A broadening formation is an example of a consolidation pattern and a highly useful tool in the prediction of the likelihood of a reversal in the direction of a current trend. When found in an uptrend it indicates not a continuation of that trend, but a near-term reversal of the price action.
The broadening formation occurs when the fluctuation within the price produces a series of higher highs and of lower lows that steadily widen over time and are generally thought to be found only in found in topping formations where they are considered to be the result of unrealistic expectations of bullish investors.
Unlike the majority of other consolidation patterns, broadening formations feature increasingly wide ranges and are subject to much greater levels of volatility as time passes. Volume levels increase as the share price rises, which although normally indicates bullish position rallies in this instance usually prove to be very short-lived and the following declines are prone to decimating former support levels leading to an eventual collapse.
Profiting from Broadening Formations
Broadening formations might worry long-term investors and trend traders because they bring more uncertainty without a clear direction for the market. However, they’re good news for swing traders and day traders who aim to profit from market ups and downs instead of hoping for the market to move in one direction. These traders use technical analysis tools like trendlines or indicators to make quick decisions about when to enter or exit trades based on short-term movements.
For instance, a swing trader might spot a broadening formation and decide to buy when the price hits a lower trendline or sell short when it hits an upper trendline. The wider the gap between these trendlines, the bigger the potential profit for each trade compared to the previous one. This is different from patterns where trendlines converge (like in a symmetrical triangle) or stay parallel (like in a price channel).
Besides trendlines, these traders also look at momentum indicators to guess if the market might change direction soon. Day traders especially notice these patterns more because they focus on short time frames, sometimes just minutes or hours, where broadening formations happen more frequently.