CHAPTER 1

Big M

I fired up my computer and typed "big M chart pattern" into a search engine and my website (thepatternsite.com) came up first on the list. That tells me not a lot of research has been done on the big M.

You might think that the big M is a burger joint, but in technical analysis, it is a variation of a double top chart pattern. The difference between a double top and a big M is that the big M has tall sides (when it works). When it fails, the left side remains tall, but the right side is amputated.

Let us take a closer look.

■ Behavior at a Glance

FIGURE 1.1 shows the typical behavior after a big M chart pattern forms. The big M is shown in a slightly thicker line.

FIGURE 1.1 This is the typical behavior of a big M chart pattern.

The launch price is where the uptrend begins that leads to the big M. Often the run up to a big M is a straight-line affair, not a rounded turn. The climb lasts as long as bullish enthusiasm drives price higher. Eventually, however, the stock peaks and retraces. That retrace forms the first peak of the big M.

Bulls gather and attempt a new high, but price stalls at or near the price of the first high and drops back. This up-and-down movement forms the second peak.

When price closes below the valley between the two peaks, it confirms the chart pattern as a valid one and signals a breakout. Timber!

Price drops an average of 17% below the breakout price, but that is for more than 1,300 perfect trades. Do not expect to duplicate those results. You might hurt yourself.

Comparing the ultimate low with the launch price, we find that 60% of the big Ms see price returning to or dropping below the launch price. That also means 40% remain above the launch price.

• After a big M, the stock returns to the launch price 60% of the time.

Pullbacks

Figure 1.2 shows what happens to big M patterns 63% of the time.

FIGURE 1.2 Statistics related to pullbacks.

A big M appears as peaks AC with B marking the lowest valley between the two peaks (the so-called confirmation, or breakout price). A close below the price of B means a downward breakout. If price closes above the highest peak (A or C) before closing below the breakout price (B), then you do not have a big M.

D represents a pullback when the stock returns to the breakout price within a month after the breakout. The one-month window is arbitrary, but it serves as a good benchmark. I prefer that white space appear between the breakout and pullback as shown in the figure.

After a downward breakout, price drops an average of 7% in 5 days. Price reverses and retraces the drop for 5 more days (10 calendar days total since the breakout) until it peaks again at the top of the pullback (E).

Thirty-six percent of the time price continues higher, often leaving traders with a loss on their ledgers. However, the vast majority of the time (64%) price continues lower.

• A pullback occurs 63% of the time and price continues lower 64% of the time.

Busted Tops

Figure 1.3 shows the performance of busted big M chart patterns. A pattern busts after a downward breakout when price drops less than 10% before reversing and closing above the top of the chart pattern.

FIGURE 1.3 The average performance of big Ms that bust a downward breakout.

I found that 33% of big Ms will bust a downward breakout in a bull market. That means 1 in 3 trades will likely lose money. However, if you see a busted big M, then buy it. The average rise for a single busted chart pattern is a mouthwatering 47%. Of course, a single bust can turn into a double or triple bust, too. That is a risk. I will explain double and triple busts later or you can visit the glossary, which shows a picture (see Figure G.1).

• Big Ms bust 33% of the time.

■ Identification

Figure 1.4 shows an example of a big M chart pattern. The launch price is at A. The bulls get excited about the stock and bid it up, day after day, so that a straight-line run forms and takes price much higher, to the first top (B).

FIGURE 1.4 This big M looks like a double top with tall sides.

The first peak's shape can vary from rounded looking (as in this case) to a one-day needle ready to draw blood. Following the first peak, price tumbles to C when the bears take charge of the stock, often forming a V-shaped turn. The BC drop averages 10%.

The bulls counterattack and force the price back up. Those buying the stock near the first peak say, "as soon as I get my money back, I'm selling." And they are as good as their word. That forms peak D near the same price as B. The two peaks need not match the same price exactly. However, I found that the average price difference between the two is about 1%.

When people sell near the second peak, that selling pressure forces the stock lower. When it closes below the price of the valley between the two peaks (C), it breaks out and confirms the chart pattern as a valid big M. In this case, price pulls back to E before continuing lower.

Table 1.1 shows the identification guidelines for finding big Ms.

Table 1.1 Identification Guidelines

Rise. Price should rise quickly, often in a steep, straight-line run leading to the first peak. The move from A to B in Figure 1.4 shows an example of a typical move higher.

Avoid selecting potential big Ms with a rounded turn on the rise leading to the first peak. I show an example of that in Figure 1.5. BD is a double top, not a big M. The inset shows the difference between the two chart patterns.

• Avoid selecting potential big Ms with a rounded-looking turn leading to the first peak.

FIGURE 1.5 The ABCD pattern is a double top and not a big M because of the rounded turn leading to peak B.

The rise from A to B starts as a nice straight-line run, but it is not long enough when compared to the size of the drop from the first peak (B) to the valley floor (C). The AC price distance is shorter than CB.

For valid big Ms with peaks spaced months apart, the rise to the first peak is often more sedate (less vertical) than for big Ms with narrower peaks. Use common sense when looking for big Ms.

Height. The height of the big M is an important feature. Consider the big M in Figure 1.6. The launch price is at A1, and the stock flies up quickly to C1. The run is straight, almost vertical, not curved like that shown in the approach to A in Figure 1.5.

FIGURE 1.6 A swift move higher from A1 to C1 forms a big M pattern when price closes below B1 on the way to E.

Look at the inset of Figure 1.6. The horizontal line at B marks the valley floor between the two peaks of the big M. The price difference from A to B should be at least as big as the move from B to C.

The measure is like playing horseshoes or tossing hand grenades: close is what counts, but allow variations. On the stock chart, the price change from A1 to B1 is about the same as the change from B1 to C1.

Take care when comparing the move visually. The logarithmic price scale can make a visual examination difficult. Either switch to the linear scale or whip out your calculator and tabulate the price difference if it concerns you.

• Beware using a log scale when visually inspecting a chart pattern.

Twin Peaks. Price should form two peaks in the big M. The peaks can be any shape from gently rounded turns to needle-thin spikes. Both peaks should top out near the same price.

Breakout. A breakout occurs when price closes below the valley between the two peaks. In Figure 1.6, that means a close below the price of B1 as the stock drops on the way to E. When a breakout happens, it changes squiggles on a price chart to a valid big M chart pattern. If price first closes above the top of the big M (C1, the taller of the two peaks in this example) before confirmation (before price closes below B1), then you do not have a big M.

M Shape. Finally, look for the overall...