This is a reversal pattern that forms after excessive speculation which drives prices up too far too fast. It was developed by Thomas Bulkowski and it can be found in his recently published book, the Encyclopedia of Chart Patterns shown in the Analysis book section.
During this pattern, there are three distinct phases: lead-in, bump, and run.
Support Turns Resistance – Once the trend line is broken there can be a retracement that tests the new resistance level.
This chart pattern can be applied to multiple time periods from a daily all the way to monthly charts. These patterns are loved due to the fact that they mainly help to identify speculative advances and if the price rise is very steep then the reversal can be just as ferocious.This is one of my favorite patterns due to its high probability but the entry point is critical and it can sometimes be easier to be slightly late than early.
Lead-in Phase – The first part of the pattern would be an upward trend that can last 1 month or more. This forms the basis of the first trend line. During this time, you see an orderly advance in price which should be moderately steep but the steeper the pattern the after bump will be too small to make sufficient games. If the trend is not steep enough, then the broken line will occur too late to profit from the pattern. Bulkowski recommends an angle of 30-45 degrees but most of the time it can be done with just a quick visual assessment.
Bump Phase – This forms with a sharp advance as prices move further ahead of the trend line. Ideally, you will want the bump to be about 50% greater than the angle of the trend. Using this you will want the bump trend line to be anywhere from 45-60 degrees.
Bump Validity – It is very important that the bump represents a speculative advance that goes beyond the trend which cannot be sustained for a long time. Bulkowski developed a measuring technique to validate the level of speculation. The distance from the highest high of the bump phase to the lead-in trend line should be at least twice the distance from the highest high in the lead-In phase to the lead-in trend line.
Bump Rollover – After the initial jolt of speculation it will form a peak and the top part of the pattern forms. As in the example above you have a series of descending peaks but you can also see other top formations such as double tops.
Volume – During the first part of the trend the volumes are normal but you would expect to see a large increase in volume during the initial bump.
Run phase – This phase begins when the pattern breaks through the support from the lead-in trend line. You will find the price can bounce off this trendline before breaking through as shown in the screenshot below. Once the break has taken place the run phase is now in effect.
The run then turns into a reverse of the pattern with a strong trend line followed by a reverse bump.This is then followed by a reverse back to the original trend line.
In the below chart of GBPUSD back in June we have a strong bull trend with Sterling rising in value along the trend line. There is then a move away from the trend line during the exuberance phase of the pattern lifting at a much steeper angle.Once the point of exhaustion has been reached the market trades sideways creating a short double top formation. The price then falls back through the original support line where an entry point can be placed. Some may prefer to wait for a retesting of the break line before entering the trade. Due to the type movement, it can lead to a drop of up to 50% of the original trend giving a strong risk-reward ratio.