Inflection points in trading refer to key turning points or reversals in the direction of a financial instrument's price movement. These points indicate a shift in market sentiment and can provide favorable risk-reward setups for traders. Understanding inflection points and their associated patterns can help traders identify potential entry and exit points in the market.In Darvas’ case, patterns with clearly established, horizontal support and resistance zones, are ideal. And these will hold true for us as well, though they’re not the only patterns that demonstrate higher probability momentum trades.
Triangle formations can often precede significant price moves, and are characterized by converging trend lines, where the price consolidates within a narrowing range. This consolidation creates a coiling effect, as price volatility decreases. Traders consider triangles as periods of price contraction or low volatility, indicating a potential breakout or expansion in volatility in the future.
Triangle patterns provide traders with the opportunity to identify low volatility entries before high volatility episodes. Traders often look for specific characteristics within triangle patterns, such as decreasing volume as the pattern progresses. This decline in volume suggests a lack of interest or indecision among market participants. This also brings down options prices associated with that stock. More on that soon.
As the triangle reaches its apex, a breakout is likely, which can result in a sharp price move accompanied by a surge in volume.
The premise behind trading triangle formations and inflection points is to take advantage of the subsequent volatility expansion and potential trend continuation while also minimizing position size, and therefore risk. Darvas did this with stop losses, we’ll be doing this with options contracts with tighter timelines.
While triangles (and all other patterns for that matter) don’t predict which direction price will go next, they do provide a clear point of inflection where the trade can be easily invalidated if assumed direction turns out to be wrong.
This is particularly important for us, because we’re not going to wait for the breakout, which is generally accompanied by volatility that spikes options premiums. We’re going to anticipate breakouts, focusing on call options (long positions), and buy on the cheap during low vol windows where price is coiling into a tighter range.
This is the difference between buying with 6-12 weeks of time on the option at one price, versus having no clear timing indicator and paying 2-3 times that price for an additional six months of time. More on options shortly.
Now, let’s look at a few relevant charts in the next blog post, both to get an idea of market potential, as well as to identify a few of these patterns.
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