Trading Setups (Part 4)

07/03/2008 12:00 am EST

Focus: STOCKS

Toni Hansen

President and CEO, Trading From Main Street

The Avalanche

The Avalanche is a reversal pattern that triggers a short. Essentially, it is the first continuation pattern that creates a new downtrend. It can occur as a breakdown from an uptrend, or as a smaller breakdown pattern within a larger trading range breakdown. Two specific types of Avalanches are more commonly known as a Head & Shoulders pattern and a Reverse Cup-with-Handle. The entry trigger on an Avalanche, however, is not the same as on a Head & Shoulders pattern.

Criteria:
1. Uptrend or sideways trend
2. Stronger than average rally.
3. Pullback that is comparable to or stronger than previous rally, usually on increasing volume into moving average support (typically the 10, 20, 40 or 50 simple moving average).
4. Hugs the moving average support on decreasing volume.
5. Moving averages start to converge (10 and 20 sma if it's been hugging the 20 sma.)

Entry: Switch to smaller time frame and enter on a breakdown in support or going into resistance. A break in the trend line from the lows of the congestion along the support level can also be used, particularly if the waves of buying and selling within that congestion are more difficult to discern.

Stop: Over the last pivot high within the trading range, or drop down to smaller time frame and look for a smaller base at lows in the larger base and place a stop over the highs of that smaller base.

Target: Next major simple moving average support. An Avalanche along the 20 sma would have a target of the 40 or 50 sma. Also watch for an equal move compared to the drop into the Avalanche range from the highs. This works best if the pace of the breakdown is the same as the pace of the drop into the Avalanche base. Notice how this level stalled both the move in the ES intraday, as well as on the daily of GROW, which also was subject to simple moving average support at the 100 day sma when the 40 day sma that the Avalanche formed along gave way.

Ideal 5 Tech Tools Traits on an Avalanche Short Setup:

Pace: Above average pace on the reversal from highs, followed by slower than average upside as support holds. Within that congestion along support, it is preferable to see the momentum slow on the upside moves and increase on the downside.

Volume: An increase of volume into the simple moving average support, declining volume as the support holds and congestion forms (particularly at the end of that congestion), followed by an increase in volume as the support level gives way and the pattern triggers. This provides confirmation for the setup. The volume will often spike again as it comes into the next support level and first target zone. Within the congestion itself, prior to a breakdown, it is best that upside volume is lighter than downside volume.

Correction Periods: Higher probability if the setup triggers coming out of a correction period.

Support/Resistance:

  • When the base of the Avalanche pattern is directly on top of or is cut in half by the moving average that it is hugging, the odds are higher for a strong momentum breakdown than if the base or consolidation is directly under the moving average.
  • When forming along moving average support, the approach of the next fastest moving average and an impending crossover of those two is a strong pro. For instance, if the security is basing along the 20 day sma, then the imminent crossover of the 10 and 20 day simple moving averages will increase the success of the breakdown.
  • Check the next larger time frame for support. For instance, if an Avalanche is forming on a daily chart at the 20 day sma, then the 20 sma on the weekly chart is strong support. So if it is near at hand, then it can place a strong constraint on the reward potential for the setup.
  • If the Avalanche is forming within a trading range, then it is nice to see the range pulling into a larger moving average resistance level just prior to breaking lower.

Trend Placement/Trend Development:

When a security has had three waves of buying already and then attempt to form an Avalanche, the odds are higher for success on a subsequent Avalanche. When dealing with an Avalanche that forms within a trading range then it is best if there have been at least two waves of selling already within the range, if not three.

An example of an Avalanche in tomorrow's Tips for Traders
By Toni Hansen
http://www.TradingFromMainStreet.com

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