When I first started swing trading, I decided that I felt most comfortable trading reversal patterns. It took some time to come to this conclusion, after trying all different types of methods. It was a long road, filled with trial and error, but in the end, I found that it was the best method for me because it fit my personality.
But figuring out that I was best suited to swing trade reversals was only the beginning.
I would take trades on patterns that I thought looked pretty similar. However, I didn’t quite understand why some trades worked out and some didn’t.
If I looked at the basic pattern, they seemed similar.
It took some time to fine tune exactly what I was ideally looking for. And some of what I was looking for ended up being small details that I didn’t even notice when I first started trading my reversal patterns.
Some of these details are so very small, but they make a huge difference!
I’m going to break down a few of my recent trades and focus on a few of the key things that I look for with my trading patterns.
What I look for might be different (and should be) than what you might focus on. But whether you trade breakouts, breakout failures, dead cat bounces, gap plays…whatever…you should study all of your trade patterns and try to find commonalities. Try to understand the push/pull forces at play so you can try to get favorable odds.
My trade pattern analogy: BUNGEE Jumping
First of all, I don’t think I would every want to bungee jump…it’s too freaking scary for me!
But for trading, bungee jumping matches quite well with what I look for.
So as you probably might know by now, I take a trade after:
- A stock had a previous rise (this crazy guy standing at the top of the bridge) and is at the peak.
- I watch the stock fall (the crazy guy is falling faster and faster)
- I watch for signs of selling pressure drying up (the crazy guy is slowing down)
- I wait for a quiet period and enter the trade, where volume slows down and the price declines also show signs we are near the bottom (the crazy guy is at or near the bottom and the bungee cord is stretched)
- I hold and hope for the bounce back (the crazy guy starts to slowly turn back up and then accelerates back up in the direction he came from).
- And of course, sometimes the price heads lower after I get in (I guess the bungee rope snaps: that’s why I’ll never jump off of a bridge tied to a rubber band) and my stop-loss get’s triggered.
I primarily look at pricing action and volume
In the bungee analogy with the speed and rate of change, with reversals, there are signs that a slowdown is coming and a potential change of direction will occur if you pay attention to the pricing action (open/close/high/low) and volume (increase/decrease).
Let’s take a look at a recent trade so you can see some of the specific details that I look for with my typical trading patterns:
I took this trade in SUPV the very next day (11/15 after the first white candlestick occured on 11/14 after the downtrend
Why did I take the trade?
Let me show you this same chart with the phases of my trading pattern highlighted:
I ended up taking the trade in the “bounce” section, right after that white candlestick that I circled.
- First, I looked at the prior pricing action (in grey). It was narrow…not too much going on.
- The upswing was nice (in green), it started with a big white candle and continued until you see that “spinning top” candlestick pattern, (a reversal signal).
- Then, sure enough, the downtrend started (in red). It then reached the trendline and finally had it’s first up day after about a week and a half of a decline. I liked that sign.
- I entered the trade the very next day in the morning (As I write this post on 11/17, I’m still in this trade).
But volume (and the pricing action: an up day) also helped me decide whether to take the trade. I put together a spreadsheet table below showing the volume and price action and broke things out based upon these 4 phases that I just broke out on the chart.
Here is the table showing the volume:
You can see that I averaged the volume for each one of the periods:
PRIOR – Prior to the initial upswing volume was about 490,000 a day, and when compared to the other phases, you can see that it was fairly stagnant.
UPSWING SETUP – Look at the volume jump during the upswing! It was over 2 times the volume of the prior phase. Buyers are stepping up… bidding the price up.
DOWN – The volume dropped during the downtrend. This is the key that made me feel very comfortable that this was not a rabid selloff. Compared to the upswing, this is rather tepid selling…it wasn’t rampant.
BOUNCE – You can see that the bounce started with the white candlestick on 11/14. I took the trade on the 15th. Volume is increasing (almost double), so this might run higher the next few days.
Notice the average volume that occurred over the phases of the pattern. Low, high, low, high
I want to enter a trade during the quiet times, when selling (and buying) has dried up and then I want to exit during wild times, when price and volume is soaring.
Can you how the analogy of the bungee jumper is pretty a pretty apt description of my trading pattern?
The volume really tells the story on this trade. Look at what happened on Friday 11/16, with the volume: 1,558,000!
I would expect/hope that this opens higher this coming Monday. I’ve moved my stop up a bit, so while I hope it runs further on Monday, at least I got a profit at this point, even if it drops into my protective sell-stop.
Let’s take a look at another recent trade: NFEC
This pattern looks different, but the concept is EXACTLY the same.
We had the previous period of blahhhhh, where the stock was flat, volume was low.
We had the nice increase in volume on the preceding price rise that I look for.
We had the price decline… to about where the initial rise occurred. Notice how the volume was high at the start of the decline, but became lower each of the 3 days.
Then we had the quiet period where I entered the trade in the green circle. Volume was super low compared to the initial rise and decline.
We then have the bounce, with volume accelerating.
Another key with this particular pattern is the candlestick characteristics each day.
- Notice how the first two days of the decline are huge red bodies, where the price just dropped like a rock, but then we had relatively narrow trading range on the third day of the decline.
- I paid attention to this stock after the up day that occured after the 3 red candlesticks. I entered the next day and held, hoping for a bounce.
- It didn’t bounce right away, but went sideways. Volume was low…nice
- Then you can see the bounce finally took place, with volume jumping.
Do the trades always work out like this? No! Sometimes after I enter a trade after a “quiet” period after the decline, the volume picks right up again and the price drops further. Trading is a game of odds.
That why it’s important to use sell stops and get out when it is obvious that the pattern did not go as you had expected.
I entered on the day of the green circle.
Notice how the volume declined from the first 2 huge red candlestick days.
Then there was the narrow trading range on 11/9 (Friday).
On 11/12 (Monday), I entered the trade towards the end of the day. This was another narrow trading range (2 in a row). Also, on this day the U.S. stock market was down quite a bit and the stock held firm, which was a good sign.
The next day, you see that bounce. I sold some on that day and locked in a majority of the gains. Volume didn’t increase significantly on that price jump.
I held onto a token amount of shares, hoping the bounce would continue, but I got stopped out on the next day (red candlestick). By the way, look at that horrible decline yesterday (11/16)! The company announced they were going to issue convertible securities that will amount to a dilution to existing shareholders (more shares being printed).
Look at how a stop loss around that horizontal blue line would not have saved me (that news was released outside of trading hours). That stock opened WAY lower on Friday. Another case to be made for not taking a huge position size as it relates to your overall portfolio. 🙂
Knowing what to look for
So as it relates to volume and price, these are the major things that I look for. As I stated in the beginning, it took me some time to figure out exactly what to look for.
If I a stock retraced and holds the same basic patterns as above, reaches an area of logical support but the volume and pricing action don’t show signs that a turnaround is likely to occur, I don’t take the trade. It’s the little details that I learned with time that helped to increase my understanding of what was happening and whether the signs were there that the stock would reverse.
It really doesn’t matter what your method is, but what matters is knowing what to look for. Sometimes the smallest detail(s) are the critical, important pieces that lead to success.
With your trading method or system….do you know exactly what you are looking for in an “ideal” trade?
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