As of 12/07/2022
  Indus: 33,598 +1.58 +0.0%  
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YTD
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-16.4%  
-0.8%  
-30.0%  
-17.5%  
  Targets    Overview: 12/01/2022  
  Up arrow35,500 or 32,800 by 12/15/2022
  Down arrow13,400 or 14,500 by 12/15/2022
  Up arrow1,000 or 925 by 12/15/2022
  Up arrow12,000 or 10,600 by 12/15/2022
  Up arrow4,250 or 3,850 by 12/15/2022
CPI (updated daily): Arrows on 12/5/22
As of 12/07/2022
  Indus: 33,598 +1.58 +0.0%  
  Trans: 13,768 -130.21 -0.9%  
  Utils: 973 -6.18 -0.6%  
  Nasdaq: 10,959 -56.34 -0.5%  
  S&P 500: 3,934 -7.34 -0.2%  
YTD
-7.5%  
-16.4%  
-0.8%  
-30.0%  
-17.5%  
  Targets    Overview: 12/01/2022  
  Up arrow35,500 or 32,800 by 12/15/2022
  Down arrow13,400 or 14,500 by 12/15/2022
  Up arrow1,000 or 925 by 12/15/2022
  Up arrow12,000 or 10,600 by 12/15/2022
  Up arrow4,250 or 3,850 by 12/15/2022
CPI (updated daily): Arrows on 12/5/22

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.

Trading Head-and-Shoulders Bottoms: 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 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...

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...

To improve performance, try these tips.

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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.

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 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:

Table 1: Various Trailing Stop Settings: Net Profit and (Average Loss)
Data 10%  15%  20%  25%  Stop Loss 
Only
 No Stop
Non-busted buys, non-busted sales 7% (-4%)  10% (-7%)  15% (-10%)  19% (-12%)  45% (-14%)  143% (-33%) 
Non-busted buys, busted sales 6% (-5%)  9% (-7%)  14% (-10%)  18% (-12%)  39% (-13%)  154% (-32%) 

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.

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

Picture of a busted pattern pair.

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.

Table 2: Statistics for head-and-shoulders bottoms
Sell PatternAverage
Win
Average
Loss
NetAnnualized
Net
RankNo Stop
Net
Win/Loss
Samples
Win
Loss
Average
Expectancy
Expectancy
Rank
Broadening bottom222%-14%44%20%1974%210/65024%$0.0657
Broadening top159%-13%41%20%20107%521/113132%$5.6811
Broadening formation, right-angled and ascending166%-13%40%19%2270%245/58230%$1.9446
Broadening formation, right-angled and descending136%-15%30%14%4365%179/42330%$1.2751
Broadening wedge, ascending231%-15%76%40%2126%174/29737%$4.6520
Broadening wedge, descending178%-13%36%19%2366%112/32126%$2.0844
Bump-and-run reversal top163%-14%52%29%5102%557/95037%$3.8327
Diamond bottom161%-14%40%22%1288%72/16131%$2.2240
Diamond top166%-13%49%25%9116%240/45535%$4.6421
Adam & Adam double top275%-12%65%26%7157%947/254627%$8.891
Adam & Eve double top214%-13%53%22%14128%483/116929%$7.574
Eve & Adam double top223%-13%52%21%17137%504/131428%$5.6212
Eve & Eve double top201%-14%48%22%13126%562/140229%$5.7310
Falling wedge114%-14%14%9%5844%110/39822%-$1.9864
Head-and-shoulders top216%-13%56%26%8114%1951/449030%$4.9518
Sell PatternAverage
Win
Average
Loss
NetAnnualized
Net
RankNo Stop
Net
Win/Loss
Samples
Win
Loss
Average
Expectancy
Expectancy
Rank
Head-and-shoulders, complex top145%-14%35%18%2766%350/78331%$1.5050
Rectangle top186%-14%44%21%1695%263/65629%$4.5022
Rising wedge142%-13%34%17%3387%511/115431%$2.8034
Rounding top179%-14%38%17%3575%238/65327%$2.1942
Ascending scallop224%-15%65%42%198%159/31833%$2.2041
Descending scallop182%-14%32%18%3076%590/191624%$0.8856
Scallop, inverted and ascending215%-12%49%19%24111%73/19727%$2.6537
Scallop, descending and inverted187%-14%45%24%1074%418/101229%$0.9555
Triangle, ascending164%-13%37%19%2689%276/69828%$3.4331
Triangle, descending125%-15%21%12%5149%263/76726%-$1.0662
Triangle, symmetrical147%-14%31%15%4276%844/220728%$2.1043
Triple top201%-13%49%21%15114%1297/312829%$5.3714
Rectangle bottom119%-15%13%7%6130%141/54720%-$1.7463
3 falling peaks221%-13%46%23%11102%1102/325825%$2.7136
Roof129%-13%34%16%4195%80/16433%$5.2715
Roof, inverted117%-13%24%13%4987%119/29429%$3.6030
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 Bottoms: Non-busted Buy, Busted Sale

Picture of a busted pattern pair.

