For someone like me that always follows a battle-tested trading system, transition markets can provide some frustrating moments. 

What do I mean by this?

Well, in my style of trading, I simply do NOT chase trades.

Therefore, when the market is ripping higher off the lows as it did this past week, being able to capture some of that movement can be difficult.

That’s when as traders we have to adapt and be ready to pounce on the opposite side of the market, by finding stocks that have rallied too far, too fast, and are likely in need of a breather (i.e., a correction).

Today, I am going to show you what I saw in NVIDIA Corporation (NVDA) before I decided to speculate that it would be one of those stocks that looks too tired to continue higher after a big runup.

NVDA’s Huge Tuesday Rally Took it Up to Big Resistance

Over time, you’ll learn to look at a price chart and be able to notice that there has been a significant increase in price volatility, without the help of any volatility indicators. 

For instance, as this first chart of NVDA’s raw price action (without indicators) shows, the left-hand side of the chart clearly shows a period of low volatility, followed by a significant increase in volatility on the right side of the chart.

Figure 1

Then, when we bring in a volatility indicator to quantify what we’re seeing with the naked eye, our initial observation is confirmed, as we notice a sharp jump in the Average True Range (ATR) indicator in late October.

Figure 2

But, I think what is even harder to learn for newer traders is how to identify those one-day moves that are just so large and so anomalous (statistical outliers) that it would be very unlikely for such a large move to continue without the stock price pausing or even correcting for a few days.

In the beginning of their careers, new traders tend to chase these huge moves at the wrong time.

More often than not, this is when they learn the hard way that the stock is going to need a rest before it resumes the trend in its desired direction. 

The huge 1-day price move we’re dissecting today is highlighted by a green arrow on Figure 3, which also shows the 1-Day Rate of Change (ROC) at the bottom of the chart. 

Figure 3

Now, it is important to note that the Rate of Change indicator is a simple momentum indicator that often defaults to a measurement period of somewhere between 10 to 14 days, depending on the charting service you’re using.

The calculation for the ROC is very simple, and it is important to understand before I move on. 

To calculate it, simply subtract the close from a certain number of days ago (in this case Monday’s close) from the current close (in this case, Tuesday’s close) then divide that by the same close from a certain number of days ago (in this case Monday’s close).

The formal calculation looks like this:

ROC = (Close – Close n Days Ago) / Close n Days Ago

Why is this important to understand for today’s lesson?

Because I’ve modified the measurement window from the default 12-day window on Stockcharts.com to 1 day.

Why?

To capture the scope and size of Tuesday’s rally and compare it to the size of recent rallies. 

Figure 4 shows the result of this analysis, where Tuesday’s rally (see green circle) ranks among the largest of this period of time where NVDA has seen a massive increase in volatility.

Figure 4 

What Figure 4 also shows us that the 2 prior rallies that also ranked high in terms of their size were followed by periods of weakness.

Why?

Again, because those rallies were simply too large for the stock to continue to rally without first correcting lower.

So, I took this information and combined it with the fact that NVDA’s price rallied up to two interesting resistance levels (the Descending Trendline Resistance Level and the Prior High Resistance Level) shown in Figure 5 earlier this week to use as the basis for purchasing a “put debit spread,” which I continued to build on throughout the week.

Figure 5

I began the trade with a starter late Monday by buying 20 Dec 23 puts at the $305 strike for $16.27 and selling 20 Dec 23 puts at the $270 strike for $4.27. 

With NVDA’s stock continuing to digest Tuesday’s large rally by slipping lower as the week progressed, , I continue to pay attention to the trade’s progress. 

To YOUR Success…