Part 1: reversal patterns in exaggeration situations
When the capital markets come to wider fluctuations, we Trader and our trading strategies are put to the test. The result can be disappointing if the account value falls. But with the right tactics, you can trade successfully in such phases. You are going to learn in this series, which strategy works particularly well. These trading strategies unfold their highest efficiency in market phases in which there is high volatility. If there is also panic, then the chances of success increase further.
What situations are we looking for?
The courses on the stock markets have risen steadily over a period of time. Eventually the time has come to take profits and the fluctuation (volatility) of the courses increases. The number of sellers in the market is rising steadily. Emerging panic opens the door for strong sales. To detect such a situation a look back in the history will help you. These phases are repeated again and again in the capital markets and they all unfold price patterns that work on the same principle. In periods of falling prices that are, for example:
* Reversal patterns in exaggeration situations
* Panic sellouts
* Strong price movements after exhaustion gaps (price gaps)
* Price reversal after strong movements in a trend
Your task is to identify these situations and to look for the right price patterns. In crash phases the focus lies on exaggeration situations. Because, often a natural short-term counter reaction with strong price-rise follows after exaggerated price-moves. Thus, the exaggerated situation is moderated.
Definition of exaggeration situation
To find out when a value is in a phase of exaggeration, you can use the Bollinger Bands * by default (20, 2). In the chart are three lines drawn between which the prices move. The oscillation takes place - as shown in Figure 1- around the center line. The top and bottom line (gray) represent the limits of the variation. If the price of a security is at the lower Bollinger band it is quite likely that prices eventually begin to rise again towards the center line, and vice versa. An exaggerated price movement is then visible when the price is outside of the bands. As you can assume that the market will moderate this exaggeration with a counter-movement, this situation increases the probability of successful trades.
Determination of the reversal pattern
By finding outliers from the Bollinger Bands you have mastered the first step in identifying suitable trading candidates. However, this feature alone has only a small influence on the probability of a short-term impending counter-reaction. You also need a sign of market participants that there is no longer interest in continuing the resulting movement. So you look – as shown in figure 1- after a day's candle that signals to you that there are no more sellers when prices are falling outside the lower band. If no market participants are willing to sell, so the likelihood of a counter-reaction increases greatly. When exceeding the upper band, the opposite is true. The daily candle should show you that currently a strongly decreasing buying interest exists. In this case, the number of sellers obviously outweighs. This increases the probability of falling prices. These defined situations occur when a Hammer (below the lower Bollinger band) or an inverted hammer or Hanging Man (above the upper Bollinger band), with closing price outside the Bollinger bands, are formed. A Hammer is characterized by a small candle-body with no or only a small upper shadow (wick) and a long lower shadow (wick), which should be at least twice as the candle body. It is irrelevant whether the candle-body is colored red or green. Optimally, you see even an increased trading volume (shown in the chart below).
Opening a long position
You know now that the title of your choice in a special situation outside the Bollinger Bands is. The existing Hammer signals to you that there are currently more buyers than sellers in the market. To open a position only an additional price-strength is missing. This is apparent when prices rise above the high of the hammer. For the Entry, you place a buy-order per Stop above the high of the hammer. Only when the market plays your scenario, your order is executed. Conversely, works the short entry in a Hanging Man outside the upper Bollinger band.
Position hedging (protection)
To establish this trading strategy, a solid risk management is necessary. To determine the price of the initial hedging you have to answer yourself the following question: At which point can be anticipated that there are more lows in the course of movement? At this point the trade scenario has no more legitimacy. Figure 1 shows the low of the existing hammer which provides the low of the movement. This point must be the place for the first hedging-order and determines your position risk.
Determination of the target
The idea of this trading strategy is to trade the counter-movement as long as it goes. Your position should therefore be completed by executing a stop order. To do this, use the BarByBar strategy. Drag the initial hedging stop daily, after the markets close to the low of the completed daily-candle. The only exception is daily-candles that are located within the width of a previous candle - so-called interior candles or Inside Days. In this situation - highlighted in yellow in Figure 2 - the stop will remain lying on the low of the outer candle until a daily candle is closed above the high of the corresponding period. To give the trade some space at the beginning, the tightening of the Stops begins on the second trading day.
The share of Stada Arzneimittel (Figure 3) formed on 02.09.2016 a Hammer outside the Bollinger Bands. In addition, the trading volume was increased on this day. Candles highs and lows were at 29.00 or 28.05 euros, and thus set the price for entry and initial stop. The Purchase Order (green arrow) was placed on the 02/10/2016 per stop-buy order at 29.02
Euro about over the candle high. The hedging stop (red mark) was placed under the candle low at 28.03 euros. The market had accepted the trade scenario and the buy-order was executed. Later in the trade, we had to retighten the stop-order on the candles lows (blue markings). The Trade ended with a gain of about ten per cent, as the price on 23/02/2016 fell below the low of the day-candle on 22/02/2016 at 32,05 Euro (red arrow).
It does not come so often that a Hammer is formed outside the Bollinger Bands. This occurs mostly when the stock markets are running hot in the one or another direction, and the cards for trend-trading are bad. So then, when long moves in one direction strain the nerves of the investors and force them to emotional acts. In such phases, this trading strategy plays out its strength. You are emotionally unencumbered and are concentrated on looking out for promising special situations. The moment of tension is high and you are promptly aware of what is played. Either things get really speedy or nothing happens. The strict risk management gives you peace at the beginning of the trades and ensures in the further course that gains are closely protected.
Mike Seidl is a banker and trades with real money on the capital markets since the late 1990s. Since 2013 he managed full time his own property and passes on his knowledge to people (in seminars and coaching) who want to shape their own way to achieve independently their financial goals. firstname.lastname@example.org
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