What are Springs?
Springs are false breakouts that can trap the unsuspecting trader. Spring patterns quickly reverse, with the stock or index then often testing the opposite end of the trading range. A spring is a false breakout to the downside. It is so-named because prices "spring" back.
How Do Springs Work?
Springs are a type of technical pattern named by legendary technician Richard Wycoff. The quality of the spring can be judged by an examination of the degree of penetration of support or resistance, as well as the volume on the day or period this penetration occurred. These four scenarios are possible:
-- Large penetration on large volume
-- Large penetration on small volume
-- Small penetration on large volume
-- Small penetration on small volume
For a spring, a small penetration on small volume is bullish, as it indicates there are few traders who are willing to sell their shares below support.
Springs provide the swing trader with good opportunities. First, they can provide a stop loss, which should be placed just below the extreme of the day the spring occurred. They can also create a target, since the stock is likely to test the opposite end of the trading range.
Why Do Springs Matter?
Being able to accurately recognize a spring can turn a potential threat from a false breakouts into an opportunity. Swing traders should always watch the activity following a breakout to confirm whether a stock is behaving as it should. If not, then it might still provide an excellent trading situation -- if you a spring in the making.