Active Trader Magazine
  


Trading Strategies

The slingshot bottom setup

By Jeff White

Because the market presents many dangers and opportunities, it’s important to be prepared for anything. One setup that can help you take advantage of the occasional big up moves that follow emotion-driven sell-offs is the “slingshot” pattern. It’s a variation of the rounded-low pattern, but rather than being followed by the gradual reversal that tends to emerge from this type of bottom formation, the slingshot has the potential to be followed by explosive upside moves — when certain conditions are present. Let’s examine the traits that set this pattern apart from the typical rounded-low formation.

Roots in the rounded low
The rounded-low (or “saucer”) pattern represents a slow directional shift from down to up. Generally, a rounded low forms after a significant correction, such as the one shown in Figure 1. A steady decline in Transocean Ltd. (RIG) was followed by a slow change in direction, with the gradual creation of a multi-week rounded low from late 2011 into early 2012. 


The pace of the price decline steadily slows to equilibrium, creating the left and center portions of the pattern, as sellers gradually exhaust themselves and recognize the correction has ended, at least temporarily.

As buyers timidly re-enter the market, the right portion of the pattern mirrors the left, and price gradually increases. Once completed, the pattern represents a relatively flattened semi-circle, much like a saucer. Price has slowly turned higher after a sell-off, and upside momentum becomes a possibility again. This directional shift reflects a mood shift that changes the path of least resistance from down to up.

One way to think of the slingshot is as a faster-moving and more “temperamental” version of the rounded low. It’s essentially a compressed version of the saucer pattern: It has a similarly rounded appearance, but forms more quickly and with stronger emotion. When you stretch back a slingshot, you stop at the point the band can’t extend any more, and when you finally let go, the band snaps back with great force. That’s what this setup is like. In the markets, a slingshot occurs when a stock has swiftly declined to the point that it has become “stretched” in the short-term. This move is followed by a brief pause (sometimes only a couple of bars), which opens the door for a potential snap-back move to the upside. The faster reversal that often emerges from a slingshot pattern makes it more of a momentum setup than the standard rounded bottom.


For the complete article, see the May 2012 issue of Active Trader magazine. Click here to subscribe.



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