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An island reversal forms with a gap, consolidation and then a gap in the opposite direction. The opposing gaps form an area without any price data that isolates the consolidation. In this regard, the consolidation becomes an island that is separated form the rest of the price action. There is some debate on the length of the consolidation and the form its should take. It can be a little as one day or as long as two weeks. The important thing is that both gaps create an island.
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The first chart shows the XLK with a bearish island reversal in late October and a bullish island reversal in early December. The bearish island reversal did not workout, while the bullish island reversal is holding so far. Notice how XLK gapped down below 25 on November 21st, consolidated and then gapped above 25 on November 30th. These opposing gaps created an area without any trades to isolate the consolidation.
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The second chart shows E*Trade (ETFC) with a bearish island reversal in late October. The stock gapped above 10.75, stalled for three days and then gapped below 10.75 on November 1st. There was a throwback to the gap with a rising wedge and the stock broke wedge support with another gap.
