Trading Opportunity

Buy signal after false sell signal

Theory: A sell signal from a price formation is triggered when an important support level is broken. The psychology of the market players and the company's position in its business cycle then predicts that the price will drop further. Many investors will sell. If the price does not fall down to the price target of the formation, but instead rises, this often indicates that new and positive information has become available, and that new investors are buying. The sell signal was false. There are few things that are as irritating as a stock that one just has sold, rises strongly. But the stock is now more expensive than when one sold, so most of those who sold on the break down, will not do anything now. The stock continues to rise and breaks up on the opposite side of the formation. Sellers at the resistance level of the formation are gone now, there is a lack of sellers and a buy signal has been triggered. What is special about this situation is that also the sellers below the floor of the formation are gone, so that there will be an even greater imbalance between buyers and sellers than with a normal buy signal. A further rise is indicated, and one has the possibility to sett a tight stop loss right below the ceiling of the formation.
Another way this can be explaned is that the news surrounding the company became negative, or less positive than earlier, at the break down through the formation. Many sell based on this fundamental information. However, this turned out to be wrong, because the news turns positive again and the price rises. That which seemed negative, was not so negative after all, and new positive impulses have come. The price break upward through the formation resistance and both sellers below the floor of the formation and at the resistance are gone. A powerful buy signal has been generated, and a further rise is indicated.

Score: The most important criteria for calculating score for this type of trading opportunity are wether the break up happens relatively quickly after the break down, wether the volume development is positive and wether the price is near the support in the ceiling of the formation. In addition the quality of the formation and the direction of the trend is taken into account.

Buying price: The ceiling of the formation is calculated as the line between the tops in the two shoulders in a head-and-shoulder formation, as the line between the two tops in a double-top formation and as the resistance line in a rectangle formation. A buy signal is given when this ceiling is broken, and the buying price is set from the ceiling and a little up (about 20% of the height of the formation).

Price target: Is set to 90-125% of the price target from the formation break.

Stop loss: Is set to 20% of the formation's heigth under the ceiling of the formation.

Time horizon: >From 40% to 80% of the formation's length.