How to trade the Volatility Contraction Pattern

The Volatility Contraction Pattern, (VCP) is a famous trading pattern identified and dissected by Market Wizard, Mark Minervini. The premise of the pattern is that stocks in long term up trends will pause and consolidate as some holders exit their positions and the stock is accumulated again by buyers in the market. The chart pattern can provide opportunities for powerful break outs and can be used across any time frame. This allows traders to jump in on potential moves before they explode.

Mechanics of the pattern

The background of the pattern is relatively simple. The stock has been previously rising in an uptrend and has found some resistance. It then moves into a period of consolidation categorised by 2-6 retracements with each one being smaller than the previous one. The volume should usually be decreasing as the chart moves to the right. The pattern culminates in a powerful break out that can often be long lasting.

The key for this pattern is that there needs to be a contraction of volatility as the chart moves from the left to the right. This highlights that the volume available is decreasing and becoming scarce. In addition, the more dramatic in volume, the more likely that the move will be explosive. Below the breakout is accompanied by an increase in the relative volume.

In the chart below for Natural Gas, the decrease in volume can be associated with the contracting candlestick pattern. This occurs prior to the break of the long-term resistance. The breakthrough was also associated with a large amount of buying volume.

The VCP can manifest itself in other patterns such as a cup and handle patterns. The key is that the candlesticks must be decreasing volatility.