PROBABILITY

Island Reversal ????

Island Reversal


Island reversals are isolated data points separated by gaps. After an extended rally the stock "gaps" higher, that is, it proceeds to open outside of the most recent trading range. After trading in the new higher range for several sessions, a second gap occurs only this time the move is lower.

Why Does It Happen?

After an extended rally the stock opens well above the most recent trading range following news. This break out from the previous consolidation pattern occurs on huge volume and appears legitimate but after several days the stock fails to move significantly higher. New buyers become anxious, sellers should have been removed with the most recent move through resistance, something is wrong. Days later there is fundamental news that contradicts the news that initiated the breakout and already anxious new buyers panic, the stock opens lower. Weeks later the stock is well off the recent highs.

How Are Technical Targets Determined?

Like the one day reversal, island reversals usually occur at the start of larger technical patterns and as such, technical targets are not implied but these patterns usually lead to much lower prices.

The Magna International Island Reversal



Riding a wave of outsourcing, Magna International was supposed to have a business model that would smooth the cyclical nature of the auto industry. On August 13, 2001 the stock zoomed to a relative new high on impressive volume after a Merrill Lynch analyst upgraded the stock from neutral to accumulate. Merrill had been absent in the cheerleading that helped the stock move from $38 in December 2000 to $66 on August 13 so investors naturally took this recommendation as evidence the coast was clear for new investments. However in the days immediately following the Merrill recommendation the stock failed to move beyond $69 and to make matters worse, volume increased steadily. On August 17 Ford Motor Co. (F) issued an earnings warning and suddenly all of the bullish talk about Magna seemed insignificant. Magna shares opened lower and proceeded to work lower for the next several weeks despite a very bullish recommendation by Deustche Banc Alex Brown.

Vital Signs

Island reversals are news driven and usually occur because conflicting news events occur within short time frames.

Volume should accelerate on both the initial breakout and the subsequent failure for island reversal.

Island reversals are "trend killers" and usually lead to the formation of large patterns that follow the trend.


Now let's move-on to some the larger reversal patterns. We'll start with the double top