Introduction: Sell high, Buy low?Many years ago, I was teaching a group of brokers from Oppenheimer at the New School in New York, and was asked, "Are point and figure charts are always bullish at the top and bearish at the bottom?" I answered "No, most investors are often deceived into thinking that stocks making new highs are always good and stocks making new lows are always bad; but for the disciplined p&f trader there are some good chart signals that are bearish at the highs." In this article, we are going investigate one of three of these bearish top signals: The Bull Trap.
You can look at the other 2 Signals in the articles The Buying Climax and The Broadening Top in the Point & Figure College section of the Investors Intelligence ’University’.
The Bull TrapThe Nicholas Darvas book "How I made Two Million Dollars in the Market" vastly increased the popularity of stop losses and, coupled with a shift to institutions doing more of the trading, tended to work against the effectiveness of Triple Top and Triple Top Breakouts, two of the most popular and obvious places for stop losses.
The rationale behind a triple top breakout is that a stock would rally to a certain level, say $40, pull back to say $37, rally again up to $40 and then pullback to $37 and then move up again and break the three tops at $41. Behind this was the assumption that at the first highs at $40 the supply overcame the demand and the stock pulled back. On the third try the assumption is that demand has now overcome Supply as the stock broke to new high.
With increasing sophistication, the large sellers, with probable help from the Specialists, are aware that there are a lot orders to buy on Stop at $41 from a combination of people who want to buy at that breakout level and from short sellers wanting to cut their losses. Thus, it is to the sellers’ advantage to hold back on their sales until $41 is hit where there is a lot of demand for the stock. When the stock now "runs out of gas" at $41 and pulls back to $38, the Bull Trap is in place Demand did not overcome Supply, the sellers just held back, knowing they would get a higher price for the stock they wanted to sell.
The same thing is true on the downside as triple bottoms are logical places for sellers to keep their stop losses and for short sellers to initiate their trades. The immediate upward reversal from the downside breakout level now becomes a Bear Trap to the detriment of those with their sell stops at the obvious levels.
On a lighter noteI remember a scene from the TV program "Maude" many years ago:
Maude’s husband was feeling good on his 50th birthday and told his doctor friend he was going to play golf with a mutual friend.
The doctor replied: "You didn’t hear, he dropped dead on the golf course last week".
Maude’s husband was shocked and replied " I don’t understand it, last time I spoke to him, he had a physical and everything was just great. "
The doctor said: "Right, the first sign of trouble was at the 15th hole! "
Same thing with stocks, great one minute, dead as a door-nail the next. Make sure you keep an eye out for our classic ending signals!