Sometimes a stock’s price bar is much longer than the norm, signifying a period of intensive trading within a wider trading range than usual. On such bars, the high or low is generally quite distant from those of the surrounding price bars, as if the bears or bulls made a furious effort to force a change in trend but couldn’t arouse sufficient market energy for success.

An example of such a spike is shown below:

Interpreting a spike on the day it happens is difficult at best, as there are many possible causes:
•    A few traders heard a rumour that no one else believed, and either bought or sold the stock mistakenly.
•    A buy-and-hold investor became bored with the stock’s lack of movement and exited an open or short position.
•    A large institutional trader made a determined attempt to break a support or resistance level through buying or shorting the stock.

Any of these possibilities would create a blip for other traders to exploit. It’s not uncommon, as in the example above, for the stock to shrug off the spike within a few price bars and continue on as if nothing had happened.

But sometimes a spike is more than an anomaly or mistake. Sometimes it signals a change in trend, reversing a downtrend to an uptrend, or vice versa. Such a spike is called a key reversal, and an example is shown below:

In such an instance, the spike is often the shares market’s reaction to a fresh headline that changes the underlying perception of the company or its industrial sector. When that happens, a key reversal will show the change in trend within a few price bars, as illustrated above.

While only the price bars following the spike can determine whether it’s an anomaly or a key reversal, traders can still analyze the spike itself to some degree:
•    Check the company’s headlines. If something concrete happened to cause the spike, it’s more likely to be a key reversal than an anomaly. Examples include higher or lower earnings than expected, a corporate acquisition or sale, a new product, new personnel, or a new regulatory environment for the industry sector. If the headlines are blank, it’s more likely just a blip.
•    Give the most credence to the close. If the close is near the high or the open, it’s more likely the price bar will continue the trend and the spike is meaningless. But if the close is nearer the low, it’s more likely to prove a reversal.

For traders actively holding a stock that just registered a spike, the new low is the price to watch. Conservative traders also holding this stock will tend to exit if the price drops beneath that low over the next two or three time periods, which will drive the price even lower. Unless one’s confidence in the open long position is stout, it would be appropriate to join the sellers.

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