As of 04/23/2024   Indus: 38,504 +263.71 +0.7%     Trans: 15,436 +212.01 +1.4%     Utils: 886 +2.63 +0.3%     Nasdaq: 15,697 +245.33 +1.6%     S&P 500: 5,071 +59.95 +1.2%	YTD  +2.2%   -2.9%    +0.5%    +4.6%    +6.3%	Targets    Overview: 04/12/2024     39,800 or 37,150 by 05/01/2024   16,200 or 15,000 by 05/01/2024   885 or 850 by 05/01/2024   16,700 or 15,800 by 05/01/2024   5,250 or 5,025 by 05/01/2024
Chart Pattern Indicator: on 4/23/24

As of 04/23/2024   Indus: 38,504 +263.71 +0.7%     Trans: 15,436 +212.01 +1.4%     Utils: 886 +2.63 +0.3%     Nasdaq: 15,697 +245.33 +1.6%     S&P 500: 5,071 +59.95 +1.2%	YTD  +2.2%   -2.9%    +0.5%    +4.6%    +6.3%
Targets    Overview: 04/12/2024     39,800 or 37,150 by 05/01/2024   16,200 or 15,000 by 05/01/2024   885 or 850 by 05/01/2024   16,700 or 15,800 by 05/01/2024   5,250 or 5,025 by 05/01/2024
Chart Pattern Indicator: on 4/23/24

Bulkowski on Pattern Pairs: Head-and-Shoulders Bottoms

Initial release: 12/14/2021.

The idea behind pattern pairs is to pick a chart pattern type (like head-and-shoulders bottoms) to buy and another to sell (like double tops). You buy the upward breakout from the head-and-shoulders bottom, hold for a few years, and sell when a double top appears and breaks out downward. Along the way, you give price a chance to rise far enough to overcome those trades which are stopped out for a loss. This is a trend-following strategy.

• Summary
• Entry and Exit Conditions
• Stops
• Busted Patterns
• Results: Non-Busted Buy, Non-Busted Sale
• Results: Non-Busted Buy, Busted Sale
• Performance Improvements
• Trend Start: Short, Medium, or Long
• Moving Averages: 50 and 200 SMA
• Selling First Bearish Chart Pattern
• See Also

Trading Head-and-Shoulders Bottoms: Summary

The figure illustrates the idea for trading pattern pairs, where price is the red line and the boxes are chart patterns. This articles assumes you buy an upward breakout from a head-and-shoulders bottom. On the sale side, you can sell the first bearish chart pattern which comes along, or you can wait for your favorite bearish chart pattern to appear and sell then.

In the following discussion, if I write "HSB", I mean a head-and-shoulders bottom.

Here's a list of the top five performing sell signals, based on annualized gain (annualized because the hold time is often years, in parenthesis).

Sell a...

• 1. Ascending scallop (42%)
• 2. Ascending broadening wedge (40%)
• 3. Busted diamond bottom (36%)
• 4. Busted symmetrical triangle (32%)
• 5. Bump-and-run reversal top (29%)

The following list shows the expected performance of chart pattern pairs, ranked by their expectancy. Expectancy is a way of gauging winning and losing trades and how much money you might make trading a pattern pair. I put the expected profit per trade, per share, in parenthesis.

Sell a...

• 1. Adam & Adam double top ($8.89)
• 2. Busted diamond bottom ($8.38)
• 3. Busted Eve & Adam double bottom ($7.85)
• 4. Adam & Eve double top ($7.57)
• 5. Busted Adam & Adam double bottom ($7.54)

To improve performance, try these tips.

• Table 4: Buy double bottoms with a short-term (up to 3 months) duration from the trend start to the pattern's start.
• Table 5: Buy a head-and-shoulders bottom with a breakout price below the 50-day or 200-day simple moving average.
• Table 7: If you want to sell the first bearish chart pattern which appears, stick to selling non-busted patterns.

Trading Head-and-Shoulders Bottoms: Entry and Exit Conditions

The databases I built over several decades doesn't identify every chart pattern. There may be plenty of double tops over the years, for example, that I didn't catalog on the way to the one I did catalog. So buying an upward breakout from a double bottom and selling at the double top I cataloged would be different than choosing to sell a different double top. However, the following analysis does give a real-world flavor for how well you might do trading chart patterns if you follow the pattern pair strategy.

