Retracements: Proof Positive

Bottoming action comes in all shapes and sizes. As we previously discussed, there are plenty of ways to get to a bottom, but how can we be fairly certain an area a stock got to, whether a top or bottom, will hold? A seasoned chartist can rather easily spot a likely area from where a stock can react. The proof in how reliable the area actually is will not necessarily be determined by how a stock acts once it gets there, but in how it acts once it gets back. When a stock revisits an area that it's previously been to, be it recently or at some point far in the past, it can be called a retracement.

While you may lament missing the initial move that a stock makes into a good area, you can take solace in knowing that in most cases, the first opportunity to get involved with a stock in a certain area will not necessarily be your last or even best opportunity. Once a stock gets to its area, it will have some sort of reversal, but will then usually revisit the area or retrace back, either all the way (full retracement) or part of the way (partial retracement), which is where the more significant opportunity might await. Should the retracement lead you to substantial profits, then the area is like the reliable neighborhood diner that you can always count for the best breakfast in town! If the area doesn't hold on the retracement, well, then it wasn't such a great area after all, kind of like that flash in the pan neighborhood hot spot that ends up closing up shop almost as quickly as it opened.

In order to determine whether or not an area is likely to hold, we can look to the short-term charts, to see if a retracement is forming over the course of a number of days, or even within the confines of a single session. However, if a stock is falling or rising through an immediate area, we need to chart historically, looking back over weeks, months, and even years, to find an area for a potential reaction. From there, based on that initial reaction from a historic area, we can chart the behavior of the specific reversal. While the initial reaction might be somewhat severe, there will likely be at least some sort of short-term retracement, which will likely take at least one of four forms:

1. The Historical Area

2. The Double Bottom (or Double Top)

3. The Head and Shoulders (for bottoms and tops)

4. A String-along (also known as Consolidation or Pan and Handle)

Over the course of the next few postings, we'll examine some examples of these different types of retracements, taking into consideration more immediate retracements as well as historical ones, and how they relate to each other. Our discussion today will focus first on the historical retracement which is often the most difficult to spot, but it also tends to lay the groundwork for the more immediate types of retracements that will signify a definitive move in a particular direction.

History Repeats?

In my last posting I discussed the possibility that home fitness equipment maker Peloton (PTON) might have been making a bottom at around $36 right before Christmas 2021 based on certain technical analysis that suggested bottoming. To visit that posting and get an understanding of the reasoning behind that analysis of PTON, please click here. Suffice to say, PTON had not in fact bottomed at around $36 ($35.90 to be exact) and instead began to work lower during the following week, right after Christmas.

What made PTON's move lower all the more notable was that once it broke its $35.90 low, there was no immediate point of reference- areas of support -on any of the recent intraday charts on which to base a trade. It's times like these when an undisciplined trader can cause herself or himself unnecessary damage because they may be tempted to pick an area out of thin air and hope that it works, which is the very definition of trying to catch a falling knife. 

Once PTON broke the recent $35.90 low on 12/28, without a point of reference to the left on the intraday chart (as seen above), the quick-thinking trader must shift gears to the daily chart in order to sniff out where the next trade could be. As proper form would have it, the $33.91 low that it made the very next day on 12/29 made perfect technical sense.

As soon as momentum carries a stock past the recent intraday low or high, the disciplined trader will then begin to look to the historical chart in order to plan an area of attack based on prominent technical features such as gaps and/or other examples of support or resistance which might set off a reversal. A careful audit of the PTON historical chart revealed an abundance of technical data that would signify a reversal at around the $34 price point, which was basically $2 below the low it had made the previous week. The chart directly above is a daily chart for PTON, dating back a little over two years. As we can see, it had been quite some time since PTON had dropped into prices among the mid $30s, which means we needed to be alerting ourselves to noteworthy support features beginning at the prices that PTON was coming back into. For example, are there upcoming gaps? Was there ever a period of consolidation that led to a defined move in one direction or another? Or can we find patterns of highs and/or lows that preceded a momentous reaction?

It turns out that there was a rather small gap on the chart at $34.17 on 5/4/20, of only 8 cents, which began a more or less relentless 8-month run up to an all-time high of $171.09. Gaps are powerful technical components to charting because they are catalysts for deep runs in whichever direction they occur. In this case, the move that the gap created eventually ended in an all-time high. The fact that it was a narrow gap of only 8 cents, as opposed to a wider gap of a dollar or more, made revisiting it a stronger indication for a reversal because we could pinpoint a buy area more precisely.

If we wanted further confirmation that the gap at $34.17 gave us a strong hand to play, looking a bit more to the left showed us a high of $34.09 on 2/5/20, which was the last high before PTON’s pandemic-driven all-time low of $17.70, made on 3/16/20, in sympathy with the broad market sell-off at the time. From a technical standpoint, a high or low on the chart, or combination of the two, that predated a move to a significant price point is a facet of strength that we can use as a basis for a trade, either on its own, or in support of another technical indicator. The combination of the $34.17 gap that led to an all-time high, and the $34.09 high from three months earlier that came shortly before an all-time low was just too good of an area to pass on with PTON coming down into a price area that it hadn't seen in nearly 18 months. Identifying small gaps and other areas of support on a daily chart could be difficult, especially to the uncultured eye, so below is both the $34.17 gap and the $34.09 high in greater detail.

The low PTON made of $33.91 on 12/29 was exactly one red penny above the close on the 5/4/20 gap that we were playing against. So, if you were taking the whole picture into account, with the $34.17 gap and the $34.09 high, you could have set your buy at a price close to $34.17, with an incredibly easy, low-risk stop a bit below the gap-day close of $33.90 and you would have been a winner! For the time being, PTON has held this historical area around $34 and ran up as much as $4, to a high of $37.90 the very next day, which would have provided a return of more than 10% in just one session. PTON has retreated a bit since making the short-term high of $37.90, but for now, the $33.91 low from 12/29 has worked and we can look to determine whether or not it will make the type of intraday retracements we'll examine in upcoming posts before embarking on a decided move up.

Traders constantly straddle the fine line between the good behaviors that lead to profits and the bad behaviors that can preclude disaster. If you aren't careful, proactive aggressiveness can give way to reckless impatience. By the same token, patience can turn into complacency. That's why it's critical to have a firm understanding of where the areas are that offer trading opportunities and to follow through when the areas arise. Day traders (or swing traders, if you'd prefer) who don't necessarily hold positions very long and go after quick gains, can make a good living off of the intraday charts that show the immediate areas and ranges where trades can be made. But once an immediate range is broken, we need to pay attention to the historical daily charts in order to plan how to strike. Some traders believe that trying to time a trade against a historical area is akin to chasing windmills and red knights. In many cases you'd be well-served to let a stock that has broken out of an immediate area find its footing before revisiting it. Also, a stock may pause and form up at some point before the area you had been anticipating, at which point you'll have the opportunity to adjust your thinking and make a trade based on the action that the stock took. However, a stock that you watch regularly and that you trade with frequently must not be ignored and an awareness of key historical areas will help you to stay a step ahead of the market and make winning trades. With that said, Happy New Year and Happy Trading for 2022!