Volatility Contraction Pattern (VCP): A Trader’s Guide to VCP Trading
The Volatility Contraction Pattern (VCP) is a trend-following setup used to identify high-probability breakout trades. It was coined by Mark Minervini, and it finds stocks with contracting price ranges and declining volume that can lead to an explosive breakout. Minervini used the VCP setup to win two U.S. investing championships, including an audited return of over 334% in 2021.
This article explains the VCP meaning, how to trade it, and how to use TrendSpider’s VCP scanners to automate the process of trading it.
Key Takeaways of the Volatility Contraction Pattern
- The VCP is a trend-following breakout strategy coined by legendary trader Mark Minervini.
- Mark Minervini scans for VCP patterns from his Trend Template criteria.
- You can use TrendSpider’s Trend Template scanner, VCP scanner, and VCP breakout scanner to automate the process of finding and being alerted to high-volume breakouts.
What is the Volatility Contraction Pattern (VCP)?
The Volatility Contraction Pattern (VCP) is a price pattern as a stock’s price fluctuates and contracts in volume over time, and eventually breaks out. Made famous by Mark Minervini in “Think and Trade Like a Champion”, VCP still holds good in its “line of least resistance,” where relief from selling pressure is a precursor to a follow-through spurt when buying gets the upper hand. This is a timeless classic of the Mark Minervini trading strategy, perfect for high-reward, low-risk traders.
How to Identify a Volatility Contraction Pattern
To recognize a VCP pattern, a stock has to meet the Trend Template criteria set by Mark Minervini, which define a strong uptrend. Some of the main features of a VCP pattern are:
- Long-Term Uptrend: The stock has to be in a very strong, stable upward cycle, which is generally the result of buying from an institution.
- Base Formation: The stock slows down, producing a consolidation base with 2-6 pullbacks and every next one being smaller than the previous one (e.g., 20%, 10%, 5%,) and therefore new lows and highs are created.
- Declining Volume and Volatility: As price ranges get smaller, volume decreases, which is a sign that the selling pressure is less than before.
How to Trade the VCP
Traders need to use a certain level of control and accuracy while dealing with the VCP:
- Entry: Open a long position when the highest resistance of the consolidation pivot is broken by a high-volume line, thus confirming a strong demand.
- Stop-Loss: Set a close stop-loss below the prior contraction’s low to limit risk.
- Exit: Sell into strength as the stock rises, scaling out or adjusting stop-losses upward to lock in gains.
This method is based on VCP’s good risk-to-reward ratio, which is a signature of Minervini’s strategy.
How to Scan for the VCP Pattern
TrendSpider’s volatility contraction pattern screener makes it simple to locate VCP configurations. The scanner locates the stocks whose prices have become more constrained and volume has declined, while the VCP breakout scanner identifies the stocks that surpass their pivot points, thus allowing the best entry time. Such scanners not only save time but also automate the process of finding entry points.
To get a complete understanding of the scanners, watch this live webinar:
Using Mark Minervini’s Trend Template
Mark Minervini’s Trend Template is a stock filter for VCP analysis that verifies the trend is positive. The main requirements are:
- Relative Strength (RS) above 70: The stock should be outperforming at least 70% of the market.
- Price above the 50-day, 150-day, and 200-day SMAs: This confirms that the stock is trading above key short, intermediate, and long-term trend levels.
- 50-day SMA above the 150-day and 200-day SMAs: Shows that the short-term trend is stronger than the longer-term trends.
- 150-day SMA above the 200-day SMA: Confirms that the intermediate trend is stronger than the long-term trend.
- Price at least 30% above its 52-week low: Ensures the stock has recovered strongly from past lows.
- Price within 25% of its 52-week high: Suggests the stock is trading close to its highs, with limited overhead resistance.
- 200-day SMA higher than 30 days ago: Confirms the long-term moving average is rising, showing sustained upward momentum.
The TrendSpider Trend Template scanner is the tool to find those stocks that satisfy the above conditions, and hence it provides an excellent starting point for VCP setups.
FAQs About the VCP Pattern
What is the VCP Pattern?
The VCP pattern is a visual representation of the market where price volatility and volume shrink, indicating a possible breakout with impressive upper side potential.
Who created the VCP trading strategy?
Mark Minervini, a U.S. investing champion and author of Think and Trade Like a Champion and Trade Like a Stock Market Wizard, developed the VCP strategy. He used the strategy to generate an audited return of over 334% in the 2021 U.S. Investing Championship.
How do you trade the VCP breakout?
Trade the VCP breakout by entering on a high-volume move above the pivot point, setting a tight stop-loss below the last contraction, and selling into the uptrend.
