Market stock swing trading
The three most important principles of swing trading: First, price is not random. Second, price anticipates perceptions of fundamental change. And third, the relationship between price and time is linear. With that road map in mind, it is time to begin unfolding approach to the practice, rather than theory, of swing trading. Start with the basics of the views on why stocks trend, and then discuss the psychology of support and resistance, move on to the most useful chart patterns for reversal, and end with the favorite patterns for continuation plays.
Finance professors would have us believe that price action in stocks and markets is random. But that is nonsense. Instead, prices move in regular patterns on concert with the ebb and flow of supply and demand. Price consolidates when supply and demand for a security are in relative equilibrium, and price advances or declines rapidly in a trend when there is an imbalance between supply and demand. One of the hardest concepts to grasp is that the relationship between price and time is linear. That is, the longer that price fails to behave as anticipated, the more likely we are to amend our expectations.
The simplest example of the phenomena involves our ability to take losses. Most investors do not like losses. When they buy a stock wrong, they will often attempt to get out of that position without suffering a loss, but as days turn into weeks and weeks turn into months their stubbornness takes a back seat to common sense. a rationalization process begins and slowly the perception of a suitable exit level changes. Obviously, no one wants to sit on a bad stock forever. This is the linear relationship between time and price the longer the time frame stretches, the more elastic price expectations become.
Chart patterns reversal
Stocks go up and stocks go down. But swing traders can learn with practice that in most cases the reversal is easily detected and capitalized upon. Although the fundamental and technical factors that lead to reversals may be varied, every stock price reversal is ultimately the result of one of two themes: distribution or accumulation.
One Day Reversal
The one-day reversal is the starting point for most reversal patterns. After an extended rally the stock gaps higher at the open to trade at a new high on a positive news announcement. As the session proceeds, volume expands significantly but by the close the entire rally disappears and the stock closes lower.
Why Does It Happen?
One day reversals occur because large investors need liquidity to close long positions. They understand that the best way to liquidate a large position is to sell into good news when liquidity is highest so they are willing sellers on a day when the stock is making a new high and everyone is saying good things. Investors and media wonder how such good news could have resulted in such poor price performance. Indeed, over the next several sessions analysts and traders rationalize that the selling was simply overdue given the strong rally leading into the news, but every subsequent rally fails. Weeks later the stock is well off its recent highs.
How Are Technical Targets Determined?
One day reversals are by definition one-day events and as such technical targets are not implied. But if you look at every major reversal pattern, you will quickly see that it all began with a one-day reversal that led to good swing trades.
Vital Signs
- One-day reversals occur because large investors choose to liquidate positions into strength, so it is vital that volume accelerate as the stock begins to work lower.
- The stock must close on the day of the reversal at or very near the session lows.
- Predictable swing trades on the short side are initiated the day after the one-day reversal provided that the stock opens modestly lower. If the stock gaps more than five percent lower, then you have missed the trade. And if it opens higher, it was not a one-day reversal. Place a stop just above the midpoint of the previous days trading range.
Wholesale liquidation into good news is on ongoing theme in reversal patterns. Now that we understand the basic premise of the one-day reversal, let us tackle the island reversal.
Island Reversal
Island reversals are isolated data points separated by gaps. After an extended rally the stock higher that is, it proceeds to open outside the most recent trading range. After trading in the new higher range for several sessions, a second gap occurs only this time the move is lower.
Why Does It Happen?
After an extended rally the stock opens well above the most recent trading range following news. This breakout from the previous consolidation pattern occurs on huge volume and appears legitimate but after several days the stock fails to move significantly higher. New buyers become anxious; sellers should have been removed with the most recent move through resistance ; something is wrong. Days later there is fundamental news that contradicts the news that initiated the breakout, and anxious new buyers panic sending the stock opening lower. Weeks later the stock is well off the recent highs.
How Are Technical Targets Determined?
Like the one-day reversal, island reversals usually occur at the start of larger technical patterns and, as such technical targets are not implied but these patterns usually lead to much lower prices.
Rounding Top
Technically speaking, a rounding top is a rally to a new high on strong volume, several weeks of light trade with limited upside progress, and several more weeks of light trade with a decided downward bias, followed by a sharp move lower on strong volume.
Why Does It Happen?
At first and maybe even second glance, rounding top patterns are going to look very familiar. This is because they have many of the same characteristics of head and shoulders top patterns. Often there will be a very clear head, that is, a rally to a new high in the middle of the pattern. Rounding top patterns differ from garden variety head and shoulders top patterns in the very often there are multiple shoulders. As you might expect, rounding up top patterns occur for many of the same reasons as do head and shoulders top patterns. The first part of the pattern will always take shape after an extended rally to new highs. The flow of fundamental news is usually positive and buyers seem willing to pay increasingly higher prices for a while. Following one positive development the stock rallies to a fresh new high on strong volume but to the surprise of bullish investors, sellers are more than willing to liquidate positions.
After a few sessions, the stock begins to move lower on increased volume. Investors and analysts will normally rationalize this development as simple profit taking but the rise in volume and weak price action are clues. Longer-tem investors who bought at lower prices are selling; they are using good news to distribute stock. The rally to new highs and pullback to a nearby support level completes the first place of the pattern.
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