As of 05/18/2022
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  Up arrow15,500 or 13,700 by 06/01/2022
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  Up arrow12,800 or 11,000 by 06/01/2022
  Up arrow4,250 or 3,850 by 06/01/2022
CPI (updated daily): Arrows on 4/21/22
As of 05/18/2022
  Indus: 31,490 -1,164.52 -3.6%  
  Trans: 13,692 -1,096.25 -7.4%  
  Utils: 992 -9.94 -1.0%  
  Nasdaq: 11,418 -566.37 -4.7%  
  S&P 500: 3,924 -165.17 -4.0%  
YTD
-13.3%  
-16.9%  
 +1.1%  
-27.0%  
-17.7%  
  Targets    Overview: 05/15/2022  
  Up arrow33,500 or 30,500 by 06/01/2022
  Up arrow15,500 or 13,700 by 06/01/2022
  Up arrow1,050 or 940 by 06/01/2022
  Up arrow12,800 or 11,000 by 06/01/2022
  Up arrow4,250 or 3,850 by 06/01/2022
CPI (updated daily): Arrows on 4/21/22

Bulkowski on Pattern Pairs: Head-and-shoulders Tops

 

Initial release: 12/14/2021.

The idea behind pattern pairs is to pick a chart pattern type (like broadening bottoms with upward breakouts) to buy and another to sell (like double tops). You buy the upward breakout from the broadening 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.

Trading Head-and-Shoulders Tops: Summary

Picture of the pattern pairs.

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 a busted head-and-shoulders top (price breaks out downward, drops no more than 10%, reverses, and closes above the top of the pattern). Buy as price rises above the top of the pattern.

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 this article, if I refer to a HST, assume I mean an head-and-shoulders top.

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).

Buy a busted Head-and-shoulders top and sell a...

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.

Buy a busted Head-and-shoulders top and sell a...

To improve performance, try these tips.

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

The databases I built over several decades doesn't identify every chart pattern. There may be plenty of rising wedges over the years, for example, that I didn't catalog along the way to the one I did catalog. So buying a busted HST and selling the downward breakout from a rising wedge I cataloged would be different than choosing to sell a different rising wedge. 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.

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

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Trading Head-and-Shoulders Tops: Stops

I used a stop loss order set a penny below the bottom of the busted head-and-shoulders top. 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 busted head-and-shoulders tops and sold various non-busted patterns (broadening bottoms, broadening tops, head-and-shoulders tops, and so on), I made an average of 18% ("Stop Loss Only" column) after having a stop loss order in place. Losses averaged 10%. Replacing the stop loss with a 10% trailing stop cut the gain to 4% but also trimmed the average loss to 6%. Using a 25% trailing stop allowed me to keep more money, 14%, but losses climbed to 15%. If I didn't use any type of stop, the gain averaged 83% with losses averaging 27%.

The results show that:

Table 1: Various Trailing Stop Settings: Net Profit and (Average Loss)
Data 10%  15%  20%  25%  Stop Loss 
Only
 No Stop
Busted buys, non-busted sales 4% (-6%)  7% (-7%)  12% (-11%)  14% (-15%)  18% (-10%)  83% (-27%) 
Busted buys, busted sales 3% (-6%)  5% (-7%)  11% (-11%)  12% (-15%)  17% (-10%)  91% (-25%) 

Trading Head-and-Shoulders Tops: Busted Patterns

A busted Head-and-shoulders top has a downward breakout but price drops no more than 10% before reversing and moving above the top of the pattern.

In 22 contests (selling 22 different chart pattern types, depending on which apply), I compared the performance of buying busted HSTs and selling non-busted patterns with selling busted patterns. Selling a busted pattern wins a contest (outperforms selling a non-busted pattern) 59% of the time. Even though busted patterns work better, it's not by a compelling amount.

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Trading Head-and-Shoulders Tops: Busted Buy, Non-Busted Sale

Picture of a busted pattern pair.

The figure shows the setup for this scenario. When price busts the downward breakout from a bearish head-and-shoulders top, buy. Sell after a downward breakout from a non-busted target chart pattern.

Table 2 shows the performance of this scenario. A stop loss order was used and priced a penny below the bottom of the HST (after buying).

For example, buying a busted head-and-shoulders top in a bull market (the entry price is really the higher of a penny above the top of the pattern or the opening price) and selling after the downward breakout from a broadening bottom shows winners averaging gains of 67%. Losses average 10%, for a net of 5%. Because trades are often years long, annualized the net becomes a loss of 3%. Fully 198 trades occurred with a win/loss ratio of 20%. This scenario ranks the net gain as 57th among the two tables (2 and 3). If you traded this as a buy-and-hold position, meaning no stops were used, the net gain climbed to a gain of 57%. Expectancy was a loss of $1.03 per share, ranking 61th where 1 is best. As good as the numbers suggest, expectancy suggests you'd be hard pressed to make money trading this pair.

