Primary characteristics of trend resumption days:
- The day has a strong trend in the first hour or so and then enters a trading range.
- The trading range lasts for hours and often lulls traders into thinking that the day will be quiet into the close.
- The trend resumes in the final hour or two.
- The second leg often is about the same size as the first leg.
- The protracted trading range is often a very tight trading range.
- There is often a breakout from the trading range late in the day that tries to reverse the trend, but it is usually a trap. The market then reverses and breaks out in the opposite direction into the close. A trap is more likely when the trading range is unusually tight.
- There is often a breakout pullback entry for traders who did not enter earlier or on the breakout.
Sometimes there will be a strong trend for the first hour or so and then the market goes sideways for several hours. Whenever this happens and especially if the sideways action is in a very tight trading range, the day is likely becoming a trend resumption day. Don’t give up on the boring midday trading range, because there might be a strong trend in the final hour or so. The breakout is usually in the direction of the earlier trend, but sometimes it can be in the opposite direction and turn the day into a reversal day. For example, if the trend from the open was a bear trend, there is usually a late downside breakout from the trading range, and the day often opens near its high and closes near its low. There is frequently a brief one- or two-bar strong reversal breakout that fails between 11 a.m. and noon PST, trapping traders into the wrong (long) direction, and it is usually followed by a breakout in the other direction. This happens quickly, but if you are expecting it, you have a chance of catching a big bear move into the close. Less often, the reversal breakout succeeds and the trend in the final hour, if there is one, can retrace all or part of the opening bear trend.
The midday sideways action does not have to be a tight trading range, and it often has tradable legs in both directions. Sometimes there are three countertrend lazy pushes, creating a wedge flag. At other times the third leg fails to surpass the second, and this forms a head and shoulders flag (most head and shoulders reversal patterns fail and become continuation patterns). Because the pattern often has three pushes instead of two, it traps traders out of their positions from the open, thinking that this countertrend action might in fact be a new, opposite trend. However, don’t let yourself get trapped out, and be ready to enter when you see a good setup that will get you into the market in the same direction as the morning trend. Traders are scaling into positions in both directions and, at some point, many reach their maximum size. Once there is a breakout, the losing side cannot scale in anymore, and their only choices are hope and getting stopped out. For example, if there is a strong morning bear trend and then the market goes sideways, both the bulls and the bears will continue to add to their positions during the trading range over the next several hours, and many will reach the maximum size that they are willing to hold. Once the market begins to break to the downside, the bulls can no longer continue to buy. With a lot of bulls no longer able to buy, the bears are unopposed. As the market falls, it will often accelerate as more and more bulls give up and sell out of their losing longs, adding to the collapse into the close. The difficult part of this type of day is that the quiet midday sideways movement often leads traders to give up on the day when in fact they should view this as an opportunity. Just be ready to enter. The best forms of this pattern occur only a couple of times a month.
Instead of a midday trading range, the market will sometimes form a weakly trending countertrend move for a couple of hours, leaving traders wondering if the day is a reversal day instead of a trend resumption day. What might be developing is a weak trend resumption day, one that feels more like a trading range day but ends up opening on one extreme and closing on the other. Watch for the trend of the open to resume in the final hour, and be prepared to enter. For example, if there was a strong sell-off on the open, and then a lower-momentum rally with three pushes up that retraces some or even all of the initial sell-off, be prepared for a break below that bull channel and a resumption of the bear trend into the close. If there is a breakout of the top of the bull channel that reverses back down, this can be a good swing short entry for the trend into the close. Instead, there might be a setup that looks like a good low-risk short on the breakout below the channel. Otherwise, you can wait for the bear trend to resume and then look to enter on a breakout pullback or a pullback near the moving average. Even though the 5 minute chart might look like a trading range, maybe like an ABC on a higher time frame chart, if the market closes near the low, the day will create a bear trend bar on the daily chart.
Trend resumption patterns often take place over two or more days. Although the 5 minute chart might look like it has huge swings during those days, they may create a simple ABC on the 60 minute chart. For example, if yesterday had a strong bull spike for a couple of hours and then entered a trading range and that trading range continued for a couple of hours today, yesterday’s trend might resume at any point. If you are aware of this, you will be more likely to be willing to swing a larger part of your position for what could be a big move.
Figure 25.1 Gap Test after a Gap Up
On big gap days, the market often tests the open before the trend begins. In Figure 25.1, the market opened with a large gap up and then had a double bottom test of the low followed by a big rally up to bar 3. From there, it traded in a tight range for more than three hours, lulling traders into thinking that the good trading was done. Bar 6 reversed up from a poke below a bear trend channel line and it also dipped one tick below the bar 4 signal bar high. This trapped some bears into a short and many bulls out of their longs. The signal bar for the rally into the close was the first moving average gap bar of the day.
There were several other chances to get long, like the reversal up from the failed breakouts below micro trend lines at bars 7, 9, and 10.
