Congestion

Congestion is the segment of the cycle when the participants are confused by

the current price action. The long and the short traders will exchange positions as

the strong hands continually change. If you are a short-term trader, this can occur

as many as five or six times during a session. Unless you are a countertrend trader

(selling as price advances and buying when it declines, also known as the weak

hands), trading in this type of market can be frustrating. You may buy a number of

tops and sell a number of bottoms. This is known as getting whipsawed, and it is one

of the problems of being a reactive trader. Another name for reactive traders is a trend

following. They look for the direction that price is moving and then use technical

analysis to ‘‘follow the trend.’’ I am not a strict trend trader but, rather, react to the

current market phase.

Unfortunately, when the market begins to whipsaw, I always lose money on the

first set of trades. However, once I recognize that the market is in congestion,

I shift gears and take advantage of the opportunities that congestion creates. The

congestion phase is marked initially by imaginary boundaries known as support and

resistance. It might help to think of support as the floor of the market and that

resistance is the ceiling.

Support is where the weak hands will average down and buy extra shares of

stock or contracts to lower their average cost. It is also the position where traders

who have been observing the current market will make a buy. If the support holds,

the long traders will become the strong hands and the shorts (weak hands) will be

forced to either take profit or begin to cover their loss and look for a new spot to

enter. If the new buyers are strong enough, they will push the market to the other

side and it will begin to find some resistance.

Resistance will bring sellers back to the market, countertrend traders will ‘‘average

up,’’ and the shorts sell extra shares or contracts in an attempt to raise their average

sales. The resistance will also bring back traders who have been observing, and they

will begin to sell. If the resistance holds, the short traders will become the strong

hands, and the market will force the long traders (now the weak hands) either to take

profit or lock in their loss. If the sellers are strong enough, they will push the market

back to test the support a second time.

This test is known as a double bottom. It is significant, as it will be one of the

most profitable trades that you make in weekly options. If the double bottom holds,

it will bring more buyers into the market, and the sellers will begin to take profit or

lock-in loss. The strong hands will now be the buyers, and they will take the price

back to the previous resistance. If that point holds, it will become a double top,

and it is very significant as the congestion area will now be defined.

As long as the market remains in the congestion pattern, it will be traded the

same—buying the double bottoms and selling the double tops. Congestion can last

for a very long time. If you trade on a daily basis, it might last for months, even

longer. If you are a day trader or a swing trader, it could last several days or weeks.

Most technicians believe that that market is in congestion more than 60 percent of the

time. When we get into the chapters on option pricing, I will explain mathematically

why we are in congestion for such long periods of time.

https://youtu.be/gDXSFHG2R0Y