Broadening Formations

The right-angled and ascending broadening chart pattern is not one you might choose to trade. Other chart patterns perform much better. Downward breakouts have a big break even failure rate which may disqualify them from your trading tools. Upward breakouts have only a middling average rise, and that is if you trade them perfectly.

Would you trade a pattern with a likely profit potential of 10% or less? Perhaps a bearish chart pattern would appear, and the measure rule for that formation implied a downturn from 2700 to 2550, would you consider pursuing it further?

Some of these queries came up when the megaphone-like formation in the Dow Jones Transportation Average was noticed over the last two months. This compilation, with a flat, horizontal bottom and a progression of higher highs as well as a up-sloping trend line, is known as a right-angled broadening formation. Since the pattern is registering higher highs, it is referenced as an ascending broadening formation. However often “ascending” is a bit of a misnomer. Right-angled ascending broadening formations are bearish beasts.

Prior to taking a closer look at the pattern developing in the DJTA, more can be said about right-angled ascending broadening formations. Unlike other chart patterns, right-angled ascending broadening formations have an variable volume trend during the development of the formation, after all a volume surge on the breakout is common. While premature breakouts (upside or downside) tend to be isolated, pullbacks to the horizontal trend line are quite common. Also common are “partial rises” during which prices move toward the up-sloping trend line. These “partial rises” can be indications for a coming breakout, especially on the downside.

Fixed support at 2700 and higher highs in November and December establish this right-angled, ascending broadening formation. The declining relative strength also conveys a bearish retreat for the DJTA. Graphic provided by: MetaStock.

These characteristics are evident with the right-angled ascending broadening formation in the DJTA. The series of higher highs is present; the up-sloping trend line connects the highs of November with those of December. Also notice the steadfastness of the horizontal trend-line, which is hardly penetrated during the pattern’s development over the past two months. The “partial rise” phenomenon also seems to be effected, as the mid-December rally seems to have topped out at 2900.

Possibly one of the reasons why it is recommended that this formation is probably less beneficial has to do with waiting for the downside breakout. In the chart, a downside breakout would suggest a penetration of the horizontal line at 2700. The measure rule for right-angled, ascending broadening formations is sort of prudent, simply measure the distance from the highest high in the formation to the horizontal line at the bottom of the formation, then subtract that value from the horizontal line’s value. In this case, the formation’s high is at about 3000, while the horizontal line at 2700. This should give a formation size of 300 and cause a likely decline to as low as 2400.