20 Golden Rules
for Traders
Trading Tactics
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SKILLS & TECHNIQUES
FINDING THE EDGE
Daily
Swing Trading
Market Dynamics
Anticipating Market Direction
Trend-Range Mechanics
Modern markets shift
gears constantly. Stay
ahead of the curve, learn
to act quickly and
capitalize on fresh trading
opportunities.
When stock movement breaks
the rules, it could be emitting a
very strong signal. Here's what
to look for when you're
expecting the unexpected.
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Powerful Tools
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Bilateral Trade Setups
Overcome directional bias and
let the price action tell you
which way to go.
Exploring Market Physics
Price movement follows natural
physical laws. Learn how to
profit from these powerful
hidden forces.
In Defense of the Killer
Instinct
Everyone who plays the
markets has to choose whether
to take, or be taken.
Pattern Cycles
Syllabus from the live
presentation at the National
Online Trading Expo in New
York City.
Scanning Tips and
Techniques
Train your eyes to look at
charts this way the next time
you do your market homework.
Trading Execution Zone
A pattern is only as good as
the price action that follows it.
Clear Air
Clear Air identifies price levels
where volatility should spike
sharply. Use these zones to
execute high-reward, high-risk
entry.
Cutting Losses
Attention to loss is a sign of trading
experience. Attention to gain is a
sign of trading immaturity.
Effective Market Timing
Folks believe chart-reading
automatically leads to profitable
trading. This isn't true.
Exit Strategies
Most traders don't have an exit
plan, whether their positions are
turning a profit or going down in
flames.
Mastering Reward:Risk
Most traders ignore reward/risk,
hoping that luck will save them
when things start to go bad.
Measuring Reward:Risk
Trading is an odds game, in which
anything can happen at any time.
Overbought/Oversold Overload
Should we run for the hills because
a market is overbought, or load up
the boat because it's oversold?
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Complete 7Bells Scans
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Trading with Stage Analysis
What if you could just glance at
a chart, and find good trades
immediately?
20 Golden Rules for Traders
Add these simple rules to your
daily trading and build
consistent profits.
20 Rules for Effective Trade
Execution
It's easier to find good stocks
than to trade them for a profit.
20 Rules for Effective Trade
Management
Managing open positions is the
most difficult task the trader
faces.
20 Rules to Stop Losing
Money
The best way to start making
money is to stop losing it!
TREND REVERSALS
Bottoms & Tops
Pattern Failure
The best trade may be in the
opposite direction from the one that
you're planning.
Playing Failed Failures
Modern markets try to burn
everyone through rinse jobs before
they launch definable trends.
Hard Right Edge
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Stop Loss Q&A
What takes place at the end of a
trade usually reflects decisions
made at the beginning.
RIDING THE WAVE
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Breakouts
Trend Following Systems
Breakouts through key support
or resistance signal price
movement that will likely
persist for some time. Use
these key trend and breakout
patterns to capture large
pieces of the move.
Fishing for Profits
Trading bottoms and tops
have the highest
reward:risk ratios of all
short-term trades. But it's
still very easy to miss your
opportunity. Use these
informative strategies to
locate outstanding entry
points.
Adam & Eve & Adam
Learn two variations of the
double bottom that get you in
at the lowest risk.
Adam & Eve Tops
Use this classic topping
formation to identify profitable
short sales.
Breakout Trading
A market starts rising when it stops
falling. Hidden in the final twists and
turns of long bottoms, new uptrends
go unnoticed by the crowd.
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Buying The Pullback
The pullback is a great way to lose
money if you jump in too early or
too late.
Catch The Dow and Elliott
Waves
Dow Theory hasn't missed a beat in
over 100 years. So what does
Charlie Dow have to offer modern
traders?
False Breakouts and Whipsaws
Breakouts occur in zones of
conflict. Both bulls and bears are
very passionate at these turning
points.
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Hell's Triangle
The development of three
descending highs and a
horizontal floor often sets the
stage for a major selloff.
