Technical Analysis 101: Island Reversal Gaps
Updated: Mar 5
Thanks for taking the time to read today's blog post where we discuss the importance of recognizing gaps in price and overhead supply that impact stocks from a Technical Perspective. These are great TA tools everyday market precipitants use to understand where to take profits and understand the impact it has on price.
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Tools are the Technical Analysts way of crafting a picture of the markets that fit their thesis, strategy and back testing. We are constantly finding easy simplified ways to understand markets and how we can take action on the stocks we hold and let the charts do the work for us.
Patterns combined with tools are a powerful way to predict human behavior in the markets. The buying and selling of anything that has a price (equities, bonds, commodities, cryptocurrency) that is bought, sold and plotted on a chart we will show us the patterns we utilize to make the best decisions in the market.
Sometimes due to the pressure of increased selling from a distribution pattern, where there is increased selling by the retail and institutions, we can gap down in price creating what are called island reversals, we can see this on our most recent blog post of Meta and Snapchat. As well as the chart below of Simulations Plus or $SLP., remember it could be any chart or asset that has time gaps in between when you can buy and sell that asset.
An island reversal is a price pattern on bar charts or candlestick charts that, on a daily chart, features a grouping of days separated on either side by gaps in the price action.
An island reversal can be a top or a bottom formation for a stock or asset, tops tend to be more frequent though. Here are five characteristics that define a typical island reversal:
A lengthy trend leading into the pattern.
An initial price gap, up or down.
A cluster of price periods that tend to trade within a definable range.
A pattern of increased volume near the gaps and during the island compared to preceding trend.
A final gap which establishes the island of prices isolated from the preceding trend.
In our last blog post we were talking about selling and now we are seeing the evidence of bearish patterns that indicate that our thesis was correct. This is that Aha moment! Technical Analysis is actually more of a science and charts are the art we use to craft our Hypothesis. So if are theory is "If we are going to move lower here based on the data we are seeing than we expect that to happen in our charts."
We posit the theory and then use data (price and charts) to confirm that what we are seeing is correct. So where do we see bearish island reversals or gaps in price that fall from highs? At tops in stocks...
We saw this in Snapchat and Meta (Facebook) this year and my theory is we'll continue to see it in other charts as well. Be on the lookout for tweets of new charts showing this price behavior and maybe even some island reversal bottoms! Thanks for reading and remember to trade confidently!
Essex Trading Quote of the Day (#EsxQotD)
“When you get a range expansion, the market is sending you a very loud, clear signal that the market is getting ready to move in the direction of that expansion.”
~ Paul Tudor Jones