Rinse Jobs

The rinse job denotes a sudden dislocation within a trading range, in which price thrusts above or below support/resistance and then reverses, closing back within the boundaries of the sideways pattern. These spikes shake out stops and trigger all sorts of contrary entry signals. Rinse jobs can unfold in many ways, but two manifestations are most common in our modern markets:

 

  • Bull or Bear Trap – The instrument gaps out of a 15-minute or 60-minute range at the opening bell, draws in breakout or breakdown traders, and then reverses hard, filling the gap.

 

  • Stop-Gunning Exercise – The instrument grinds sideways for a few hours, attracting the continuation trade. Price suddenly jumps out of the quiet range, thrusts a few ticks and then reverses hard.

 

Traps are most common in the latter phases of established trends, in which one side is controlling the tape. As a rule, complacency runs high in uptrends, setting up abnormally low put/call readings. Flip over this tendency in downtrends, when fear yields equally high put/call readings. Both scenarios present ideal conditions for gaps against the prevailing trend, shaking out weak hands and reestablishing a balance between positive and negative sentiment.

Traps are also set when one side of the market gets overcrowded because news is so bullish or bearish that traders overreact and chase one strategy too aggressively.  The capture of Saddam Hussein in 2003 and the London bombing in 2005 both yielded this type of extreme reaction, with massive gaps that filled immediately, trapping bulls after the first event and bears after the second event. These contrary dynamics play out all the time, to a lesser degree, after economic or earnings releases that shock the prevailing wisdom.

 

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[The Nasdaq-100 Trust closes at high tick (1) on May 4th and pulls back the following day. It closes just under the high and breaks out on May 6th, in a healthy gap. Sellers enter the market immediately, knocking the fund back under the two-day high (2) in a rinse job that yields a vertical selloff. The decline breaks the low of the prior day (3) and then recovers strongly, closing about 35-cents under the opening high. The ETF gaps above the prior day’s recovery high (4) the next morning and sells off, in yet another rinse job (5). This decline also breaks the low of the prior day (6). Price tests the multiday low (7) in the next session and closes strongly.  A third rinse job erupts the following morning, with a down gap (8) that undercuts the multiday low and then zooms higher, trapping early short sellers.]

 

Overnight rinse jobs, especially on the major indices, get most of our attention but midday events are also common, especially in dull or sideways markets. These rinse jobs take on two distinct scenarios.

 

  • A morning trend reverses and pulls into a common support or resistance level. Pullback traders jump in, price cuts sharply through that level, and shakes out those orders. The instrument then reverses and reestablishes the early trend.

 

  • A trading range, lasting days or weeks, is broken suddenly by a vertical rally or selloff, triggering a variety of entry and exit signals. Price takes in these orders and then reverses, closing the session back within the daily or weekly range.

 

The first scenario has great value when it occurs on the index futures because equity positions are likely to reverse in lockstep behavior.  In addition, these small patterns yield instant trade setups because we can place stops just outside the buying or selling spike, and capture a low risk entry into the morning trend. Once positioned, price should “snap back” through support/resistance by the close of the next 15-minute bar.

You might not locate second scenario events until they show up in your end-of-day research because they often print daily-scale hammer or doji candlesticks.  This rinse job generates ideal conditions for the instrument to trend sharply out of the opposite side of the trading range because the event cleans out one side of the supply-demand equation, setting up an imbalance between buyers and sellers.

 

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[Rinse jobs often unfold when price tests a rangebound high or low. Cavium Networks sets up a trading range (1,2) between 16 and 17.50. The stock sells off toward range support on July 7th and closes (3) near 16.30. It breaks down in the first hour of the following session, dropping 50-cents and then shooting higher (4), closing above 16 in a daily-scale bull hammer reversal. Price continues higher for the next three sessions and then breaks out strongly (5).]

 

Rinse jobs can evolve over a few days, rather than aligning with a single intraday session. In a classic example, a stock sells off for several days, finally reaching a major support level, like the 50-day EMA. It breaks down in the following session and closes poorly. Price then pops back above support and traps late sellers, or hovers just under the moving average for up to a week and then shoots higher, having the same effect over a longer time period.

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