Reversals following “Spike plus Trading Range” formations
This lesson will cover the following
- What are these formations and how to interpret them?
- Trading these patterns
When we talk about a climax, we mean a move that the market has reached quite far and quite rapidly, after which this move is followed by a reversal. Climactic reversals represent huge momentum moves, comprised by several large trend bars, which often breach a trend channel line and then reverse. “Spike plus trading range reversals” do not include a strong reversal move through the exponential moving average. The market instead reverses direction for 1-2 bars, after which trading becomes sideways and a tight trading range appears. Breakouts from the range can occur in either direction, something a trader needs to be aware of. This is as if a situation, where the market attempted to reverse, but could not quite accomplish that. If a trader is examining higher time frames, he/she would not detect a large reversal bar, but a large bar with a large wick, which closes around its midpoint.
At times within the trading range one can spot a countertrend double top or double bottom flag, which provides a signal for an entry against the trend (in case a with trend double top or double bottom flag appears, this is a signal for an entry in the direction of the trend).
What is specific about the reversal move, which leads to the trading range, is that it is relatively short, especially if compared to the previous trend. Regardless of that this move usually breaches the trend line. Some traders can even view it as the initial leg of a trend in the opposite direction. This move may lead to a failed test of the previous trend extreme (a lower high in case of a peak in an uptrend/a higher low in case of a bottom in a downtrend), or it may reach a new extreme level and still not become a reversal. In case the move is a successful reversal, however, the new, opposite trend has the potential to gain strength quite fast and become a spike plus channel type of trend.
There are also cases, where a distinct spike appears, followed by a pullback and the beginning of a channel. However, the channel fails to lead to a trend and reverses. At some time later, a trader realizes that the pullback was actually the spike in the opposite direction, which led to the appearance of the channel. As soon as the spike plus channel pattern is recognized, a trader should look for any suitable entry in the direction of the trend.
Dow Jones Industrial Average showed a sharp rise on the 1-minute chart until a bear reversal bar appeared (bar 2), which was 4 points tall and can be considered as a spike to the downside. Then the market entered a trading range for about 30 bars and many of them were dojis. Bar 3 breached the lower area of the range and the new downtrend began.
On the 5-minute chart of LBTYA above bar 1 spiked up and then reversed down, after which the market entered a trading range for about 20 bars and formed a lower high at bar 2. Bar 3 was an EMA Gap bar and a good short setup. Bar 4 was a M2S setup, while bar 5 was a bear spike followed by a tight bear micro channel, which did not manage to test the beginning of the bull micro channel, following bar X spike, during the current trading day. Such a test usually occurs within 1-2 days.