Trading the spike phase of spike plus channel trends
This lesson will cover the following
- Spikes are breakouts
- The cumulative effect
- Spikes in trading ranges
The spike is simply a breakout and should be traded as such. In case the breakout appears to be strong and successful, a trader can enter the market immediately. As this spike can be viewed also as a climax, at some time a pullback can occur. This provides the trader with another opportunity to enter the market in the direction of the trend.
In a strongly trending market it is also possible a spike in the opposite direction to appear. If so, this spike may simply lead to a pullback, after which the original trend usually continues. In case, however, one or two more spikes appear within the following 20 bars, this means increasing countertrend pressure and a transition to two-sided trading. The market is set to enter a trading range, while a larger retracement and even a trend reversal are also possible.
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Let us have a strong uptrend, no matter the type (if the market tends to remain above the exponential moving average for over 20 bars, this is a sign of strength). Eventually a bear trend bar of medium size appears, which opens near its high price and closes near its low price (it is a bear spike). This bar can be a bear reversal one, an inside bar or an entry bar below a bear reversal bar. This first bear spike usually leads to a bull flag. Next, the uptrend will probably continue and another bear spike may occur. If so, this second spike may probably be followed by a pullback to the exponential moving average. This pullback to the EMA is usually followed by a test of the high of the uptrend (the test may be a higher high or a double top). Sometimes the pullback to the EMA extends far enough and breaches the bull trend line, while the following price surge may appear to be the last surge before a formidable pullback or even a trend reversal occurs.
In case a third bear spike, larger than the prior two, occurs at the new high, it is possible that at least a two-legged retracement may follow, while the move to the downside after the spike may appear as a channel. Some traders may suppose that the market did not take into account the first two spikes. That is incorrect. There was actually a cumulative effect from the prior two spikes.
If the second bear move was exceptionally strong, after which prices surged to a new high and then the third bear spike was more moderate, but triggered a retracement, this whole situation could be interpreted in a different way. The second bear spike was probably the most important one and it caused the move to the downside. The surge to the new high after this bear spike was probably a pullback from that spike.
Beginners should note that any pullback after a breakout may test the prior extreme level with a higher high, a lower high or a double top, while the test itself may be the starting point of a bear channel.
In our case the third small bear spike may be considered as the start of the downtrend, while the channel after it may be the first bear channel. However, at times, the earlier spike may actually be the one to cause the greater impact on the market. Its channel may start to develop at the high of the uptrend. The channel after the earlier spike may also start with the smaller spike (the third spike) down from the high. And the channel, following this smaller bear spike may now be inside the larger channel, (the one that started from the high of the uptrend).
Spikes in trading ranges
Sometimes a huge bull trend bar (bull spike) may appear, followed by a large bear trend bar (bear spike). If this occurs during an uptrend, that has developed for some time, it is possible that the market may enter a trading range. Now buyers and sellers will try to overpower each other, with buyers attempting to create a bull channel and sellers attempting to create a bear channel. One of the sides will eventually take control over the market and either the uptrend will continue, or a spike plus channel bear trend will be formed. The opposite situation can be seen during a downtrend, that has developed for a while. First a large bear trend bar may appear, followed by a large bull trend bar soon afterwards. Then the market enters a trading range.
In some cases one of the sides may take control, which appears as a second spike. However, this spike may not extend very far and after a few bars a channel in the opposite direction may form.