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The Volatility Contraction Pattern, heavily touted by Mark Minervini and other traders, is similar to the Darvas Box Theory in wanting to find stocks that have recently pulled back from all time new highs, consolidation occurs, and we look to enter on the breakout of the consolidated area. Here is one example of the VCP method, but it is best explained by Mark in his book 'Trade Like a Stock Market Wizard' (Scroll to the link at the bottom of Fintwit).
The best explanation of this phenomenon:
Price rose significantly, typically during Stage 2, and reached ATH or a new high.
Institutions decided to sell to lock in profits
As the pullback occurs, retail sellers often are scrambling to lock in their profits
Those that did not lock in their profits early often wait until the next rise to close their position which sends the stock down again. This process continues several times causing a stock to continually be pushed down with more sellers. You might recognize this concept as a double top pattern.
VCP's can take weeks, months, and in some cases years to form before a continued and sustained rise
At some point, there are fewer and fewer sellers and price will begin to rise as institutions start to rebuy into their positions
There will be many shakeouts with stop losses being hit to assure that there are only buyers and more shares available for institutions
Shakeouts occur when people place tight stop losses right below previous resistance points. You will learn about this in Broadening Candle Formations as a part of the SSS50% Rule and how we take advantage of these moves.
Below are some of the many patterns the VCP that you should be able to recognize. The farther right we move, the greater the strength of our move at our pivot point. It is common that each drop is often significantly less than the previous letting us know that sellers are slowly moving out.
Similar to the Cup and Handle Formation, Darva Box Theory, Broadening Candle Formation
We are looking for a stock coming off of a 52-week high (ATH) and on a pullback
Essentially, our pivot point will likely be near the ATH, though it could happen below that point, but will need to go through several pullbacks to shakeout sellers from the market
We look for high areas of consolidation
If it looks like each drop creates a new low, then you are in way too early
We are looking for basing and drops with higher lows
Remember, this could last weeks, months, or even years
Large spikes will often be short lived
Many bag holders and new sellers will enter to take their profit or in some cases break even
A new pullback will occur to begin the next T
We would like to see each drop being 50% less than the previous drop
In this time, we are looking for consolidation at each new level at potential entries
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