It’s tempting to place your stop just above an area of distribution, or just below an area of accumulation. The problem is that these areas can only be roughly defined. Support and resistance levels are hardly at an exact point like $323.54, but more like an area around a level, with the wideness of that area depending on the volatility of the stock.
Let’s take an example in a mega-cap, Boeing. Below is a chart of Boeing (BA), illustrating what I’m talking about. BA is entering what looks like a period of distribution, where the “composite operators” are beginning to offload their shares onto the public.
Just by glancing at the chart, you can observe that the range is there, but it isn’t neat by any means. We see a few highs around $360, $380, and even $400.
A novice might see this chart and decide to place his stop at $401, just above what seems to be the point of resistance. See the next chart of Boeing below to see the typical fate of the trader who can’t grasp that support and resistance levels aren’t exact price points.
Admittedly, most traders who took sold Boeing short in the distribution zone before it’s run to $440 were stopped out, but that’s not the point.
Final Thoughts
Reversals are some of the trickiest setups to trade. They unfold differently in each asset class, and according to the current market sentiment.
While they can reward us hugely, being wrong in a reversal trade can be quite painful. Nobody likes being on the wrong side of an aggressive trend.
In my opinion, trading reversals is best suited for traders who have some experience, especially with reading the tape. And, as always, this strategy should be practiced in a simulator before risking real money!