Last week AJ Brown from TradingTrainer.com gave us a great article to 'chew on' covering OTM near-term vertical debit spreads. The response was pretty good, but I think we'll get him an even greater number of comments with this article on momentum, reversals, and bar patterns. Please enjoy the article and if you haven't done so yet, I recommend you check out AJ's training videos as you'll learn a TON!
Every day’s bar tells us something about what to expect the next trading day. In other words, today’s bar affects tomorrow’s bar. So how do we know what that effect will be?
Not every bar will give you clear insight into where the market is headed. But there are certain bar patterns that are more informative than others. Allow me to share a few of these bar patterns with you.
You can often determine if the next trading day is going to be an up day or a down day by looking for a “key reversal up” or a “key reversal down.”
A key reversal up is when today’s low is lower than yesterday’s low, but the close is higher than yesterday’s close. When this happens, the next trading day will usually be an up day. Here’s a chart showing a key reversal up :
A key reversal down is when today’s high is higher than yesterday’s high, but the close is lower than yesterday’s close. When this happens, the next trading day will usually be a down day. Here’s a chart showing a key reversal down:
During a key reversal up, the bears try their best to push the price down. But then the bulls come back strong and drive the price higher than the previous day’s close. This indicates the price will go even higher on the next trading day.
During a key reversal down, the bulls try their best to push the price up. But then the bears come back strong, taking back all the the price gains and then some. This indicates the price will be headed lower on the next trading day.
Two more bar patterns that can be used to determine where the price of a stock is headed are a doji with an intraday low and a doji with an intraday high (a “doji” is a one-day bar with virtually the same open and closing price).
As you can see here, the price opened and closed at almost the same exact spot. But the price ran up quite a bit before running out of steam. The pattern looks like Lincoln’s famous top hat.
When you see a pattern like this, you can be reasonably sure the price will go lower on the next trading day. And, of course, if you see a cross pattern (an upside-down Lincoln’s Hat), then the price will probably go higher the next trading day.
In every case I’ve shared here, the momentum from one day spills over to the next.
One last note: When there is very little trading volume, then these patterns are not quite as reliable. But the more volume there is, the more reliable these bar patterns become.
Best regards always,
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