Expect a Pause in Selling, and Then a Return Trip Back Up

By L.A. Little  JUN 26, 2012 2:30 PM

Trade the opposite side of a 4% decline in four short days on no volume into huge anchor bars with an almost completed and unconfirmed AB=CD target.


MINYANVILLE ORIGINAL Last Thursday, I penned a piece regarding a high probability reversal setup in the major indexes and illustrated that pattern via the Nasdaq 100 (^NDX) proxy, PowerShares QQQ (QQQ). The minimum target cited was 1.5% to 3%. We have shaved off more than that already in three days so it’s time to flip around to the other side once more.
The setup today is roughly equal in terms of probabilities. You can see the key technical components of that setup here on the QQQ chart once more.

Source: investools.com
As described in the previous article, anchor bars come in three flavors: bars that have wide price spread and/or high volume relative to all other bars on the chart, and bars that are prior swing point highs ("SPH") or lows ("SPL"). In this chart, you can see that the intersection of the two wide price spread bars from May 17 and May 18 (with the latter being a high volume bar also) create an anchor zone. Because that zone is below the current price, it is therefore a support zone. That’s one reason to expect this selling to at least pause and possibly reverse.
The next piece of evidence is that, like last Thursday, we now have an AB=CD target to the downside that measures right into the top of that anchored support zone. Yesterday’s low came within a whisper of that area and it may or may not get there. I say that because the AB=CD pattern is unconfirmed; it didn’t exhibit volume expansion as the B point of the pattern was surpassed. That is true of this chart and all the other major indexes as well.
The lack of volume expansion as price moved lower is the third and most important point. There are no sellers of size. We have just witnessed an almost 4% decline in all the major indexes in just four days and volume is drying up, not expanding. That’s not something I would want to be selling.
Last week, I spoke of a high probability that the markets would reverse and work lower. Today, I am suggesting just the opposite. I will trade the opposite side of a 4% decline in four short days on no volume into huge anchor bars with an almost completed and unconfirmed AB=CD target. Add that to end-of-month and end-of-quarter window dressing ideas and the possibility of news out of Europe on a planned summit at the end of the week. All of this strongly suggests that, at worst, a buyer at these levels almost certainly witnesses a pause in the selling and more likely a return trip back up the other side.
Finally, I have yet to talk about money management at all in this forum -- but without it, you can be the best chart reader or fundamentalist, for that matter, and still go broke. Using this trade as an example, and assuming the market opens about where it closed yesterday, a purchase of roughly 40% of the desired size can be made. I would save the other 60% to use if the market works deeper into the anchored support zone and does so on less volume and immediately (today or tomorrow).

Scale purchases are the simplest and most effective tool for a trader to manage how they add risk while adding size and they put the odds further in your favor. The other risk tool is stops; how one manages and places those is multifaceted. In all cases, deciding those levels before you make the trade is critical.

Twitter: @tatoday
No positions in stocks mentioned.