Technical traders are interested to know when the price of an asset is moving to take a position in the market. They recognise various chart patterns that capture price volatility. Broadening formation is one such chart pattern which captures rising volatility in the market. A broadening formation denotes increasing disagreement among investors, which result in the price registering simultaneously high and low. The upper and lower trend lines gradually move away from each other, creating a symmetrical triangle or megaphone shape.
Why is it important? The broadening pattern is a consolidation pattern and indicates a short-term trend reversal.
Consolidation is a market condition that refers to a situation of market indecision. The stock price moves within a tight range, means there are fewer trading opportunities until a new trend emerges. Broadening top formation, appearing in an uptrend, almost always indicates a near-term trend reversal.
The broadening formation occurs when the price continues to fluctuate, producing a series of higher highs and lower lows with steadily widening gaps. When occurring in an uptrend, it represents an unrealistic expectation of bullish traders.
Understanding Broadening Top Chart Pattern
Unlike other consolidation patterns, broadening pattern indicates higher volatility, when the market rallies to attend a higher high. But the rally is often shortlived. Instead, itsignifies higher volatility in price action with little or no direction. It reflects general disagreement between the buyers and the sellers. Price action indicates that buyers are willing to buy ata higher price, which results in interim highs. On the opposite side, sellers simultaneously grow eager to sell and book profit, reflecting lower prices. As a result, when these price points are connected, they form a wide triangle.
A strong disagreement between buyers and sellers can be random. Still, it can stem from more fundamental factors as well, like an impending election result or before a company earning is announced. In these situations, the market can feel extremely hopeful at times or passive on the other. Price bars will register both higher highs and lower lows on the price chart before the trend breaks into a new trend.To put it simply, broadening formation is a rare occurrence and doesn’t occur in normal market condition.
How to trade in broadening formation
broadening top formation is a reversal pattern that indicates the market to turn bearish. It signifies rising volatility in the market without a clear direction. Hence, only swing traders and day traders trade during the period to earn a small-term profit. Using technical charts and indicators to help them predict market moves, they would quickly open and close several positions to capitalise on the short-term asset price movement.
The discrimination between the top and bottom of the broadening formation indicates a higher profit with each move. A swing trader would enter the market when the price hits the low and exit when it rises. A converging triangle pattern doesn’t present such trading opportunities.
Day traders and swing traders enter the market when the price line breaks out of the top pattern boundary to trade in an uptrend. When traders trade in such volatile market condition, they need to put tight stop-loss and take profit limit to avoid market adversities. In the case of broadening formation, a swing trader entering the market will place the stop-loss limit tightly at the breakout price.
Broadening formation results from market hyperactivity, marked by wide price fluctuations and increasing volume, that occurs atthe market top. It is a rare pattern that occurs when price action is unpredictable. It is a reversal pattern formation comprising one line connecting three successively higher peaks and another one joining the two lower lows, which gives it the distinctive shape.
General investors perceive broadening formation as a bearish reversal, but high price volatility opens trading opportunities for swing traders and day traders.