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32 Measured Move Down

RESULTS SNAPSHOT Appearance

Prices move down, retrace, and then move down again.

Reversal or continuation

Intermediate-term bearish reversal Bull Market

Bear Market

Performance rank

Not Applicable

Not applicable

Change after trend ends

46%

49%

Volume trend

Downward

Downward

Average first leg decline

27% in 61 days

36% in 45 days

Average corrective phase retrace

48% in 30 days

44% in 22 days

Average last leg decline

25% in 62 days

36% in 46 days

Percentage meeting price target

35%

39%

Percentage meeting time target

53%

49%

Surprising findings

The larger the corrective phase retrace, the better the chance of meeting the price target. The decline is steeper and farther in a bear market. Patterns with U-shaped volume reach their price targets more often.

Synonym

Swing measurements; simple ABC correction

See also

Flags; Pennants

The measured move down (MMD), or swing measurement as it is sometimes called, is an exciting formation because it vividly tells how far down price is 496


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Tour

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going. Unlike other chart patterns, I classify MMDs as bearish reversals over the intermediate term. With other patterns, I gauge the term by the time to the ultimate low, but with MMDs, I am using the pattern length instead. I do not show the average decline or the failure rate. The average decline measures the move from the breakout to the ultimate low, and neither applies to this pattern. The failure rate is a measure of how far price moves after the breakout. That also does not apply. The Results Snapshot is self-explanatory with a few exceptions. The “Average corrective phase retrace� is how far prices move back up the first leg. In both markets, prices retrace nearly half the first leg move. The second leg is longer than the first one between 35% and 39% of the time on a dollar, not a percentage, basis. On the time scale, about half (53% in a bull market and 49% in a bear market) of the second legs are longer than the first ones. What does this information mean? If you measure the first leg price decline and project it downward from the top of the corrective phase, you will hit your target between 35% and 39% of the time. If you take half of the first leg move and project downward, you will hit your target between 83% and 93% of the time. On a percentage basis, however, the first and second leg declines are about equal. A surprising finding that helps with gauging performance is the retrace amount of the corrective phase. Large retraces, over 62%, are more likely to be followed by a second leg decline that matches or exceeds the first leg decline. Small retraces (less than 38% of the first leg move) show a larger likelihood of the second leg being shorter than the first. Also, the decline is steeper and price travels farther in a bear market than in a bull market. That should not be a surprise because MMDs are a bearish chart pattern. Finally, MMDs with Ushaped volume tend to have second legs that are as long as or longer than the first leg decline.

Tour Figure 32.1 shows what a typical measured move down looks like. The decline from the high (point A) to the start of the retrace (point C) is called the first leg. The retrace is commonly referred to as the corrective phase and the remaining decline to the low is called the second leg. The first and second legs are nearly the same size, but their behavior is described in more detail later in the Statistics section. The corrective phase is simply an upward retrace of the downtrend. It is a place for the stock to catch its breath and for novice investors to buy into the situation. They purchase the stock and push it up, believing the decline is at an end. Do not be fooled; the decline is only half over. That is the beauty of this formation. Before you buy a stock after a long decline, consider that it might


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Measured Move Down Fleetwood Enterprises (Manuf. Housing/Rec. Veh., NYSE, FLE) – 25

A

– 24 – 23

B

– 22

C

– 21 – 20

D

First Leg

– 19 – 18 E

Corrective Phase

– 17 – 16 – 15

Second Leg

– 14 – 13 – 12 – 11 – 10 – 9 – 8

Mar 92

Apr

May

Jun

Jul

Aug

Sep

Figure 32.1 A typical measured move down. The slope of the trend line is similar for both legs. Points A, B, and C mark a nested measured move.

be making a measured move down and that the decline is not over. Paying attention might save you some big bucks. Returning to Figure 32.1, you can see the two legs following a trend line that has nearly the same slope. This is not always the case, but a surprising number of formations obey this dictum. Further, a channel—two parallel lines that follow prices down—can encompass the two legs. Although the example in Figure 32.1 is weak on the first leg, you can see how the second leg follows a top trend line, connecting points D and E and extending down. Lastly, the three points marked A, B, and C mark another measured move down. This one is more compact and it is not uncommon to find nested formations like this. Sometimes, you get one measured move right after another.

