Bulkowski's Toll Brothers (TOL) Quiz

Look for the following chart patterns (If you find others, great!): Ascending scallop, descending scallop, rising wedge, broadening top, head-and-shoulders top.

The head-and-shoulders top has broken out downward.

Question 1: Do you buy, short, or avoid trading this stock?

Question 2: If trading this one, what is the target price?

Question 3: If trading this one, what is the stop price?

Answer 1 (buy?): Sell a long holding. If considering a short, answer the next two questions first. That will tell you if you can make a profit commensurate with the risk.

Answer 2 (target?): Measure the height of the head-and-shoulders top from head peak (high price) to the neckline (the slanting blue line) directly below (shown as orange line B). Then subtract the height from the breakout price. In this case, since the neckline slopes downward, use the right shoulder low as the breakout price. The target computation is: 58.67 (high) – 47.81 (neckline) = 10.86 height. Breakout is at 46.97 for a target of 36.11. That's a 23% decline from the current close, which seems high. But it corresponds to point A, a likely support point.

Answer 3 (stop?): Volatility is 3.39, which is unusually high. The volatility stop is thus 51.25 or 9.7% above the close.

Compute a volatility stop by using the last 30 calendar days of high - low differences, averaged and multiplied by 2. Volatility stops help avoid positions from being stopped out by normal price action. Since the stop is near the right shoulder top, it's a good stop location.

As you can see in the above chart, price moved lower and made it below the target, bottoming at a recent price of 28.70, a decline of 39% from the breakout.

I show the turning points in the stock, most of which correspond to a prior peak or valley (horizontal red lines).