[[Start here]] → [[expose to return drivers|drivers]] → [[strong stocks beat weak stocks|momentum]] → VCP --- When share prices consolidate in a [[share prices exist in four stages|stage 2]] uptrend, it’s not unusual to see strong pullbacks that settle down into a range. Each pullback may become smaller than the last as the consolidation zone develops. The range narrows, volume dries up, and the chart sees a sequence of higher lows. These are very positive signs, and can be a precursor to the price breaking out on a large increase in volume. That whole sequence - is what the famous US trader **Mark Minervini** called the **Volatility Contraction Pattern (VCP)**. It’s his signature setup described in [[Minervini - Think and Trade Like a Champion|Think and Trade Like a Champion]][^1]. It’s built on a simple observation: **volatility drops when sellers are finished, and breakouts that follow are often the start of powerful uptrends.** ![[vcp-volatility-contraction-pattern.png]] ### Why it works Each pullback shakes out weaker holders, while buyers step in earlier if they feel they missed the bottom of the range on the last pullback. That shrinking range is effectively _pressure building_. When the breakout finally comes - often on much higher volume - it’s because there’s literally no supply left, and the buyers lose patience. The stock “jumps” upward, and the trend continues. ### What the research says Although Minervini’s term is new and the idea anecdotal, the mechanics around it are supported by lots of academic research. - **Trading-range breakouts can outperform.** Studies have show that simple breakouts can generate returns well above randomness[^2] - **Recognisable consolidations predict future gains.** Machine learning research showed that tightening chart patterns like triangles and wedges led to returns[^3] - **Volume confirms conviction.** When breakouts occur on heavy trading after a period of “volume dry-up,” future momentum is stronger and more persistent [^4] Even studies on **Bollinger Band squeezes** - another form of volatility contraction - find that compression alone doesn’t make money, but **a breakout after compression does**. The quiet phase sets up the power move. ### Rules of thumb 1. **Start with a prior uptrend.** The best VCPs occur in trending stocks. 2. **Wait for two or more contractions.** Each dip should be smaller than the last. 3. **Look for volume drying up.** If it starts shrinking below average, supply is low. 4. **Wait for the breakout.** Minervini likes to buy the breakout above the final, consolidation. 5. **Sell quickly if it fails.** ### Related notes - [[big jumps on earnings announcements predict future drift]] - [[momentum continues for three to twelve months]] - [[smooth trends beat volatile trends]] --- ### Sources [^1]: [[Minervini - Think and Trade Like a Champion]] [^2]: Brock, W., Lakonishok, J., & LeBaron, B. (1992). “Simple Technical Trading Rules and the Stochastic Properties of Stock Returns.” _Journal of Finance_, 47(5), 1731–1764. [^3]: Lo, A., Mamaysky, H., & Wang, J. (2000). “Foundations of Technical Analysis: Computational Algorithms, Statistical Inference, and Empirical Implementation.” _Journal of Finance_, 55(4), 1705–1765. [^4]: Lee, C., & Swaminathan, B. (2000). “Price Momentum and Trading Volume.” _Journal of Finance_, 55(5), 2017–2069. [^5]:Kumar, Lee, & Ng (2014). “Popularity versus Profitability: Evidence from Bollinger Bands.” [SSRN].