Identification Guidelines Table 32.1 highlights identification characteristics for the measured move down chart pattern. First leg. The first leg occurs as prices reach a new high and a trend change begins. Prices decline, leaving a price peak on the chart. From there, prices continue moving lower, usually in a straight-line run. Most times you can draw two parallel lines, one connecting the minor highs and one joining the minor lows, forming a down-sloping trend channel. Corrective phase. The corrective phase stops the decline. Prices can move horizontally but usually retrace a significant portion of their losses, usually between 38% and 62%.


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Identification Guidelines

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Table 32.1 Identification Characteristics Characteristic

Discussion

First leg

Usually begins from a new high. Prices decline rapidly in a straightline fashion. Avoid declines that curve (they are rounding turns, scallops, or saucers).

Corrective phase

Prices can move horizontally but usually rise and recover from 38% to 62% of the prior decline before resuming the downtrend. If the corrective phase nears or rises above the first leg high, look elsewhere.

Second leg

The slope of the first leg down trend line often carries onto this leg. Both legs usually fit inside their own trend channels.

Avoid

For cascading measured moves, use the first retrace and not later ones as they get progressively closer to the end of the trend. Avoid horizontal, saw-tooth consolidation regions and measured moves that rise from a flat base. Make sure the measure rule does not predict prices will fall below zero.

Second leg. When the second leg begins, the downturn resumes. Prices usually follow the slope set by the first leg but this varies from formation to formation. Of course, the two legs will not share the same trend line since the corrective phase offsets them. Even so, the second leg usually fits inside its own trend channel as prices decline in a straight-line fashion. The second leg decline approximates the price decline set by the first leg and the time it took to accomplish it. Avoid. There are several guidelines that you should follow when searching for the measured move down. Avoid formations that show a rounded first leg, where prices move lower but curve around in a sort of rounding turn, scallop, or saucer. The trend should be a straight-line decline. During the corrective phase, prices should not rebound (or come close) to the high set by the first leg. If prices near or rise above the first leg high, then avoid the formation. Watch for consecutive measured moves in a declining price trend. The downtrend eventually will end, so it is best to trade on the first or second measured move and avoid the rest. Occasionally, the prevailing price trend will be horizontal. Prices rise up and reach a high then begin down in the first leg. When prices return to the base, they bounce. This bounce, wrongly interpreted as the corrective phase of a measured move down, is really a minor high in a consolidation trend. Prices return to the base and may bounce several more times before beginning a sustained move upward. The overall picture looks like a horizontal saw-tooth formation. Avoid measured moves that spring from a horizontal trend. The last caveat is to consider the measure rule. I discuss the measure rule in the Trading Tactics section of this chapter, but the measure rule says the


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second leg will approximate the price move of the first leg. If the first leg has a large decline, you may find that the predicted price is very close to zero or perhaps even negative. Obviously, the stock is not going to go negative and probably will remain far above zero, so you might look elsewhere for a more promising trade. Examples of these idiosyncrasies follow in the Focus on Failures section. Figure 32.2 shows two examples of the measured move down formation. The first one, marked by points A, B, C, and D, begins after a long price rise. The stock moves up from 43.13 in late November 1994, to 59.63 in early July. Then, prices decline following a down trend line and stay within the trend channel until mid-August, when they reach a low of 51.50. The corrective phase begins on volume that is high but not unusually so. Prices move up and retrace 68% of the decline before tumbling again. In the second leg, prices move below the low (point B) and continue lower to point D. Then it is over. The second leg is steeper than the first leg and covers the ground in about half the time (36 days versus 19 days). In addition, the second leg is slightly shorter than the first one (the first leg declines by 8.13, whereas the second one falls 7.25). Another measured move occurs in mid-November and ends at about the same level as the first formation in late January (see points E, F, G, and H). If you look closely at Figure 32.2, you can see another measured move that forms in the first leg from point E to point F. Points E1 and E2 mark the corrective phase. Air Products and Chemicals Inc. (Chemical (Diversified), NYSE, APD)

– 61

A

– 60 E

– 59

C

– 58

E2

– 57 – 56

G

– 55 E1

– 54 – 53 – 52

B

F

– 51 H

– 50

D

– 49 – 48 – 47 – 46

Jun 95

Jul

Aug

Sep

Oct

Nov

Dec

Jan 96

Feb

Mar

Figure 32.2 Two measured moves. Notice how they fit neatly inside a trend channel. With measured moves, the price decline from C to D nearly matches the decline from A to B.


