When a stock breaks to new highs, how can you tell how
long the rally will last? In astronomy, scientists understand why the star that burns
brightest extinguishes itself long before one emitting a cooler, darker light. So it is
with market rallies. Parabolic moves cannot sustain themselves over the long haul.
Alternatively, stocks that struggle for each point of gain eventually give up and roll
over. So logic dictates that the most durable path for continued uptrends lies somewhere
in-between these two extremes.
New high trends may end in a few bars or last for years.
But as impulse and reaction carve out the uncharted territory, familiar features start to
emerge. Elliott's Rule of Alternation offers one important lesson when
rallies thrust upward into new prices. He notes that congestion patterns formed between
rally impulses tend to alternate between simple and intricate shapes. And complex
congestion takes longer to resolve than simple reactive movement.
Overbought conditions lead to a decline in price momentum
and illustrate one ever-present danger when trading new highs: stocks may stop rising at
any moment and enter extended sideways movement. Watch rallies closely with your toolbox
of technical indicators to uncover the early warning signs for this range development.
The first break in a major trendline that follows a big
move flags the end of a rally and beginning of sideways congestion. Momentum-based
positions should be exited until conditions once again favor rapid price change. In this
environment, consider countertrend swing trades when other forces favor success. But stand
aside as volatility slowly dissipates and crowd participation fades.
Traders avoid unnecessary losses when they stay prepared
and recognize the type of range being drawn after an extended rally. Observant chartists
quickly discover that the second corrective range of a dynamic uptrend tends to carve out
the more complex formation. This suggests the basing process often found right near old
highs will complete more quickly than expected.
No trend lasts forever. Inevitably, crowd enthusiasm
outpaces a stock's fundamentals and the rally stalls. But topping formations do not end
uptrends all by themselves. These stopping points may only signal short pauses that lead
to higher prices. Then again, they could be long-term highs just before a major breakdown.