Alan Farley on Spotting Trading Opportunities in Failed Failures Using eSignal

Twisted logic can devise very profitable trading strategies. For example, we're taught early in our careers to buy breakouts and sell breakdowns, but market contrarians pay their bills doing the exact opposite. They wait for a move to fail and then sell the breakout or buy the breakdown. These mind-bending tactics don't end there. Many smart traders take it one step further and buy when the failure fails.

Let's back up and examine this way of thinking one step at a time. Most of us follow a common path -- we pile into stocks because they break out of resistance, but contrarians know exactly how you'll react when your pretty breakout drops like a rock. So, they guess where your stops are hidden and enter short sales at the same price to capitalize on your misfortune.

Now, twist your brain a little more and take this reasoning to the next level. The stock breaks out…you sit on your hands. The stock fails the breakout…you wait and do nothing. But, when the stock jumps back above the breakout price…you buy. Got it?

Modern markets try to burn everyone before they launch definable trends. My friend Bo Yoder calls this action a "rinse job." Whether through manipulation or mechanics, price gets drawn like a magnet through common support and resistance levels. This whipsaw movement cleans out the stops before a market ramps higher or lower. Not a pleasant experience when you're caught holding the bag but an excellent opportunity when you come off the sidelines.

How does price action "know" where the stops are hidden? The answer is quite devious. Retail traders are well versed in the basics of technical analysis. They take positions using common methods already deconstructed by the smart money. The result: Price passes through support and resistance far more easily than in the past. But, keep your chin up. Whenever the market comes up with a new way to take your money, it also gives you a new way to make it.

eSignal advanced charting makes it easy to find failed failures and take advantage of hidden trading opportunities. Let's look at two examples.

We made the case for a Concord bounce play. Using eSignal's Fibonacci tool, we drew intersections at two key retracements. Notice how this valuable advanced charting feature highlights the exact price at each level. Using this tool, we predicted CEFT would reverse near 29 and start a run back toward its high. But, things didn't work out that way. Four days later, CEFT gapped down through the entry target and made a mad dash to the 50-day moving average. It tagged it early in the session and reversed, closing back above 29. The next morning, price gapped above the entry target and completed an Abandoned Baby, a significant one-bar reversal pattern. CEFT then rallied to test the old high.

Fortunately, the gap down should have kept swing traders on the sidelines. Most effective trading strategies limit entries after unusual gaps. But, those already positioned had stops in the middle of that rinse job because it looked like a safe level on the price chart. There's a diabolical trading lesson here: Safe prices are also the most dangerous ones. How twisted is that?

We looked at the intraday bars of the last 2 trading days in the red circle and predicted an immediate Oxford Health Plan breakout. Wrong! OHP decided to go in the opposite direction on the same day. See how the razor-sharp eSignal charts expose a 2-day rinse job that fills the gap -- before the price finally jumps back into the resistance line.

What happened next is even more interesting. OHP spent a week gathering into a tight little ball. In fact, the last bar before the breakout printed an "NR7," the swing trader's term for the narrowest range bar of the last 7 bars. This quiet signal often precedes major price expansion and is a telltale sign of a market ready to move.