Dan Zanger 10 Keys I Use to Recognize Market Reversals

By TradersLog on November 22, 2013 in Articles

By Matt Blackman Learning to recognize key turning points in markets is one of the most important lessons any trader can learn,

according to Dan Zanger, the world record stock trader and author of the Zanger Report newsletter. There are only two ways to learn

this lesson; either through years of expensive trial and error, or through the experience of pros like Dan who can gently guide traders

away from making costly mistakes with an arsenal of online tools.

I first interviewed Dan for an article entitled Chart Patterns, Trading and Dan Zanger (Technical Analysis of Stocks & Commodities

magazine, August 2003). I had a chance to speak to him again recently.

So how much has trading changed for Dan since then? Surprisingly, even with the upheavels resulting from the financial crisis of 2008,

many of the same rules still apply (wth a few major exceptions) and Dan stressed the importance of understanding his 10 Key Reversal

Signs which help indicate when conditions are right to jump in with both feet or head for the exits.
Figure 1 Daily chart from the October 2012 Zanger Report newsletter showing this very bearish Head & Shoulders pattern

flashing on the Nasdaq Composite. Chart courtesy The Zanger Report Newsletter

http://www.chartpattern.com/cf/registration_form.cfm

1) Learn to recognize major reversal chart patterns.

Zanger: The Head & Shoulders is one of the most powerful chart patterns. Other reversal patterns include the double and triple top

(and bottoms), the rounding top (and saucer bottom), bearish and bullish wedges and parabolic curve. Lesser known but equally

important is the broadening or megaphone top pattern.

Stocks and markets rarely reverse without providing important warning signs. These patterns provide powerful clues. These (and other)

patterns are explained in more detail at http://www.chartpattern.com/understanding_chart_patterns.html

2) Dont get hung up on the news.

Zanger: Its basically impossible for most individual traders to trade the news, which for the most part is old information by the time its

published.

Its important to remember that markets experience bottoms when there is blood in the street and the news is bad. Tops happen when

the news is great and everyone is bullish. Unfortunately when everyone who is going to buy has bought the rally, whos left to buy more

shares? And without more buyers there is only one direction markets can go and thats down. Check out the other expensive mistakes

that Dan says can wipe out your portfolio at Buy, Hold and Fold Tricks of the Trade at http://www.traderslog.com/buy-hold-fold/

3) Know the key differences between bull and bear markets rallies.

Zanger: There are huge differences between bear market and bull market rallies. For example, buying the dips in a true bull market

can work very well. Buying dips during a bear rally will wipe you out.

Do you know what the differences are between bull and bear market rallies and are you able to recognize them quickly? Check out this

article that discusses the major differences between the two that Dan looks for in The 10 Key Differences Between Bull and Bear

Markets at http://www.traderslog.com/the-10-key-differences-between-bull-and-bear-rallies/.

4) Learn to recognize the market leaders.

Zanger: Apple exhibited a nice rounded bottom and started leading the market higher in 2008, well before the rest of the market

followed. Those who recognized this, other leaders like Baidu, Priceline and some of the other stocks I was discussing in my Zanger

Report newsletter starting in 2008, made a lot of money. Financials like Goldman Sachs and JP Morgan did well during the 2009-13

rally thanks to all the money the Fed pumped into the market after the financial crisis. During the rally in 2004-6 Google was a huge

market leader that made me a lot of money.

In every rally, there are market leaders and laggards. By identifying the stocks making the greatest gains, you will know which stocks

will be leading the market. When they stop leading, its time for caution as leaders often falter ahead of the pack when the rally is

weakening. Dan shares more ideas on how to recognize market leaders in Trail Guide Through the Stock Jungle at

http://www.traderslog.com/stock-jungle/
Figure 2 Companies that make Three Dimensional printers have been powerful market leaders in the Application Software

space. Three-D Systems Corp has been a huge winner but its also been very volatile. Chart courtesy The Zanger Report

Newsletter http://www.chartpattern.com/cf/registration_form.cfm

5) Never ignore the Fed.

Zanger: What the Fed is doing has become more important than ever. Back in the 1990s and early 2000s the Greenspan Put

described how the Fed supported stock prices during periods of economic uncertainty and ahead of presidential elections Its been

stepping on the fiscal gas pedal since 2008 and the market has become more focused on the Fed than anything else because stocks

have been a big beneficiary of these programs. And with Janet Yellen taking over for Bernanke means that the Fed will keep the pedal

to the metal as far as quantitative easing goes.

