A period of extraordinary volume which comes at the end of a rapid and comprehensive decline which exhausts the margin reserves of many speculators or patience of investors. Total volume turnover may exceed any single day’s volume during the previous upswing as Panic Selling sweeps through the stock or commodity. Also called a Clean-Out Day, a Selling Climax reverses the technical conditions of the market. Although it is a form of a One-Day Reversal, it can take more than one day to complete.
Source: Edwards, Robert and Magee, John. Technical Analysis of Stock Trends 9th Edition; (c) 2007.
During weak market conditions, and for specific counters, we often see major down days – shocking and trapping investors who had bought at what they thought were lows (Remember DHFL at Rs 300 or Yes Bank at Rs 200) – only to see new lows being tested and panic resuming.
A contrarian investor may wish to dabble in these – and its okay from a long term perspective – but random bets for short term trades may cause catastrophe. This is where the identification of a “selling climax” becomes important.
Defining the Climax
The Selling Climax volume-price chart pattern is a Bullish trend reversal pattern. It is considered as a strong but rare signal. A Selling Climax is a high volume decline that is suddenly reversed. When prices have been pushed down by strong continuing Bearish pressure, a strong counter attack, a major one, of Bullish pressure is required to break the decline. When “Smart Money” starts putting a lot of buying pressure and we receive a strong volume surge, we may be at the cusp of a reversal in prices.
Writing about “The Selling Climax” in Technical Analysis Of Stock Trends, authors Robert Edwards and John Magee observe that:
Most true Selling Climaxes, if not all, have been produced by distress selling … They have come at the end of rapid and comprehensive declines which exhausted the margin reserves of many speculators and necessitated the dumping of their shares at whatever the market would bring. This process is progressive — feeding upon itself, so to speak — with each wave of forced sales jeopardizing another lot of margined accounts, until at last millions of shares are tossed overboard, willy-nilly, in a final cleanup.
Just looking at price action may not help – as it may still be a trap. One could therefore look at establishing some ground rules before participating in what could be a trend reversal condition”:
- Check if price have been in a strong down-trend,
- The last lowest bar has to be on an extreme high volume suggesting that possible “Bull Money” entered the game challenging the bears,
- The last lowest bar should be narrow bar – close and open very close- or it can be a long bar yet with close above the middle of the bar, called a long lower shadow, indicating that bears ceded ground to bulls at some stage amidst high volumes.
Candlesticks are especially helpful for identifying a selling climax.
Yes Ban showed very high volumes thrice in the above charts – the first peak in volume (above left) ended the decline and stock started trending upwards followed by a test at 200 DMA and high volume surge with inverted hammer pattern and then the third huge volume burst with a white candle decisively reversed the downtrend.
DHFL showed a bullish hammer pattern after a sharp correction and trapped investors – but the second time around the high volume day was tested with a higher close , higher low and then the uptrend started around Rs 125 or so.
Of course, just volume and price action may not help.
In particular, chartists should be on the look out for high volume Hammers, Bullish Engulfing patterns and Piercing Lines. A Hammer is a signal candlestick pattern with a long lower shadow and a small body near the top of the range. This patterns shows that sellers pushed the stock sharply lower during the day, but buyers reasserted control to force a strong close. Bullish Engulfing patterns and Piercing Patterns are a lot like Hammers and may also help indicate this reversal.High volume reinforces this pattern. Positive divergences with oscillators are a proven way of improving the risk/reward ratio when gaming market bottoms. The moving average convergence/divergence histogram (MACDH) extremes can also play a role in helping determine whether a decline has been severe enough to possibly create a bottom.
Unfortunately, selling climaxes are not always accompanied with positive stochastic divergences. But when those divergences occur alongside some of the other technical factors already mentioned, they can be powerful clues and are worth watching. It is recommended that one wait for a confirmation on the succeeding day, which should be on decently high volume compared to the previous 10 or 15 days, and a higher close than previous day (a white candle) before participating in a contrarian buy.
Generating A Potential Buy Signal
After you spot a 50% + increase in volume on the capitulation , you should ideally wait for a re-test of the low of the selling climax day. However, the volume must decrease by at least 10-20% on a re-test of the low and the price must close above the low of the selling climax day. The lower volume re-test is usually an indication that the sellers have truly stepped aside and a close above the lows confirms that the market may be about to turn. Simply put, a decrease in volume on the re-test and a close above the lows could be your strong buy signal.
The key is to ensure that you wait for a re-test of the selling climax low as that is key to the seller gang- dont make the common mistake of jumping in on the day after the the Selling Climax without the low having been tested – real money will be made after the re-test and close above the low because it will usually trigger an upside trend that can last for many days or even weeks. So a little patience is needed here.
Using PL Mobile App
The PL Mobile App has a section called Rise and Fall within its Scanners section that shows a 3 day volume change versus 3 day price change which may help you catch some of these fish – and the live charting / Resistance and Support scanners may help you time bottoms better using your own methods. Download this app from Google Playstore or Apple Store.
Write in to us at firstname.lastname@example.org for any suggestions, ideas or contributions!
PS: Rinse, Shake and Repeat all the above steps for “Buy Climaxes”