Deeper Discussion of This Chart
In Figure 25.1, bar 7 was a high 2 entry and a reversal up from a one-tick break of a small bull trend line. Bar 1 was the high 1 entry.
Bar 8 was a high 2 variant (bear-bull-bear bars: the bar after bar 7 had a bear body and therefore the first push down, the next bar had a bull body and therefore traded up, and then the following bar had a bear body again, for a second push down).
Figure 25.2 Tight Trading Range and Then a Reversal
Sometimes a tight trading range that follows a strong trend can lead to a reversal instead of trend resumption. In Figure 25.2, today had a strong sell-off from bar 3 and then entered a tight trading range for a few hours. This often leads to a bear trend resumption into the close with the final sell-off often being as large as the initial one. There is frequently a failed breakout of the top of the range before the final bear leg begins. Bar 12 was a perfect setup for a swing short because it was a bear reversal bar that broke out of the top of the tight trading range late in the day. However, instead of the next bar being an entry bar for a large bear move, it was a small bull inside bar, and therefore a breakout pullback long setup. Bar 12 broke out and this inside bar was a pause, which is a type of pullback.
Deeper Discussion of This Chart
In Figure 25.2, the day opened with a large gap down and a strong bull reversal bar, setting up a failed breakout long and a possible trend from the open bull day.
Bars 13 and 14 were large bull trend bars that formed a two-bar breakout. Any breakout often is followed by a measured move based on the spike. It is usually based on the height from the open or low of the first bar of the spike to the close or high of the final bar. The closing high of the day was at a measured move from the open of bar 13 to the high of bar 14.
Most trend resumption bear days do not have a large rally on the open, and that large rally is an indication that the bulls were willing to buy aggressively today. Even though the middle of the day was setting up perfectly for a big sell-off into the close, you can never be certain and there is always about a 40 percent chance that the exact opposite can happen. Another clue that the market might rally to test the open of the day was that the low of the day was almost a perfect measured move down from the open of the day to the top of the initial rally. That means that the open of the day was in the middle of the day’s range. If the market could get back up there, the day could be close to a doji day, which is fairly common. Notice how the market repeatedly tested the support line at the bar 7 low to the tick and continued to find buyers. There were double bottom pullback long setups at the inside bar after bar 8, the inside bar after bar 9, and the higher lows at bars 9 and 11.
The support line was one tick below the initial bar 5 entry bar for the expected pullback from the sell climax. Bar 5 was the entry bar above the two-bar reversal setup at the low of the day. The market ran the stops below that entry bar by one tick, but, despite many attempts, it could not go any further down. This is a sign of strong bulls at work. Both buy and sell programs continued throughout the tight trading range, but eventually the buy programs overwhelmed the sell programs. All of those shorts had to be bought back, and this added to the buying pressure. Also, many sell programs reversed to buy programs, adding to the buying. The bars 14 and 15 spike up was followed by a channel into the close.
Figure 25.3 Trend Resumption
Even though the initial rally may only have a couple of strong trend bars and appear to be leading to a trading range day, the trend resumption can still be strong. In Figure 25.3, the market started as a trend from the open bull trend when it rallied from an expanding triangle bottom and a failed breakout of yesterday’s low. It then ran for two bars, but it stalled in the middle of yesterday’s trading range. A rally from any three-push pattern usually results in at least two legs up, which ultimately developed here. Bar 2 was a breakout pullback that led to another small rally, but then the market lost momentum. It continued to weakly trend above the moving average until bar 3. At this point, it was clear that something was not right. A trend from the open bull trend is one of the strongest forms of trends but this was clearly not trending strongly. That meant that traders would soon decide that the day was not what they thought and they would exit and wait. They would then be looking for a trading range day and a possible new low for the day. It was possible for the bar 2 low to be followed by a double bottom bull flag, but, in the absence of strong early bulls, bears would aggressively push for a new low of the day and the bar 2 low would likely fail. Bar 4 was a second small push below bar 2 and it was followed by a trend into the close, creating a trend resumption bull day, albeit a weak one, and giving the expected second leg up from the expanding triangle bottom. Bar 4 was an exact breakout test of the trend from the open signal bar high.
Figure 25.4 Trend Resumption after Several Days
Trend resumption can take place over the course of several days. In Figure 25.4, the market had a strong move down to bar 2 and then entered a trading range that lasted two and a half days. Trading ranges can last a long time, but usually break out in the direction of the trend. The bear trend resumed and had a second leg down from bar 5 to bar 14, five days after the first move down.
The bear leg down from bar 5 to bar 6 was followed by a trading range, and the second leg down ended on the open of the next day at bar 9.
The sell-off from bar 7 to bar 9 was followed by a trading range to bar 13, and the bear trend resumption occurred with the move down to bar 14. This was a three-day trend resumption pattern.