Lowdown on Bottoms
There are many variations on
the theme, including rounded
bottoms, triple bottoms and Vbottoms.
The Big W
Use the Big W to trade your
way through major reversals.
PROFITING FROM DECLINE
Corrections
Effective Short Selling
When markets break
down, they display
common characteristics
over and over again.
Identify the current phase
of the decline and position
yourself to capitalize on
the panic of the crowd.
Anticipating a Selloff
How You Could Have Seen
ImClone's Implosion Coming.
Common Pitfalls of Selling
Short
The bear market will end when
Joe Sixpack quits his job so he
can sell short for a living.
5 Wave Declines
Declines are not chaotic
events. Look for the orderly 1-23-Drop-Up in corrective
movements.
Selling Declines
The fearful crowd provides a
rich source for profits on trades
initiated during corrections and
declines.
Morning Gap Strategies
Having trouble with those irritating
morning gaps? You're not alone.
The Gap Primer
Old traders' wisdom advises that
gaps get filled. However, some
gaps never fill.
Trend, Direction and Timing
Learn what to look for before you
commit your capital.
Trend Waves
Add Elliott Wave Theory to your
chart analysis and discover a new
world of trading opportunities.
FAST FINGERS
Day Trading
Intraday Cycles and Tactics
Day traders face intense
competition and hidden traps
set by insiders. Avoid common
intraday pitfalls and make
market cycles work in your
favor.
3-D Trade Execution
Use multiple time frame pattern
analysis to identify profitable
intraday trade setups.
Bid-Ask
The bid/ask spread reveals
underlying supply and demand on
the ticker tape.
Extended Hour Trading
The trading day doesn't begin at
9:30 a.m. New York time, nor does
it end at 4 p.m.
Pullback Day Trading
Learn to step in front of other day
traders on intraday pullbacks.
Tale of the Tape
The years you spent studying
technical analysis may not make
you a good trader.
7-BELLS SCANS
CD-ROM
&
BOOKLET
Surviving Bear Markets
Most players wrongly believe
that profits will continue in a
major decline as long as they
just flip their long strategies
upside down.
Surviving The
Chopping Block
Retail traders abandoned the
markets, and there are few
signs they'll return anytime
soon.
MARKET MATHEMATICS
Indicators
Traders Toolbox
The right technical tools
will get you into good
trades and keep you out of
bad ones. Use these
powerful indicators and
tools to cross-verify the
message of your chart
pattern.
Bollinger Bands Tactics
Use Bollinger Band strategy to
pinpoint major swing reversals
and breakouts.
Five Fibonacci Tricks
Add these Fib twists and turns
to your toolbox, and apply them
to your next trade.
Fun with Fibonacci
Fibonacci numbers consistently
mark hidden support and
resistance.
Moving Average Crossovers
Add the Golden Cross and
Death Cross to your trading
arsenal.
Trading the 50-Day MA
This neutral ground between
bulls and bears offers a perfect
view of the market's playing
field.
Tape Reading
Learn the subtle skills of tape
reading and understand the ways
that insiders manipulate the
markets.
UNCHARTED TERRITORY
New Highs
Momentum Trading
Stocks at new highs display
unique momentum
characteristics that can persist
for months. Jump on the
momentum bandwagon but
minimize the considerable
risks when you do.
Mastering The Momentum Trade
Momentum trading can be
mastered. Three disciplines will
break destructive habits and
reprogram trading for success.
Momentum Cycles
Minimize the risks of momentum
trading by tuning your positions to
the hidden action-reaction cycles of
dynamic trend.
Uncharted Territory
Use the Rule of Alternation to
measure opportunity as stocks rally
to new highs.
Trading The Stochastics
Indicator
I used to think only price bars
could predict the future.
Voodoo Trading
Magic numbers, astrological
dates and prayer wheels have
all been enlisted in the search
for that elusive trading edge.
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20 Golden Rules
for Traders
Trading Tactics
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BILATERAL TRADE SETUPS
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When it comes to trade setups, it's not always an either-or situation. In fact, you
can double your fun with bilateral trade setups.
