An easy-to-see, obvious reversal is the Island Reversal. It provides a dramatic reversal in that the enthusiasm that sent a price in a particular direction is countered with the same enthusiasm going the other way. In the example of Orbital Sciences Corp. ORB,
Figure 29, the up-trend can be easily seen. At the top, after the buying enthusiasm created a long bullish candle, the price gaps up away from the previous trading. This really demonstrates that the enthusiasm had reached an apex.
But upon inspecting the formation that it made, a long-legged Doji, the Candlestick investor should have been alerted to the indecision that was illustrated during this gap up. The following day did not show any evidence that the buyers were still present. This would have been further warning that the blow off top was in place. Finally the gap back down illustrates the great enthusiasm to get back out of the stock. This is an Island Reversal, usually very accurate and powerful.
Figure 29 - Orbital Sciences Corp.
An Island Reversal doesn’t have to be a quick move. Note in the Circuit City chart, Figure 30, how the gap down was countered with a gap up over six weeks afterwards. This formation indicates to the long-term investor that a new long-term trend has started.
The gaps on both sides of the bottom trading area make the Island Reversal an easy-to-see situation.
Figure 30 – Circuit City
As long as the gaps remain unfilled, the trend should remain up.
Next.....................Forex Strategy Bad News Gaps