One of the more fascinating things to watch in the marketplace every day is the obsession with picking tops and bottoms. Why can’t we just be somewhere in the middle? Markets trend; this is a fact. So looking for reversals in the market is difficult because you’re going against the tide. It seems counterintuitive no? Remember that major historic tops take time to develop. Same thing with bottoms. This notion is something that’s easily forgotten. So let’s get back to basics and see what Edwards and Magee had to say about this in the 1940s:
Stock prices move in trends. Some of those trends are straight, some are curved; some are brief and some are long-continued; some are irregular or poorly defined and others are amazingly regular or “normal”, produced in a series of action and reaction waves of great uniformity. Sooner or later, these trends change direction; they may reverse (as from up to down) or they may be interrupted by some sort of sideways movement and then, after a time, proceed again in their former direction.
In most cases, when a price trend is in the process of Reversal, either from up to down or from down to up, a characteristic area or “pattern” takes shape on the chart, becomes recognizable as a Reversal Formation. Some of these chart pictures are built and completed very quickly, while others may require several weeks to reach a stage one can surely say that a reversal of trend is definitely indicated. Speaking in broad generalities, the greater the Reversal Area – the wider the price fluctuations within it, the longer it takes to build, the more shares transferred during its construction – the more important its implications. Thus, roughly speaking, a big Reversal Formation suggests a big move to follow and a small pattern, a small move. Needless to say, the first and most important task of the technical chart analyst is to learn to know the important Reversal Formation and to judge what they may signify in terms of trading opportunities.
There is one recognized Reversal Pattern which appears and is completed within a single day’s trading, and is, in consequence, named the “One-Day Reversal.” There are times when it has great significance as calling a halt, at least temporarily, to any up or down move, but in its ordinary manifestations it does not imply much of an immediate move in the opposite direction. It is a useful pattern…..but the price formations from which extensive new trends proceed take time to build. One does not bring instantly to a stop a heavy car moving at 70 miles an hour and, all within the same split second, turn it around and get it moving back down the road in the opposite direction at 70 miles an hour.
Good things take time….
Technical Analysis of Stock Trends (Edwards and Magee)