Start by overcoming directional bias when you look at a price pattern. Although
you may see it in your mind as a long or a short, chances are it will work in either
direction. The trick is to let the price action tell you which way to go.
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Let's back up a step and see how this works. Many patterns exhibit well-defined
support and resistance. Bilateral setups use both levels for trade execution. A long
entry is signaled if price breaks resistance to the upside. Conversely, a short sale
is signaled if price breaks support to the downside. But you still have more work to
YOUR DAILY do before taking a bilateral trade. After all, making money is the whole point of the
MARKET exercise.
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Every trade setup generates a unique reward/risk profile. In other words, it tells
you how much you stand to win or lose should you decide to take a position. Each
side of a bilateral setup carries a different reward/risk ratio. Most of the time, one
side shows more profit potential than the other side. This can be frustrating
because the calculation is independent of the odds that either outcome will actually
take place. So you may have a great, high-odds setup with little or no reward, or a
lousy, low-odds setup that would earn a fortune if it ever happens.
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The price trigger complicates bilateral trade entry. Trading signals come in all
varieties. The best ones ring very loud bells within very narrow price levels. One
classic example is a high-volume breakout through a major moving average.
Bilateral strategies force you to locate trigger prices on both sides of the pattern.
Many times one side will bark much louder than the other when price hits the
associated trigger.
Bilateral setups work best when they fit into larger cycles that encourage price
movement in either direction. For example, a stock drops off a broad rally into an
extended correction. Smaller patterns within this correction may trigger short-term
rallies or selloffs. Bilateral strategy lets the trader take advantage of the mixed
environment and execute price swings in both directions.
Let's review the signposts of this two-way trading street. We need well-defined
support-resistance levels, a defined reward/risk ratio on both sides of the equation,
clean price triggers and a big picture that lets us execute in either direction.
Sounds simple enough, and it is.
The difficulty lies in our ability to control bias and to let the market tell us which
way to go. Very often the best trade is in the opposite direction from the most
obvious outcome for that pattern. In other words, the majority piles in one way, but
the profit comes from trading it the other way.
The good news about these fascinating patterns is they may tell you when the
move is about to happen. Congestion often narrows toward a trigger point. We see
this in triangle patterns where two trendlines converge in price and time. Bilateral
setups may show this convergence through simple lines, or sometimes through
more complicated volatility cycles.
Volatility drops off through the formation of most bilateral patterns. It tends to reach
a definable low, and then trigger a sharp price expansion. Traders examine narrow
range price bars near support or resistance levels in order to predict impending
price triggers. They also study classic volatility indicators to locate these turning
points in developing patterns.
Swing traders go long or short, depending on the opportunity. Bilateral setups cut
their workloads by presenting two possible trades in a single pattern. So always
look at both sides of the equation when examining a price chart. Then leave your
bias at the door, and take whatever the market gives you.
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20 Golden Rules
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Trading Tactics
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EXPLORING MARKET PHYSICS
The swing trader faces a considerable challenge mastering the puzzle of market movement.
While most of us recognize conflict and resolution within the price chart, we fail to utilize these
dependable mechanics in our trading strategies. Fortunately, repeating elements of the charting
landscape offer a powerful context to understand and manage these vital aspects of trend
development. Through repeating dynamics of crowd behavior, price action tends to mimic classic
rules that modern scientists apply to our physical universe.
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This is probably no accident of nature. Emotion and mathematics interact continuously while they
draw the Fibonacci retracements that we see every day through our chart analysis. This fascinating
relationship offers a glimpse into the profound order beneath common price movement. At its core,
convergence-divergence between these two forces helps us to understand and trade the market
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swing. For example, we may search the chart for a reversal or breakout pattern that spells
MARKET
opportunity, but we also watch the ticker tape to gauge the crowd's emotional intensity, and to
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Successful traders draw intuitively upon these bilateral market mechanics as they master the
art of speculation. Their advanced skills correspond with the peculiar logic required to unify left
and right brain functions into a focused trading methodology. Perhaps future technicians will
quantify these profound interactions between herd behavior and physical law, and even open up a
new branch of technical price prediction. In the meantime, let's explore some primary characteristics
of these underlying market physics.
