Reversals show up in many forms – but in the moment, how do you know when a trend is about to lose momentum and turn in the opposite direction?
There are no guarantees that an apparent turn in direction is going to be permanent. However, one relatively simple technical indicator helps you to spot the strength of a move, its timing, and the likely future trend. The level of volatility affect all of this, of course, but the more volatile a stock the more useful the trendline. Even better, channels for dynamic trends help identify both entry and exit points.
Candlestick reversal and confirmation signals help time the reversal first indicated by the trendline. You do not need to run from high volatility and its lack of dependability. Trendlines and channels with confirmation provide better insights to even the most volatile trends. Adding to this, the well-known technical signals such as gaps, double tops and bottoms, and breakouts, all add to improved timing.
For example, the chart of Intuitive Surgical (ISRG) highlights a consolidation channel and a bullish trendline. Beyond the interesting technical nature of these price patterns, the trendlines and channels point to entry and exit for options trades based on the price activity.
During consolidation, numerous options trade make perfect sense. These include credit vertical spreads confined to the established trading range; covered straddles; synthetic stock positions; and naked contracts with buffer zones above resistance or below support.
The end of consolidation often is easily spotted as well, signaling time to close higher-strike short positions. In this example, the three identical white soldiers in early January marked a breakout above resistance followed by an upside gap. When trading in a consolidation trend, “reversal” that normally is applied to price direction and be applied differently, reversing the trend from consolidation to dynamic.
As the bullish trend is established by January 25, a new bullish options trade would be well timed. Following the retracement after the breakout gap, a second upside gap led to a prominent long white candlestick. This marked confirmation that the consolidation breakout had succeeded. At this point, a bullish credit vertical spread, synthetic long stock, or below-trading range uncovered short put would all make sense as nicely timed trades.
The bullish trend was over by March 6, identified by the simple but reliable trendline. As the line bumps into a declining price level, the question has to be addressed: Is this a reversal or a retracement? It looks like a retracement in hindsight, and lacking any other clear bearish reversals, that is how it appeared. Even so, closing out a bullish trade after a 60-point price move (from $$670 on January 25 to $730 on March 6) is sensible. Taking certain profits is a wise move if the alternative could lead to a decline in value.
This analysis of trendlines and channel lines not only to identify trading ranges but also to time entry and exit is of great value in options trading. The simplicity of these straight-line indicators conforms to the tendency for trends to behave in a particular manner but inevitably to end, points out why even the most seasoned trader needs chart-based guidelines as part of an orderly timing system.