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Trader's Corner

Feeling Disorganized?

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Traders trying to catch a market move these days soon conclude that the markets are disorganized. That disorganization is a perfectly natural thing to happen.

Learning to recognize and even anticipate periods of disorganization helps traders keep more money in their trading accounts. Traders can have deftly caught a trending move at its inception. They might follow that trend all the way to its completion, stepping out at just the right time, only to find that the resultant action chops them out of a major portion of their earnings.

Thirty-Minute Chart of the USD/JPY:
[Image 1]

In both cases pictured above, the resumption of trending behavior was preceded by a period of disorganization. The rally off the 9/29 low appeared to the unsuspecting to be a beginning V-shaped recovery. The move then morphed into a W-shaped recovery that eventually took on the look of a two-headed inverse or reverse head-and-shoulders formation.

The ending move after the rally off the 9/29 low appeared to be setting up as a nicely shaped regular head-and-shoulders formation. However, would-be bears who had set stops just above the right-shoulder level or even just above the top of the head were likely stopped before the descent really got going.

What's the point? After a strong move, expect disorganization before the move resumes or a clean new trend begins. Sometimes an immediate V-shaped recovery or inverse-V-shaped decline begins a clean new trend in the opposite direction. However, that clean and immediate new trending move happens less seldom that the more typical intervening period of disorganization. During that period of disorganization, expect one formation to morph into another, just as the 9/30 move shown above morphed from a potential head-and-shoulders formation into a double top (if closing values are considered) one.

One common rhythm that's often seen after a big move stalls is for increased volatility to set up the outer boundaries of a formation that will eventually settle into a triangle. That triangle can then be filled out with a narrowing pattern that is formed of bull or bear flags that head up to or down to one of the triangle's narrowing boundaries. A slanting head-and-shoulder or reverse head-and-shoulder formation sometimes sets up inside the triangle shape.

Sometimes the first break of that triangle will then set the next trend in motion, either a resumption of the prior trend or the beginning of a new trend the opposite direction. Sometimes not.

Thirty-Minute Chart of GE:
[Image 2]

Three-Minute Chart of INTC:
[Image 3]

As should be evident from the inclusion of a three-minute chart as well as a thirty-minute one, this period of disorganization occurs across all time intervals. Such disorganization is apparent now on the daily charts of some indices.

Daily Chart of the NYSE as of 10/26/08:
[Image 4]

What lessons should we take from studying these few charts and thinking about the disorganization we're seeing now on daily charts of some indices, such as the NYSE's? First, the disorganization is not a new feature born of the particular stresses our markets are enduring right now. It's to be expected after such a strong move.

Second, the break of the triangle's support and subsequent move up through the triangle again might or might not have been significant. The formation may yet be morphing into another one, a wider descending price channel than the one seen earlier this year. Previous anecdotal evidence should already have warned traders that this kind of morphing from one formation to another often happens after a dramatic move. Traders who elected to trade the downside triangle break would have been wise to remain vigilant, but now bulls need to be vigilant in case the former triangle resistance holds on daily closes and the indices head down again and finally chop out some sort of tradable formation.

Whether the next trending move results in a new uptrend or a resumption of the prior downtrend, it will at some time end and settle into a period of disorganization. Traders would do well to remember the shifty and disorganized nature often seen after a trending move ends. Sitting back and watching, at least until the violent, choppy moves settle into some sort of tradable formation, can be the wisest step. Even if the break of that first formation proves to be a false one, traders would at least have some close-by benchmark that helps set meaningful stops.

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