When a Market Moves Too Far, Too Fast

Traders effort to catch a trend early and ride to the end. To accomplish that requires incredible timing on both entry and exit. To improve timing we need to know when a market has moved too far, too fast and is therefore likely to stall out or reverse direction.

Markets often telegraph an end of a trend by simply going through a period consolidation. Markets were created to facilitate trade. When a market moves in a direction and the day ranges and volume decrease, it is not facilitating trade. Subsequently, a reversal often occurs.

Another type of reversal comes when a market is overextended. This is commonly known as overbought or oversold. Many analysts use technical indicators to track the speed of a move, the most popular are RSI and Stochastics. When either of these indicators get above 80, a market is thought to be overbought. On the other hand, a reading below 20 signals an oversold situation. One problem with these indicators is that a market may hang around that 20 or 80 level for weeks. This makes timing a reversal difficult.

A trader can become more skilled at picking tops and bottoms by being familiar with market dimensions, mainly average ranges over a few time frames. If we track benchmarks regarding range, we can define when odds have shifted to favor the end or reversal of trend.

For example, if a day range spans more than 1.75 of the average in a 24-hour period, it is considered overdone. Thus, odds flip to favor a rest period or reversal. If you prefer to sell options to collect premium, this may be an ideal situation. This formula works for longer time frames. Calculate an average week range. If a market moves that length in a 48-hour period, chances are it will stall or reverse. If you are a day trader or investor, it is imperative to know the average range of your preferred trade duration. 

John Seguin, Market Taker Mentoring

Trader Education