1. AN OBJECT IN MOTION TENDS TO REMAIN IN MOTION
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directional price momentum. During the early phases of new trends, volatility rises but inertia
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tends to slow down price rate of change. This often generates a series of tests or congestion minipatterns while price tries to escape the influence of the old range. Eventually, momentum
overcomes inertia and price movement takes on a more vertical appearance. This freedom of
motion actually lowers volatility as friction eases and a one-sided market assumes control.
New trends can be very difficult to stop once they are underway. As with other objects in
motion, trends feed on themselves because they draw in fresh energy (from cash and emotions on
the sidelines). This induces price movement to travel well beyond arbitrary barriers, such as targets
set by outside forces. But no trend can last forever or travel to infinity. Just like its physical
counterpart, intervening market force will eventually stop or reverse directional price movement.
Simple friction slows down a rolling ball. Active trends experience friction in the form of market
Powerful Tools gravity. Classic trading wisdom notes that rallies take buyers, but that markets will "fall from their
for Traders own weight" under the right circumstances. Unfortunately, the dynamics of this well-understood
mechanism don't quite match those of Mother Earth. If they did, all markets would fall to zero as
soon as buying and selling dried up. The fact that markets retain value suggests that each one has
a hidden center of gravity that price development will reach if all participants step aside at the same
time. This "central tendency" gently pulls market movement toward a hidden mean during quiet
times, but can act with shocking intensity when price action generates strong imbalances during
extreme market conditions.
The distance from the current price bar to this elusive value quantifies a level of market
inefficiency at each point in time. It also defines most opportunity for the swing trader. Bollinger
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Complete 7- Bands present a common tool to measure tension on this hidden spring. But other indicators that
Bells Scans rely upon deviation from the mean perform an adequate job as well. And don't overlook simple chart
patterns. Certain formations can reveal major inefficiency through a simple set of price bars. For
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example, a Shooting Star candle after a strong rally signals an invisible wall to the observant
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The Pull of Central Tendency
Combine candlestick patterns and Bollinger Band extremes to uncover hidden friction that will stop
or reverse a strong market trend. Note how Immunex pierces the top band on July 19th, but closes
back within its boundaries in a tall Shooting Star candle.
2. FOR EVERY ACTION, THERE IS AN EQUAL AND OPPOSITE REACTION
Traders at all levels must deal with the wavelike motion on price charts. These define
underlying cycles that strategies must align with, or risk failure. At their core, these waves reflect
constant battles between bulls and bears, and the underlying trend-range axis. Price thrusts forward
in a surge of participation but then pauses to test prior boundaries and dissipate volatility. Price bars
contract, volume drops significantly, and the trend pulls against its primary direction. But just as that
market returns to a stable state, the action-reaction cycle suddenly regenerates and volatility
surges. Fresh momentum carries the reawakened trend toward a new price level, or reverses it
back toward its origins.
But why aren't markets stuck between two horizontal extremes if trend and countertrend act
with equal force, and are polar opposites? The answer lies in how active markets dissipate
directional force. Every buyer must eventually sell and every short seller must eventually cover. This
induces layers of cycles that equalize price action and reaction over time. Swing traders observe
this dynamic process in the trend relativity of different length charts for the same trading instrument.
In other words, a single market may print a strong rally on the daily chart, a bear market on the 60minute chart, and sideways congestion on the 5-minute chart, all at the same time. While this
phasing process may seem chaotic, it actually reflects the dissipation of underlying action-reaction
polarity. This 3-D trend-range axis also carries an added benefit: its alignment generates many of
the setups in the swing trader's playbook.
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Locate these important opportunities in the convergence of specific action-reaction
imbalances through several layers of price activity. This logical analysis also supports the
contrary attitude that leads to successful swing trading. For example, while the crowd sees a buying
opportunity when price surges on heavy participation, the swing trader sees selling power
increasing in that market due to the entrance of a new crowd of buyers. Fortunes are made through
this type of counterintuitive logic, generated by recognition of the underlying power in market
physics.
