Part 3 - strong price movements after exhaust gaps
After a situation was illuminated in part 1 of the series (TRADERS' 09/2016), in which the price was outside the Bollinger bands *, the second part (TRADERS' 11/2016, in the shop under www.traders-media .de), focus on strong price movements without interim corrections. The third part now follows the previous one. You comb through your trading-universe in order to find chart-constellations, which show strong price-declines - this time in combination with price gaps, which increase further the sell-pressure.
What characterizes the price-development in the chart?
With this strategy, you focus on titles that are within a superior downtrend in the chart history. A strong price drop during the last trading days, triggered by downside gaps, has ensured that the price is far in the movement of the main trend. The fact that there was in the meantime no room for corrections, increases the probability of a counter-movement. The special role of downside gaps is that these are often a sign of a severe weakness in liquid values. The price-pressure on the corresponding stocks exhausts itself and good buy-opportunities can be developed.
How do you trace candidates in this situation?
The following prerequisites are necessary to identify potential trade candidates:
1. Existing downtrend
2. Far advanced movement within the trend
3. Exceptional price drop due to gaps within the last three to five trading days
One way to perform the first pre-filter is to select your trading candidates using Simple Moving Average (MA). For example, you can use the MAs of the last 20 and 50 trading days. In a downtrend, both averages should trend downwards within the last 20 trading days, with the MA (20) recording below the MA (50). The current price of the securities is also under the MA (20). The selected values from the first step are now subjected to further filtering. We are for chart patterns that have the scenario outlined in Figure 1: A downward directed trend, which is far in the movement. This point can be worked through via through-view of all relevant charts or software supported. For the software-based filtering, set the parameters of your chart program to show only trade candidates that have already fallen below the last low point of the existing down trend.
Last but not least, look for strong sales that were initiated by the formation of downside gaps. Two to three gap days are not uncommon within three to five consecutive trading days. The more aggressively the price-drop is due to gaps, the greater the probability of a counter-movement. At least then, if there were no bad news in connection with the price decline. Since the formation of this situation takes a few days, it has proven useful in practice to run a watch list. In order to search a large number of values without having to spend a lot of time, filter the gaps with your chart software. As shown in Fig. 2, you can see, by an additional column in your table with the observed securities, the percentage change between the closing price of the previous trading day and the opening price of the current trading day. The values with negative signs show downside gaps and are placed in your watch list for further observation. In the event that your chart program does not provide such a solution, add three additional columns in your table of observed securities: the first with the closing price of the last trading day, the second with the opening price of the current trading day, and the third with the difference of the two values. Then, record negative deviations on the watch list.
The reversal formation for trade-legitimation
The price fluctuations of the last trading days were used to create a list of promising trade candidates. If the strong price-drops did not occur through bad news, the buyers should now take the scepter in their hands again and provide for rising prices.
The trading setup for an Entry on a daily-basis
Wait until a reversal situation has been developed in the chart immediately after the sell-off - this signals a rising probability of rising prices. The hammer-candles or reversal-candles already discussed in part 1 and 2 are used in the daily chart. Your trading position will be opened on the next trading day only if prices continue to rise. According to this, you do not buy via market-order, but you place a stop-buy-order over the high of the signal-candle. If after the day of the signal-candle, a week day follows which does not trigger the order, it is deleted again.
Initial-stop and trailing-stop on a daily basis
As soon as prices reach new lows, the position should be closed. For this reason, you must place a stop directly at the position-opening below the low of the previous downward movement. If your position is as expected in the profit, pull the stop for example using the bar-by-bar method. However, at the beginning, give the trade some space and do not drag the stop too closely. Alternatively, you can only move the price of the initial hedging to the purchase price if you are so far in the profit that you have already earned the risk.
The trading setup and Entry on an intraday-basis
If you want to open your position within the current trading day, you can use the trends in the subordinate time units. The trend chosen from you is seen as a downtrend during the price-drop. For a trade opening, a counter-trend must be formed in the chart. You use this trend to open the position and to trail your stops.
Initial hedging and trailing-stop on intraday basis
You place the first stop for your trade under the low of the downward movement exactly as you did with the daily trade-setup. The profit-taking-targets are defined by means of trailing-stops on the correction trend of the traded trend.
Determination of profit-taking-targets
This strategy should also keep your position running as long as possible. Since it is a trade against the trend, you can use a limit sell order to place a profit target in the range around 50 percent of the level of the previous downward movement in the market.
The Allianz share (ALV.DE) lost almost ten percent of its value during the period from June 9 to June 14, 2016 (Fig. 3). Within this period, three downside gaps occurred, followed by trading days with further price losses. On 15 June there was an Inside Day, followed by the demand reversal (green candle). Thus, the prerequisite for a long entry was fulfilled:
* Position opening via stop buy order at 129.62 euros
* Initial stop: 127.33 euros
* Profit sharing: 134.80 euros
* Trailing stop: Bar-by-bar strategy
Through the Up Gap on 17 June, the order for the market opening was executed at 130.50 euros. In the course of further trading, the initial stop was traded at 129.49 euros before the profit-taking order on 20 June was triggered.
Also in this setup, you do not have to worry about price-declines. You simply wait until the market shows you that the buyers will return and then only you should be active. In this way, you avoid the commonly known “catching a falling knife”.
Mike Seidl is a trained banker and has traded real money on the capital markets since the end of the 1990s. Since 2013, he has been managing his own assets on a professional level and is giving his knowledge through seminars and coaching sessions to help people who want to shape the way to achieving their financial goals independently. Info@investorschule.de
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