Table 2: Statistics for Busted Buys, Non-Busted Sales
Sell PatternAverage
Win
Average
Loss
NetAnnualized
Net
RankNo Stop
Net
Win/Loss
Samples
Win
Loss
Average
Expectancy
Expectancy
Rank
Broadening bottom67%-10%5%3%5757%39/15920%-$1.0361
Broadening top95%-9%19%13%1361%126/34627%$6.0713
Broadening formation, right-angled and ascending73%-9%12%9%3756%47/13326%$1.7945
Broadening formation, right-angled and descending48%-10%2%2%6125%32/12121%$0.6453
Broadening wedge, ascending60%-10%14%10%2657%42/8034%$5.9614
Broadening wedge, descending62%-9%7%5%5154%29/9923%$0.7052
Bump-and-run reversal top73%-10%14%9%3447%104/26328%$2.8337
Diamond bottom60%-10%6%5%5082%10/3423%$0.7351
Diamond top128%-10%38%23%284%67/12735%$7.287
Adam & Adam double top146%-9%29%15%799%297/92524%$8.883
Adam & Eve double top141%-9%35%18%397%159/39029%$9.991
Eve & Adam double top125%-10%23%12%1581%142/44624%$6.4310
Eve & Eve double top95%-9%16%10%2779%136/42324%$4.0030
Falling wedge72%-10%5%4%5622%19/8219%-$3.5663
Head-and-shoulders top97%-9%19%11%2069%517/140727%$7.078
Sell PatternAverage
Win
Average
Loss
NetAnnualized
Net
RankNo Stop
Net
Win/Loss
Samples
Win
Loss
Average
Expectancy
Expectancy
Rank
Head-and-shoulders, complex top74%-10%11%8%4148%65/20224%$3.1433
Rectangle top87%-9%16%12%1456%67/19326%$3.1932
Rising wedge70%-9%12%9%3160%135/36527%$1.6547
Rounding top125%-10%18%10%2962%48/18720%$0.1555
Ascending scallop79%-11%19%11%1934%36/7433%$2.5140
Descending scallop99%-9%20%11%2559%191/51027%$4.3423
Scallop, inverted and ascending75%-10%10%6%4543%20/6623%-$0.5258
Scallop, descending and inverted61%-10%8%5%4833%90/26625%$1.8344
Triangle, ascending94%-10%21%13%969%76/17830%$6.1312
Triangle, descending85%-11%13%9%3253%52/15325%$2.5539
Triangle, symmetrical86%-10%14%9%3344%202/60025%$3.0734
Triple top109%-9%19%12%1678%328/103624%$5.0819
Rectangle bottom91%-11%3%2%6015%19/11714%-$0.3857
3 falling peaks88%-9%15%9%3669%340/102225%$3.6231
Roof69%-8%15%10%3062%26/6130%$4.9521
Roof, inverted88%-10%22%17%572%40/8233%$4.4122
Sell PatternAverage
Win
Average
Loss
NetAnnualized
Net
RankNo Stop
Net
Win/Loss
Samples
Win
Loss
Average
Expectancy
Expectancy
Rank

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Trading Head-and-Shoulders Tops: Busted Buy, Busted Sale

Picture of a busted pattern pair.

Table 3 shows trading statistics for busted head-and-shoulders tops as the entry signal and various busted chart patterns as the exit signal. A stop loss order was used and priced a penny below the bottom of the head-and-shoulders top (after buying).

The associated figure shows the setup.

For example, buying a busted head-and-shoulders top and selling a busted broadening top made 57% from the winners, lost 8% on the losers for a net gain of 7%. Annualized, it was 5%. The net gain placed the performance of this setup at 49, where 1 is best.

Removing stops from the trades allowed them to make 67%. Only 99 trades were taken and 23% of them were winners. Expectancy was a gain of $2.14 per share, ranking 43rd where 1 is best.

Trades with sample counts below 30 are not ranked.