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.

Table 3: Statistics for Normal Buy, Busted Sale
Sell PatternAverage
Win
Average
Loss
NetAnnualized
Net
RankNo Stop
Net
Win/Loss
Samples
Win
Loss
Average
Expectancy
Expectancy
Rank
Broadening bottom125%-12%30%12%5062%96/21831%$2.0345
Broadening top150%-12%40%17%3496%225/47532%$5.0016
Broadening formation, right-angled and ascending135%-13%30%14%4764%83/20429%$3.7028
Broadening formation, right-angled and descending112%-13%25%12%5263%88/20530%$2.5638
Broadening wedge, ascending171%-13%36%18%2888%31/8527%$7.236
Broadening wedge, descending103%-12%22%11%5357%72/16730%$1.6949
Bump-and-run reversal bottom134%-12%25%10%5575%47/14025%$2.7635
Cup with handle80%-14%12%6%6232%28/7527%$0.9554
Diamond bottom379%-11%95%36%3141%52/13927%$8.382
Diamond top128%-12%29%14%45103%81/19729%$4.7819
Adam & Adam double bottom262%-12%51%19%21150%256/84823%$7.545
Adam & Eve double bottom179%-13%32%14%44121%151/49823%$6.738
Eve & Adam double bottom200%-12%43%16%38119%122/34526%$7.853
Eve & Eve double bottom145%-13%20%10%5778%92/35121%$4.9717
Falling wedge100%-13%23%11%5487%103/21832%$3.2332
Head-and-shoulders bottom157%-12%38%16%3677%367/86830%$3.8626
Sell PatternAverage
Win
Average
Loss
NetAnnualized
Net
RankNo Stop
Net
Win/Loss
Samples
Win
Loss
Average
Expectancy
Expectancy
Rank
Head-and-shoulders complex bottom246%-11%63%28%6100%57/14129%$6.857
Rectangle top176%-12%36%18%2996%119/34626%$3.6529
Rising wedge135%-12%32%16%4092%84/20030%-$0.9261
Round bottom211%-14%37%17%3277%16/5423%$1.2652
Rounding top214%-14%32%19%2546%21/8320%-$0.5760
Ascending scallop108%-13%24%14%4662%108/24730%$1.1453
Descending scallop110%-13%16%8%6062%37/12323%$1.9048
Scallop, inverted and ascending155%-12%40%18%31110%159/35231%$6.239
Scallop, descending and inverted59%-12%10%5%6336%50/11530%-$0.3159
Triangle, ascending148%-14%35%16%3992%141/32430%$2.4939
Triangle, descending100%-12%18%10%5660%108/29927%$1.9147
Triangle, symmetrical270%-12%69%32%4130%417/102029%$4.2524
Triple bottom224%-13%50%20%18108%352/98026%$4.3623
Rectangle bottom114%-12%18%9%5959%66/21324%$2.8633
3 rising valleys154%-13%30%13%48101%219/63926%$5.5113
Roof185%-11%38%16%37101%20/6025%$3.9525
Roof, inverted63%-11%7%5%6476%35/10525%-$0.2758
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 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.

Table 4: Short (S) Medium (M) or Long (L) Trend Start and Performance
 Sell Non-Busted PatternSell Busted Pattern
Buy non-busted patternS56% M34% L12%S50% M28% L10%

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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 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 5: Above (A) Below (B) 50-Day Simple Moving Average
 Sell Non-Busted PatternSell Busted Pattern
Buy non-busted patternA32% B55%A26% B49%

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.

Table 6: Above (A) Below (B) 200-Day Simple Moving Average
 Sell Non-Busted PatternSell Busted Pattern
Buy non-busted patternA40% B53%A33% B48%

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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.

Table 7: Selling the First Bearish Pattern (Annualized)
 Sell Non-Busted PatternSell Busted Pattern
Buy non-busted pattern18% (39% v 21%)11% (22% v 17%)
Expectancy (Below)
 Sell Non-Busted PatternSell Busted Pattern
Buy non-busted pattern$2.61$1.28

-- Thomas Bulkowski

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See Also

 

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