Time Frame Divergence
Price action in 3 time frames generates different support-resistance considerations while Qualcomm
tries to halt a sharp decline. The daily chart prints a hammer reversal near a 6-month low. The 60minute chart shows a bearish pullback into an ugly down gap, while the 5-minute chart offers shortterm traders excellent profits through a midday bounce near whole number 50.
3. THE STAR THAT BURNS BRIGHTEST BURNS OUT FASTER THAN THE STAR THAT EMITS
A COOLER, DARKER LIGHT
We measure the health of a rally or weakness of a selloff by the angle of its rise or fall.
Common sense dictates that more vertical price bars reflect more powerful price moves. But how
does the intensity of price change interact with the persistence of the trend itself? To answer this
question, we can rely upon the characteristics of central tendency discussed earlier. If each market
carries an underlying fair value at each point in time, a dynamic move should reach that price in less
time (fewer bars) than a slow hike in the same direction. In other words, vertical trend bars should
burn out and end their movement much sooner than slower trend bars.
Unfortunately these angles of inclination and declination are relative to the observer. Low
price distorts movement on arithmetic charts. A spectrum of growth rates distorts movement on log
charts. So before we can objectively measure how bright our market star burns, we need to adopt a
common system of viewing price change. Unfortunately this is more difficult than it first appears.
Diverse charting types and methods force us to apply measurements that are often dependent upon
the software or service that we use. The most fruitful analysis adopts a common view across an
entire database, so that visual comparison of trend intensity has a point of reference. Then we can
use our eyes and simple standard deviation to examine the duration and stability of price change.
Apply this charting method to locate parabolas that are ripe for strong reversals. In the
contrary view of the swing trader, vertical price movement is seen as a prelude to a reaction of the
same intensity in the opposite direction. Just as a supernova signals the imminent demise of an
aging star, the parabola informs the market that its trend fuel is about to run out, and likely cause a
violent reaction. First set a fixed log chart percentage between 15% and 20%. Then scan the entire
database for issues with the steepest angles of short-term price change. Isolate those markets with
the tallest price bars and visible trends in excess of 45 degrees. Then reset the log scale to
automatic for these filtered issues, so that recent price action fills the screen. Apply a standard
Bollinger Band and look for bars that print well outside the upper or lower band. Find your fade entry
level by dropping down to a lower time frame and locating a small-scale reversal pattern that aligns
well with broader landscape features.
A trend that moves at a very shallow angle also predicts its own demise, but for different
reasons. This reversal follows the mechanics of the rising or falling wedge patterns seen on many
price charts. Both traders and investors want excitement in their lives. They buy or sell so they can
watch price ramp to new levels. Shallow trends never fulfill this need for gratification. For example,
participants watch price rise in an uptrend to a marginal new high over and over again, but never
gather enough momentum to accelerate the rate of ascent. Shareholders eventually lose interest in
this type of price action and jump ship in search of a more exciting trading vehicle. The market loses
broad sponsorship and finally drops off a cliff.
Locating Blowoffs
Skilled eyes uncover the most dynamic parabolic trends and then execute fading strategies at
natural reversal levels. Start with a fixed log chart setting, such as the 15% in figure A. Scan your
database quickly and locate the most vertical price movement that you can find, up or down. Return
to a more comfortable chart scale (figure B) and apply 3-D charting landscape techniques to identify
low-risk entry.
4. ENERGY SOURCES LEAVE TELLTALE SIGNATURES IN THE FORM OF EXHAUST OR
RADIATION
This classic principle of physics requires little translation for the financial markets. Real
trading opportunities look like opportunities because they emit characteristics of impending
directional price movement. This reveals itself in crowd participation, price action at known
boundaries, the creation of recurring price patterns, and the convergence of technical indicators.
Interpret these diverse market signatures correctly and book consistent profits as a swing trader.
