|No trend lasts forever. Inevitably, crowd enthusiasm
outpaces a stock's fundamentals and rallies stall. But
topping formations do not end uptrends all by
themselves. These stopping points may only signal short
pauses that lead to higher prices. Then again, they
could be long-term highs just before a major breakdown.
||What hidden patterns can you use to identify and trade
reversals before your competition sees them? Successful
short-term traders get in the reversal door early and
allow the herd to trigger sharp price movement. Familiar
trend-change formations, such as the Head & Shoulders
and Double Tops, take so long to develop that many
profitable entries pass before they finally signal an
impending break to the waiting crowd.
|First Rise/First Failure offers traders an early method
to identify reversals following new highs or lows in any
time frame. FR/FF identifies the first 100% retracement
of a dynamic trend move within the time frame of
interest. In order for any trend to continue, price
movement should find support near a 62% retracement,
measured from the starting point of the last thrust that
pushed price to the new high or low. From this pullback,
trend must base and test its extension before it can
break out to further continuation highs or lows.
rings a loud bell. Note how the uptrend line
broke on the same bar as the violation of the
62% fib retracement following this late 1998
AMZN explosion. The familiar triangular shape of
First Rise-First Failure makes identification
easy when flipping through many price charts.
100% retracement violates the major price direction
and terminates the trend it corrects. Completion also
provides significant support/resistance, where bounce
trades can be initiated with low risk. From this point,
continuation trends may reawaken in the next larger time
frame by a new break through the 38% (prior 62%) S/R and
continued push past the 62% retracement, toward a test
of the high/low extension.
Bounce reversals represent superb entry points when the
100% violation coincides with a 38% or 62% retracement
of the next higher dynamic time frame. However risk:
reward requires careful measurement, as the trade may
develop more slowly than expected. In other words, a
successful position must be held through expected
congestion at the 38%-62% zone before it can access a
profitable retest of the double top/double bottom
Allow minor testing violations for all major Fibonacci
retracements before taking positions. Specialists and
Market Makers know these hidden turning points and
conduct stop-gunning exercises to take out volume just
beyond the breaks. And watch out for trend relativity
errors. Bull and bear markets exist simultaneously
through different time frames. Limit FR/FF trades to the
time frame for which the retracement occurs unless
cross-verification supports other setups.
Every popular topping formation has its own unique
pattern features. But all tell a common tale of crowd
disillusionment. Whether printed in the manic highs and
lows of the Head & Shoulders or the slow capitulation of
the Rising Wedge, the final result remains the same.
Price breaks sharply to lower levels while unhappy
shareholders unload positions as quickly as they can.
Early in a rally, value and improving fundamentals
attract knowledgeable holders. But as an uptrend
develops, the motivation for new participants becomes
vastly different. News of a stock's rise generates
excitement and attracts a greedier crowd. These momentum
players slowly outnumber the value investors and stock
movement becomes more volatile. The issue continues
upward as this frantic buying crowd feeds on itself well
beyond most reasonable price targets.
Both fire and ice will kill uptrends. As long as the
greater fool mechanism holds, each new long allows the
previous one to turn a profit. Eventually changing
conditions force a final end to the upside action. A
shock event can suddenly kill the buying enthusiasm,
forcing a sharp and immediate reversal. Or the trend's
fuel just runs out as the last interested buyer enters
one last position.
Many traders mistakenly assume bulls turn into bears
immediately following a dramatic, high volume reversal.
They enter short sales well before the physics of
topping and decline rob the crowd of its momentum. In
fact, these early shorts provide fuel for the sharp
covering rallies seen in most topping formations.
Skilled traders wait and measure the process of crowd
disillusionment before they enter large short sales.
Decline characteristics can be predicted with great
accuracy using pattern analysis. While they wait, the
repeating character of the topping event provides a
natural playground for swing positions.