Spotting Reversals

[TopstepTrader 10]

The great trader, Larry Williams, said: For the most part, commodity prices are like a drunken sailor, wandering down the street without any knowledge of where he is going, or where he has been....Although he swaggers, staggers, and seemingly moves in a random way, there is method to his madness. He is trying to go someplace, and we can usually find out where. (Long-Term Secrets to Short-Term Trading, Pg. 14). He's right -- the market does leave clues about where it is going.

 

The chart below is how the S&P mini's looked on Monday, July 30, 2012. On a strong rally, the market had briefly poked above resistance. The following day, the market went largely sideways showing a lack of strength to continue the move up. That's when I forecast in the chat room two days in a row that the S&P would move back down to the black horizontal Support line as shown on the chart.

 

 

There has to be a seller for every buyer, and no one wants to buy at the top, so how does the other guy sucker you into buying at these prices? By making it look like a breakout above resistance. That is exactly what happened here. The very next day, the last day shown on this chart above, barely went above the previous day's bar then pulled back and closed in the middle of the day's range. That's a sign to watch carefully what comes next: a continuation move up or reversal -- at some point it's got to be one or the other. That's where the suckers are getting reeled in to buy. The difficult part is, sometimes that is a legitimate continuation move up.

 

When the following day fails to show enough strength to continue the move, watch for the definition of a reversal: lower highs and lower lows. That occurs on the very next bar, the first red one shown of the past 3 down days in a row (see chart below). Here's how the chart looked later in the week, as of Thursday, August 2, at 8 pm Mountain time:

 

 

You can see that the market dropped pretty hard. To summarize, here are the signs of a potential reversal based on the past week of trading:

 

1. The market goes up to or slightly above resistance. Remember, resistance is not an exact price but a general area

2. A day that barely goes above the previous up day, showing potential loss of momentum at resistance

3. Lower highs and lower lows, by definition, signals a new down trend on the daily charts.

 

These daily charts don't show the whole story. The chart below is very important, because it shows you the big picture about how the market moves during a reversal. I'll let you study it to see how the market moved intra-day, and how to best profit from it based on your individual strategy.

 

 

If this is too small, you can see it on my web site at http://www.tradergstocks.blogspot.com

 

Many Profitable Returns,

Trader Gregg

 

 

Mr. Killpack has been studying the markets since 1988. He has read over 40,000 pages about trading and investing strategies, fundamental and technical analysis, and related topics. He began day trading in 2001.