Chapter 6-3 Failed Signals
Very large size on the limit book or ECNs at key technical levels typically act like a magnet drawing the stock price to it as traders and investors look to test the size. This large limit order typically creates a level of either support or resistance.
When a support/resistance level, moving average, or trend formation (especially one with a large limit order) is broken there is typically a flood of orders causing a quick and dramatic move in stock price known as a breakout (or breakdown if bearish).
However, when such a flood of orders can not create enough momentum to carry a stock through a level, it is known as a failed signal. In other words, failed signals are reversals in trend due to a change in direction of the current pattern. This change of direction is often caused by lack of follow-through and conviction.
Keep in mind though if the overall market momentum remains the same look for another test of this level at a later point in time.
Good questions to ask yourself to help identify failed signals:
- Are buyers/sellers testing the support/resistance for the first time or has it been tested numerous times?
- How aggressive are the buyers or sellers? Is there a lot of depth on the book in either direction?
- How aggressive is the overall market?
What are some signs a move is failing?
- Weak prints, a large exhaustion print, sudden lack of interest on the limit book or ECNs, no significant breakout/no follow though, a turn in overall market momentum
Suggestions on what to do:
- Sell/Cover your position immediately if you are expecting a break and notice the move failing.
- Look for a possible reversal opportunity, but make sure appropriate exits exist.
- Be ready to potentially reenter if stock retests the level again later.