foxex: Reversal Signal

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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Wednesday, June 24, 2020

1. Candlestick patterns imply more selling ahead

2. The divergence signal you should not ignore

3. Protecting a position

Market Moves

Stock indexes fell significantly in today's trading session. The S&P 500 (SPX) fell 2.6% wile the Nasdaq 100 (NDX) shed just over two percent. The chart below gives a sampling of the reversal signals that appeared on many stocks today.

The chart features four influential stocks with bearish reversal signals. The first is an evening star candlestick formation on Invesco's Nasdaq 100 ETF (QQQ). The next chart, at top right, features a dark cloud cover pattern on Amazon (AMZN). The lower left panel displays a bearish harami on Netflix (NFLX), while the lower right panel marks three bearish engulfing signals on Comcast (CMCSA).

Many stocks showed similar patterns as of today's close. The fact that these signals are not only prevalent but also occur on the benchmark indexes is an indication that selling is likely in the near term at least.

[READER SURVEY: We are running a two-week survey of our U.S.-based readers to gauge your sentiment and see what moves, if any, you have been making with your money given the market recovery. We'll share the results, as always, and we thank you for your time and participation.]

The Divergence Signal You Should Not Ignore
Apple (AAPL) shares opened lower and held onto most of their gains over the past few days. However a close look at the price action for this stock shows some underlying weakness in its price pattern.

The chart below shows a bearish divergence between the price action and the movement of the Stochastic oscillator (shown below). As the price makes higher peaks, notice how the indicator is making lower peaks. This sets up conditions for an increased likelihood that the trend will change for this stock. Because Apple shares are so influential, a change of trend on this stock will likely mean a change of trend for most of the market.

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Protecting a Position

At times when selling behavior begins to dominate price action, it is virtually impossible to distinguish between a price movement that leads to a major trend reversal and a price move that represents a buy-the-dip opportunity as part of a continuing trend. In such circumstances investors are usually better off setting a stop loss order to protect their investment gains. The chart below provides two examples of how this might be done.

The upper panel features Apple shares and three different settings of the Donchian Channel indicator. This indicator tracks the highest high and lowest low prices in a specified time period. It is an excellent tool for following a trend, especially when traders adjust the time period smaller as the trend begins to weaken.

The lower panel shows how a trader holding Microsoft (MSFT) shares could use the Keltner Channel indicator. By using a 10-day Keltner Channel and setting its multiplier setting to 2, a trader could generate the line shown here. This line makes a good price level to adjust a stop-loss setting. No matter which setting a trader chooses, it is far better to have a stop loss of some kind set on open positions than to risk not doing so.

The Bottom Line

Indexes sold off sharply today and left numerous warning signals on bellwether stocks. Such signals usually indicate that investors should take action to avoid short-term drawdowns. Setting a stop loss is a good practice for traders that have long-running profitable positions.