Technical Analysis – ABC Down Formation

ABC Down Formation is a technical analysis formation used not only to predict entry and exit points on a trade, but also to determine potential targets. Knowing stock target helps us determine risk/reward ratio. One can not determine risk/reward ratio without knowing, or having some idea where the targets are. We could know the risk based on where we plan on establishing the stop, but how much is our reward?

In this article we will discuss ABC Down formation. I first heard about this formation from Tom O’Brien, of Tiger Financial News Network. Now I am not saying he is the inventor of this technical analysis pattern, or the very first one to ever use it. All I am saying that I have heard him explain it first.

OK now, let’s get into discussing the Abc Down Formation. You take a chart of any security you’d like. Be it forex, index, etf, futures chart, and find a point where the stock started declining and has declined for a period of at least 3 bars. You are looking for the “bounce.” The first point in that chart will be the “A” point. The low point, just before the bounce, is your B point. You take Fibonacci retracement tool on your stock charting program, and you drag the Fibonacci retracement to the “B” point on your chart. This will draw 23.6%, 38.2%, 50%, and 61.8% retracement levels on the chart (Retracement levels drawn can vary depending on your stock charting software). During the bounce, the high point, before the stock starts to decline again, is your “C” point. That “C” point should not be higher than 50%. Ideally, we are looking for this to be between the 38.2% and 50%. We call this area “Confluence Level.” if the retracement level is between 38.2% and 50% the chances of the last leg of this formation being equal to the first leg of the formation (C-D will equal the A-B), are greater than 70%.  Here is a chart of what I am suggesting…

One Important part you have to pay really close attention to is the Volume. While the stock is going down, we need to see heavy volume, as highlighted on the first portion of the chart (Red/Pink). As the stock is bouncing, (the green highlighted area), the volume is decreasing, and then the third part, as the stock breaks the “B” point on the chart, the volume is increasing. The volume is extremely important in this technical analysis pattern. Without proper volume confirmation, we can not consider this to be a valid formation, and thus should not be trusted to trade.

I am not suggesting that t the stock will not complete an ABC-Down formation even if the pattern is not confirmed with volume. Noone can predict what can happen with 100% accuracy, but in order for this pattern to be confirmed, it has to be confirmed by the volume as well.

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