Trading The Pause In A Stock or ETF Wave Trend
Trading the ABC Sentiment Shifts Ahead Of The Crowd
Spotting the 3 day 'Rest' B Wave for profits
One of the most obvious keys to successful trading or investing is buying low and selling high. The problem being if it was that easy to pinpoint those low and high points then all option traders would be batting 1000%. What we use is a combination of fundamental analysis and catalyst spotting, inter-twined with charting techniques. Most of our work revolves around buying substantial dips in a strong stock, 3x leveraged ETF's, or reversal patterns. Ultra and leveraged ETF's are great for short term swings as they function almost exclusively on crowd behavioral patterns, but it also applies to individual stocks.
In all cases what traders really need to spot ahead of the masses of investors is a subtle shift in sentiment. That key pivot point where the negative sentiment whether it be short term or long term is about to run out of gas, and the bullish sentiment is going to take over and reverse the stock or ETF higher or break the position out of a base pattern.
One of the most common patterns amongst many that we use as trigger points is the ABC pattern. This is a situation where the stock or ETF recently had a strong run. That run produced a flurry of over-optimistic sentiment and is reflected in the high spike in the stock from the prior base. We call this the "A Wave High" pivot point. This is where many of the traders who chase short term performance come in with a bang, right near the top.
The next key component is obviously then the "B Wave" pattern. There are many different formations for B Wave patterns, the one we will look at today is the "3 day rest" pattern.
B waves simply serve to work off the overbought sentiment of the crowd and remove the chasers who came into the trade high, at a loss. As the stock pulls back hard initially in the B Wave, stop losses are triggered by those with discipline. However, many traders continue to buy more of the position a bit early during this crucial B Wave pattern and then later they also get stopped out. Finally, Margin Calls are common and more stops are triggered and the B wave winds down and sentiment is horrible.
At that strategic bottoming area of the B Wave correction is where you want to start scaling long into the position for the ensuing reversal to the upside. Sometimes these are very short term trades as in 48 hours or so, and sometimes they are several weeks long depending. Many of the B waves on daily charts are what we term a "3 Day Rest" pattern, spotting these is very profitable.
Below we have a very recent sample 3 day rest B Wave pattern in a stock prior to a 15% one day move, this being Vivus (VVUS).
This produced an 11% net gain inside of 4 trading days after a 15% one day pop C wave rally. This chart shows the 10 day chart with the 3 day rest pattern which can be scaled into, and then the C wave to the upside. Also shown below is a longer term chart where you can see the pattern as well. This same pattern in Alpha Natural Resources (ANR) recently led to 9-11% gains in the underlying stock inside of 48 hours as well - with the leverage of option trading this kind of gain in the underlying can be magnified 5x, 10x or more.
Courtesy of David Banister, www.activetradingpartners.com
[Vintage image courtesy of Coca-Cola]