Here's what I used in my analysis.

• Head-and-shoulders bottoms provided the buy signal.
• No commissions or fees were included.
• Entry:A buy stop placed a penny above the top of the right armpit (the peak between the head and right shoulder) was assumed to be the entry price unless the stock gapped higher on the breakout day (in which case, the opening price was used).
• Busted patterns included. For sales, bullish patterns which bust can be used as a sell signal.
• Stop loss: A penny below the bottom of the pattern served as the stop price. The stop was not raised, but I did test trailing stops separately.
• Sell signal: Downward breakouts from various bearish chart patterns (or busted bullish patterns) provided the sell signal.
• 984 stocks tested. The first chart pattern appeared in July 1991 and the last in May 2021, giving me 61,888 trades.
• Bear market excluded. If the breakout from the double bottom was in a bear market, I excluded the trade because I only wanted bull market results. If price dropped into a bear market while in the trade, that was fine.
• Sales. Sales happened when price dropped a penny below the bottom of the bearish chart pattern (or busted bullish one) or the opening price if the stock gapped open lower.

I used the following 43 chart patterns in the analysis, but some only applied if they were busted.

• Broadening: bottoms, tops, right-angled and ascending, right-angled and descending
• Broadening wedges: ascending and descending
• Bump-and-run reversal: tops and bottoms
• Cup with handle
• Diamond: tops and bottoms
• Double bottoms and tops: all four combinations of Eve and Eve
• Rising and falling wedges
• Head-and-shoulders: tops, bottoms, complex top, complex bottom
• Rectangle: tops and bottoms
• Roof, inverted roof
• Rounding: tops and bottoms
• Scallops: ascending, descending, ascending and inverted, descending and inverted
• Triangles: ascending, descending, and symmetrical
• Triple tops and bottoms
• Three rising peaks
• Three falling valleys
• Ugly double bottom

Trading Head-and-Shoulders Bottoms: Stops

I used a stop loss order set a penny below the bottom of the HSB. Price on the way down may have gapped below the stop price (for the sale price), so I used the lower of the stop price or the opening price on the day of sale).

For trailing stops, I removed the stop loss order and used a trailing stop set at 10%, 15%, 20%, or 25% below a peak, never lowering the stop value, but raising it if a higher peak came along during the trade.

In Table 1, I calculated the percentage net gain (the average of gains and losses) when using various trailing stop loss amounts (10%, 15%, 20%, and 25%) for all tested chart patterns according to the busted/non-busted buy/sell configuration. In parenthesis is the size of the average loss so I could detail how losses change with various stop loss orders.

For example, if I tested non-busted head-and-shoulders bottoms and sold various non-busted patterns (head-and-shoulders bottoms, broadening tops, head-and-shoulders tops, and so on), I made an average of 45% ("Stop Loss Only" column) after having a stop loss order in place. Losses averaged 14%. Replacing the stop loss with a 10% trailing stop cut the gain to 7% but also trimmed the average loss to 4%. Using a 25% trailing stop allowed me to keep more money, 19%, but losses climbed to 14%. If I didn't use any type of stop, the gain averaged 143% with losses averaging 33%.

The results show that:

• Using a stop loss order or trailing stop does best for trading non-busted patterns.
• Trades which do not use a stop make the most money but losses are huge.

Trading Head-and-Shoulders Bottoms: Busted Patterns

Trading using a busted chart pattern often results in worse performance than using non-busted patterns (at least for head-and-shoulders bottoms as the buy signal).

I compared the performance of sell signals for 22 different chart patterns and found that only 23% of the contests did a busted pattern outperform a non-busted one. To do this, I averaged the performance of each chart pattern and then compared that average to its busted counterpart in 22 contests. The pattern with the higher average gain won.

Trading Head-and-Shoulders Bottoms: Non-busted Buy, Non-Busted Sale

Table 2 shows statistics I collected for head-and-shoulders bottoms using the trading rules described above and shown in the figure. I placed a stop loss order priced a penny below the bottom of the HSB (after buying).