Engineers build machinery to investigate exhaust emissions and measure their internal
characteristics. For example, a hose attached to a vehicle's exhaust pipe tells the auto mechanic
the current condition of the internal machinery. Swing traders build similar measurement tools to
evaluate the state of internal market activity. But just as the engineer designs instruments to
examine a very narrow range of physical information, swing traders must limit data intake to specific
market characteristics and filter out many noise levels that can defeat profits.
Chart patterns with true predictive power emit evidence that these market engineers can
detect and measure. The radiation of opportunity builds through convergence of diverse elements
at narrow intersections of price and time. Each independent signal drawn into this small space
raises the odds that a trade setup will produce a valid result. Heat builds strongly at these important
levels and tells the swing trader to get on board quickly.
Reading the Charting Landscape
Highly predictive charts print well-organized patterns at expected price levels. AMCC starts with an
Island Reversal (1) that ends a clear Elliott 5-Wave (2) rally. Price drops under the intermediate high
at 48 and the 62% retracement (3) of the prior move. Weak congestion (4) forms under the
retracement level. The bottom Bollinger Band (5) expands downward, opening the door to falling
price. All signs points to an impending first failure event (6), in which price will retrace 100% or more
of a prior trend leg. The swing trader measures this evidence, sells short into the congestion, and
waits for the pattern to work out the expected result.
CONCLUSION
Modern traders have great difficulty organizing market movement into a manageable
feedback and execution system. Too often, they ignore important chart data because it doesn't fit
into a convenient system of horizontal price boundaries. This obsession with simple-minded pattern
recognition exposes a trader's inability to grasp the more powerful mechanics of price prediction.
Unfortunately, concentrating on a narrow execution strategy is like trying to play music with a single
note. It works only when a fleeting moment of opportunity demands a single, flat tone.
Expand your trading knowledge through the application of market physics. Each new aspect
expands your ability to profit from subtle aspects of crowd behavior. Keep in mind that these natural
forces rely upon mechanics that many speculators will overlook. This lets you gain an important
edge on the path to successful trading. It might take a lifetime to explore these complex interactions
between evolving price and the emotional crowd. But each piece of this fascinating puzzle adds new
levels of empowerment to trading performance.
Hard Right Edge Recommends:
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All original materials: © 2003 Brooke Publishers, Inc.
Comments: [email protected]
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IN DEFENSE OF THE KILLER INSTINCT
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Stand apart from the crowd at all times. Be the first in and out of the profit
door. Your job is to take their money before they take yours. Be ready to
pounce on ill-advised decisions, poor judgment and bad timing. Your
success depends on the misfortune of others.
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-- Alan Farley, The Master Swing Trader, 2000.
OK, it's not Sun Tzu or Jesse Livermore, but I think it makes the point. I'm
attacked whenever I talk about trading with a predatory instinct. These
obvious "sideliners" accuse me of contributing to the fall of civilization by
not playing fair when it comes to the markets.
I call them sideliners because it's obvious they don't trade, nor do they
have an appreciation for the laws of supply and demand. In their naive
vision, the markets are evil and need to be reformed so they can take
advantage of its opportunities. In other words, they never made a dime
trading in the real world.
Welcome to the myth of the democratic markets. After two decades of
unrepentant greed, we've spent the last three years atoning for our sins,
and looking for scapegoats. This self-deception has been so effective we
now believe we'd never have bought bubble stocks if "they" had only told
us the truth. Yeah, right.
What better entertainment in these mea culpa times than watching a
PICKS, CHARTS, successful woman being prosecuted to the full extent of the law?
SCANS, IDEAS & Undoubtedly none of us would have acted in the same manner had
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ImClone Sam called us up on that fateful day. At the least, we wouldn't
have been caught so easily or fought so hard to prove our innocence.
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The markets have never been a pretty place. Just ask the Dutch traders
who bought into the tulip mania back in the 17th century. You think 'Net
and
stocks were bad? Imagine paying $10,000 for a single tulip bulb, sight
EVERY MARKET unseen. Where were the enforcers back then, when they were really
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needed?
