LOOK OUT! High-Reliability Reversal Signals

Some stocks have seen some amazing gains in the past two days, just look at Morgan Stanley (MS), up over 130%, and you’ll see what I mean. These returns are no joke, but when is it time to consider selling or at least scaling out of a long position especially during power spikes?

Below are four of the most highly-reliable reversal signals that every long should watch out for:

For now, ignore the red candles and focus only on the white and black candles that form the left sides of each drawing.

You may have noticed that a lot of “spikers” have gone up too far too fast. These are the stocks that become perfect short candidates for a 1-3 day hold. You may have noticed some of the patterns (above) before, but I’ll give you some examples and what to look out for.

Evening Stars are one of the most reliable reversal patterns available. The failure rate is extremely low and I can’t remember the last time I had a major problem with them. What’s happening is that as each day passes during the rally, the open-close range gets smaller meaning that the buying is starting to slow down. The “cross”, called the doji, at the top signals that the rally has entirely stalled and there is some confusing among both bulls and bears as to which direction the stock should go. This doji day is critical because what happens the next day will most likely continue in the direction of the winner.

Because the rally stalled, it means that the bears have taken some control away from the bulls and there is a very high chance that the stock could drop the very next day. If that does occur, that’s called the evening star and that consists of a long white candle, the doji in the middle, and a down day. Just because a stock dropped to confirm this pattern does not mean that it’s too late to short. Most of the times, this is only the beginning.

Here are some examples of stocks that “may” become evening stars imminently:

Are there pattern failures? Absolutely! That’s why strict risk management and controls must be in place to handle these types of failures. Take a look at Citigroup (C). Notice how it formed a second doji. Shorts would have lost over 18%. This is why I like to wait for confirmation in a signal to go forward before “assuming” that the pattern will go the way I want it to go.

Shooting Stars are one of my favorite patterns. They remind me of a comet (or shooting star) falling down to Earth and that’s exactly how the Japanese rice futures traders named this pattern. It’s an ominous sign that a stock (or rice) will drop very, very soon.
The failure rate is extremely low, but is higher than an Evening Star pattern. What goes on during a shooting star day is that a stock gaps up, moves higher throughout the day, but for some reason is unable to hold its intra-day highs, and falls back near
its close. From the open to its high, the shooting star is formed when at least 2/3^rd’s of the day’s gains are gone. Take a look at Fifth Third Bancorp (FITB) and you can see the shooting star clearly.

Bearish Engulfing patterns are just as reliable as shooting stars, but not much so than Evening Stars. Still, they show serious warning to traders that sentiment has almost entirely changed from yesterday. What happens here is that the first day opens and closes well over it’s open but on the next day, the stock gaps up and drops like a rock throughout the day and the open-close range penetrates so deep that it completely “engulfs” the previous day. This action basically cancels out yesterday entirely and shows that something happened that made investors/traders to dump the stock right after they bought it. Take a look at Massey Energy (MEE) and Yingli Green Energy Holding (YGE) below:

Another favorite of mine are bearish gap ups, or formally known as Bearish Belt Holds. These are stops that gapped up considerably but sold off throughout the day, closing well below its open. The gap is usually not filled on the same day. This pattern represents the ultimate change in extreme sentiment because investors/traders were so excited, they continued to buy after-hours and pre-market the next day that the stock gapped up significantly. However, they all just dumped it. Why? Who cares! Just know that you probably shouldn’t own a stock that just sold off from the start. Here are a few examples. In the case of National City (NCC), look how sometimes it may take two bearish gap ups to complete the pattern.

I want to remind you again that there are pattern failures and nothing is a guarantee. Just look at Sallie Mae (SLM). Shorts would have lost 35% in a single day! Practice strict risk management and make sure you cut losses QUICKLY if this does occur.


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TODAY'S BREAKOUTS & BREAKDOWNS

WHAT A DISASTER! The Dow dropped 777.68 points or 6.98%, the Nasdaq dropped 199.61 points or 9.14%, and the S&P 500 dropped 106.59 points or 8.79%. Today was the Dow’s largest one-day drop, EVER. Oil dropped $10.52 or 10.1% to $96.36, but not before hitting $95.04 intra-day. Wachovia’s (WB) banking operations get bought out by Citigroup (C) and the stock lost about $19 billion in market cap in a single day. We continue to make financial history and every day is comparable to the most recent thriller/suspense movie you’ve seen.

