Breaking Down Thursday’s Action

Thursday’s action in the US Equity Markets was quite … interesting.  The day began with a large volatility move down 300 points, reversed, then the Dow closed 400 points higher.  I wanted to deconstruct some of the action and highlight a particularly interesting set-up.

October 16, 2008 DIA 5-Minute Chart:

The day initially retraced into resistance via the falling 20 period EMA (forming the “Impulse Sell” trade) and then making new lows on the day.  A three-swing positive momentum divergence formed, hinting that at least a small reversal was likely yet to come, which was realized just after 11:00am.

Price broke the 20 and 50 period EMAs with no resistance, forming a new momentum high and what would correctly be interpreted as a “momentum impulse” forming the “Pole” of a potential “Bull Flag” trade.

What I wanted to point out was that it wasn’t your classic – easy – bull flag trade.  Entry came as price broke above the upper trendline at $85.50 (where I’ve labeled “Break”) with a stop being placed beneath the lower trendline around $84.00.  Instead of price rocketing up to the target, price retraced back to test the uppper trendline, causing a little nervousness to longs as they took ‘heat’ in the trade.  Usually, flags don’t retrace to test this level – they resolve quickly.

The impulse move was from $82.00 to $86.50 for a $4.50 target upon break, which – when added to $85.50, would be $90.00 – the exact intraday high – but keep in mind I used rough estimates in this example – you would use exact prices in actual trading and targeting.

I also labeled a simple Elliott Wave count into the close.  It resembled to me to be Wave 3 of a larger impulse on the day (Wave 1 was the 11:00 to 12:00 move; Wave 2 was the correction to this move (the flag) and Wave 3 was the impulse into the close, which also sub-divided), which we’ll see if it plays out by the close of Friday’s action (Wave 4 would retrace down to around $88 before wave 5 goes up to test the $90 level or beyond).

Thursday’s action was quite interesting – print it out and annotate it on your own for additional insights.