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Friday September 05, 2008 |
One
Day Reversal
The one day reversal is the starting point for most reversal
patterns. After an extended rally the stock gaps higher at the open to
trade at a new high on a positive news announcement. As the session proceeds volume expands significantly
but by the close the entire rally disappears and
the stock closes lower.
Why Does It Happen?
One day reversals occur because large investors
need liquidity to close long positions. They understand that the best way to liquidate a large
position is to sell into good news when liquidity is highest -- so they are
willing sellers on a day when the stock is making a new high and everyone is
saying good things. Investors and media wonder how such good news could have
resulted in such poor price performance. Indeed, over the next several sessions analysts
and traders rationalize that the selling was simply overdue given the strong
rally leading into the news but every subsequent rally fails. Weeks later
the stock is well off its recent highs.
How Are Technical Targets Determined?
One day reversals are by definition one day
events and as such technical targets are not implied but if you look
at every major reversal pattern you will quickly see that it all began with a
one day reversal.
The Amazon.com One Day Reversal
With a virtual marketplace Amazon.com (AMZN) was supposed to
make traditional retailing obsolete. The concept was so compelling that
Wall Street analysts began devising new data points to make valuations
"work". This rationalization process saw the stock vault from
pennies in 1998 (on an adjusted split basis) to $110 in late April
1999. It was amazing. Then the firm reported record revenues for the
first quarter and several Wall Street analysts reiterated their "buy"
ratings and raised targets. After closing the previous day at $103.59, the
stock opened April 27 at $105.50 and proceeded to rally to $110.63, a record
high. Volume swelled and it looked as though the non-believers were
finally throwing-in the towel but by midday the stock was flat. By the
close, the stock was actually lower for the session. Over the coming weeks
new "buy" recommendations and positive comments continued but the
stock sank to just $35 in early August.
Vital Signs
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One day reversals occur because large
investors choose to liquidate positions into strength so it is
vital that volume accelerate as the stock begins to work
lower.
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The stock must close on the day of the
reversal at or very near the session lows.
Liquidation (distribution) is an ongoing theme
in reversal patterns. Now that we understand the basic premise of
the one day reversal, let's tackle the island reversal.
reversal
patterns 
island
reversal
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