Three things you need to know:
1) How to measure momentum.
2) What a divergence is.
3) What a reversal day is.
Momentum can be measured by the price swings. Here’s what I mean. For a stock going up, measure the downswings. Once you have a downswing that is the greatest in either price or percentage, then you have a change in momentum.
I know of no easy way to measure this then to use your eyes and look at a stock chart.
Here’s an example of Scandisk Corp’s stock price rising, then making a change in momentum.
The last downswing was for $4.344 from $29.344 to $25.000. Compared with the previous three downswings, the most recent downswing is the largest drop in price from a swing high to a swing low.
You could say the previous downswing was the largest compared with the previous two downswings.
But remember, the downswing is only part of the equation for selling a top. The next piece of the equation is a divergence.
A divergence occurs when a momentum indicator, such as the stochastic indicator, RSI, or MACD makes a lower high while the stock price makes a higher high.
The next chart shows SNDK with the slow stochastic indicator plotted below the price.
The price has made a new high, but the indicator has failed to also make a new high – that’s the divergence between price and the indicator to look for.
Next comes the reversal day. Once the stock has shown signs of losing momentum and is setup to make a divergence, then look for a reversal day.
For selling, a reversal day is a day with the open greater than the close. An added bonus is if the close is also less than the previous day’s close.
In this case, SNDK does both. Just as soon as the stock makes a new high, the very next day is a reversal day. The open is greater than the close and the close is less than the previous day’s close.
Once all three of the requirements have been met, then sell as the stock trades below the reversal day’s low.
Of course, if you are selling short, then a protective buy stop goes above the most recent swing high.
Of course, just the opposite is required for buying a bottom.
So there you have it, the best method for buying bottoms and selling tops. Make sure you have all the criteria in place; change in momentum, a reversal day as the stock is making a divergence.
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P. S. In case you are interested, here is how SNDK dropped since making a high price on a divergence . click HERE
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