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Sunday September 07, 2008 |
Island
Reversal
Island reversals are isolated data points
separated by gaps. After an extended rally the stock "gaps" higher, that is, it proceeds to open
outside of the most recent trading range. After trading in the new higher
range for several sessions, a second gap occurs only this time the move is
lower.
Why Does It Happen?
After an extended rally the stock opens well above the most
recent trading range following news. This break out from the previous consolidation
pattern occurs on huge volume and appears legitimate but after several days the
stock fails to move significantly higher. New buyers become anxious,
sellers should have been removed with the most
recent move through resistance, something is wrong. Days
later there is fundamental news that contradicts the news that initiated the
breakout and already anxious new buyers panic, the stock opens
lower. Weeks later the stock is well off the recent highs.
How Are Technical Targets Determined?
Like the one day reversal, island reversals usually occur at
the start of larger technical patterns and as such, technical targets are not
implied but these patterns usually lead to much lower prices.
The Magna International Island Reversal
Riding a wave of outsourcing, Magna International was supposed
to have a business model that would smooth the cyclical nature of the auto
industry. On August 13, 2001 the stock zoomed to a relative new high on
impressive volume after a Merrill Lynch analyst upgraded the stock from neutral
to accumulate. Merrill had been absent in the cheerleading that helped the
stock move from $38 in December 2000 to $66 on August 13 so investors naturally
took this recommendation as evidence the coast was clear for new investments.
However in the days immediately following the Merrill recommendation the stock
failed to move beyond $69 and to make matters worse, volume increased steadily.
On August 17 Ford Motor Co. (F) issued an earnings warning and suddenly all of the
bullish talk about Magna seemed insignificant. Magna shares opened lower
and proceeded to work lower for the next several weeks despite a very bullish
recommendation by Deustche Banc Alex Brown.
Vital Signs
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Island reversals are news driven and usually occur because
conflicting news events occur within short time frames.
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Volume should accelerate on both the initial breakout and
the subsequent failure for island reversal.
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Island reversals are "trend killers" and usually
lead to the formation of large patterns that follow the trend.
Now let's move-on to some the larger reversal patterns.
We'll start with the double top.
one
day reversal 
double top
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