Reversal days usually signify turns of minor or intermediate importance and provide timely buy-and-sell signals. When they appear as part of larger, more important reversal formations, their significance is greatly enhanced as a leading indicator of an impending major trend change.
Reversals that occur on the longer-term charts, such as the weekly and monthly charts are more significant, as each bar represents a longer time frame. The study of long-term charts is extremely important in determining which way the market is going to move. Weekly and monthly charts focus on the big picture.
When a one-month reversal occurs at a new contract low, after an extensive move down both in time and price, and is accompanied by a close higher than the previous month’s high price – this special case becomes a key reversal as shown in the accompanying chart (A). This type of market turn takes on more significance than just a minor trend change. The reverse applies when a key reversal occurs at a major high.
As an indicator of reliability, one-day, one-week and one-month reversals should be accompanied by exceptionally high volume. The session’s trading range (the difference between the high and low price) should be wide and the market should first advance into new highs/lows prior to reversing direction.
One-week reversals are found on weekly bar charts and one-month reversals develop on monthly bar charts.
The most common variation is the one-day reversal. At a bottom, this begins with prices reaching a new low for the current move. The market rather suddenly encounters a large supply of contracts for purchase which initially halt the price decline. The selling fails to absorb this heavy buying and prices begin to strengthen.
During the same day the buying moves up, creating more pressure. When prices rally above the previous session’s closing level, additional buying materializes. Thus, after dropping to new lows, the market ends the session on a strong note, often substantially higher than the previous day’s close.
The initial buying which halts the decline is predominantly by large market participants and is a combination of shorts taking profit and longs establishing positions. The buying which occurs after prices strengthen (they exceed the previous session’s closing level on the upside) reflects smaller speculative shorts taking profits.
The two-day, two-week or in this example, the two-month reversal is a 180-degree turn in sentiment. Referring to pattern (B); the shorts are comfortable and confident, as the market’s performance provides encouragement and reinforces the expectation of greater profits when the market closes lower for the move on the first month.
The second month’s activity is psychologically damaging. It is a complete turnaround from the preceding month as prices strengthen and serves to destroy or at least shake the confidence of many who are still short the market. The immediate outlook for prices is abruptly put in question. Shorts respond to strengthening prices by exiting the market.
At tops, these quick-developing reversal sessions are the same as described at bottoms, but inverted.
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presentation about this article and chart. David Drozd is president and senior market analyst for Winnipegbased Ag-Chieve Corporation. The opinions expressed are those
of the writer and are solely intended to assist readers with a better understanding of technical analysis in the markets influencing
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