As of 12/27/2024   Indus: 42,992 -333.59 -0.8%     Trans: 16,031 -73.46 -0.5%     Utils: 987 -4.51 -0.5%     Nasdaq: 19,722 -298.33 -1.5%     S&P 500: 5,971 -66.75 -1.1%	YTD  +14.1%    +0.8%    +12.0%    +31.4%    +25.2%	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 12/27/24

As of 12/27/2024   Indus: 42,992 -333.59 -0.8%     Trans: 16,031 -73.46 -0.5%     Utils: 987 -4.51 -0.5%     Nasdaq: 19,722 -298.33 -1.5%     S&P 500: 5,971 -66.75 -1.1%	YTD  +14.1%    +0.8%    +12.0%    +31.4%    +25.2%
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 12/27/24

Bulkowski on Money Management

Money Management: Overview

This page explores money management using throwbacks and pullbacks, answering the questions, should I exit a position if a throwback or pullback retraces too far, and does a close stop result in more profit than a stop farther away?

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My book, Getting Started in Chart Patterns, Second Edition, shown on the left, discusses throwbacks and pullbacks starting on page 217.

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.

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Money Management: Summary

In the book, Swing Trading: Power strategies to cut risk and boost profits, by Jon Markman, Markman writes (page 36) "Upside breakouts through the reaction high often lead to small two percent to three percent advances followed by an immediate test of the breakout level. If the stock closes below this level (now support) for any reason, the pattern becomes invalid." In other words, if price throws back below the buy price, then exit. You can make the same case for pullbacks. If price climbs too far then exit a position. Is that the proper thing to do?

To answer that question, I looked at both throwbacks and pullbacks. The average rise for chart patterns with throwbacks that do not drop below the breakout price is 41.3%. When a throwback takes the stock below the breakout price, the average rise is just 26.7%. Pullbacks are similar with declines averaging 25.1% when price does not climb above the breakout price to 17.3% when it does.

If you follow his advice, you will be stopped out more often with a smaller loss, but trades that work will tend to do well.

If you place a stop loss order two cents below the breakout day's low and then calculate a volatility stop (using the higher of the two), you will make 11% more than if you just use a volatility stop alone. However, this finding applies only to throwbacks since I did not run the same test for pullbacks.

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Money Management: Methodology and Results

I sifted through three databases from July 1991 to June 2008 to find chart patterns that qualified for the test. I included only those patterns with throwbacks or pullbacks, and measured how far price dropped (during a throwback) or rose (during a pullback). I found 9,372 samples in 841 stocks using 30 different types of chart patterns (such as triple bottoms, head-and-shoulder tops, and so on). Not all stocks covered the entire period, and I used over a thousand securities to winnow it down to 841 unique ones.

The following table shows the results.

I show the difference between a partial retrace and a full retrace in the chart. The left image shows price breaking out at point A, climbing and then throwing back to the triangle at C, but not quite making it. Price climbs after that.

The image on the right shows a similar situation only price completes the throwback and drifts into and below the lower trendline of the ascending triangle, bottoming at D, which is below the breakout day's low price, B.

What Markman suggests is that the partial retrace (the left image) represents a better trading setup than the right image. My tests verify that. Those chart patterns with a throwback that does not drop below B (the breakout day's low price) show a post breakout climb that averages 41.3%, using 1,717 samples. For chart patterns like those on the right, a full retrace, the average post-breakout rise is 26.7%, using 3,311 samples.

Pullbacks show a similar trend and you can think of the picture flipped upside down. When the stock tries to pull back to the breakout price but does not quite make it, the average post-breakout decline is 25.1%, using 1,355 samples. Those situations in which the pullback rises above the high on the day of breakout show drops averaging 17.3%, using 2,989 samples.

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Money Management: Stops

In another test, I wanted to determine whether a stop placed two cents below the breakout day's low and then using a trailing volatility stop thereafter (whichever one was higher) performed better than just using a volatility stop from the start. In other words, would a stop placed at B (see above chart) result in more profitable performance than one farther away?

For this test, I used only chart patterns with upward breakouts and throwbacks, not those with downward breakout or pullbacks. I found 5,188 samples that qualified using 811 unique stocks from 1991 to June 2008 (the same setup as with the prior test). The following table shows the results.

For those chart patterns using the breakout day's low (resembling the left image, above), the trade's gross profit was $165,148.26, using $1,000 per buy and not including commissions, fees, slippage or anything else. Using a volatility stop beginning on the day of breakout, the gross profit was $148,499.56, a difference of 11%.

In other words, my tests showed that a stop 2 cents below the breakout day's low (a tight stop) followed by a trailing volatility stop works better than does a trailing volatility stop alone.

The bottom line for traders is this: After you enter a trade, place a close stop below the breakout day's low. As price rises, calculate a volatility stop and use that once the stop value rises above the original stop. This technique will cut your losses and yet allow you to stay in trades that perform better.

-- Thomas Bulkowski

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See Also

• After a throwback, when should you buy?
• This article discusses throwbacks.
• And this article covers pullbacks.
• Partial rises/declines and throws/pulls. Do throwbacks/pullbacks occur more often after partial rises and declines?
• Triangle apex and turning points. Price turns at apex 60% of the time.
• Stop placement, part 1.
• Stop placement, part 2.
• The best stop locations, by chart pattern.
• Example stop placement in a straight-line price run.
• Stan Weinstein has developed a unique stop placement technique.
• Can stops hurt? Find out here.

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