Table 3: Statistics for Busted Buys and Sales
Sell PatternAverage
Win
Average
Loss
NetAnnualized
Net
RankNo Stop
Net
Win/Loss
Samples
Win
Loss
Average
Expectancy
Expectancy
Rank
Broadening bottom57%-8%7%5%4967%23/7623%$2.1443
Broadening top110%-9%21%13%1258%60/18225%$8.234
Broadening formation, right-angled and ascending50%-10%4%2%5926%18/5824%$1.3148
Broadening formation, right-angled and descending48%-9%5%4%5531%23/7224%$2.2442
Broadening wedge, ascending97%-10%21%16%666%10/2529%$4.0827
Broadening wedge, descending41%-9%3%3%5819%14/4424%$0.5554
Bump-and-run reversal bottom68%-8%7%4%5492%13/5220%$2.3841
Cup with handle58%-9%16%8%4027%12/2038%$4.0628
Diamond bottom65%-9%8%6%4621%14/4823%$6.3511
Diamond top143%-8%20%12%1756%17/7518%$1.0949
Adam & Adam double bottom112%-9%17%9%3578%82/29522%$8.135
Adam & Eve double bottom136%-9%20%10%2877%43/17520%$4.0629
Eve & Adam double bottom105%-9%15%8%3979%44/16721%$5.0520
Eve & Eve double bottom85%-9%13%8%4225%32/10723%-$0.8260
Falling wedge259%-10%44%32%1111%14/5520%$4.1126
Head-and-shoulders bottom92%-8%20%11%2249%109/28028%$6.509
Sell PatternAverage
Win
Average
Loss
NetAnnualized
Net
RankNo Stop
Net
Win/Loss
Samples
Win
Loss
Average
Expectancy
Expectancy
Rank
Head-and-shoulders complex bottom77%-7%19%11%2338%15/3431%$2.6238
Rectangle top104%-9%22%13%1060%40/10428%$5.5217
Rising wedge107%-9%33%17%471%29/5136%$3.0735
Round bottom133%-11%53%76%11/1444%
Rounding top69%-9%9%4%5215%7/2423%$1.7546
Ascending scallop46%-10%2%1%6264%21/7622%-$0.6559
Descending scallop60%-9%14%6%4749%16/3134%$5.6215
Scallop, inverted and ascending97%-9%25%12%1869%46/9632%$4.3324
Scallop, descending and inverted51%-8%8%4%5374%16/4427%$0.9450
Triangle, ascending52%-9%9%6%4447%36/8630%$0.0856
Triangle, descending70%-9%16%11%2449%33/7132%$5.3818
Triangle, symmetrical104%-8%19%11%2155%109/33924%$4.2925
Triple bottom92%-9%17%9%3863%113/31826%$5.6116
Rectangle bottom128%-8%21%14%889%18/6621%$7.756
3 rising valleys84%-9%12%7%4373%80/27123%$3.0136
Roof75%-8%17%13%1179%9/2130%$9.532
Roof, inverted29%-9%1%0%6331%11/3226%-$1.4762
Sell PatternAverage
Win
Average
Loss
NetAnnualized
Net
RankNo Stop
Net
Win/Loss
Samples
Win
Loss
Average
Expectancy
Expectancy
Rank

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Trading Head-and-Shoulders Tops: 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 head-and-shoulders top. 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 two combinations of busted/non-busted trades and the resulting performance.

A short-term (0-3 months) inbound trend gives the best performance.

Table 4: Short (S) Medium (M) or Long (L) Trend Start and Performance
 Sell Non-Busted PatternSell Busted Pattern
Buy busted patternS26% M17% L11%S29% M11% L9%

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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 selling busted or non-busted patterns when the breakout price was above (A) or below (B) the 50-day simple moving average (SMA).

The results say that buying a busted HST when the buy price is below the 50-day SMA gives the best performance. Selling a busted pattern outperforms the non-busted ones.

Table 5: Above (A) Below (B) 50-Day Simple Moving Average
 Sell Non-Busted PatternSell Busted Pattern
Buy busted patternA16% B98%A14% B129%

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 buy time, if the buy price is below the 200-day SMA, the odds favor better performance.

Table 6: Above (A) Below (B) 200-Day Simple Moving Average
 Sell Non-Busted PatternSell Busted Pattern
Buy busted patternA17% B25%A16% B23%

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Selling First Bearish Chart Pattern

The prior discussion assumes you buy a busted head-and-shoulders top but sell a chart pattern of your choosing, such as a downward breakout from a double 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 a busted head-and-shoulders top and sell the first non-busted chart pattern which comes along, you'd make 7% on average. Annualized, you'd make 18%. This compares to an 11% 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 best result comes from selling the first non-busted pattern which appears. Avoid selling busted patterns.

The bottom half of the table shows expectancy for the two combinations with selling non-busted patterns having the highest expectancy of profit.

Table 7: Selling the First Bearish Pattern (Annualized)
 Sell Non-Busted PatternSell Busted Pattern
Buy busted pattern7% (18% v 11%)2% (5% v 10%)
Expectancy (Below)
 Sell Non-Busted PatternSell Busted Pattern
Buy busted pattern$2.62$-0.62

-- Thomas Bulkowski

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See Also

 

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