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Uncharted
Territory
| When a stock breaks to new highs, how can you tell
how long the rally will last? In astronomy, scientists
understand why the star that burns brightest
extinguishes itself long before one emitting a cooler,
darker light. So it is with market rallies. Parabolic
moves cannot sustain themselves over the long haul.
Alternatively, stocks that struggle for each point of
gain eventually give up and roll over. So logic dictates
that the most durable path for continued uptrends lies
somewhere in-between these two extremes.
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New high trends may end in a few bars or last for years.
But as impulse and reaction carve out the uncharted
territory, familiar features start to emerge. Elliott's
Rule of Alternation offers one important lesson when
rallies thrust upward into new prices. He notes that
congestion patterns formed between rally impulses tend
to alternate between simple and intricate shapes. And
complex congestion takes longer to resolve than simple
reactive movement.
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| Overbought conditions lead to a decline in price
momentum and illustrate one ever-present danger when
trading new highs: stocks may stop rising at any moment
and enter extended sideways movement. Watch rallies
closely with your toolbox of technical indicators to
uncover the early warning signs for this range
development.
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The first break in a major trendline that follows a big
move flags the end of a rally and beginning of sideways
congestion. Momentum-based positions should be exited
until conditions once again favor rapid price change. In
this environment, consider countertrend swing trades
when other forces favor success. But stand aside as
volatility slowly dissipates and crowd participation
fades.
Traders avoid unnecessary losses when they stay prepared
and recognize the type of range being drawn after an
extended rally. Observant chartists quickly discover
that the second corrective range of a dynamic uptrend
tends to carve out the more complex formation. This
suggests the basing process often found right near old
highs will complete more quickly than expected.
No trend lasts forever. Inevitably, crowd enthusiasm
outpaces a stock's fundamentals and the rally stalls.
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.
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| Rule of
Alternation: When complex basing occurs early in
a dynamic uptrend, alternation predicts major
price thrusts with few retracements. This CMGI
parabolic move supports that theory. Note the
extended range at the right shoulder of the
Inverse Head and Shoulders pattern, probably
driven by inadequate accumulation. Once the
building process was complete, price ejected
into an astounding rally.
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