A stock you follow takes off and trends
sharply. But you miss your entry and watch in frustration as it clears one
hurdle after another. Finally it stops and reverses. As it pulls back on
your 5-min chart and Level II screen, you have to decide whether or not to
join the action.
Predicting price movement when an
intraday trend pulls back requires both skill and patience. Some
corrections persist or roll over into ranges that empty trading accounts.
But others quickly bounce and take off to new highs. How can you tell
which outcome is more likely?
The first pullback from a breakout has
high odds of rapidly ejecting in the direction of the new trend. But watch
the depth of the correction. If it breaks through several minor support
levels before reversing, sellers will likely emerge when price tests the
short term high. This common scenario will still produce good trades. With
enough reward between your entry and the short-term high, you can place a
sell order 1/16th or 1/8th below the top and ride the bounce into a quick
Use a 6-Out rule to measure trend
pullbacks. Start your count with the first bar lower than the parabolic
extension of the trend. Watch for a pullback at the same angle as the
trend itself or in a tight sideways pattern. The next trend leg should
begin no later than the 6th congestion bar.
Why does this work? Many day traders set
their short-term chart indicators to periods that measure 5 to 8 price
bars. 6 bar corrections will often reflect short-term support at these
common settings. If price does not eject, the next bar can signal a trend
change and trigger waves of reflex selling by this fast-finger crowd.
Keep in mind that markets often move in
1-2-3 patterns. Countertrends follow a natural tendency to pullback,
bounce and then pullback again before finding support. Traders often fool
themselves by jumping on the first bounce rather than waiting for the
corrective move to unwind. The deeper a stock corrects, the less likely it
will take out the old trend high and break into another wave. For this
reason, only tight and small 1-2-3 patterns signal new trend movement.
Use a short-term oscillator, such as
Stochastics, to measure an intraday rallys duration. After each price
thrust, odds decrease that the trend will continue. Oscillators measure
the depth of this overbought condition and provide early warning when a
pullback lasts too long. Set these indicators to watch the same signals
that other traders use to make their decisions. Then plan your trades to
step in front of their reactions.
Moving averages and Bollinger Bands
measure how far price should pull back before reversing in the direction
of the trend. Notice how this NXTL intraday trend repeatedly bounces at
the 8 bar MA. Trends tend to find support at similar levels on each
correction. Use Moving Average Rainbows to identify the right settings for
each unique pattern.