Friday, December 12, 2008

Short-term traders discover great rewards in uncharted territory

Short-term traders discover great rewards in uncharted territory. Stocks at new highs
generate unique momentum properties that ignite sharp price moves. But these dynamic
breakouts can also demonstrate very unexpected behavior. Old battlegrounds of
support/resistance disappear while few reference points remain to guide entry and exit. In
this volatile environment, risk escalates with each promising setup.
The final breakout to new highs completes a stock's digestion of overhead supply. But the
struggle for greater gains is far from over. Issues reaching new highs often undergo
additional testing and preparation before resuming their dynamic uptrends. The skilled
trader can follow this building process through the typical pattern development expected
during these events.

Price may return to test the top of prior resistance several times. This can create a variety
of stepping or basing ranges before trend finally moves sha rply upward. Other times,
stocks will immediately go vertical when new highs are printed. The challenge is to
decide which outcome is more likely.

Use Accumulation-Distribution analysis to predict whether new highs will escalate
immediately or just mark time. Price either leads or lags accumulation. When stocks
reach new highs without sufficient ownership or buying pressure, they will often pause to
allow these forces to catch up. Other times, accumulation builds more strongly than price.
The initial thrus t to new highs confirms this accumulation. The breakout triggers a new
round of buying interest and price immediately takes off with no basing phase.
On Balance Volume and similar accumulation-distribution indicators are essential tools
to evaluate the strength of new high breakouts. Expect an immediate upward thrust when
OBV draws a pattern more bullish than the price chart. Alternatively, when multiple accdis
readings show ownership limping behind price, prepare for an extended basing
period. And always use caution with NASDAQ stocks. Their odd transaction reporting
may lead to false OBV readings.

Final phases of congestion often print sharp initiation points for the breakout impulse.
Locate this hidden root structure in double bottom lows embedded within the congestion
just prior to the trend move. The distance between these lows and the top resistance
boundary will yield price targets for the subsequent rally. Barring larger forces, this new
high breakout should extend no more than 1.38 times the distance between that low and
the resistance top before establishing a new range.
Once price clears a new high base, the bull impulse escapes the gravity of final
congestion. This often triggers a dramatic 3rd wave for the trend initiated at the
congestion low. This thrust can easily exceed initial price targets when it converges with
larger scale wave movement. In other words, when forces in the daily and intraday charts
move into synergy, trend movement will inevitably be more dramatic than anticipated.

When complex basing occurs early in a dynamic uptrend, alternation predicts major
price thrusts with few retracements. This CMGI parabolic move supports that theory.
Note the extended range at the right shoulder of the Inverse Head and Shoulders
pattern, probably driven by inadequate accumulation. Once the building process was
complete, price ejected into an astounding rally.

Measure ongoing new highs with a MACD Histogram or other widely used momentum
indicator. Whatever your choice, allow your math to support the pattern rather than the
other way around. For example, if an established trendline can be drawn under critical
lows, key your trade timing off that line rather than waiting for your indicator slope to
turn up or down.
Effective trading of post-gravity impulses relies on the interaction between current price
and your momentum indicator. At new highs, prior support/resistance can't be used to
predict swings. Follow the MACD slope to flag overbought conditions favorable for
ranges or reversals. Enter long positions when price falls but the slope begins to rise. Or
be conservative and wait for the zero line to be crossed from below to above.
Patterns point to low risk momentum trades. Enter retracements to a trendline or moving
average and you’ll ride the dips just as new buyers jump in. Short sales should be avoided
completely when momentum is high unless you’re an experienced trader. Trying to pick
tops is a loser's game. Delay short sales until momentum drops sharply but price is high
within its range. Pattern analysis can then locate favorable countertrends with limited
When a stock breaks to new highs, how long will the rally last? In physics, a star that
burns bright extinguishes itself long before one emitting a cooler, darker light. So it is
with market rallies. Parabolic moves cannot sustain themselves over the long haul.
Alternatively, stocks that struggle for each point of gain eventually give up and roll over.
So logic dictates that the most durable path for uptrends lies somewhere in-between these
two extremes.
Overbought conditions lead to a decline in price momentum and illustrate one everpresent
danger when trading new highs: stocks may stop rising at any moment and enter
extended sideways movement. Watch rallies closely with your toolbox of technical
indicators to uncover any early warning signs for this range development.
The first break in a major trendline that follows a big move flags the end of a rally and
beginning of sideways congestion. Exit momentum-based positions until conditions once
again favor rapid price change. In this environment, consider countertrend swing trades if
other forces favor success. But stand aside once volatility slowly dissipates and crowd
participation fades.

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