A strategy that can used on its own, or in conjunction with other strategies, this is one of my favorites. Why do I like it? It gets a trader into a move early, using a couple of confirmation tools. While no system is perfect, this strategy does often provide very high rewards for the risk, and we often know quite quickly if the market gave us the correct signal.
I will call this strategy the Truncated Price Swing.
A truncated move I will describe simply as a move that falls short of the previous move. I especially like this near the open. This is often when the most profit potential is available, but it can be used at any point in the trading day. Let's say a $50 stock drops $0.50 off the open, pulls up and then start heading back to test the lows. But this current price swing fails to reach it. This can provide a low risk opportunity to enter the market long (in this example), and the entry could be based off another signal, such as a doji, engulfing pattern or trend line bounce.
Using profit targets and estimated daily ranges a high reward to risk trade can be set up. The down side is that we don't know if (in this example) the stock is actually going to reverse, although based on the evidence we are making a educated estimate that it will. We are buying on the truncation using a simple signal, but in a few minutes the market could head back lower and break the lows (or highs if shorting an up move).
As I am writing this, this strategy could have been used on July 10, 2009 (check out your intra-day charts). It sets a low, then sets high, then lower low, but when it tries to test the highs again it fails. In this example a small range was created below the old high (rectangle). A break below the little range singled the truncation and short could have been place around the bottom of the rectangle. The market for much of the rest of the day.
To summarize we are watching for any move that is heading to test a daily high or low, but does make it there. Once the price stalls and starts to reverse away from the daily high or low, we are watching for a confirmation signal – this could be a candle stick pattern, bounce off a trend line, or as in the example above, a collection of bars and then a breakout from those bars away from the daily high or low.
Stops can be placed outside the daily high or low, or alternatively just above the truncated high or low which will likely not be too far from where we entered our position.
Profit targets for this trade vary on the daily market dynamics.