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Playing The Pauses In The Market

10/26/10 12:10:04 PM
by Billy Williams

Great musicians, like great traders, play the pauses between the notes, or price action, for runaway moves in the stock market.

Security:   RVBD
Position:   Buy

Great musicians will tell you it's not the sound of the notes that the great masters aspire to, but the pauses between the notes. Without those small moments of time, devoid of sound, then the listener cannot appreciate the quality of the pitch and tone in the piece of music that they are presenting.

In much the same way, the great masters of trading can make the argument that it's not the trend itself that they are trading but the pauses in between the periods of expansion that take place in a stock's price action. These brief periods of pause in the trend's price action are where both buyers and sellers come to the edge of the proverbial cliff, to the point in the trend where doubt and fear rise collectively among all participants in the trend's move and cause them to reassess whether to remain in a position, add to it, take profits, or trade in the opposite direction.

These brief pauses, these periods of consolidation in the stock's price action, offer both crisis and opportunity to the skilled trader. If the worst were to happen, then it can be dealt with through effective risk management, in the form of stop-loss points to exit a position, or if the trend resumes, then effective trade management will help you find the optimal entry point to latch onto the trend's momentum.

In a bull market, where the major indexes are in a confirmed uptrend, for example, you have the larger market's strength and momentum behind any potential long positions in a given stock, provided that the stock possesses strong relative strength comparatively to the rest of the universe of stocks available. This by itself gives an edge to the stock trader because 70% to 80% of the stocks will move in tandem with the overall market. So if the major indexes are in a confirmed uptrend, then that is the direction to trade for potential outsized gains.

The question that comes next is: If the market is confirmed upward, then how to trade stocks themselves?

FIGURE 1: RVBD. RVBD formed a triangle pattern in its bullish trend before resuming its uptrend. Brief pauses in a stock's price action reveal low-risk entry points.
Graphic provided by:
Fortunately, there are some proven guidelines to follow: Look for stocks that are trading near their all-time high (or at the very least, their five-year high), look for strong price action in the price bars leading up to their all-time price highs (that is, price bars closing in the upper 25% of their daily range, price bars that are two to three times their normal daily trading range, gaps in the direction of the primary trend), stocks that are being accumulated by major financial institutions and, most important, increasing trading volume, especially at the moment the price action breaks higher to a new high. See Figure 1.

Back to pauses in the price action, look for continuation chart patterns in a strongly trending stock such as a flag, pennant, triangle, or other such pattern. These pauses in a stock are the optimal points in which to enter a stock that is trending upward in a market that is in a confirmed uptrend resulting in a low-risk entry, leading to higher potential gains.

Study these pauses in the trend by looking for qualified stocks in the right market conditions and you should be able to improve your entries, lower your losses, and make larger gains.

Billy Williams

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

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