Discover The Early Tip Off to Take Profits And Run The Other Way
Parabolic moves in a share price can often signal the end of a trend or a sharp reversal in direction. Similar to a rounding bottom the share price rises faster and faster until it is pushing up almost vertical. This move is unsustainable as profits are being made very quickly.
If you made a profit of 20%, 50% or 100% in a week, what would you do? The obvious answer is to sell the share to lock in profits. This selling can result in a rapid reversal in the share price.
Look at these examples of the price action in Silver. The price took off to the upside climbing more rapidly as the move established itself. Silver increased in value from $5.60 to $6.60 over a month with most of the increase appearing in the last week.
This is an increase of 20% in a month, however most traders trading silver would be trading futures contracts, giving a return of 200% or more for the month. The price of silver dropped rapidly as profit taking drove the price back down.
The price of gold behaved in a similar way during the same period of time. Gold climbed rapidly from $390/oz through to $430/oz in a month. This was a 10% move, with futures contracts yielding a profit of 100% or more during this time. Profit taking dropped the price of gold over $10 in a day.
A more recent example is the blistering move up in the Nikkei. It appears that the Japanese market is finally staging a recovery after falling for the last 15 years. A lot of the issues with bad debts and loan repayments are now resolved and the economy is starting to look much better than it has for many years. And, it seems, everyone wants to get on board for the rise.
The sharp break down on the Nikkei a fall of 2.8% in one day is one of the largest fall the Japanese market has experienced during the last year and is likely to lead to further falls as profit taking ends this rapid upward move.
The parabolic move is often the end of a rounded bottom or top and can result in very healthy profits if the share is bought early enough. Once the share is moving strongly it should be avoided, even though it is very tempting for the beginner trader to buy at this time. The result will generally be a loss on the trade as the chances are very high that the share will reverse direction.
If you own a share that starts into a parabolic move to the upside then it is essential to have a stop loss in the market and it is recommended to move the stop loss level closer to the share, because once the reversal starts it can drop very quickly.
An alternative approach to trading the parabolic move is to look for a parabola in the downwards direction and use the reversal to enter a trade. This in an aggressive approach to buying a share that can result in quick profits; or large losses if the discipline to exit the trade is ignored.
You are violating the rule trade in the direction of the trend and anticipating a reversal in trend. If you are right the profits will flow, if you are wrong losses can be large because you are buying a share that is dropping in value.
The example above of Macquarie Group (MQG) shows this parabola as a downside entry opportunity. In MQG the trade would have gone exceptionally well, however tight stops are necessary as the bounce could have been short lived.
By understanding the parabolic pattern it can alert you to possible reversals in the share direction. This allows you to take profits if you own a share or for more aggressive traders to buy a share as it reverses.