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Popped Stops and History Repeating in SPX

I had a suspicion a big pop might happen but it’s still sometimes surreal to see it happen first thing in the New Year!

Let’s take a look at the “repeating history” (you might be very surprised) and learn lessons from yet another excellent example of one of my favorite concepts – Popped Stops.

First, the overall structure of the SPX beginning 2011:

Instead of a broad overview, I wanted to focus your attention on two things:

First, the Popped Stops single day ‘slaughter’ (for the bears) that occurred in early November and just repeated today.

Second, the price and divergence structure that preceded the pop, which served to trick the aggressive bears and pop them right out.

Let me do a brief overview of Popped Stops as it applies to the example above, a concept I discuss frequently in intraday summaries and in prior seminars/webinars.

Generally, when price pushes up to a resistance level or the upper Bollinger Band and divergences are present, aggressive short-sellers go ahead and position AHEAD of an official entry signal, such as the breaking of a rising trendline or moving average (neither of which happened in either situation).

Condition 1 is that Bears must be compelled/enticed by the charts to enter.  Upon entering, they (usually) place stop-losses (buy to cover) above their entries and a resistance level.

Condition 2 is that – for whatever reason – buyers/bulls ignore the divergences and press ahead buying anyway – which is a source of demand that overcomes the selling pressure of the bears.

Once bears enter and place stops, then bulls buy to force price higher, bears then – you guessed it – BUY to cover, locking in their losses.

This then often creates a short-term “Positive Feedback Loop” wherein for a brief time, BULLS are buying (to profit) and BEARS are buying (to limit losses).

To the extent that these two forces create more and more buying, the market will surge.

Usually it happens in a single day or over a few sessions, which gives the very aggressive trader (who understands this concept) a chance to profit FROM the feedback loop and ‘crushing’ of the short-term bears.

That being said, look at the near-perfect repeat of history that gave clues that an upside explosion was on the table as a possibility … and today became reality.

Here is a ‘price purism’ view of the charts and the pattern repeat:

Generally – in fact quite frequently – an overextended price swing that contains negative divergences tends to retrace sharply – if not reverse course entirely.

That’s the ‘common’ and expected play, but the Popped Stops concept teaches one of my favorite quotes:

“If something SHOULD happen but does NOT, then it often leads to a LARGER THAN EXPECTED move in the opposite direction.”

The “larger than expected” move can be traded by aggressive, savvy traders.  Others who are building experience should learn this concept and use it to LIMIT LOSSES, and not fight a breakout move no matter how bearish (or bullish if this situation was reversed in a downtrend) the charts look.

Positive feedback loops can be painful and if you’re caught short and refuse to exit, you can lose a lot of money quickly.

Rule 1 is therefore to protect capital.

Rule 2 – with experience – is to profit from these little pops in price.

One of the facts of Technical Analysis – and trading in general – is that history repeats.  Sometimes, it repeats from one day to the next, but generally patterns repeat.

It takes practice to see and classify the patterns (and I’m not necessarily talking about triangles or bull flags, though those are very common, repeating patterns too) but STRUCTURAL patterns like this.

Anyway, take some time to study this example, how it developed, how bears were lured in, and then forced to liquidate on the pre-market morning rally and of course throughout the morning session of the day – which gave sharp intraday traders a quick opportunity for some profits from the feedback loop.

By the way, if history continues to repeat, what happened AFTER the pop in November was a little (expected) pullback.

Watch to see if that develops and if not, then we’ll see even higher prices as more bears rush to cover.

I’ll be discussing more about trade execution tactics of patterns and structure  in a presentation on “Trade Execution Tactics” at the New York Trader’s Expo – February 20 – 23.

I really enjoy the Expos and traders of all experience levels benefit from attending and networking and I hope you can join us all there!.

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

Order your copy of The Complete Trading Course (Wiley Finance) now available.

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