Trading megaphone patterns

Applying classic chart patterns to current trading opportunities

Megaphone patterns were first described in Richard Schabacker’s 1932 book: “Technical Analysis and Stock Market Profits,” as rare and intricate patterns. Megaphone patterns are considered both reversal and continuous patterns and usually appear at major market tops and bottoms. This pattern may be also called an “Inverted Symmetric Triangle” pattern or “Broadening” pattern and usually develops after a strong up or down trend in the stock price.

Megaphone pattern formations have five distinct swings. Each swing is larger than the previous swing, which gives the formation its megaphone appearance. The key swing points in the megaphone pattern are structured with lower low troughs and higher high peaks and are connected by two diverging trendlines. Each of these swings may also include small minor swings. The key swings of the pattern are the first and the fifth swings, which show the reversal of major direction prior to the formation of the pattern. Another unique characteristic of Megaphone top/bottom patterns is that each swing’s increasing volatility triggers the reversals of upside and downside swings.

Key pattern characteristics

Fibonacci Ratio-based Swings: Most geometric trading patterns exhibit Fibonacci ratio relationships in their swings. By that, each swing has a Fibonacci ratio relation to prior swings. Megaphone patterns exhibit this characteristic as each of its swing has a 1.27 to 1.62 extension ratio of prior swings in price and time.

Megaphone Wedges: Megaphone patterns form with slightly angled trendlines, both in the same up or down direction, connecting the tops and bottoms. These are called “Megaphone wedges.” They may be also classified as a “Megaphone Ascending Wedge” or a “Megaphone Descending Wedge.” Megaphone wedges have similar characteristics to conventional wedges, but form near market tops and bottoms and have high reliability. After completion of wedges, breaking out of the upper or lower trendlines broadening wedge patterns become very volatile.

Megaphone Failures: Megaphone patterns are highly reliable but not infallible. The longer the timeframe it is based on, the stronger the signal. Like most pattern failures, megaphone pattern failure moves are explosive in the opposite direction. A critical area of retest and failure is the mid-channel line. In many cases of failure, the rally/decline stops at the mid-line and retests the prior trendline. Usually, the failure occurs on the last swing before a clear breakout/breakdown occurs.

Trading Megaphone Patterns

Megaphone patterns present two trading opportunities: Trading the breakout as a megaphone continuous pattern and trading the reversal as a megaphone reversal pattern. Trades are placed after price reverses from the 5th swing pivot level.

To trade a megaphone breakout pattern as a continuation of its up-trend, trades are taken in the direction of the breakout/breakdown from the pattern (see “Breaking out,” below).  When a price bar closes outside the pattern (above upper trendline) in the direction of the breakout/breakdown, a long trade is triggered.

When price reaches the 5th swing point and fails to continue higher (as a breakout), a megaphone pattern may be presenting an opportunity to short on its reversal (see “Failure to launch,” below). Once price starts to decline from the 5th swing point, wait for prices to close below the 3rd swing and enter a short trade.

Price Targets

The price targets in a megaphone breakout pattern are computed using the Fibonacci ratio of the pattern height (vertical distance) added from the breakout levels.  The price targets for the Megaphone reversal pattern are the midpoint of the pattern and the area between the 4th swing and lower trendline. Historically, this would be the widest part of the pattern and is a very profitable target.

When trading Megaphone pattern breakouts, the “third swing high or low” and the “mid channel point” in the pattern are the critical points and trades should be protected with a stop at these levels. When trading the reversal, the stops should be placed outside the trendline above the 5th swing point.

Example 

Priceline Group (PCLN) stock has completed the 5th pivot of a megaphone pattern but has not yet signaled a continuation or reversal pattern. Priceline stock rose from a low of $45 in 1998 to a recent high of $1,600, a 3,400% increase. Currently, it made three swing highs and two swing lows in a steep uptrend.  As of this writing both options are still available so we will present options for both scenarios. 

Trading PCLN breakout: 

  1. If the price trades above the $1,601 at the 5th swing pivot, a megaphone breakout pattern is initiated signaling a continuous trend higher.
  2. Enter a long trade above the high of the bar that closed above $1,601.
  3. Place a stop near the 3rd swing high ($1,475).
  4. The height of the Megaphone pattern is $650. 
  5. Targets are placed at 62% and 79% of its height computed from the breakout level.

Trading PCLN reversal 

  1. If the price fails to break out and trades below the 3rd swing high ($1,475), PCLN is signaling a short trade.
  2. Enter a short trade below the 3rd swing high ($1,475).
  3. Place a stop above the 5th swing high ($1,601).
  4. Targets are placed at the mid-point of the pattern ($1,200) and near the 4th swing low to the down-trendline ($900-$950). 
About the Author

Suri Duddella