4. Reversal Day Trading Strategies

Indicators That Help Spot Reversals

I’m going to assume you’re trading a parabolic low-float stock, the stocks that most WT members prefer. For large-cap and assets that move slower, study the Wyckoff market cycle.

When trading reversals in parabolic stocks, I’m assuming that you’re trying to trade them from the short side. These stocks hardly go down exponentially, only to come back up days later, so the primary people tend to trade reversals on these stocks is on the short side. With that settled, let’s move forward.

A parable I trade by is that “momentum precedes price,” I’m not sure who was the first to say it, but it’s a core principle that I learned from Linda Raschke. It means that momentum, or the propensity of the market participants to move price aggressively in one direction, comes before the change in trend becomes apparent.

There’s many ways to identify a momentum divergence, but a straightforward technique is to exercise caution when price makes a new high, but a momentum oscillator like MACD doesn’t register a new high. Of course, this isn’t foolproof, but I’ve found it to be a simple way to spot a red flag quickly.

Here’s an example in a current runner, SNGX. The stock has shown lots of steam and has been running up all month. However, we see significant resistance around the $3.00 level, and the stock can’t seem to hold above the level for now. After a three-day sell-off, we can see that the stock caught a bid today (the time of this writing).

To many, this would seem like a sign that the stock may be preparing for another run, but there are a few warning signs that would either (a) stay out of the stock completely, or (b) look for short-selling setups.

The first red flag here is the low relative volume on the first green day after three previous bearish days. The stock failed to penetrate it’s declining 5-day volume average. The strongest leading stocks attract more volume when they’re advancing and less when they’re declining.

The next sign is an apparent loss of short-term momentum. As you can see on the 3-10 oscillator, which is just a modified MACD, the slow-line has flattened while the fast-line has lost its steam and crossed below the slow-line, a significant warning sign. We also didn’t see any action from the oscillator as a result of today’s semi-bullish market action.

From a Wyckoffian perspective, the stock could be entering a distribution zone as the smart money liquidates, leaving retail to hold the bag. In these microcap runners, the moves are so compressed, time-wise, that fewer data points are created, making it more difficult to identify each point in the cycle until after the fact. This could simply be a pullback in a continued uptrend or a top forming.

Of course, these technical signals are coming from the perspective of a short-term momentum trader. I have no idea where the stock is going. These are just reasons that indicate to me that the trend might be reversing and that alert me to be extra careful on the long side.

Leave a Reply

Your email address will not be published. Required fields are marked *