Applying Full Stochastics to Bearish Reversal Patterns
Look for overbought readings in Full Stochastics when trading bearish reversal patterns. Remember that overbought, as defined by Full Stochastics, is below 80.
Bearish reversal patterns and overbought readings go hand in hand. Bearish reversal patterns predict the reversal of long-lasting bullish trends. Naturally, stocks should be overbought after long bullish trends.
A sell signal in Full Stochastics combined with the formation of a bearish reversal pattern combines to give a very strong signal that a stock is going to reverse its bullish trend and move lower. Furthermore, the sell signal in Full Stochastics helps to spot earlier entry points, which can be of tremendous benefit when managing the volatility that usually accompanies a reversal of trend.
Figure 11.9
Example:
The triple top that formed in shares of Chicos (CHS) predicted a reversal of the existing bullish trend as shown in Figure 11.9. The bullish trend did reverse and the stock dropped dramatically over the course of the following months. The triple top was confirmed when CHS dropped below horizontal support at the $24 level.
Full Stochastics signaled an entry point well ahead of the breakdown below horizontal support. The sell signal in the indicator occurred when CHS rolled over the $27.50 level for the third time, completing the triple top. The sell signal in Full Stochastics occurred when the indicator was above 80, or the overbought threshold.
Figure 11.10
Example:
The head and shoulders top that formed in shares of Citigroup (C) led to a big drop in the stock as shown in Figure 11.10. The pattern was confirmed when C dropped below horizontal support at the $51.50 level.
An earlier entry point was offered when the Full Stochastics generated a sell signal at the 80 threshold. The sell signal came as C was forming its right shoulder at the $53 level. The sell signal in the indicator not only offered an earlier entry point, but added credibility to the head and shoulders top pattern.