What amazed me the most? It was the media coming out on Sunday night peddling this fluff that they called a “the deal that had been reached”. What I don’t understand is if a deal had been reached, why did it completely breakdown? If you were watching the House vote and watched the market intraday alongside, you could see how each update on the vote count actually moved the market considerably. There was a sight delay in my opinion and I was able to short when there were only about 50 or so votes left and the “nays” were well in the lead. At that point, whatever confidence I had in the financial media completely disappeared. The House is expected to present a new proposal on Thursday at the earliest, at least that’s what the media is saying…

On September 5, I wrote an article titled “The Rally is Over”. Several people made some stupid comments. Look at this comment:

“It's amazing that by just looking at charts one can predict the future and make bold statements such as "This Rally Is Over".

I wonder if there are other forces in life which could affect iron clad chart trends, and perhaps make "This Rally Is Over" sound a bit more uncertain. Nah. Wishful thinking on my end.”

Haha, whatever, I don’t have to prove anything. Never underestimate the power of technical analysis. The breakouts and breakdowns I profile daily are the biggest harbingers of a chart. They will give you clues as to where the stock will go.

Anyway, I searched for my usual breakouts and breakdowns and I found 5 breakouts, one of which was the VIX, which doesn’t really count. I was shocked with the breakouts, which I’ll talk about later in the article.

Thornburg Mortgage (TMA) gapped up 310.71% today, the largest gainer by far. However, look how the volume didn’t support price action. I can pretty much say for a fact that TMA will drop tomorrow. The board announced a one-for-ten reverse split, which is intended to boost the stock’s value above $1. TMA is also currently in negotiations with repurchase counterparties (who helped avoid TMA’s bankruptcy) and extended its tender offer for preferred stock. It’s still a $1 stock, and I would avoid it at any cost.

Delia*s (DLIA) agreed to sell its CCS brand for $102 million to Foot Locker (FL) and as a result, the stock jumped 17.2%. Not bad considering that everything else went down the toilet. How bad was it today? Out of all the industries, Alternative Fuels as a whole was the best performing sector with a 0% gain!

VeraSun Energy Corp. (VSE) spiked 81.8% today. There was no news out, at least to the public. VSE has started to fill its gap; however, I would the hell out of VSE if there is any size gap down at the open. Be warned: VSE may fill the gap intraday. Shorting spikers on no news is a great way to go.

Another stock that spiked on no apparent news is Raser Technologies (RZ). Looks like a major short squeeze to me. 24% of the float is short (or was). Any gap down warrants a short at the open.

The VIX is the last “breakout” to profile. In my weekly technical commentary that is distributed early Monday, I wrote that the VIX was forming a high-and-tight flag and that a breakout was imminent. I had no idea it would be today. At this level, the VIX will hit the 50 level. I would also like to point out that a flag or any type of consolidation pattern was never formed on the VIX for at least the last 3 years, so I knew it was something special. People are scared, and the bull camp is getting smaller and smaller each day. Expect these fear levels to remain elevated for a while.

As for the breakdowns, I found over 300 of them. If I tried to profile all of them here, the article would be almost 700 pages long. That’s how bad of a day it was.

Here are some of the biggest losers. I declined to draw trend lines because I thought they were obvious and pointless. Many of these no longer have any support levels remaining. I warn you NOT to go long in any of the following:

Once again, NO long positions, please! I don’t care if you think that the stocks are “cheap”. Trust me, they’ll get even cheaper (you might even get a 50% discount tomorrow!). If you don’t know how to short, just stay in cash. Standing aside is also considered a position.

On the top 100 largest declines for both the NYSE and the Nasdaq, all 200 of them declined by 17% or more. I highly recommend that no long positions be entered in any of them.

Today, there were 1,142 new lows hit and only 23 new highs made. The market cannot rally with these kinds of numbers being hit.

The rally has been over, and I can confirm that we officially began the third primary leg of this bear market. Don’t ignore chart patterns; they’re trying to tell you something!

Fair warning to longs: we have a lot more new lows to hit.