Recognizing Reversal Signals
Throw a baseball straight up into air. As the ball approaches the top of
its projectile path it will decelerate to a speed of zero, and then
reverse downward picking up speed as it approaches the ground.
Now imagine yourself drilling into a piece of wood. You suddenly hit a
hard spot in the wood at which time bear down with all of your might
to overcome the temporary resistance created by the knot in the
wood.
When you penetrate the knot you surge forward and quickly poke
through to the other side. These are two analogies to help explain
the patterns of stocks as they transition between one move and the
next move.
When a stock is completing a move, it experiences a period of
deceleration, which is referred to by chartist as price consolidation.
Consolidation is one of the most important signals that a stock is about
to begin a new move.
The move can be a continuation in the same direction, or it can be a
reversal in the opposite direction.
The area of consolidation represents a battle zone where the bears are
at war with the bulls.
The outcome of the battle often defines the direction of the next move.
As short-term traders, it is important to identify these areas of
consolidation and enter a trade just as the new move is beginning.
During the consolidation period or 'battle zone', traders, both long and
short are patiently waiting on the sidelines watching to learn the
outcome of the battle.
As these winners emerge, there is often a scramble of traders jumping
in with the winning team.
The candlestick patterns gives the trader excellent clues on when this
move is about to take place, and helps the trader time his entry so
that he can get in at the very beginning.
There are four different consolidation patterns experienced by stocks.
They are 1) Bearish Continuation, 2) Bullish Continuation, 3) Bearish
Reversal, 4) Bullish Reversal.
The Bearish Continuation Consolidation Pattern
Several strong bearish candlesticks precede the Bearish Continuation
pattern where the bears are clearly in control (Figure 12).
The bears and bulls then begin to battle by pushing the stock up and
down in price in a tightly formed consolidation zone.
The narrowing size of the candlesticks toward a line of support
indicates that the bears are winning the battle.
The bulls finally weaken and allow the bears to penetrate the line of
support, at which time the bears quickly conquer new territory by
taking the stock to lower prices.
By recognizing the consolidation pattern the trader is able to short the
stock just after the stock breaks the line of support, and profit from
the sharp move downward.
The cause of the sharp sell off is fueled by the emotions of the traders
watching for the outcome of the battle. Traders who bought the stock
in the area of consolidation in hope of a rally off of support, are now
scrambling to exit their losing positions.
Traders who are short from the period before the area of consolidation
are realizing that their original entries were correct and are adding to
their winning positions.
Figure 12The Bullish Reversal Consolidation Pattern
Several strong bearish candlesticks precede the Bullish Reversal
Continuation pattern where the bears are clearly in control (Figure 13).
The bears and bulls then begin to battle by pushing the stock up and
down in price in a tightly formed consolidation zone.
The narrowing size of the candlesticks toward a line against upward
resistance indicating that the bulls are winning territory from the
bears.
The bears finally weaken and allow the bulls to penetrate the line of
resistance, at which time the bulls quickly conquer new territory by
taking the stock to higher prices.
By recognizing the consolidation pattern the trader is able to buy the
stock just after the stock breaks the line of resistance, and profit from
the sharp move upward.
The cause of the rally is fueled by the emotions of the traders
watching for the outcome of the battle.
Additional traders who jump in to buy the stock now that its strength
has been confirmed fuel the sharp upward move.
Traders who are currently short the stock in the area of consolidation
waiting in hope of a breakdown, are now scrambling to cover their
short positions.
This buying action also fuels the fire pushing the stock to higher
prices.
Figure 13The Bearish Reversal Consolidation Pattern
Several strong bullish candlesticks precede the Bearish Reversal
Continuation pattern where the bulls are clearly in control (Figure 14).
The bears and bulls then begin to battle by pushing the stock up and
down in price in a tightly formed consolidation zone.
The narrowing size of the candlesticks toward a line of support
indicates that the bears are winning the battle.
The bulls finally weaken and allow the bears to penetrate through the
line of support, at which time the bears quickly conquer new territory
by taking the stock to lower prices.
By recognizing the consolidation pattern the trader is able to sell short
the stock just after the stock breaks the line of support, and profit
from the sharp spike downward.
Additional traders who jump in to short the stock now that its
weakness has been confirmed fuel the sharp sell off.
Traders, who are currently long the stock in the area of consolidation
waiting in hope of a breakdown, are now scrambling to sell their long
positions.
This selling action also fuels the fire pushing the stock to lower prices.
Figure 14The Bullish Continuation Consolidation Pattern
Several strong bullish candlesticks precede the Bullish Continuation
Consolidation Pattern where the bulls are clearly in control (Figure 15).
The bears and bulls then begin to battle by pushing the stock up and
down in price in a tightly formed consolidation zone.
The narrowing size of the candlesticks toward a line of resistance
indicates that the bulls are winning the battle.
The bears finally weaken and allow the bulls to penetrate the line of
resistance, at which time the bulls quickly conquer new territory by
taking the stock to higher prices.
By recognizing the consolidation pattern the trader is able to buy the
stock just after the stock breaks the line of resistance, and profit from
the sharp move upward.
The cause of the sharp sell off is fueled by the emotions of the traders
watching for the outcome of the battle.
Traders, who shorted the stock in the area of consolidation in hope of
a sell off in the area of consolidation, are now scrambling to exit their
losing positions.
Traders who are long from the period before the area of consolidation
are realizing that their original entries were correct and are adding to
their winning positions.
Figure 15
No comments:
Post a Comment