How to Identify a Topping Action Before the Correction Starts
By Martha Stokes CMT
The technical trader needs to be able to see the increasing risk of a top formation in a stock prior to the top in order to avoid buying late and having whipsaw trades due to entering on weaker buying volumes as giant lots begin rotating to lower their risk due to over-speculative pricing.
Sandisk Corp, SNDK, is a stock that has been running up with a runaway trendline pattern that has had profit-taking retracements that have not adequately patterned out the speculative nature of the buyers. Unfortunately, such runs, which are wonderful for technical traders who entered early, eventually end, and often abruptly.
SNDK has been a superb stock for position traders since it started building platforms back in 2013. Platforms develop as giant- and large-lot institutions slowly accumulate a stock over time. Their controlled bracketed orders maintain buy zones that are not sufficiently wide enough for swing traders but are ideal for low-risk position trading. Position trading is the easiest of all the trading styles to learn and is far more lucrative than day trading.
The SNDK chart started out as a position-style platform-building stock that provided several levels of entry at low risk. The position trader is able to ride these up with minimal effort and time monitoring the trade, far less time than day or swing trading requires.
In May, the stock’s price action started moving with momentum energy, driving the price up vertically with too steep of an angle of ascent. Now as the stock reaches above $100, there is an increased risk of profit-taking by pro traders and rotation by some of the larger funds. Profit-taking puts this stock at higher risk of a correction due to the overly speculated price action.
The goal of this lesson is for technical traders to see the price trend shift from platforms to a momentum price pattern with an angle of ascent that was far too steep to sustain. Like an airplane, if stocks move too quickly and too steeply, the risk of a “stall” increases exponentially. The higher the stock climbs too quickly, the steeper the correction must be. Support for this stock is weak, so the risk of a deep correction is likely.
There are only two ways to correct and pattern out such extreme price action in a stock:
- The stock must correct back down to a prior moderate support level, around $80-84 on the SNDK chart.
- A wide sideways price action must develop, either a trading range or platform that lasts for many weeks or even months.
At this time, SNDK shows weaker candles, some quiet distribution in TechniTrader’s Volume Accumulation and Flow of Funds indicators, and more sell side volume than buy side volume. TTVA is declining in a negative divergence from the stock’s price trend, which is indicative of profit-taking even though price has not moved down yet. Remember that the institutions have special orders that can control price and do not move it much at all.
Buying this stock at such an extreme pattern is a very high risk. Profit-taking has already started and the indicators are all diverging away from the stock’s price trend. Learning to identify a topping action, before the correction starts, can help the technical trader avoid whipsaw trades, weaker trades, and chronic losses.
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Martha Stokes CMT
Master Rated Technical Analyst: Decisions Unlimited, Inc.
Instructor & Developer of TechniTrader Stock Market Courses
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