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Focus on Failures

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Focus on Failures There are a number of identification mistakes that I want to point out. Figure 32.3 shows the first one. The semiconductor maker’s stock reaches a high, along with a host of other chip makers’ stocks, in the summer and fall of 1995. The stock forms a head-and-shoulders top in August and September before burning out. In a near straight-line run, the stock tumbles from a high of 33.50 to a low of 9.13. If this decline marks the first leg of a measured move down, how far will prices fall in the second leg? That depends on how far up the corrective phase brings prices. The corrective phase rises to a high of 15.25. I discuss the measure rule later, but it says the second leg approximates the price decline of the first leg. If we run through the computations, we discover that the predicted decline is minus 9.13. Even if the company were to declare bankruptcy, its stock price would never go negative. Another key to this failure is the size of the corrective phase. Usually, prices recover 38% to 62% of the first leg decline, but this one does not come close (about a 25% retrace). With larger price declines, the corrective phase is proportionally larger too. However, the formation in Figure 32.3 does not show such behavior.

Integrated Device Technology (Semiconductor, NASDAQ, IDTI)

Left Shoulder

Head

– 35 – 34 – 33 – 32 – 31 – 30 – 29 – 28 – 27 – 26 – 25 – 24 – 23 – 22 – 21 – 20 – 19 – 18 – 17 – 16 – 15 – 14 – 13 – 12 – 11 – 10 – 9 – 8 – 7 – 6

Right Shoulder

Neckline and Pullback

First Leg

Corrective Phase

Second Leg Jul 95

Aug

Sep

Oct

Nov

Dec

Jan 96

Feb

Mar

Apr

May

Figure 32.3 A head-and-shoulders top leading to a measured move down. The head-and-shoulders top forms the basis for the large decline. The corrective phase is small in comparison to the large first leg decline. The measure rule for the measured move formation predicts prices will go negative.


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Measured Move Down Anadarko Petroleum Corp. (Petroleum (Producing), NYSE, APC) – 54 – 53 – 52 – 51 – 50 – 49 – 48 – 47 – 46 – 45 First Leg

Second Leg Corrective Phase

Support Line

– 44 – 43 – 42 – 41 – 40 – 39 – 38 – 37

Apr 95

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Figure 32.4 A measured move from a horizontal base. These formations rarely work out as anticipated.

Figure 32.4 shows another situation: the flat base problem. Prices are essentially flat from the start of February. By that I mean the minor lows all share the same value—about 40. When prices move up in August and reach a minor high in September, it is nothing unusual. Although the prior minor highs do not ascend to this height, there is no reason to suspect that a measured move will follow. When prices decline to the base at 40 and bounce, a naive investor might think a measured move down is forming. The corrective phase in late October and early November sees prices rebound far up the first leg before curling over and heading down. If the investor sells short at this point, it will be a costly mistake. Prices quickly skyrocket to 60 by May from the second leg low of 44.88. Why does this formation fail? The strong support level at 40 curtails any meaningful decline below that point. In other words, there is nothing to reverse. Figure 32.5 shows the last failure, a case of mistaken identity. After a long, extended rise, a retrace can be expected, maybe even a trend change that takes prices drastically lower. When prices turn down in early January, a decline is long overdue. If you connect the minor lows in the uptrend, you discover that prices pierce the up trend line in mid-December. This piercing supports the theory that the trend is changing. It is not conclusive, but it does tilt the scales in that direction. Throughout the month of December prices essentially move horizontally before perking up and making a new high just before prices plummet. The failure to continue moving higher is another clue to a trend change. The final clue is when price drops below the prior minor high


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Champion Enterprises (Manuf. Housing/Rec. Veh., NYSE, CHB) – 19 – 18 – 17 – 16 – 15 – 14 – 13

