GMCR Reveals a Prelude to a Pullback Lesson

Nov 26, 2014: 3:44 PM CST

We can learn valuable lessons by studying classic examples of price action – in this case, a large divergence into snap-back reversal event (which stuns traders when they’re caught in the sharp sell-off).

Let’s take a quick look at a recent clear example in Keurig Green Mountain Coffee Roasters (GMCR):

The Daily Chart revealed a strong uptrend with a series of higher price highs and lows along with a bullish moving average orientation.

However, scratching the surface, we see volume and the momentum oscillator declining (making a steady series of lower highs as price continued to break to higher highs).

This is a classic negative divergence; the longer this “divergent” situation continues, the more likely price is to snap-back sharply.

Think of it like a rubber band – the further the band stretches, the more violent the snap-back when the force is released.

For GMCR, the snap-back was a four-day plunge straight down from $158 to $138.

We can see the progression and snap-back also from the hourly chart:

Sometimes patterns or indicators become clearer if you drop down to a lower timeframe.

Note the series of higher price highs (blue) and the lower relative highs both in volume and momentum.

While the price trend suggested bullish strength, the underlying structure continued to deteriorate, reducing the actual probabilities of further price highs yet to come.

Price initially broke the rising (black) trendline at $155 just hours ahead of the gap-down collapse of November 20th toward the $137 “midpoint” target.

In fact, we can take away the indicators and focus specifically on a price pattern that often precedes explosive moves:

Note the Bearish Rising Wedge pattern which we can draw by connecting the series of price highs and price lows.

Wedge patterns are like Triangles but Rising Wedges often suggest a bearish reversal breakout (like we’re seeing here) while Falling Wedges paradoxically suggest a bullish reversal breakout.

Continue to study both the price pattern – the wedge – and the indicators (volume and momentum) for clues that suggested caution was a better strategy that aggressive bullishness, especially when we’re seeing lengthy divergences and tight price-bar overlap (compression) after a lengthy rally.

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Corey Rosenbloom, CMT
Afraid to Trade.com

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