What is a 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 trendlines form a widening pattern that looks like a megaphone or reverse symmetrical triangle. The chart below shows an example of a classic 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 points and very bearish at other points. Broadening formations may also occur during earnings season when companies may report differing quarterly financial results that can cause 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, 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, who attempt to profit from volatility rather than relying on directional movements in a market. These traders rely on technical analysis techniques, such as trendlines or technical indicators, to quickly enter and exit trades that capitalize on short-term movements.
For example, a swing trader may identify a broadening formation and enter long positions when the price hits a lower trendline and/or short positions when the price hits an upper trendline. The widening of these two trendlines means the potential profit for each swing trade is higher than if the trendlines were converging (as in a symmetrical triangle) or parallel (as in a price channel). In addition to looking at trendlines, 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.