For example, if you were to buy the upward breakout from a HSB and hold it until you encountered a broadening bottom (the first chart pattern listed in the table), but one with a downward breakout, you'd make an average of 44% (annualized: 20%, ranking 19th) on the 860 (210 winners, 650 losers) trades. That's an average of 222% on your winners, and 14% average loss on your loser. You'd find that only 24% of the trades made money.

If you removed the stop loss order and just held on until the broadening bottom with a downward breakout appeared, you'd make an average of 74% per trade.

The expectancy posted just $0.06 per share per trade which ranks 57th where 1 is the best value. In other words, if you traded these two chart patterns, you'd have a hard time making money. I'd pick another pattern pair to trade.

Trading Head-and-Shoulders Bottoms: Non-busted Buy, Busted Sale

The figure shows an example of how this trade unfolds.

A bullish chart pattern appears and you buy at the breakout. Continue holding until your selected chart pattern appears. The chart pattern is bullish because it has an upward breakout but then things go wrong. Price reverses. Sell when the stock dips below the bottom of the chart pattern (meaning it busts the upward breakout).

Table 3 shows the performance statistics for this setup (buying a head-and-shoulders bottom and selling only after a busted chart pattern). A stop loss order was used and priced a penny below the bottom of the HSB (after buying).

For example, buying a HSB with an upward breakout in a bull market and selling a busted broadening bottom shows winning trades making an average of 125%. Losing trades lost 12%, giving a net of 30%, and ranking 50 (where 1 is best). Because the hold time is often years long, the annualized gain is 12%.

If you traded this without a stop, the net gain climbed to 62%. Of the stocks I looked at, I found 314 trades with 31% of them winning. Expectancy was $2.03 per share, ranking 45th where 1 is best.

Trading Head-and-Shoulders Bottoms: Performance Improvements

Here are a few ideas the data suggested which may improve performance of your pattern pairs trading.

Trend Start: Short, Medium, or Long

Find the trend start for your HSB. Often you can just look at a chart and see where the trend begins. If not, or you want to be sure, then the glossary describes how to find it.

Determine the length from the trend start to the pattern's start: short term (less than 3 months), medium term (3 to 6 months) or long term (more than 6 months).

Table 4 shows the results for the combinations of busted/non-busted trades and the resulting performance.

Buying HSBs with a short-term (up to 3 months) duration from the trend start to the pattern's start outperformed the other two durations.

Moving Averages: 50- and 200-Day SMA

I checked two moving averages at buy time, 50- and 200-day simple moving averages (not as a crossover setup). I compared the breakout price to the value of the moving average. Table 5 shows the performance of buying or selling busted or non-busted patterns when the breakout price was above (A) or below (B) the 50-day simple moving average (SMA).

Buying head-and-shoulders bottoms with breakout prices below 50-day moving average showed better performance than from those above the SMA.

Table 6 shows the results of using a longer moving average, the 200-day. Traders often use this as a proxy for the long-term trend.

At the time of the buy, if price is below the 200-day moving average, you improve the chances of a more profitable trade.

Selling First Bearish Chart Pattern

The prior discussion assumes you buy a HSB and sell a chart pattern of your choosing, such as a downward breakout from a head-and-shoulders top (you wait for one to appear). What if you sold the first bearish chart pattern which comes along? How would you do?

Table 7 shows the results sorted by the type of patterns involved (busted or non-busted). For example, if you buy an head-and-shoulders bottom and sell the first non-busted chart pattern which comes along, you'd make 18% on average. Annualized, you'd make 39%. This compares to a 21% annualized gain if you sell a designated pattern (like you waited for a double top before selling, which may or may not be the first bearish chart pattern to come along).

The bottom half of the table shows expectancy for the combinations. For example, the best performance comes from buying and selling non-busted patterns.

-- Thomas Bulkowski

See Also

• Head-and-shoulders bottoms
• Busted double bottoms
• Hold on. How long do you need to hold onto a stock? Find out...
• Moving average study & stock trends. Buy in a downtrend, sell on the uptrend.
• Moving averages. Boost performance using chart patterns with moving averages!
• Can Stops Hurt?

 

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