Stocks & Commodities V. 23:3 (16-21): What Powers Chart Patterns? by Thomas N. Bulkowski
Have you ever wondered if small-cap stocks perform better than large caps? Does heavy breakout day volume really power prices higher? Here’s a closer
look at variables that affect chart pattern performance.
“What powers stocks?” If you asked me that 25 years ago when I first started investing, I would have rattled off
a bunch of fundamental factors such as good earnings, strong sales, little or no debt, insider buying and no selling, not to mention the ratios: price to earnings, price to sales, debt to equity, and so on. Since I defected from the fundamental side to technical analysis, the question becomes, “What powers chart patterns?” My answer today is shorter: supply and demand. If no one wants to sell Google and everyone is clamoring for the shares, the stock will rise. If research becomes public saying that a drug kills people, investors will dump the shares of the company that makes it, and the stock will tumble. Quickly.
This article discusses results of research I conducted on nearly 7,500 chart pattern samples in 13 bullish and 13 bearish chart pattern types during the writing of my book, Trading Classic Chart Patterns. The research includes the years from 1991 to 2001, but not all 500-plus stocks covering the period. I’ve found the answers to certain questions about what affects chart patterns.
What length of price trend leading to a chart pattern results in the best post–breakout performance? Answer: The short term. For chart patterns with upward breakouts, a price trend of less than three months’ duration leading to the start of a chart pattern yielded the best performance eight times. The intermediate term (three to six months long) worked best twice and the remaining four times did well for trends longer than six months, including one tie. For downward breakouts
(bearish patterns), the short term worked best nine times, and the intermediate did best four times. None of the long-term trends performed well.