3 Early Signs of an Intraday Reversal

06/05/2012 9:25 am EST

Focus: STRATEGIES

Michael Bellafiore

Author, One Good Trade: Inside the Highly Competitive World of Proprietary Trading

There are select times when it’s prudent to trade against the overall trend, writes Mike Bellafiore, citing intraday action in Facebook (FB) that suggested a change in character was giving way to a bullish reversal.

I stress for our traders at our prop firm to trade with the trend. We teach generally that if a stock is in a clear downtrend to follow that trend. There are exceptions, however, and Facebook (FB) last Thursday was one such exception.

After the close, I pinged to our traders and asked, “Why would it have been correct to get long FB today even though it has been in a complete downtrend? I cannot give you guys too hard of a time for not getting long, but we need to review an important market principle.”

One of our traders who caught some of the FB long that day said it well:

“A lot of people are caught short over the last few days as Facebook has been in a downtrend. On top of that people were caught short intraday. Above $27.36, everyone short intraday would cover because this was the level that it failed at several times. Also, this was the reversal pattern on the hourly chart, adding more fuel to the fire. A ton of volume came in and the stock showed tremendous relative strength that we have not seen in this stock lately. This was a change in character.

This powerful move up on:

  1. A lot of volume, and...
  2. A reversal of the intraday and multi-day hourly downtrend can lead to a very big move up.

Upon noticing this, if one missed the initial move, one could get first pullback to the $27.70/$28 area which was around VWAP. Additionally, the market broke above the intraday high of the SPY as even more volume came in to FB and people piled in.

chart
Click to Enlarge

This was the first time that we saw such strength in the stock as of late. People have been afraid to buy the stock because there are no known support levels with an IPO.

Thus, when we finally saw this explosion to the upside, people finally showed willingness to buy and piled on. This doesn’t necessarily mean that the stock will go all the way back up to levels of the IPO, but it can certainly continue to trade higher, and we now know important levels to focus on in future trading of FB. We should make money of off this tomorrow and in days going forward.”

I responded, “Very good language, Leo. If a stock in a longer-term downtrend clearly has a change of character, then you can consider getting long.”

These three things are critical to see:

  1. Increased volume
  2. Breaks the intraday downtrend
  3. Lots of shorts perhaps trapped

This was a good example that happened to be on Facebook, but it is key in spotting a breakout reversal in any stock.

By Mike Bellafiore of SMB Capital

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