Major Principle
1. Euphoria/Capitulation. An acceleration in the price advance, almost
vertical movement accompanied by a volume surge, is usually not sustained
and indicates the end of this stage of the move (euphoria stage).
(See Figure 9.1.) This is a perfect example of how the majority is usually
wrong as it lets greed overtake fear. This is often the last stage of the
move, as the majority finally sees what everyone was trying to hide and
jumps on the bandwagon. Distribution takes place by smart money. Since
our understanding of the tape principles dictates that the majority is usually
wrong, it is time to unload positions or at the very least, not get caught
up in the buying frenzy that usually signals the top of the move. Ask yourself
how many times you bought the top. We prefer not to count them (on
both hands and feet), as we move through our learning phase regarding
true market reality. This is a feeling of unbearable pain from missing the
train, from standing on the sidelines while "the entire world is making
money" that causes those late entries on a parabolic stage of the move-
and those entries are being punished severely.
An acceleration in the price drop, almost vertical movement accompanied
by volume surge, is usually not sustained and indicates the end of
this stage of the move (capitulation stage). (See Figure 9.2.) Once again,
tape-reading principles save us from our ego and misunderstanding of
market behavior. The capitulation scenario is the opposite of euphoria.
The majority is selling in aggregate during the phase where fear overtakes
greed. In this case it's still the same unbearable pain; this time it is the
pain of holding the plummeting stock that causes this screaming reaction,
"Just get me out!" Traders or investors just don't care anymore. They want to forget this stock. Their pain has reached the threshold where their
loss has exceeded all expectations and effectively numbed all their feelings
but "sell and forget!" The smart money waits for this level of selling
to slow down and looks to support the stock for a trend reversal by establishing
a position favoring the long side or by covering portions, if not all,
of its short positions.In our practical, intraday trading this principle serves two purposes.
First, we use vertical spikes with a volume surge to liquidate our positions,
selling our shares into a buying frenzy or covering our shorts into a
sharp sell-off. This effectively puts us on the side of the smart money as
we ride the trend while it's slow and get out when the crowd comes in.
You can see how this corresponds to the ideas we discuss at the beginning
of this chapter and how those ideas tie into practical reading of the market
movement. By using this price/volume correlation, you can position
yourself on the right side, trading against the majority instead of being a
part of the losing crowd.
Many traders we taught over years have told us that this approach of
liquidating their positions into price/volume spikes entirely changed the
way they traded and made their trading orderly and more profitable. It
helped them cure the problem of selling too soon, since they stopped taking
little profits just because they had some measly 10-cent movement in
their favor. This also helped them solve the problem of holding too long,
which allowed profits to evaporate. Instead they started selling or partialling
out into those spikes, which brought nice structure to their trading.
Second, we start hunting for a trend reversal when we see hysterical
movement. We talk more about this in Chapter 10. For now, let's say that
this kind of play is based on the same idea: When the movement becomes
parabolic and the volume surges, it is an indication of majority action.
Since the crowd is last to act, we can assume that the trend is about to
reverse.