Even before the dawn of major stimulus programs in 2008, it was important to know what the Federal Reserve is doing. Experienced

traders quickly learn that what the Fed does and how it is stimulating the economy has a huge effect on stocks first.

6) Know what sectors are moving.

Zanger: At the very early stages of the recovery in 2002, home builders and consumer stocks like department stores and restaurants

did well. Financials and semiconductor stocks followed. Next are the energy and commodity stocks such as industrial metals as the
economy gets going. Bond prices are usually the first to get hammered when interest rates start rising which means its only a matter of

time before the stock market rally comes to an end. As we saw in July 2008 with record high oil prices, by the time commodity prices

peak, stocks can be well into bear market mode.

If transports and technology stocks are leading the market, chances are that stocks are entering a new bull market. If stocks that have

been lagging the market, take off and the dogs grow wings, or defensive sectors like utilities are strongest, be careful. This often occurs

at the tail end of a rally. Which sectors are leading speaks volumes about where we are in the economic cycle.

Figure 3 Daily chart of Goldman Sachs showing how powerfully it rallied into early 2013 thanks in a large part to rising

interst rates. But it also performed very well in 2009 jumping more than 200% thanks to the Feds QE programs. Chart

courtesy The Zanger Report Newsletter http://www.chartpattern.com/cf/registration_form.cfm

7) Pay attention to volume.

Zanger: When the market has been moving up on falling volume, its a warning sign. The same holds true when stocks fall on rising

volume which usually means that the number of sellers is increasing. Selling will continue until selling volume peaks which is called a

capitulation. Falling volume during a bear market is actually bullish However, this has been less true since 2009 when stocks have

experienced more of a constant melting up as opposed to the powerful surges that we saw in 2004-6. That has made it more difficult to

trade since I concentrate on volume and big sharp upside moves.

Volume is the fuel that all rallies need to last. Rising volume in a rally is bullish. In a correction, falling volume is usually (but not always)

bullish.

8) Watch market breadth.

Zanger: I use one custom oscillator in particular which uses market breadth advance-decline data to give me a heads up on trend

strength and potential reversals. When it hits extreme lows or highs, it usually means a reversal of some sort is ahead and its time to

take some profits.

Figure 4 Chart showing the custom market breadth oscillator Dan uses to help him gauge the strength of the move. Chart

courtesy The Zanger Report Newsletter http://www.chartpattern.com/cf/registration_form.cfm

More often than not, the number of advancing versus declining issues provides a leading indicator of where stocks are headed.

9) Other important patterns to watch for.

There are some patterns other than those discussed in point number one which Dan has also found to be powerful tools. The first is

the Key Reversal bar. If a stock puts in a new high on lots of volume then falls to put in a two or three day low, exit. Next is the Naked

Bar which is similar to a Key Reversal Bar except that as the name implies, has a buying spree that drives it much higher than previous

bars. It can also signal the end of a parabolic blowoff.

The Frozen Rope pattern in the figure below occurs when a stock moves up in an orderly fashion too orderly on a 45 degree (or so)

angle. The narrowing range shows falling volatility and when volatility falls to a multi-month low, more often than not these ropes lead

to a move lower.

Similarly, a stock move confined in a narrow trading channel can mean the end of a run.

Figure 5 Daily chart showing Dans bearish Frozen Rope chart pattern. It along with a rising channel often warn that a top in

stock prices isnt far away. Chart courtesy The Zanger Report Newsletter

http://www.chartpattern.com/cf/registration_form.cfm

10) Never get attached to a belief or opinion.

Zanger: I love trading stocks but I learned long ago to never get attached to a belief or fall in love with a stock. I did that once and it

cost me a bundle. I watched the stock drop in disbelief. How could a stock with so much going for it get crushed? I only found out later

that the insiders had been dumping the stock by the truckload. Funny thing about emotion. Once you find it creaping in to your trading,

big losses will eventually follow. The same holds true for how you view the market. Once you believe that markets cant go down, they

will do exactly that.

When you make a trade, it is based on where your evidence tells you a stock is headed. Dont stay in a trade if does not materialize as

expected. Also be sure to read Dan Zangers 10 Golden Stock Trading Rules at http://www.chartpattern.com/10_golden_rules.html

Trader Advantage

Experience is what separates the novices from the experts in this business. Tools like the Chartpattern.com chat rooms and The Zanger

Report newsletter help traders learn from the experience of those who have gone before them without having to suffer through years of

expensive school of hard knocks lessons on their own to get to the same point.

For other great articles on how Dan trades and what he looks for, check out this media page at http://www.chartpattern.com/media.html

for the link.