Start of Second Leg

First Leg

– 12 Corrective Phase

Up Trend Line

– 11 – 10 – 9 – 8 – 7 – 6 – 5

Jul 95

Aug

Sep

Oct

Nov

Dec

Jan 96

Feb

Mar

Apr

May

Figure 32.5 This measured move down is really the corrective phase of a measured move up.

reached in late October. The stock even tumbles below the support level at 12.63 before recovering. The corrective phase of the measured move down sees prices retrace 85%. That is well above normal and should flag a potential problem. With such a large retrace, prices will probably decline to the prior low and stall (because the second leg is slightly smaller than the first one). The stock did not even go that far. Prices declined to the prior minor high at 13.50 and held steady for a week before moving higher. Why did this formation fail? The choice of a measured move down for this situation is poor because of the extent of the corrective phase. If we look at the larger picture, we discover that the first down leg is nothing more than the corrective phase of a measured move up!

Statistics The tables in this section differ from those given in other chapters because of the uniqueness of this chart pattern. Many of the statistics provided elsewhere do not apply because there is no breakout and no ultimate low. Table 32.2 shows general statistics for MMDs. Number of formations. I found 911 MMDs using 5 years of daily price data beginning from mid-1991 on 500 stocks. Another 220 or so stocks created additional bull/bear market data, starting from January 2000 to 2003.


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Measured Move Down Table 32.2 General Statistics

Description

Bull Market

Bear Market

Number of formations

647

264

Reversal (R), continuation (C)

566 R, 81 C

214 R, 50 C

Change after trend ends

46%

49%

Most frequent corrective phase retrace

40% to 60%

40% to 60%

Average MMD length

153 days

113 days

Average first leg price decline

27% in 61 days

36% in 45 days

Average corrective phase retrace

48% in 30 days

44% in 22 days

Average last leg price decline

25% in 62 days

36% in 46 days

Reversal or continuation. About 87% of the time in a bull market and 81% of the time in a bear market, MMDs act as reversals of the price trend. A reversal happens in two ways. First, the MMD can form at the end of a rising price trend or, second, it could start a new trend after the MMD completes. I consider both movements as being valid price reversals. For continuations, the MMD forms in an established declining price trend. The size of the corrective phase, being proportional to the MMD legs, helps determine the starting and ending points of the pattern. Since price is declining into the pattern and it continues declining after the pattern, the MMD acts as a continuation of the falling price trend. Change after trend ends. After the end of the second leg, price rises between 46% (bull market) and 49% (bear market), as measured using a 20% price change (as in the search for the ultimate high). These percentages are less than the usual 50% to 60% rise posted by other chart patterns. However, they do suggest a good recovery after the pattern ends. If the stock is in a bull market, consider taking a long position after the MMD completes. Corrective phase retrace. I did a frequency distribution of the percentage price retrace of the first leg move. In both bull and bear markets, prices retrace most often between 40% and 60% of the first leg move. The larger the retrace, the more likely it is that the second leg will be as long as or longer than the first leg. For example, when the retrace is less than 38%, just 22% of the MMDs have longer second legs. When the retrace is between 38% and 62% (Fibonacci numbers), 31% have longer second legs. When the retrace is above 62%, 58% have longer second legs. Average length. From the start of the first leg to the end of the second, MMDs in a bull market were about 5 months long (153 days), and in a bear market, 4 months long (113 days). Average leg price decline. I measured the price move of the three parts of an MMD: the first leg, corrective phase retrace, and second leg. The first leg


