Possible Kangaroo Tail Developing from Longer Term Perspective

Despite the title of this post, the curious development of animal anatomy will not be the topic of discussion. Instead, readers will have an opportunity to observe a potential reversal move underway in equity markets and crude oil delineated by this distinctive price action.

No trend can last indefinitely and being able to spot signs of a reversal will help a trader better manage a position. One such method is identification of price action through what Dr. Alexander Elder describes as Kangaroo Tails. This sort of price behavior has a unique pattern. Elder states, “A Kangaroo Tail consists of a single, very tall bar, flanked by two regular bars, that protrudes from a tight weave of prices” (How to Trade for a Living, 65). Kangaroo tails that close down indicate a potential market top whereas when it closes up a possible reversal higher is developing. As with most patterns, price action on a long term basis usually carries more weight as it represents a general shift in the market tide versus a transitory ripple on a shorter time horizon. Accordingly, Kangaroo Tails found on weekly or monthly charts should carry significant weight when performing analysis. On the other hand, when this price action is represented on the daily or hourly charts it should be considered more tactically if a reversal even develops.

Additionally, Kangaroo Tails are an excellent way to identify sentiment in a market or tradable security. For example, during a swift price decline in an established downtrend when prices are bid lower aggressively (i.e. a bear raid) and prices do not hold lower but rather reverse higher, this can signal waning selling at these lower levels and potential for capitulation in the market. Psychologically, this can signal an exhaustion in the selling mentality and a developing appetite for long exposure among traders. Being able to read this market behavior will add value to a trader’s analysis. Furthermore, the same sort of reversal in emotion can be seen from the other direction. For instance, if in a sustained and extended uptrend prices spike but do not hold higher ground, traders can note that despite the forceful bullish bidding to move prices higher (i.e. bull raid) the subsequent reversal and lower close are indicative of slowing demand. In essence, the Kangaroo Tail helps traders identify where particular price action has been rejected by the market thereby aiding in one’s analysis and trade positioning.

In practice, traders should be alert for signs of a sustained reversal move after the Kangaroo Tail completes in order to extract profits from a trend. However, it should be noted that most Kangaroo Tails last only a few bars and can identify low-risk buying or shorting opportunities once the dominant trend resumes. In order to protect a Kangaroo Tail trade against any resumption of trend, Elder advises that traders set a stop about half-way through the tail since a market re-test of this area indicates possible follow-through into this price area. Of course, stops will be system and security-specific based on parameters and price volatility, respectively. Still, Elder’s risk mitigation suggestion is a good rule of thumb. Especially considering that a stop placed just past the edge of the tail is too wide for most position sizing algorithms*.

All things being considered, Kangaroo Tails are far from a perfect tool but can be juxtaposed with other market analysis methods in order assess the likely outcome after the Kangaroo Tail completes its formation. Looking at some recent and developing charts below will help add context to this concept.

In this first example, it can be seen on the daily chart how the Russell 2000 formed a Kangaroo Tail on Wednesday after experiencing consistent selling since the end of December 2015. Thus far price has followed through to the upside which indicates some lessening in the selling. A similar price reversal is displayed on the weekly chart as well and is indicative of some potential relief from these oversold levels. However, since the summer of 2015 a persistent and strengthening downtrend has been developing in equities and the psychology behind distribution in the markets should be considered when analyzing this price action. In other words, understanding that distribution in the broad-based indexes can take time due to the slow waning bull market optimism this daily Kangaroo tail and weekly reversal may prove to be no more than a dead-cat bounce. Until price action, breadth, trend indicators, oscillators, or any other preferred tools begin to suggest otherwise traders would be wise to employ tight risk management policies on any new long positions. Also, traders should consider that a reversal from this current level could offer an attractive shorting opportunity.

Crude Oil, depicted in the charts below, provides another example of Kangaroo Tails. Recently, the tails can be seen in January, March, and November 2015 on the weekly chart, as well as a possible reversal in January 2016. From a daily chart perspective, October, November and December 2015 in addition to the beginning of January 2016 all mark periods where Kangaroo Tails developed in the oil market. From a macro perspective, Crude Oil has been in a sustained down trend since 2014 and traders must identify this as the primary trend. As such, traders can overlay the primary trend when making strategic and tactical trades in Crude Oil based on reversal price action. For example, a positive reversal in Crude Oil denoted by a reversal and higher close in a particular timeframe (e.g.  daily chart of November and December 2015) can be used as an opportunity to cover a strategic short or add a tactical long position. Although, considering the power of the long-term downtrend both of the aforementioned examples did not provide much price reversal, indicative of a lack of buying demand in the market. Conversely, any negative Kangaroo Tails (e.g. daily chart of October and November 2015 as well as January 2016) have seen selling follow-through as this behavior is in line with the dominant trend and persistent market psychology.

As can be seen, identifying and trading tails can help traders identify low-risk opportunities. Implementing this tool into an existing trading method could enhance return through adding an additional revenue stream. Of course, no method is perfect so proper risk management must be employed at all times.

*See post entitled “A Primer on Position Sizing and Compounding a Winner” for more information on position sizing methods.

As always, please feel free to contact me with any questions.

JD