Island Reversal Gap
To adequately explain what an island reversal gap in a chart pattern we first need to define what a gap is in technical analysis. A gap up occurs when the price of the underlying issue opens higher than the previous days high and the days low does not trade at the previous days high or lower. This creates a gap within the price data and depending on whether it is up or down will show a bearish or bullish market direction.
In an island reversal gap you have two gaps that occur one going in the current markets trend direction showing potential exhaustion and then you see a gap against the prevailing trend showing a breakaway gap. The majority of the time it occurs over several days or weeks because it creates a look of an island sitting by itself. An island reversal gap occurs near a market top or bottom after an extended bullish market rally or a long bearish decline.
In this stock market video or stock tip example we are demonstrating the power of the island reversal gap to determine potential market tops or swing exhaustion. In any technical analysis chart is imperative that the stock chart analyst utilize several technical analysis indicators to properly ascertain the proper stock market trend.
It is important to understand the main trend of the price action and the stocks charting history before concluding that the island reversal is imminent. What I mean by this is depending upon the market volatility or the stocks personality many times it is normal to see many gaps. For example many times gaps occur often in commodity-based issues, the Forex markets, the bond market or the S&P 500 index. This can create many false signals so it is imperative to understand your market first and look for a confluence of market indicators to validate your conclusions. Market volume is an important indicator in determining the strength or validity of the price gap. The use of Japanese candlesticks can help aid you in determining trend reversals, but it is important to use confirmation by other indicators such as oscillators, volume, stochastics and look for overbought conditions such as signs of negative divergence.
Divergence using the RSI and Stochastics
In this stock chart example we were looking at the possibility that negative divergence may be occurring within the RSI and stochastic indicator.
Divergence occurs when prices are going one direction and the indicators such as RSI or stochastics are going in another. Divergence can indicate a potential trend reversal. Just as a trendline can be drawn from the lows of the price action, a trendline can be drawn from the highs on the RSI or stochastics. If this occurs in a bull move the divergence is determined to be negative. This negative divergence in the RSI or stochastics is represented by lower highs indicating potential momentum loss as prices trend higher.
It is imperative to understand when looking at divergence that it must be utilized with other techniques to confirm the underlying market condition. It is not uncommon to have the RSI and the Stochastics breakout from the trendline completely changing the analysis of divergence within the issue. It is wise to wait for confirmation on the main trend before taking action on any divergence noted within the chart.
Measured Moves
In this stock chart tip I demonstrate the fact that many price movements can be forecasted using what is called a measured move. A measured move is nothing more than taking an important impulse wave or an important swing and use that in the future to determine potential high or lows. This technique is used many times in chart pattern analysis such as the head and shoulders formation, pennants, broadening formations, triangle formations flags, wedges or rounding bottoms. These type of measurements can be very accurate and can help determine potential swing exhaustion.
Regression Channels
A Regression Channel consists of lines that are drawn on both sides of the price data usually measured by one standard deviation of the price action. They resemble a channel that holds much of the price action between trendlines.
In this stock chart you can see that prices tend to hold and bounce between the low end of the channel to the high end of the channel. These type of patterns once identified can be very reliable and can give good forecasts or the ability to trade the high and low swings. If prices break out over reliable and confirmed regression channel this can indicate a change in trend depending on the formation and direction.
Rounding Bottom Pattern
A Rounding Bottom Pattern looks very similar to a bowl and it is usually found after extended bearish move. These occur after distribution is taking place and prices after an extended decline recover and start to create new highs. The lows in this pattern create or resemble a bowl shape and depending upon where it is in the pattern he can have more volatility.
It is important to be careful during these type of patterns because many times these patterns can fail because there is the possibility that the distribution has not completed yet. If the Bulls to get their way and prices move higher many times they can accelerate quickly when they get near the three clock range in the pattern. Care must be taken when trading these type of patterns and other methods of confirmation should be used to ascertain the strength of the move.
Relative Strength Index or RSI
In the stock market video example we are using the RSI or relative strength Index to determine potential overbought or oversold market conditions. It is imperative to realize when using an overbought or oversold indicator such as Stochastics, MACD.or RSI that they have the potential to not reverse the trend but continue to be overbought or oversold.
In the stock market tip emphasis is being placed on correctly identifying the longer-term market condition. As demonstrated in the video, prices were declining for quite some time and there was a bounce off the lows in the most recent price action. Using the 50 day moving average in this example along with the RSI, helped confirm potential turning point. It is necessary to confirm the overbought or oversold condition since many times these type of indicators can continue to be oversold or overbought. Trendlines can be a useful tool in pointing out any divergence and can help confirm a trend change in the RSI.
Andrews Pitchfork
In the stock market to where demonstrating the power of three Andrews pitchfork indicator. This indicator is used to forecast potential support and resistance areas that may become important in the future this indicator resembles a pitchfork. It is drawn from the major swing high and low then projected out over time. The median line can be identified by the middle line of the pitchfork and extends between the major high and low swing. These lines are projected out and are split up by percentages and can help identify turning points in the future. They are based upon the initial vector and can resemble trendlines have the same influence as a trendline. This is a are very powerful technique that is seldom used by the average chartist but can be very effective. They can help identify corrective retracement ranges future high or lows and hold prices similar to a regression channel.
Head & Shoulders Formation
Head & Shoulders formation occurs near potential top (or bottom called and inverse Head & Shoulder pattern) and resembles a persons head and shoulders hence the name.
What happens in a head and shoulders pattern is that the left shoulder creates a high sells off and then prices advance again creating a new high and that is the head of the pattern. Prices then decline as profits are taken from the new high. The right shoulder is now formed as investors attempt to buy the dips and do not want to miss the new swing high. Momentum on this new swing decreases as more sellers dominate the swing and prices begin to stall and not advance to the new high. As investors and traders realize this they begin to sell and prices decline. The neckline is drawn from the lows of the first swing or left shoulder through head and the right shoulder. The left shoulder and right shoulder can be equal to or slightly higher or lower than the other.
It is important to correctly identify these patterns since they can continue higher and not break down. Volume is an important consideration in determining the head and shoulders formation. Since these are potential reversal patterns it is imperative to adequately determine the longer-term forecast since this will have major influence on the pattern. Always look at other indicators that may have been influence such as moving averages or retracements. All patterns in technical analysis can be subjective and also have the potential for being unreliable, this is why it is imperative to obtain confirmation especially when the chartist is new using technical analysis.
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