How to Identify Market Extremes

One of the more difficult tasks traders face is choosing areas where extremes (high or low) are likely to form.  Pinpointing ideal entry and exit levels is possibly the most difficult and desired task we face. In the industry, buy areas are known as support and sell zones are called resistance areas. To enhance your ability to identify tops and bottoms requires some history, technical tools and logic.

Fundamental Clues

Fundamentals, otherwise known as event risk, drive market movement. A chart is essentially a log that displays price action and records history. I recommend labeling prices on your charts where a sharp directional move started in response to a big event, such as an employment or inflation report. Supply and demand details, guidance and earnings are fundamental events as well. Given a bullish report, note the prices where buyers took control of momentum. These areas often provide support when retested. When looking for sell or resistance levels, search for areas where an acute move lower began following a fundamental event.

Congestion Zones Are Stop Signs

In my opinion “momentum begins and ends at high volume prices.” A high volume or fair price is the one where bulls and bears have transacted most often. Volume defines value. The more time a market spends at a price, the more value it holds. In charts, high-volume zones take the shape of flags (rectangles) and pennants (triangles). These patterns illustrate congestion zones. Trends frequently begin from consolidation areas and often end when retesting an old one. When markets revisit old high-volume zones, they tend to stop and often reverse direction.

A series of three to five days with below average day ranges and volume frequently take the shape of a triangle or rectangle. Furthermore, the daily candlesticks tend to have small candle bodies (similar open and close), which is an indication of neutrality. This pattern frequently leads to breakouts (trends), and it often provides support/resistance when retested. Congestion zones are like walls. The first test of one is tough to bust through. Speculators and counter traders tend to emerge when such areas are retested.

Double Tops and Bottoms

Always refer to recent history. Charts tell a tale, and a good technician recognizes where bulls and bears emerged previously and are likely to take a stand again. History often repeats. When markets retest a previous major low or high, a reversal often occurs. A major extreme for a short-term trader could be a weekly low/high. For a longer-term trader, a test of a monthly high or low could incite a reversal. A reversal after hitting an old critical price is known as a double top or bottom.

Make Research a Habit

Early in my career I made it a point check where daily extremes were made and how they coincided with previous price action. This practice helps me recognize where tops and bottoms are likely to form in the future. When searching for optimal entry and exit levels, history can be a great help. Tracking old low-volume prices (acceleration points) and very high-volume nodes (congestion zones) is a good start. A little charting homework will improve your trade location, which will lead to increased profits while reducing risk.

John Seguin, Market Taker Mentoring

Trader Education