Red Dog Reversal: The Most Powerful Stock Trading Counter-trend Signal

Jul 15, 2020 05:40 AM ET
Red Dog Reversal: The Most Powerful Stock Trading Counter-trend Signal

Trading is all about identifying a long-term trend, trading along with it until the trend reverses, given that no single market ever moves in one direction forever. Corrections do occur from time to time resulting in price reversing and moving in the opposite direction after an extended period.

Reversal patterns are a common phenomenon when it comes to trading. The patterns indicate an underlying trend is experiencing exhaustion and that there is a good chance of the trend reversing direction. The pattern provides entry signals early in the formation of a new trend giving the opportunity to buy stocks at a very reasonable price.

While the focus on trend reversal is usually on double tops & bottoms, triple tops, and bottoms, rounding bottom, or head shoulders, Red Dog Reversal is proving to be one of the most powerful counter-trend signals for riding out-trend reversals.

What is Red Dog Reversal?

Red dog Reversal is a typical trend reversal chart pattern that helps technical analysts determine a change in active control from bulls to bears or vice versa. Likewise, it is an early warning sign of a shift in momentum from a downtrend to an uptrend or from an uptrend to a downtrend.

The reversal chart pattern is commonly used to identify counter-trends in oversold and overbought conditions, depending on security under study. The chart pattern provides scope for making huge profits in addition to defining the parameter for setting risk.

Red Dog Reversal Buy: Parameters

  • The price must have moved lower or up for two straight days

  • Price Trades below prior day’s low the next day

  • Then trades back up through priors days low

Whenever price moves lower for an extended period, often, it reaches an oversold or overbought condition whereby reversal is usually inevitable. A move back up after two days of lower-lows could signal a trend reversal with the price likely to turn bullish and start moving up. In this case, the lows of a previous session could be used as the entry point for entering a long position with the low reached in the intra-day acting as an exit point.

Red Dog Reversal Buy Example

Consider the Google stock, which was in a five-day losing streak with price registering lower lows with each close. However, on the sixth day, a red dog reversal pattern appears, indicating that the price could reverse and start moving up.

Red Dog Reversal Buy

In the chart above, it is clear that the stock price sunk lower from the previous day low before reversing and moving high, conversely closing at the midpoint of the last day candlestick. A move back above the previous low day could be used as a trigger for buying Google shares. The low reached during the day is set as the exit to stop losses should price reverse and start moving lower in continuation of the long term downtrend.

Red Dog Reversal: XLE ETF

Consider Energy Sector ETF - XLE, which has been in an excellent run rallying to highs of $69, before price reversed and started moving lower. The price tanked from $69 to $66.82 in what appears to be a decent pullback. The next day after closing at $66.82, the price tanked, reaching session lows of $66.34.

Red Dog Reversal

However, the price reversed immediately and started moving higher. In this case, a trader could have opened a buy position at the previous day's low of $66.82 to bet on price moving higher on reversal. In this case, the stop loss would have been placed at the current's day's lows of $66.34 to protect against any further downside action.

From the chart above, it is clear that the price reversed from the session lows of $66.34 and rallied to highs of $70 a share.

Red Dog Reversals Sell

The red dog reversal chart pattern can also be used whenever price moves up for an extended period. If the price has been moving up for an extended period, you could consider a short entry on the expectation that the price will reverse and start moving lower.

Red Dog Reversals Sell

Likewise, whenever price breaches the previous highs, retraces the gains, and starts to move lower, a trader can trigger a short position on the last day high to bet on further downside action. The stop loss, in this case, would be placed at the current day's highs.

Conclusion

Red dog reversal is an effective candlestick pattern for trading reversals regardless of the instrument used. The chart pattern is highly effective in the stock market whenever price moves in a given direction, either up or down for an extended period.

Exhaustion tends to kick in from time to time, triggering reversals. Likewise, whenever traders think that price will continue to move lower or higher, a reversal occurs. The pattern is only valid when price prints a new low or high that is immediately followed by a reversal that closes below or high, a previous day close.


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