Anatomy of a Gap Up Reversal - Laboratory Corp. of America (Public, NYSE:LH) 10.03.2006

A reader asks if LH was a good long setup following the NR7 bar identified in the chart above.

I'm going to begin, perhaps unfairly, by saying that my success rate with long entries on stocks that swoon from extremely large opening gap ups, is less than 40%. If a stock doesn't start showing signs of a reversal by 10:30-10:45, it is not going to stay on my gapper watchlist. After last week's ISIS trade (posted on the blog Monday Nov. 13th), I have pretty much decided to stay away from these types of setups. Notwithstanding that little preamble, let's analyse this setup of LH from October 3rd.

Despite the high volume pullback, LH did hold its rising 10 period MA as support on a closing basis. It also carved out a bullish engulfing pattern around noon as price started to lift from the 10 period MA after some lengthy sideways action. So far, we were looking at a potentially bullish reversal. The next move takes price up to $68.25 on higher volume. Notice that the high here fairly evenly matches the low of the second bar and creates a pivot point. This is followed by some more consolidation and a potential shallow rounded pullback before a bullish break of the pivot point. Midway, we get a NR7 bar followed by some movement upwards, but volume on the bar following the NR7 is not bullish. So if you had bought this bar, you are on notice of a possible failure when the next bar shows no continuation on lower volume.

Since my experience with these is fairly negative, I would recommend longing them only after confirmation. In this particular case, confirmation would have been a higher volume break of the pivot point. Notice how the pivot point was observed the next day as resistance.

After having invested the time to map out a trade that didn't get confirmed, you could have shorted it using the pivot point as your stop. The next support level was $67.00 giving a decent risk:reward ratio.