Today’s Wild Price Action

Nov 27, 2007: 7:49 PM CST

Today’s price action in the major US Indexes can only be described as “wild.” The day began with an upside gap, continued with a failed gap-fill attempt, experienced rallies to new (intraday) highs, and then a massive selloff which gave way to a massive rally into the close. Traders were left with their heads spinning unless they were diligently following price action all day long – there was no room for relaxation in today’s market.

First, let’s look at the daily chart to see the larger context:

Notice that there really is little directional conviction, and in fact, the past four sessions have been marked by increased volatility that is counteracted with equal force the next day.

The last seven days have seen intraday ranges at least 200 Dow Points, and the last time we experienced a sub-100 Dow point range day was October 30th!

What’s unique is that, in the last four days, price opened at one extreme and closed on the other, only to reverse the momentum 100% each subsequent day, leaving swing traders sitting on losses caused by stops most likely – there’s no direction but there’s a LOT of movement. Day traders have had the edge in the previous weeks.

Now, moving down to today’s intraday action (using the DIA for a proxy), we see the following:

See the gap, failed filling of the gap, strong rally, strong sell-off, then strong close.

Let’s take it in terms of ‘idealized trades’ step by step:

  1. Whenever a gap occurs, especially on the major indexes, the FIRST play (trade) is to FADE the gap to see if it will close. Sometimes you need to let the gap run a bit before entering. In this case, the gap was about 50 Dow Points.

     

  2. The First Play of the Day – gap fade – was stopped out if you did not cover with a small profit or scratch. That is fine, because when you take a proper stop-loss on a failed ‘fade the gap’ trade, then this sends an even more powerful signal in the original direction. At this time, odds favor the initial momentum imbalance/pulse that created the gap was stronger than the counter-forces, and thus a large position should be entered and will achieve its target with high probability. In this case, price went far beyond expectations, and any leveraged (or large) position taken as a result of the failed gap would have been very profitable quickly.

     

     

  3. The Third “trade” comes in when price pulls back (in the up-trend) to a level where three moving averages are holding firm (as well as the most recent price swing high). A trade should be entered with a target of ‘just beyond the most recent swing high” which also was exceeded rapidly.

     

  4. A momentum divergence occurred during lunch, meaning that the uptrend was losing power and buyers were losing force to sellers. Through the 1:00 hour, sellers took price to a violent downswing which created a new momentum low. A nice and shallow BEAR FLAG formed (text-book example, by the way) and brought price to the confluence of the 50 and 20 period moving averages. An extremely high probability ‘short-sell’ trade should have been entered here with the target being a “Measured Move” the same as the initial downward price swing (which is where price found eventual support and reversed). Notice the ‘lightning bolt’ pattern that occurred. This is my favorite pattern to trade.

     

In this example, the first trade was a loss but it gave you extremely valuable information – that the buyers were too strong for the sellers and that the market had greater odds of rising fast and far, which it did.

I always recommend going back and annotating what the most ‘idealized’ patterns would have been in hindsight on each of the markets you trade. Only through seeing multiple occurrences of patterns can you become able to recognize actual patterns in real time and trade them efficiently.

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