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nearly equals the decline of the second leg in both time and price. For example, in a bull market, the first leg declines an average of 27% in 61 days. The second leg declines 25% in 62 days. In between the two, the corrective phase retraces 48% of the first leg’s decline. Notice that MMDs in a bear market fall farther (36%) in a shorter period (45 days) than in a bull market, on average. I measured the leg decline as a percentage from the top of the respective leg and the corrective phase retrace as the ratio of the corrective phase length to the first leg length. On a dollar basis in a bull market, the second leg decline is longer than the first leg 35% of the time. The second leg is 19% shorter than the first. In a bear market, 39% of the second legs are longer than the first. On average, the second leg is 20% shorter than the first. Table 32.3 shows volume statistics. Volume trend. I do not show performance statistics in the table, but show instead the proportion of MMDs with a rising or falling volume trend. MMDs usually have a receding volume trend from the top of the first leg to the end of the second leg. I looked at the volume trend and checked to see if MMDs with the associated trend had second legs equal to or longer than the first leg. The second leg was longer than the first most often in a bear market. Bear market MMDs with a rising volume trend performed particularly well, with 72% having second legs longer than the first. In a bull market, the second leg was shorter than the first most of the time. Table 32.3 Volume Statistics Description

Bull Market

Bear Market

Number with rising volume trend

26%

27%

Number with falling volume trend

74%

73%

Rising volume trend, second leg longer than first leg

43%

72%

Falling volume trend, second leg longer than first leg

49%

56%

Number with U-shaped volume

33%

41%

Number with dome-shaped volume

61%

53%

Number with neither U-shaped nor dome-shaped volume

6%

6%

U-shaped volume, number of times second leg longer than first leg

57%

73%

Dome-shaped volume, number of times second leg longer than first leg

43%

51%

Random volume shape, number of times second leg longer than first leg

40%

53%


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Measured Move Down Table 32.4 After Pattern Ends

Description

Bull Market

Bear Market

Price stops below corrective phase

16%

20%

Price stops within corrective phase

35%

52%

Price stops above corrective phase but below MMD high

31%

20%

Price stops above MMD high

18%

8%

Volume shapes. Again, I do not show performance but show instead the number of patterns with the associated volume shape. Most of the time, a dome-shaped volume pattern prevails. Volume shape versus leg length. Does volume shape give a clue to performance? Yes. When U-shaped volume prevailed, the second leg was longer than the first 57% of the time in a bull market and 73% of the time in a bear market. Those numbers were larger than the other volume shapes. Thus, when projecting the price trend downward, look at the volume shape. If it looks Ushaped, then there is a better chance that the second leg will be at least as long as the first leg decline. Table 32.4 shows where price stops climbing after the MMD ends. In Figure 32.2, for example, I am talking about the move from D to E after the ABCD measured move down. Why is this information important? If you hold onto a security too long, price will retrace its downward move, ending higher. In a bull market, price will stop within the corrective phase about a third of the time, on average. Only 16% of the time will price not make it to the corrective phase. In a bear market, the corrective phase shows more stopping power. Just over half the time, price stops rising within the corrective phase. Over a quarter of the time (20% + 8%), price climbs higher than the corrective phase. To put the numbers in perspective, after the MMD ends, price climbs and reaches or exceeds the start of the corrective phase between 80% (bear market) and 84% (bull market) of the time. Those figures should serve as a warning that you need to use stops to protect your short position from adverse moves.

Trading Tactics Table 32.5 outlines trading tactics for MMDs. Measure rule. Use the measure rule to help predict how far prices will decline. Refer to Figure 32.6 during the discussion of its computation. In the figure, four points outline the measured move: A through D. First, tabulate the height of the first leg (shown by points A and B) by subtracting the lowest low


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Table 32.5 Trading Tactics Trading Tactic

Explanation

Measure rule

The second leg averages 19% shorter than the first leg, so expect the actual price to fall short of the target. Compute the length of the first leg from the highest high to the lowest low (at the start of the corrective phase). Subtract the result from the highest high reached in the corrective phase to get the target price. For a more conservative target, use half of the first leg height. This shortened height means that prices hit the target 83% (bull market) to 93% (bear market) of the time.

Short during second leg, stop loss

Short the stock as soon as it becomes clear that a measured move is in progress. If prices rise above the corrective phase high, then close out your position. Prices occasionally will rise up to the corrective phase high a second time before ultimately declining, so put your stop about 0.15 above the high.

Close out

Cover your short when the price drops to a support area and meets resistance to a further decline, especially if prices near the measure rule target.

Support/resistance

The corrective phase shows future support or resistance.

