Reversing Course
The One-Day Reversal

As we all know and have experienced, trading is a game of inches and feet not leaps and miles. Thus, a trader’s ability to quickly recognize a pivot point or key juncture in market direction can be the difference between dominating performance and completely missing the boat. One of the reversal formations I’ve come to rely on in trading is a pattern called the One-Day Reversal (also known as a Key Reversal Day). This particular pattern is not one that you’ll see sparingly throughout any set of charts, and this is one of the characteristics that makes it so valuable; it’s uniqueness. It’s not a pattern that’s hard to recognize and it’s one of the most dependable signals you’ll get in any market.

The pattern itself does not carry major trend reversal implications. In itself, it’s typically a short-term reversal signal. Thus, if you have a stock that has been in a major up trend, the one-day reversal may only be a signal that the stock is ready to begin a correctional phase before it resumes the primary trend. It’s a pattern that provides a nimble trader the opportunity to pick up several points profit if he jumps in and out at the right time. I hesitate to say the formation doesn’t have intermediate- to long-term trading implications because, as I’ll show you in a minute, the one-day reversal signaled major trend changes in the indices in both October 2002 and December 2002. But, as a rule, the new trend does not carry too far right away. The prices work around in the nearby ranges for some time before they move away in Swing or Intermediate proportions. The one-day reversal is not a pattern that takes weeks or months to develop. The pattern is formed through a single day’s trading action. As I mentioned before, it typically appears at the very peak of a long advance, or the very trough of a long decline.

Distressed selling or panic buying produces most real climaxes in the market. They come at the end of rapid and comprehensive advances or declines. It’s pretty obvious that a “wipe-out” day can radically reverse the technical condition of the market (or stock) because, in the process, shares have passed from weak hands into strong hands. This is one of the major characterizing factors for a one-day reversal; HUGE VOLUME. When I say huge volume, I’m not talking about twenty-five or fifty percent better than average daily volume. I’m talking about two to three hundred percent of the average daily trading volume and it’s got to be significantly more volume than has been traded in the market or issue in the recent past. Understand, the reason this pattern works so well is because it’s a panic type day. On the sell side, investors are selling at any price. On the buy side, investors simply “have to get in” regardless of price. And, as we all know, the masses are usually wrong. The second characteristic of the one-day reversal is the day itself. On the long side, the stock typically trades significantly higher in the morning. The issue is simply continuing the up trend and pushing into new high territory as it had days before. However, by day’s end, the issue is should be trading lower than the previous days close. Thus, by the end of the day, the issue should be trading in negative territory. Ideally, the stock would be up significantly intra-day and then trading negative by the close. From the short side, we’re looking for exactly the opposite. We want the issue or market to be in a long standing downtrend and we want the stock to open the day down significantly. Literally, we want the bid to completely melt away and for panic selling to ensue. From there, we’re looking for the issue to post a strong rebound and for it to finish higher for the day.

Now, let’s take a look at a few examples. The first example below is a six-month chart for Chicago Bridge and Iron (Symbol – CBI). The stock had been in a sustained four month up trend characterized by a series of higher highs and higher lows. Volume had been strong to the buy side and traders were buying dips as the stock progressed. Now, notice the yellow circle. In the middle of this circle, you’ll see our first example of a one-day reversal (circled in green at the top). After a breakaway gap from three days priorr, CBI had been getting substantial follow thru as it ran from $15.50 to over $16.50 in just over three sessions. On the fourth day, our one-day reversal day, the stock started higher with volume. Many traders most likely believed this to be a continuation of the short-term up-trend. Weak handed novice investors were frantically trying to get into this hot issue. However, intra-session something changed. Strong hands took over. The stock began a robust sell off and, for the day, it finished in the red. Further, notice how big the volume was for CBI on this day (circled in yellow at the bottom). The volume on this particular trading session was two to three times the average daily trading volume. It was exactly the exhaustive type volume we look for as the stock reverses course. Finally, observe the fall off that ensued. CBI subsequently fell fifteen percent after the one-day reversal appeared.

Next, let’s take a look at our most recent market action. The chart below is a chart of the S&P 500 for the last six months. I used the S&P closed-end fund (Symbol – SPY) so we could analyze the volume indications during this time frame. On the chart, I’ve circled four specific days that qualify as one day reversals and, as you can see, they all marked critical junctures in our markets. First, notice the day furthest to the left. The market had been in a steep downtrend and investors were simply selling stocks irregardless of price. Investors wanted out at any cost and that’s when the strong hands took over. By the end of the day, the market was firmly in the black after starting the session plummeting to new lows. I need not mention that weak investors don’t push this kind of movement in the market. It takes a LOT of institutions plowing into the market to form this type of one-day reversal on the S&P 500 and we certainly want to try and follow the “big boys” as we trade. As a quick side note, I’m as big an egomaniac as any other trader, but even I don’t think I can push the market myself =). Next notice the second day from the left that I’ve circled. This particular reversal day came in and marked the second leg of a double-bottom formation that sent the markets trading significantly higher during October and November. Finally, if you notice all the reversal days that I’ve circled on the chart, you’ll quickly come to the realization that that reversal days marked very critical junctures, or pivot points, for the markets as a whole on four separate occasions recently. Remember, the one-day reversal is not, in itself, a major trend change indicator. It’s simply a short –term indication that the index or stock is going to correct away from the most recent trend. However, often times, you’ll see a one-day reversal capping a big run or marking a big fall that has larger ramifications than what we initially expect.