DEFINITION of 'Broadening Formation'

A broadening formation occurs during high volatility when a security shows greater movement with little direction. It can be identified by a series of higher pivot highs and lower pivot lows. When connecting these highs and lows, the trend lines form a widening pattern that looks like a megaphone or reverse symmetrical triangle. The chart below shows an example of a classic broadening formation.

Broadening Formation

Also, known as a megaphone pattern.

BREAKING DOWN 'Broadening Formation'

Broadening formations occur when a market is experiencing heightened risk over time. For example, many countries experience broadening formations due to heightened political risk ahead of an upcoming election. Different polling results or candidate policies may cause a market to become very bullish at some times and very bearish at other times. Broadening formations may also occur during earnings season when companies may report differing quarterly financial results that result in bouts of optimism or pessimism.

These formations are relatively rare during normal market conditions over the long-term, since most markets tend to trend in one direction or another over time. For example, the S&P 500 has consistently moved higher over the long-term. The formations are more common when looking at shorter timeframes, however, such as monthly, weekly, or daily price charts where trends are less pronounced.

Profiting from Broadening Formations 

Broadening formations are generally bearish for most long-term investors and trend traders since they are characterized by rising volatility without a clear move in a single direction. However, they are good news for swing traders and day traders, which attempt to profit from volatility rather than relying on directional movements in a market. These traders rely on technical analysis techniques, such as trend lines or technical indicators, to quickly enter and exit trades that capitalize on short-term movements.

For example, a swing trader may identify and broadening formation and enter long positions when the price hits a lower trend line and/or short positions when the price hits an upper trend line. The widening of these two trend lines means that the potential profit for each swing trade is higher than if the trend lines were converging (as in a symmetrical triangle) or parallel (as in a price channel). In addition to looking at trend lines, these traders may look toward momentum indicators to identify the likelihood of a short-term reversal.

Day traders tend to see these patterns more often as well since they are focused on shorter timeframes than other traders, where broadening formations tend to be more commonplace.

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