3 Com Corp. (Computers & Peripherals, NASDAQ, COMS) – 55 – 54 – 53 – 52 – 51 – 50 – 49 – 48 – 47 – 46 – 45 – 44 – 43 – 42 – 41 – 40 – 39 – 38 – 37 – 36 – 35 – 34 – 33 – 32

A Most Recent Up Trend Line Resistance

C Stock Shorted

Support, Resistance Level

B

Target Price, Position Closed Out

Oct 95

Nov

D

Dec

Jan 96

Feb

Mar

Figure 32.6 Measured move down followed by corrective phase. Eddy made $5 per share trading this (points A–D) measured move down.


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(42) from the highest high (52.88). This computation gives a difference of 10.88. Subtract the difference from the highest high in the corrective phase (point C at 47.75). The result is a target price of 36.87. Prices meet the target on December 7. Sell short. Once you suspect that a measured move down is forming, probably just after the corrective phase completes and prices start down, short the stock. Use the measure rule to predict the price target, but expect prices to come up short. Place a stop-loss order 0.15 above the corrective phase high (the corrective phase is a source of support and resistance). For a more conservative target, follow the measure rule using one-half of the first leg height. Prices reach the new target 83% of the time. For example, one-half of the first leg height in Figure 32.6 is 5.44. Subtracting this value from the corrective phase high gives a closer target of 42.31. Close out. Cover your short if prices rebound off a support zone or approach the measure rule target. Support/resistance. After a measured move down completes, the corrective phase often spells a resistance zone for future moves. Prices pause on the approach to the corrective phase low and at the high. Figure 32.6 has these zones labeled. If you are nimble, you can anticipate this rise and trade long once the measured move down completes. Sell if prices run into trouble during the corrective phase and begin heading lower. In a bull market you can generally expect prices to eventually push through the corrective phase resistance and move up to the old high, but that could take months or years.

Sample Trade People are nasty; just ask Eddy. He is an airline reservation agent. Between the company monitoring his phone calls to be sure he peddles a car and hotel when appropriate and the people screaming at him from the other end of the phone, it is a tough living. There is nothing he can do about equipment problems or the weather, but people do not seem to care. Even the full moon gets into the act as that is when the crazies call. What he would really like to do is invest in the stock market. He does it now but to a limited extent because of a cash-flow problem. Fortunately, with a few clicks of his computer mouse he can flip to the Internet and monitor his latest stock pick when he is not busy. That is how he uncovered the situation shown in Figure 32.6. He watched the stock climb from a low of about 10 in June 1994 to a high of 53.63 in October 1995. Every so often, he would draw trend lines along the bottoms of the minor lows and notice how the upward trend seemed to be accelerating (the trend lines grew steeper over time). Since he knew this could not last, he was ready for a trend change, which occurred on November 14 when prices pierced the trend line, moving down.


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For Best Performance

509

Instead of shorting the stock immediately, he decided to wait for a pullback. Much to his surprise it never came. Prices moved steadily lower until they reached a support level at 42. From that point on, prices rose higher for the next week and a half. Then, they dropped sharply, tumbling $3 in one session. When prices fell, they pierced a small up trend line, drawn along the bottoms of the climb from points B to C. Eddy recognized what was happening when he drew the trend line on his chart. The chart pattern was making a measured move down, so he shorted the stock that day and received a fill at 42. He used the measure rule to compute the predicted price move and placed an order with his broker to cover the short at the predicted price (36.88). Just 3 days after he placed the trade, the short was covered. He made about $5 a share or 12%. If you look at Figure 32.6, you can see that prices rose to the level of the corrective phase bottom (point B), then retreated 2 days after Eddy completed his trade. Later on you can see that prices also stopped rising at the top of the corrective phase. The corrective phase is a zone of support and resistance.

For Best Performance The following list includes tips and observations to help select MMDs that outperform. Consult the associated table for more information. • Review the identification guidelines for correct selection—Table 32.1. • Trade MMDs in a bear market; the decline is shorter but steeper— Table 32.2. • The second leg is about 20% shorter than the first leg, on a dollar basis—Table 32.3. • Select patterns with a falling volume trend and U-shaped volume pattern—Table 32.3. • After the pattern ends, price rises to the corrective phase at least 80% of the time—Table 32.4.


Encyclopedia of Chart Patterns 32