Eoin Treacy's view
On key reversals - There have been a number of recent key day reversals, across asset classes, which have not been effective in predicting peaks in price action. Since we have tended to give such formations considerable weight in our analysis I thought it might be instructive to review what we are looking for in order to clarify when to rely on such formations and when to be more cautious.

Veteran subscribers will be familiar with key reversals but for neophytes let me define the formation. A downside key day reversal is a two candle pattern which occurs following a consistent or accelerated advance where the second candle hits a new high but closes below the low of the previous day.

Counter wise, an upside key day reversal occurs following a decline when a new low is reached but the market rallies to close above the high of the previous day.

At The Chart Seminar, next held in London on November 18th & 19th, I describe this formation and add these important qualifiers:

1. The key to the key is size because it must have a dramatic impact on crowd behaviour if it is to change it.

2. Was there commonality to the move? In other words, did related instruments have a simultaneous pullback or rally depending on the circumstances?

3. Follow through on the next day (or week for a weekly key reversal) is essential to confirm the change to crowd behaviour.

Let's look at some recent examples:

Silver posted a new 30-year high yesterday and has become relatively overextended following its breakout from a lengthy trading range. However, it pulled back intraday and closed below the low of the previous day, thus fulfilling the criteria for the key reversal.

1. It was a relatively volatile day but the decline was no larger than some of the advances in the last week so while potentially worrying for long side traders, it did not have the dramatic impact of previous peaks such as in 2007.
2. Gold also posted a key day reversal but pared its loss intraday and rallied today. The other precious metals were relatively quiet.
3. There has been no follow through today, with silver trading back above $23.

Therefore yesterday's decline checked the advance, potentially marks a penultimate high but is not enough on its own to signal that a medium-term peak has been reached.

Oil has been range trading for more than year and has rallied sharply towards the upper side of the congestion area over the last couple of the weeks. It retested the $85 area yesterday, posting a new five-month high in the process but failed and closed below the low of the previous day.

1. It was a relatively large decline compared to the previous week's trading,
2. Heating oil and gasoline both also posted key day reversals from the upper sides of their respective ranges.
3. None have followed to the downside today but have in fact rallied to almost countermand yesterday's action.

For the moment at least, while the key was relatively large and supported by similar action in related instruments, for the moment it looks more like a consolidation of recent powerful gains in the region of the upper side of the range. Provided 50% of the recent advance is held, we can probably continue to give the benefit of the doubt to the upside.

Thailand hit a new high on October 4th and closed below the low of the previous day fulfilling the criteria of the key day reversal.

1. The decline was only marginally larger that one day pullbacks in the course of the five-month uptrend.
2. No other Asian market pulled back as sharply.
3. It has held in the region of the high and the reaction to date has been limited to a similar sized pullback to that which occurred in the September.

The Index remains overextended relative to the 200-day MA but the progression of higher reaction lows remains intact. While we are by definition closer to the next mean reversion correction than we were, the upside can continue to be given the benefit of the doubt in the absence of a sustained move below 920.

The Euro formed a key day reversal against the Pound on October 4th by hitting a new high for the six-week advance but closed below the low of the previous day.

1. The pullback was no larger than previous minor consolidations with in the advance.
2. The Euro did not pullback significantly against other currencies
3. The Euro rallied well be the following day and completely countermanded the key within two day.

The Euro posted another technical downside key reversal against the Pound today but again it will need to follow through to the downside if this is to mark anything more than a pause within the uptrend. Two downside key reversals within a week are warnings that supply may be regaining dominance but more evidence is required to confirm this hypothesis.