The Basics of Chart Patterns - Print Friendly Version

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Chart Patterns - Reversal - One Day Reversal

The one day reversal is the starting point for most reversal patterns. After an extended rally the stock gaps higher at the open to trade at a new high on a positive news announcement. As the session proceeds volume expands significantly but by the close the entire rally disappears and the stock closes lower.

Why Does It Happen?

One day reversals occur because large investors need liquidity to close long positions. They understand that the best way to liquidate a large position is to sell into good news when liquidity is highest -- so they are willing sellers on a day when the stock is making a new high and everyone is saying good things. Investors and media wonder how such good news could have resulted in such poor price performance. Indeed, over the next several sessions analysts and traders rationalize that the selling was simply overdue given the strong rally leading into the news but every subsequent rally fails. Weeks later the stock is well off its recent highs.

How Are Technical Targets Determined?

One day reversals are by definition one day events and as such technical targets are not implied but if you look at every major reversal pattern you will quickly see that it all began with a one day reversal.

The Amazon.com One Day Reversal

With a virtual marketplace Amazon.com (AMZN) was supposed to make traditional retailing obsolete. The concept was so compelling that Wall Street analysts began devising new data points to make valuations "work". This rationalization process saw the stock vault from pennies in 1998 (on an adjusted split basis) to $110 in late April 1999. It was amazing. Then the firm reported record revenues for the first quarter and several Wall Street analysts reiterated their "buy" ratings and raised targets. After closing the previous day at $ 103.59, the stock opened April 27 at $ 105.50 and proceeded to rally to $ 110.63, a record high. Volume swelled and it looked as though the non-believers were finally throwing-in the towel but by midday the stock was flat. By the close, the stock was actually lower for the session. Over the coming weeks new "buy" recommendations and positive comments continued but the stock sank to just $35 in early August.

Vital Signs

One day reversals occur because large investors choose to liquidate positions into strength so it is vital that volume accelerate as the stock begins to work lower.
The stock must close on the day of the reversal at or very near the session lows.

Liquidation (distribution) is an ongoing theme in reversal patterns. Now that we understand the basic premise of the one day reversal, let's tackle the island reversal.

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