Be Your Own Market Speedometer

Posted on Thursday, January 24, 2019 at 3:40 PM

One goal for most traders is to catch a trend early and ride it to the end. To accomplish this requires incredible timing on both entry and exit. Good traders recognize when a market has moved too far too fast and is therefore likely to stall out or even 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 (Relative Strength Index), Stochastics, MACD (Moving Average Convergence Divergence). When RSI or Stochastics 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, otherwise known as ATR (Average True Range). By tracking benchmark ranges we can determine when speed has become too rapid thus favoring a consolidation phase or possible trend change.

For a short-term speedometer I often refer to an average range of the past 20 days. If a day range spans more than 150% of the daily ATR in a 24-hour period, it is considered too quick, thus shifting the odds to favor a consolidation phase or reversal. Another near-term gauge to identify an overbought or oversold situation is when a market moves the length of an average week in a 48-hour period. Extraordinary ranges frequently occur when a trend nears exhaustion and subsequently are also common just before reversals.

Trading styles vary, but if you prefer a contrarian approach, search for markets that are overbought or oversold. Option traders who prefer to sell premium should search for markets that exceed normal speed as well.

When riding a trade, it is difficult to time when and where to take profit. A severely overbought or oversold signal can help with picking off extreme highs and lows for both entry and exit trades.

John Seguin
Senior Futures Instructor
Market Taker Mentoring, Inc.

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