Traders would love to know what will happen to price after buying a stock. No one knows with certainty, of course, but a study of chart patterns can provide an idea. Let’s consider upward breakouts first.
Figure 1 shows a broadening top chart pattern that formed in early 2011 (bounded by green trendlines). The stock doesn’t break out of this broadening pattern immediately. Instead, price forms another chart pattern — an ascending triangle, outlined in red. At point A, price breaks out of the ascending triangle on unremarkable volume. The chart inset zooms in on this price action; the breakout is at D, with the associated volume bar at E.
If you identified the ascending triangle in time and placed a buy order a penny above the pattern’s upper (horizontal) trendline, the upside breakout would have triggered a long entry. What happens to price now? It continues moving higher for five more days (six, counting the breakout day) before peaking. Traders who wanted to buy on the breakout have done so. Who remains to buy the stock and keep price moving higher?
The stock answers that question by “throwing back” to the top of the chart pattern, bottoming at B. Those not lucky enough to buy on the breakout or those waiting for the throwback are given another opportunity to buy the stock. That buying demand overwhelms selling pressure and sends the stock higher. It resumes the uptrend, pushing the stock to point C and beyond.
The move to B is a throwback. By convention, a throwback fulfills the following criteria:
1. It occurs after an upside breakout from a chart pattern.
2. Price moves up for a time and then returns to, or comes close to, the chart pattern boundary or breakout price.
3. Step 2 should leave “white space” (F in Figure 1) to distinguish cases where price just slides along the chart pattern boundary.
4. Price must complete step 2 within a month (price usually begins throwing back within a week).
A study of throwbacks helps define what happens after the breakout.
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