrace (at the link, the pothole would be ABC in the "A Simple ABC Correction" figure at page top) in an upward trend. Those potholes can lead to big gains.

Price moves sideways at A, resting on support. Although I drew the red line horizontally, the stock trends higher slightly in this example before the pothole appears.

Notice how compact the flat base (roadway) portion of the pattern looks. Price has lots of overlap, the bottom touches supports multiple times, and the top of the pattern is irregular.

After the roadway ends, price plunges to B in a strong downward push which lasts two days in this example.

After the pothole, the stock recovers. It's as if traders were trying to fool the shorts into believing the downward move would last. Instead, they buy the stock and quickly force it upward, gapping higher at C.

When price closes above the top of the pattern at C, the pothole pattern completes and price rises from there.

Pothole Pattern: Intel

This is another example of a pothole pattern, shown on the right.

The pothole pattern is at AB.

The stock is in an uptrend of several month's duration leading to the start of this pothole.

Price moves horizontally at A, forming the roadway where price rests on support. There's lots of overlap so the sideway move looks "tight," not loose with price meandering up and down.

The stock makes the pothole at B by gapping lower in this example. After the pothole, recovery takes time with price rising to the breakout (C), throwing back to D, before zipping higher to the ultimate high, at E.

Performance Hints

This analysis is based on 755 pothole patterns in bull markets with upward breakouts. Additional samples might change results. However, here's what I found common to the best performing pothole patterns.

• When the pothole pattern acts as a retrace in an uptrend (at the link, the pothole would be ABC in the "A Simple ABC Correction" figure at page top), performance improves.
• If the price trend from the trend start to the start of the pothole pattern is shorter than the median of 142 days, performance improves. In other words, a pothole pattern appearing near the start of the up trend is much better than one appearing late in the trend.
• Pothole patterns with breakouts within a third of the yearly low outperform the other two thirds (middle and highest third of the yearly high-low price range). The closer to the yearly high the breakout appears, the worse the performance. This suggests a bottom fishing stock selection method (buy low, sell high) and not a momentum strategy (buy high, sell higher).
• Patterns taller than the 8% median height-to-breakout price perform much better than shorter ones.
• Wide patterns (wider than the median 26 days) outperform narrow ones.

These ideas don't add to performance

• The depth of the drop after the roadway (which is to say, the plunge from the bottom of the road to the pothole low) isn't significant to performance.
• The time to breakout (after reaching the pothole low, measure the time to rise to the day of breakout) isn't important to performance (short rises perform better than long ones, but only by two percentage points.

-- Thomas Bulkowski

See Also

• Diving boards. These are potholes on the weekly charts.
• Busted chart patterns. The answer to profits?
• Setting price targets using Fibonacci.
• 10-baggers. Find 10-baggers using fundamental analysis.
• 3 tips to help you pick stocks.
• 12 tips for stock selection.

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