Mark Minervini has popularized the volatility contraction pattern, or VCP, as it has become known. Think and trade like a champion i Trade like a stock market magician. Despite the success of the pattern for swing trading, in this post we will delve into how to recognize it for daily trading opportunities.
History of the contraction pattern of volatility
The VCP, which goes back to Richard D. Wyckoff’s “wave pattern,” has a high success rate when run correctly. It looks essentially like a bull flag.
Many successful marketers may refer to the pattern simply as a “narrow flag.” However, this pattern implies certain criteria that may not conform to the VCP.
Regardless, the setting has an obvious influence on the teachings of Bill O’Neil and his famous book How to make money in stocks.
What Minervini discovered in the analysis of some of the biggest winners in the market was his tendency to pause during new bullish trends. This pause created a winding action after the initial upward force. It also offered a low-risk opportunity to jump on board during the next stage.
Regardless of the merger of educators influencing the pattern, it has a handful of shared criteria for qualification. We will analyze each of these aspects in more depth in a moment.
Why the volatility contraction pattern?
When analyzing different market patterns or configurations, it is essential to manage risk. It is equally important to have an advantage.
Successful traders understand that the market is a game of chance. Losses are inevitable. But an advantage that provides a higher reward / risk ratio can produce obscene benefits over time.
This is where the VCP shines. It offers traders the opportunity to take a position in an action with a growing momentum, but with a low risk.
Just ask Mark who promotes earning more than 33.554% in just 5 years using only VCP.
To that end, let’s look at each of the five criteria that create this explosive pattern.
What is the contraction pattern of volatility?
1. Strong underlying demand
For an action to create the right configuration for the VCP, there needs to be demand. Simple and straightforward. And a lot.
So far, there is no easier way to spot this demand than a strong uptrend. This may seem contrary to human nature, but the best VCP patterns come from large previous movements.
It is at this point that many investors or traders feel as if an stock has been over-bought. However, shrewd traders recognize the demand and take advantage of it. This is a classic example of high buy and sell high.
The following are a handful of flexible criteria to look for on the basis of an intraday VCP. Think of these as the backdrop to training.
- A premarket or explosive gap is left out of the sea
- High relative volume compared to the average of the previous days
- The potential for a break in higher time periods
- Important underlying support (such as a daily pivot or a moving average)
- Inability to break
Example of volatility contraction pattern: WISH
Taking these 5 points, we use a recent example of intraday VCP in a strong trend ticker, WISH.
From the daily chart, we can begin to build our case for the “daily pivot” and “moving average” support markers. In the image below, we see that we had an extremely bullish day a few weeks earlier.
We can also see that the marker now “navigates” the simple ten-day moving average. Each time it is removed at these levels, the volume is removed. This implies that the supply decreases in the daily chart.
From this daily drop, we get a little closer with the time frame of 30 minutes.
In the 30-minute chart, we see confirmation of the price action that holds higher lows. Volatility is starting to contract to the present day, suggesting an inability to break the price.
Now that we have the highest time periods analyzed, let’s look at intraday action.
Pre-marketing of the gap
In the chart below, we can see the day before, closing, and hours after the pre-market schedule from the current morning of WISH.
Although the volume is not shown, RVOL surpassed 100% that morning with more than 5 million shares traded in the premarket. Just before opening at 9:30 am EST, the ticker is already testing the maximum the day before. This is noted in the graph.
With this in mind, it would be advisable to monitor WISH for any type of configuration that may indicate imminent progress.
2. Overbought / recent supply pressure
Given the 6% gap in the WISH pre-market, and the fact that it’s re-testing the highs of the previous day, it wouldn’t be surprising that a certain amount of profit would take or sell the open pressure. This is a common area for profit in case failure fails.
What this creates is a kind of underlying compression. It’s like two opposing forces trying to outdo each other. Demand, on the one hand, supply on the other.
Our job as traders is to identify who is in control of the battle. The volatility contraction pattern helps.
To see how day-to-day work works, we take a snapshot of WISH shortly after opening.
We drew a line to the maximum of the previous day to better understand the importance of this level. We observed, from the premarket chart, that there was resistance in this pivot. Therefore, it makes sense to include these key levels.
As the morning progresses, it becomes clear that stocks are not deteriorating. In fact, the supply injected into the resistance line is absorbed in drops.
3. Decrease in supply / decrease in volatility
After seeing the “overbought” correction, we need to keep a close eye on how stocks react. Find support again? If so, where and in what convincing way?
These are questions that need to be answered with volume and price action.
According to the notes in the chart, we begin to see how the “wave” narrows with higher lows. Each withdrawal contains less and less volume / supply.
Finally, we roll towards a narrow price action area as the extreme volume dries.
Dry volume (VDU) is a popular way to find a lack of supply in a healthy consolidation. This pricing strategy often precedes a “pocket pivot” or outburst. These strategies were popularized by Gil Morales and Chris Kacher in their book Trade as an O’Neil disciple.
Ideally, at this time of consolidation, you want to see stocks that maintain a support level like VWAP or a popular moving average like 10, 20 or 50ma.
As stocks consolidate in the pattern of contraction in volatility, we begin to see that influential support indicators such as the 20th, 50th and VWAP have come down from price action. This is another red flag for traders with short trends to opt for coverage. There is no pun.
4. The Breakout
As the force of demand begins to dominate the bears, it is clear that the bulls will win. And, as we mentioned earlier, it can be explosive depending on the pressure the bears exert.
The initial sign is the bullish bullish price bar immediately after the VDU candle. After finding support throughout the 20th, the price pivots above convincing volume.
The volume returns with revenge after the winding action. Special buyers are taking the opportunity. At the same time, the shorts have a decision to make. Either cover before the loss gets worse, or increase the average, in the hope of a failed failure.
As the breakup continues to increase, the shorts are already under water, especially if they were averaged from the previous day’s maximum. They only have one option to do.
As the short hedge enters, this feeds the bullish nature of the stocks. In fact, in less than two hours, the stock exceeded 13%.
Swing traders would love to make that kind of profit in a month.
VCP variations and more resources
While there are many swing-based trading resources for VCP, there are fewer links to day traders who use this strategy. The exception is Nate Michaud of InvestorsUnderground.com.
Nate teaches a variation of this strategy called ABCD pattern in many of his free educational videos. If you have time, you can check out their YouTube channel for more information on how to spot these intraday opportunities.
How to practice VCP
Once you have seen the VCP, it is imperative to practice the pattern in a simulator before working for real money. You will want to identify when the pattern works and when it can generate false signals. After all, flag patterns can be solved in any way.
We suggest a few criteria for analyzing each operation, similar to what we mentioned above.
- Is the value of the shares mobile media and VWAP?
- Do oxen show signs of strength compared to bears?
- Is the volume higher than normal?
- Could traders with short trends be trapped?
- How far is support and resistance?
- Is the supply reduced when it recedes?
- Do you have the break volume that you are waiting to confirm?
- Does the break persist or fail?
These are just a handful of criteria you can consider tracking as you spot these settings and change them.
Over time, we would expect you to collect a data set with enough operations to know your probability in the pattern. Otherwise, you could also play.
As always, remember to create a trading plan for all your transactions. And good luck!
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