Encyclopedia of Chart Patterns. Thomas N. Bulkowski

Trade

      Figure 2.4 shows a sample trade using the AB=CD pattern.

      Jacob poked me in the ribs, then pointed to the screen to discuss his trade. “See that? It's a double bottom.”

      His fingers traced the twin bottoms at EA with a nice peak (F) between them. “I can make money trading that.”

      He placed a buy stop a penny above F. That order triggered at G, putting him into the stock near the breakout price. Immediately, he placed a stop a penny below the lower of the two bottoms, which in this case, was A, at 37.12. If the trade went bad, he'd lose about 10%.

      “That's bigger than the 8% I like to see, but you have to be flexible,” he told me.

      Figure 2.4 Jacob used the bearish AB=CD pattern to exit a trade.

For about a week, the stock cooperated and climbed to B before starting to retrace.

      “The throwback and drop to C made me nervous. I started sweating bullets because I thought I'd be stopped out. Don't believe me? The sweat started pouring off me, and the furniture started floating. I'm not kidding. You can see the watermark.” He pointed to a smudge on the wall. His wide grin made the Grand Canyon look like a small ditch by comparison.

      “I thought of selling, but I invariably sell a week or two before the stock bottoms. It's annoying. What helped me this time was when I noticed the bearish AB=CD pattern.”

      His software helped by providing the location for him. Let's run through the numbers. The low at point A was 37.13, the high at B was 43.14, and the low of price bar C was 38.42. Crunching the numbers said that the ratio of BC to BA was (43.14 – 38.42)/(43.14 – 37.13) or 78.5%. That was close to the 78.6% Fibonacci number, so the turn matched the identification guidelines (Table 2.1).

      If the pattern worked as he hoped, the CD leg would equal or exceed the AB leg and make for a tasty profit.

      The height of the AB move was 43.14 – 37.13 or 6.01. Added to the low at C (38.42) gave a target for turn D of 44.43.

      “I doubled my position right there,” he said and poked the screen, leaving a fingerprint behind. The second buy was near C, and he set a target to sell both positions at 44.43. “I raised my stop, too, to a penny below C. Just in case…”

      The stock took off in a straight‐line run up to D. The stock sold at the exact high at D, 44.43, cashing him out of the AB=CD trade and also out of the double bottom trade.

      “Let's do lunch,” he said. “I'll let you buy.”

3 AB=CD^®, Bullish

      RESULTS SNAPSHOT

      Appearance: A zigzag pattern that has four turns, two of which are governed by Fibonacci ratios.

       Upward Moves

	Bull Market	Bear Market
Performance rank	4 out of 5	3 out of 5
Breakeven failure rate	11.6%	3.7%
Average rise	38.4%	30.5%
Volume trend	Upward	Upward
Point D reversal rate	38%	33%
How many reach point D?	100%	99%
See also	Bullish bat, bullish butterfly, bullish crab, bullish Gartley, measured move down

      The bullish AB=CD pattern is a type of measured move down except that the pattern's turns are determined by Fibonacci ratios. I measured performance of Fibonacci‐based patterns differently than I do other chart pattern types. That's because we're looking for a reversal at the end of the pattern and not an up or down breakout. Therefore, the layout of this chapter is different from most other chapters in this book.

The theory behind this pattern is that if you know the first three turns (ABC), you can calculate the fourth turn (D). The method works nearly all of the time, meaning price does fall to the calculated point D. However, when price reaches D, it fails to reverse there. Only about a third (33% in bear markets and 38% in bull markets) will see price turn upward when it's supposed to.

      Of course, your software for identifying the bullish AB=CD may be different than the model I built, so your performance may vary. Add trading rules to improve performance and you may find this pattern a useful tool. Let's see what this pattern looks like.

Tour

      Figure 3.1 shows an example of a bullish AB=CD. Price begins the pattern at peak A after an exhaustion gap warns of the coming retrace. The pattern completes at valley D, with turn BC nestled comfortably between those two points. Notice that price turned at D and climbed from there (at least for a time). Price reversing at D and climbing is how the pattern is supposed to work.

      In this example, price broke out of the pattern upward at F when it closed above the top of the pattern. Not shown, but the stock continued higher to rise 119% above the low at D. If only all chart patterns worked like that!

      This chart is also a good example of the CD leg meeting the projection of AB. In other words, the height of AB subtracted from C gives turn D. Thus, if you know turns ABC, you can estimate where D will appear. However, you can also use that price information to predict where D will be using Fibonacci numbers (because turn D can be far away from the ABC turns). I'll discuss that in the next section.

      Notice volume (E) trends downward in this example. A downward volume trend happens 47% of the time in a bull market (meaning an upward trend is slightly more likely). An upward volume trend helps boost performance, and we'll see how much in the Statistics section.

Figure 3.1 This chart shows how a bullish AB=CD pattern sees price turn at D.

Identification Guidelines

Table 3.1 shows the identification guidelines, and Figure 3.2 shows an example of a bullish AB=CD pattern.

      Appearance. Bullish AB=CD patterns are a member of what I call Fibonacci patterns whose turns are set by Fibonacci ratios. I don't suggest you try finding this pattern manually. Rather, use pattern recognition software that can hunt down these patterns like a cat hunts mice. I found so many in my quest to count them that I ran out of fingers and toes and had to limit the number a stock could report.

Table 3.1 Identification Guidelines