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Price Reversal In The Works?

10/11/11 10:58:17 AM
by Billy Williams

The market is signaling that a down move may be over and a price reversal may be in the works, according to this unknown pattern.

Security:   SPX
Position:   Hold

The intermediate trend ranges from weeks to days, and based on that definition, the primary trend in that time frame is down. But over the last two months, the price has been congested and trading within a tight range. There are a number of compelling technical factors that are forming that make this an interesting period for a trader in the current market.

First, this is not an investor's market, it is a trader's market. While investors typically have a long-term horizon by buying and holding securities indefinitely, by doing so in the current context of this stock market will create a strong sense of frustration since the overall market has been in a trading range since the dotcom bubble and crash back in early 2000.

Clearly, then, this is a trader's market where their expertise of both the fundamentals and especially the technical aspects of studying price action give them a strong competitive advantage.

FIGURE 1: S&P 500, MONTHLY. The SPX experienced a strong downward move but after a shallow Fibonacci replacement failed to follow through. Instead, a 2B reversal pattern formed, and that could indicate a price reversal if the SPX breaks its downward trendline and goes on to make higher price highs and lows.
Graphic provided by:
If you take a look at a chart of one of the major indexes, the Standard & Poor's 500 (SPX), for example, you'll note that it has fallen from its peak in early May 2011 to a price low on August 9, 2011 (Figure 1). After reaching that low, price then traded back up to in between the .382 and .50 Fibonacci retracement level, where it should have gone on to trade past that current low established in early August of this year.

That it didn't continue its trend from a shallow retracement level suggests that there is resistance to the downtrend, suggesting that the market may attempt to rally from the retest of those levels on October 4, 2011, where support stood firm and rejected the downward pressure to resume the bearish trend.

If price goes on to trade upward and break the intermediate trendline from the peak of July 22, 2011, to the price high of September 20, 2011, the first condition for a price reversal could be established.

Bearish trends are in effect when price goes on to make a steady series of lower price highs and lower price lows, so when a downward trendline is broken in respect to the current time frame that it is drawn on, in this case the intermediate time frame, then it gives the trader a signal that the underlying dynamics of the market and its price action may be in a state of change.

In addition, when price challenges the established price lows and then rejected, this creates the condition for the 2B reversal.

The 2B reversal is the second marker that a price reversal may be under way and can be spotted when price tests the established price low, only to find price rejected to the opposite direction, in this case to the upside. The reversal goes on to break the intermediate-term trendline and breaks where it often goes on to establish a higher high in price. This validates a price reversal and signals that you must tighten your existing stops if your position is standing opposite of the new trend that may be emerging, liquidate your position, and/or be ready to establish a new position in the direction of the emerging trend.

The market only needs to go forward from that point on and break the upper intermediate trendline and begin a series of higher price highs and higher price lows to signal that a new trend is emerging. Using a combination of trendlines and the 2B reversal pattern will arm you with a new set of tools to spot price reversals and keep you from being run over by a new trend and help you catch the new trend early before other traders are aware of what is happening.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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