Do you know how to recognize a blow-off top and trade it to your advantage? A blow-off top is a sudden, out-of-the-ordinary move up in a stock's price following by another large move in the other direction.

If you know how to trade them successfully, they can be very profitable. But it can sometimes be hard to recognize them when they are happening.

Blow-off top example

In order to understand how to recognize a blow-off top, it's helpful to have an example. So here's a chart of one that occurred in 2014.

Digital Ally, Inc. stock had been trading within a fairly narrow range prior to August. Then, starting in the middle of August, it made a 780% move up over the course of about two weeks. It then topped out and began declining.

By the time it stopped declining just six weeks later, it had fallen by over 63% from its height.

How to recognize a blow-off top.

The easiest way to recognize this kind of chart pattern is by using the Bollinger Band indicator. When the price closes above the upper-band on a weekly time-frame, this is a sign that a blow-off top may be coming.

How to trade this pattern: strategy #1

Once you recognize a blow-off top is occurring, the first and simplest way to trade it is to enter a short position when the first red candle closes on the weekly chart. You can then exit the trade when the price goes below the lower-band.

In most cases, a blow-off top over-corrects and closes below the lower band before too long.

How to trade this pattern: strategy #2

The second way to trade this pattern is a little more complicated, but can provide even greater gains. Here are the steps to follow.

  1. Wait until a candle closes above the upper bollinger-band on the weekly chart.
  2. When the market opens on Monday, look at an hourly chart and see what happens.
  3. When you see a green candle on the hourly charts, go long.
  4. When the price falls below the previous three candles, close out your long trade and go short.
  5. When a candle closes below the lower band on the weekly chart, exit your short trade.

Here's an example of how to enter and exit the initial long trade using this strategy.

Blow-off tops can be a great opportunity for stock traders. But they can sometimes be difficult to recognize . Follow these strategies to know when they are occurring and how to take advantage of them.

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