Chapter 11: Five-Point Patterns

Using Bollinger Boxes to construct point-and-figure charts frees one from the artificial barriers created by the boundaries where box size is changed. This is obviously easier to do by computer, but then almost all technical analysis is computerized these days.3

Having developed an ideal approach to filtering stock prices, we may now proceed to categorizing the arising patterns. The first attempt to systematically categorize price patterns was made in 1971 by Robert Levy. He used five-point patterns delineated by price swings governed by each stocks volatility in his categorization and then tested those patterns for significance. Though he was unable to discover any significant forecasting power,4 he left behind a powerful tool, the five-point categorization.

This approach lay dormant for 10 years until Arthur A. Merrill picked it up and published positive results in the early 1980s. He used the same five-point approach, but used an 8 percent filter instead of Levys volatility filter. He ordered the patterns into two groups, 16 patterns with the general shape of a capital M and 16 with the general shape of a capital W.5

Merrill categorized the patterns by the sequential order of the points from high to low, creating an orderly taxonomy of Ms and Ws. An Ml is a strongly falling pattern, the middle patterns M8 and M9 are flat patterns, and an M16 is a strongly rising pattern (Figure 11.10). Likewise a Wl is a falling pattern, the middle Ws are flat, and a W16 is a rising pattern (Figure 11.11).

You also will find these patterns on the inside of the reference card bound into the back of this book. Merrill went on to show that some of these patterns had forecasting implications on their own. See his book M&W Wave Patterns for further information. Merrill also categorized some of the patterns according to the traditional names used by market technicians (see Table 11.3).

Where Merrill used a fixed-percentage filter, Levy used volatility to filter the patterns. We favor a combination of the two, Bollinger Boxes for filtering the swings and volatility for projecting the subsequent moves. Indeed, this approach lies at the core of our institutional trading platform, PatternPower, www.PatternPower.com.

One important aspect of M and W patterns is that they can be clarified using Bollinger Bands and indicators. In the following two chapters (Chapters 12 and 13) well consider Ms and Ws

Part III: Bollinger Bands on Their Own

-!---*7

--J V ).7. - .

l i i i il

• 0

i/ \ A i

J i i i il

1 LX L- i i i i

~ j ! 7 I

<* ---i-

J i J i l

• •

l I I I L

1-1-1-1

j i i i

i-1-1- "

. .--!--!-;---!.

i I I I L

Figure 11.10 Arthur Merrills M patterns, (source: M & W Wave Patterns by Arthur A. Merrill, Chappaqua, N.Y.: Analysis Press, 1983.)

-r-1-j- -

i ft I

I LAI

. . . v.

-I-1-1-1-1-I I-

l I I l

1-1-1-1

::

. . T .

j-.j-LAI-.J,

i-i-i-i

* ! i i i i

* I 1 J

" i ri" V/ f- \ * 7 -

t-I-1-1

Yffz

*"T v/- ---

J I I l

i I I i

i-1-1-

J I I l

n-1-1-r~

l I I I L

i i / i / i I -. /

l I I I l

h-1-1-1

I \ 7

I- -

i i i i i 11 i i

-1-1-1-1-

/ j

- - 4 J

J I I L

1-1-1-r-

f1 I/ -i-T ,I 2JJ--L--j-J.

Figure 11.11 Arthur Merrills W patterns, (source: M & W Wave Patterns by Arthur A. Merrill, Chappaqua, N.Y.: Analysis Press, 1983.)

Chapter 11: Five-Point Patterns 95

Table 11.3 Merrills Categorization of M and W Patterns

Technical Patterns Merrills Patterns

Uptrends M15, M16, W14, W16

Downtrends Ml, M3, Wl, W2

Head and shoulders W6, W7, W9, Wll, W13, W15

Inverted head and shoulders M2, M4, , M8, M10, Mil

Triangle M13, W4

Broadening M5, W12

separately, as they are quite different in character, and show you how to combine them with Bollinger Bands to increase your forecasting accuracy. Finally in Chapter 14 well add indicators to the mix.

KEY POINTS TO REMEMBER

Price filters can be used to filter out noise and clarify patterns.

Percentage filters are best for stocks.

Bollinger Boxes offer a superior filtering approach.

All price patterns can be categorized as a series of Ms and Ws.