Island Reversal

Entry Logic

• Enter long on the second gap, which isolates a cluster of candles below the main trend.
• Confirmation is a gap up that leaves the island behind.
• Use a daily timeframe for this pattern.
• Entry should be above the 50-day SMA.
• This pattern works best in a trending market.

Exit Logic

• The profit target is the measured move of the island, projected from the breakout.
• Scale out 50% at the measured move target.
• Trail the remaining position with the 20-day EMA.
• Exit if the second gap is filled.
• Exit on a confirmed bearish reversal pattern.
• Exit if the trade is not profitable within 20 days.
• Exit if the MACD shows a bearish crossover.

Stop Loss Structure

• Place a hard stop below the low of the island.
• A soft stop is a close below the 50-day SMA.
• Maximum dollar loss is $2000 per trade.
• Maximum percent loss is 4% of the account.
• The structural stop is the low of the island.

Risk Management Framework

• Risk 2% of the account per trade.
• Daily loss limit is 6% of the account.
• Weekly loss limit is 12% of the account.
• Maximum drawdown is 35%.
• Minimum risk-reward ratio is 2.5:1.

Position Sizing Model

• Use a fixed fractional sizing model.
• Adjust size based on the volatility of the instrument.
• Use 1.25x size for A+ setups.
• Do not scale into trades.
• Scale out at the measured move target.

Trade Filtering

• Avoid trading this pattern on illiquid stocks.
• Requires a clear island reversal pattern with two gaps.
• Trade only stocks that are part of a major index.
• Avoid trading this pattern during earnings season.
• Do not trade in markets with no clear trend.

Context Framework

• The weekly chart should show a potential bottoming pattern.
• Price should be reclaiming the 200-day SMA.
• The setup should occur after a sharp downtrend.
• The monthly chart should show signs of a potential long-term bottom.

Trade Management Rules

• Do not move the stop to breakeven until the first profit target is hit.
• Scale out 50% at the measured move target.
• Do not add to winning trades.
• Be patient, as this pattern can take time to play out.

Time Rules

• This pattern can form over several days or weeks.
• The entry is taken on the day of the second gap.
• The trade can last for several weeks to months.

Setup Classification

• A+ setup: Large gaps, high volume on the reversal, strong market reversal.
• A setup: Clear gaps, moderate volume, neutral market.
• B setup: Small gaps, low volume, counter-trend.
• C setup: No clear pattern, avoid.

Market Selection Criteria

• Trade large-cap stocks that have experienced a sharp sell-off.
• Minimum daily volume of 3 million shares.
• The stock should have a history of gapping.

Statistical Edge Metrics

• Expected win rate is 60%.
• Average win is 4R.
• Average loss is 1R.
• Profit factor is 2.4.
• Expectancy per trade is 1.4R.

Failure Conditions

• The strategy fails if the second gap is filled.
• A common failure is a failure to follow through after the second gap.

Psychological Rules

• Have the conviction to buy after a sharp sell-off.
• Do not be afraid of the volatility.

Advanced Components

• Use news analysis to understand the reason for the gaps.
• A sector analysis can identify if the reversal is broad-based.
• Avoid trading this pattern on multiple stocks in the same sector.
• The weekly chart must confirm a potential bottom.

Location

• The setup is strongest when it forms at a major support level.
• The setup is weakest in a sideways market.
• The location of the island in the overall trend is critical.