One of the most important chart patterns is the buying and selling climax. A classic example of the pattern, in the form of a potential selling climax (S/C) is showing up in the daily and weekly charts of ARKK. Climaxes are exhaustion patterns, they develop as the last needful seller (weak hands) capitulates and hits the bid. Sellers are essentially exhausted.
1) Selling climaxes exhaust the available supply and often mark an important change in the market state.
a. Even if they don't mark the end of a trend, they often lead to a period of consolidation. It is not unusual to see a trading range develop after the completion of the secondary test.
b. Climaxes are fractal, appearing in literally every time frame.
c. Climaxes appear after a long period of trend.
2) Climaxes typically appear concurrently with terrible news flow.
a. Late last week I overheard an obviously frustrated fund manager on Bloomberg state that "I'm liquidating and going back to the real fundamentals." Down nearly 60% over the course of the last year he, and many other investors were finally throwing in the towel.
3) Climax patterns occur on extremely heavy volume.
a. A clear reversal bar (often a key reversal) is typically evident.
b. But modern climaxes can take several days to complete.
c. Often the liquidated shares are distributed from weak hands, to strong hands.
d. The new buyers are not necessarily long term investors and they often take advantage of the reaction rally to take trading profits.
4) There is often a sharp rally just prior to the selling climax. Wyckoff labeled this as preliminary demand (P/D), a point where strong handed longs are beginning to accumulate shares. The P/D is an alert to begin monitoring for a selling climax. In the case of ARKK, this P/D warning did not occur.
5) Immediately following the S/C is the automatic rally (A/R). Since sellers have been exhausted, the A/R can often cover significant ground. Buyers of the selling climax often use this rally to sell a portion of the position built during the climax.
6) In the case of ARKK, there is a micro test of the S/C. The successful test set the stage for the A/R.
7) A much larger secondary test separated in time must be completed before the S/C can be trusted.
Its important to note WHERE the behavior is occurring. In past entries, I have talked about building confluences of support and resistance to create zones. These zones can then be monitored for patterns that are consistent with a change in trend.
1) Price is resting at the bottom of both short term and intermediate trend channels. I generally view channel tops and bottoms as more reliable indicators of overbought and oversold than most of the momentum suite of indicators. The two channel bottoms formed a support confluence in the 61.81 to 63.63 area.
2) There is a clear three wave move (A-B-C) that can be used to generate Fibo extension targets. I use the A-B-C pattern to generate three targets, 1, 1.382, 1.618%. The distance is then projected from the top of C. In this case the tool generated equality with the first wave at 63.38. You can use the Trend Based Fib Extension tool in MV to generate the calculation.
3) The three levels (two channels and 1 Fibo) produce a support confluence in the area between 61.81 and 63.38. This is the zone where the S/C occurred.
Most momentum oscillators are deeply oversold. I have included the weekly RSI to illustrate. Note the curl higher.
Odds are good that the selling in ARKK is essentially exhausted now. My guess, given the broader backdrop, is that it will form a trading range lasting several weeks, maybe months that will allow strong hands to redistribute shares before beginning a fresh markdown. But, opinion not withstanding, I will follow the evidence and clues as they build.
Good Trading:
Stewart Taylor, CMT
Chartered Market Technician
Shared content and posted charts are intended to be used for informational and educational purposes only. The CMT Association does not offer, and this information shall not be understood or construed as, financial advice or investment recommendations. The information provided is not a substitute for advice from an investment professional. The CMT Association does not accept liability for any financial loss or damage our audience may incur.
CMT Association is a global non-profit credentialing body committed to advancing the discipline of Technical Analysis. Improve investment performance and career opportunities: www.cmtassociation.org
I had hoped to call attention to the anatomy of an important price behavior that is important across a wide variety of assets and time frames. I also intended to highlight how I use charts to approximate where these structures might develop. Instead I gave some the impression that I thought the selling climax would mark a long term low. That was not my intent. I will be more precise in the future.
Finally, while I think ARKK represents a great example of how a selling climax develops, I don't think it's bear market is over. I made that point in the final paragraph. ARKK has a tremendous amount of work to do before the trend could be changed from bearish to bullish.
Thanks to all who posted in the comments. There are some great observations and questions. I would encourage you to read them. The community here is (for the most part) pretty cool with many very knowledgeable participants.
Clarifications:
1) Selling climaxes clear out the immediately available supply. This does not mean that new supply can't come out.
2) Selling climaxes typically stall the market for a period of time, and often result in a trading range. But they can fail, and when they fail rapidly, which they often do in bear markets, the failure says very bad things about the asset.
3) This is why climax structures MUST BE SUCCESSFULLY TESTED before they represent anything other than short term capitulation. A micro test isn't enough for more than a few days, perhaps a quick trade. This was point 7 in the post. In retrospect, I should have made it point 1.
4) A successful test must be well separated in time from the initial selling climax. I prefer to see them play out over several weeks.
5) In other words, the huge volume and the reversal bar are only a warning that things may be changing. But, without the completed test, it is only conjecture and does not constitute (at least in my opinion) it’s a data point, not a tradable event.
6) In short, YOU MUST HAVE A COMPLETED TEST before deciding that a low of any consequence has been made.
7) I ended the piece by stating that the selling in ARKK is essentially exhausted now. I should have written it…. Essentially exhausted FOR now.
8) Finally, the only reason I monitor ARKK is the individual names in the portfolio. Funds are made up of many individual assets. Individual assets may be in very different positions in their trends than a given fund, index or market. ARKK holds many names that might eventually hold interest for me.
A final point, I think the fundamental/macro influences on equity are quite negative (just my opinion, but I am wrong a lot). Given that, its difficult for me to believe that the risk reward for a long position in ARKK is advantageous or that it will survive the testing process. But, I will follow the evidence and reevaluate if a successful test of the selling climax and subsequent bullish behavior develops.
Good Trading:
Stewart Taylor, CMT
Chartered Market Technician
Shared content and posted charts are intended to be used for informational and educational purposes only. The CMT Association does not offer, and this information shall not be understood or construed as, financial advice or investment recommendations. The information provided is not a substitute for advice from an investment professional. The CMT Association does not accept liability for any financial loss or damage our audience may incur.