How To Trade Reversal Days

Getting better at trading intraday reversals

Ok, so this time last week we had a big reversal in equities.

Remember?

Sparked by this comment: KASHKARI: POSSIBLE FED WON’T CUT THIS YEAR IF INFLATION STALLS

The market got pretty battered as traders went into a mini panic.

So, let’s work out how we can improve the way we trade these kinds of days.

First, let’s consider the context:

Market theme:

Bullish market
Uptrend on the daily
Market’s engine: Inflation and war in Israel

Daily technicals

Big gap up across the board
NAS, DOW and SPOO all trading near highs

The market drifted off slightly from the open but found some support and was chugging back to intraday highs.

Everything looked bullish, normal buying service.

Then Kashkari opened his mouth and said the words that pretty much blew up the bull’s hopes and dreams.

KASHKARI: POSSIBLE FED WON’T CUT THIS YEAR IF INFLATION STALLS

No cut this year?

What?

That’s the foundation of this year’s rally, right?!

Risk off it is… (At least for now.)

The selling really started to pick up steam.

Here’s a zoomed-out 15-minute chart of NAS for context:

Ok, so where is the trade on this one?

Let’s look at some options:

Short it right away and hold?

Hindsight traders would have done this… but of course most recent dips have been bought, at the very least the market could have snapped back and stopped you out.

This is a no from me, too tough to quantify and manage the risk

Wait for a pullback?

This is more like it.

The selling is hard, there are very few buyers propping this up.

Any bounce is super small, indicating the sentiment could last for the whole day.

And by waiting for a bounce we are able to quantify the risk a bit better.

So… start with a north star “I believe we will close at or near the lows”

Why?

Well if traders are trimming the portfolio risk they only have a few hours to trade stocks with liquidity and use options as a hedge.

The pressure is on.

BTW using something like that as a north star is a great reference point, because then your job becomes, “to find a great entry and hold the thing”… That’s it.

Oh and of course your north star could have been “I think we close near to the VWAP” and all your trades would have been aligned with that.

Now in this case that would have been wrong, and with all the evidence on the day, you wouldn’t have made that call, BUT in real-world trading, sometimes we get it wrong.

The important thing is to have a north star, a thesis to work back from.

Back to the technicals:

I think these were the 4 best opportunities to get short on the day.

1: The first green candle after heavy persistent selling.
Triggers are either on a break of the green candle low, or the first red.

You had to be alert and ready for this one, also it wasn’t obvious that this would be the trend day it turned out to be.

The NASDAQ was still positive at this point!!

2: A small attempt at a retracement.
Using a break of the very small uptrend line is usually a good spot to consider short.

3: Support break and pullback
Now we are getting much deeper into the drive. You need to be mindful of a counter-trend rally here.

That doesn’t mean your thesis is wrong, but the deeper into the trend, the more likely a counter-trend move.

(Except as we approach the closing bell.)

So, selling on red needs caution at this point.

The urgency may not be as extreme, better to sell on green when the trend is already in full flow.

4: Ten minutes before the closing bell
The market attempts to pop, but sellers are still playing whack-a-mole.

Here, waiting for some kind of drive higher than fails is usually a great spot to hit it short.

Ok, so the meat of the move is already done, BUT with everyone scrambling to get out of a tiny door before the bell goes, the chances are high that sellers are going to keep smashing it right until the death.

This to me has a high probability but lower RvR.

Alright, so there you have it.

I believe these days offer fantastic opportunities for traders, and no matter how well I did or didn’t do at the time I always study these edge-case days in a bid to get better.

Capturing short-term inefficiency and supply-demand imbalances is our job, and that day was certainly imbalanced!