The NASDAQ 100 surged yesterday, closing up 2.25%. The tech-hefty index outperformed among the major US averages, boosted by a duo of positive themes: progress on the Congressional stimulus package and President Donald Trump’s release from the hospital after being diagnosed and treated for coronavirus.
However, the exuberance of the rally notwithstanding, the benchmark still remains below the resistance of the three-day Evening Star pattern, formed from Wednesday through Friday, demonstrating that supply overwhelmed rising demand. Are there still more sellers than buyers lurking?
While a retest of a bearish pattern is often the basis for a great trade, as market participants reduce exposure which increases the risk-reward ratio, should the pattern fail, it could be detrimental for bears and a boon for bulls.
On one hand, the fact that the Evening Star developed at the Sept. 10 peak confirms expectations for a line of supply at the 11,600 level—making the pattern even more bearish.
On the other hand, if yesterday’s bullishness on the progress of stimulus continues, not to mention if an actual deal is reached, it may blow out the Evening Star, upending the recently established short-term downtrend. Not just that, it will have established the last necessary signal for a short-term uptrend, the second, higher peak. Such a move would also complete a small, month-long H&S bottom (a proper H&S extends for at least 3 months).
Finally, if the Evening Star does hold and the small H&S bottom fails, it will have completed a much larger, proper sized H&S—a top—since July 1.
So, how do we know whether the 13.6% drop from the Sept. 2 record close to the closing low of Sept. 24 is not just a correction within a rising trend, but rather part of a larger move to end with a medium-term downtrend? Of course, we can't know that at this stage.
However, we can weigh the evidence and trade along presumed supply and demand indicators: volume, price average comparisons, momentum, taking into account conflicting signals.
1. Volume
- The Evening Star appears powerful, as the third candle engulfed more than the first candle, but the third candle’s volume was lower than that of the first, perhaps demonstrating bulls have more power after all.
- On the other hand, volume beautifully tracks the small H&S bottom, signifying overall support for bulls.
- Still, the larger volume scheme also supports the larger H&S since July, with volume flat or even falling amid advances of the shoulders and head, while rising on the declines.
2. Price Average Comparisons
- 50 DMA provides perfect support-resistance, separating the head from the shoulders of the month-long H&S bottom, while the 100 DMA supports the head—a signal for buyers.
- The MACD’s short MA crossed above the long MA, triggering a buy signal, in support of the short-term bullish move.
3. Momentum
- The RSI is struggling with a resistance level since April, again demonstrating the significance of this price level while also showing that anything can go.
Navigating Conflicting Signals: Trading such a complex landscape requires skill and some luck. Traders simply need to know how much risk they can afford, and whether each trade is worth their while in terms of monetary risk, the time they invest and how the pressure will affect their energy and attitude toward trading.
Trading Strategies
Conservative traders would wait for a clear trend, with either a new high above the Sept. 2 all-time high or complete the H&S top, extending the downtrend. These traders would wait for a 3% / 3-day filter (preferably to include a weekend), to avoid a bear trap.
Moderate traders, like conservative traders, would wait for clarity but would be content with a 2% / 2-day penetration.
Aggressive traders may short right now, placing a stop-loss above the Evening Star. A blowout would flip their position, using the Evening Star as a floor for their long position. Given that there are layered pressures of supply and demand, money management plays an even bigger role than usual.
Here’s an example of two different trades, in case the Evening Star blows out:
Trade Sample – Two Ways
Note: we’re using round numbers for clarity. You may change them according to support and resistance, and if you don’t understand this, do not attempt this trade.
Short
- Entry: 11,500
- Stop-Loss: 11,600
- Risk: 100 points
- Target: 10,700
- Reward: 800 points
- Risk:Reward Ratio: 1:8
Flip Position In Case of Failure
Long
- Entry: 11,600
- Stop-Loss: 11,500
- Risk: 100 points
- Target: 12,400
- Reward: 800 points
- Risk:Reward Ratio: 1:8