If It's Not Broken ...
I like my markets just the way they are, warts and all. In fact, capitalism
would get a lot worse if we didn't have a good place to make bad
decisions, at least between 9:30 a.m. and 4 p.m. EDT. Maybe that's why I
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cringe whenever lawmakers or prosecutors step onto that sacred ground.
I earn a living when other people put on their dumb hats, and buy too high
or sell too low. Traders like me don't build bridges, sell suits, or lead flocks
to salvation. We contribute nothing to society except pure liquidity and an
aggressive attitude. I wouldn't have it any other way.
Hard Right Edge
Founder
Alan S. Farley
Traders work directly with the machine language of world capitalism. It's
the only profession I know that doesn't depend on a boss, a company or an
economy. At its core, trading feeds ruthlessly off the excesses of the
marketplace. It just wouldn't be the same without all the manipulation,
misinformation and monkey business.
Many former investors now hate the markets and anyone who prospers
through trading or speculation. With biblical fervor, they believe justice
must eventually rain down on those who still appreciate the marketplace or
prosper from its existence. Amazingly, many of these folks still follow the
markets every single day. Talk about self-abuse!
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I have a standard response whenever I get flamed about my continued
faith in trading, capitalism and the modern markets: Why waste your time if
you're getting angry and upset reading the financial news? Take up knitting
instead, or better yet, join a political party. I'm sure you'll be much happier
in your misery, and Mr. Market will be a much kinder gentleman without
your attendance.
To quote a famous fictional trader, greed is good. Greed pays the bills and
gets the kids through college. Greed also performs an important
community service. It relieves the misinformed of their excess capital, and
gives it to those more deserving of its ownership. Greed greases the
engine of market inefficiency.
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Traders need to be greedy to develop the predatory style required to
prosper in our modern markets. This may be distasteful to folks who still
believe in the tooth fairy or Robin Hood. But the rest of us understand
there will be a loser for every winner. And everyone who plays the markets
has to choose whether to take or be taken.
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Price marks territory as it spikes relative highs and lows within all time frames. Skilled traders
observe this signature behavior throughout all markets and all historical charting. Relative direction also
characterizes price movement. A series of lower lows and lower highs identify downtrends while
uptrends print a sequence of higher highs and higher lows.
As bulls and bears fight for control, Pattern Cycles are born. Since markets won't travel upward to
Interactive infinity or downward below zero, identifiable swing trades appear within each time frame. Driven by
Trading
emotional behavior, trend inhales and exhales. Falling price ignites fear as paper profits evaporate.
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Bottoms exist as a direct result of this trend physics. The natural movement of impulse and
reaction dictates that two unique formations must develop at some point within each Pattern Cycle. In
an uptrend, a lower high must eventually follow a higher high and mark a new top. In a downtrend, the
sequence of lower lows ends when price prints a higher low. This second event marks the birth of the
Double Bottom.
Double bottoms draw their predictive power from the trends that precede them. As a series of
lower lows print on a bar chart, downtrends often accelerate. The trading crowd notices and develops a
gravity bias that expects the fall to continue unabated. Then suddenly the last low appears to hold. The
crowd takes notice and bottom fishers slowly enter new positions. Price stability then triggers more and
more players to recognize the potential pattern and jump in.
Stock percentage growth potential peaks at the very beginning of a new uptrend. For this reason,
being "right" at a bottom can produce the highest profit of any trade. But picking bottoms can be a very
dangerous game. Smart traders weigh all evidence at their disposal before taking the leap. And strict
risk discipline must still be exercised to ensure a safe exit if proven wrong.
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Eve's rounded bottom takes longer to form
than the sharp Adam spike. Look for volume to
decrease as the stock heals and prepares for a
new uptrend. Adam and Eve formations aren't
limited to bottoms. Watch for them at the end
of parabolic rallies.
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The Adam and Eve Reversal illustrates the importance of the center peak in the creation of
Double Bottoms. A very sharp and deep first bottom (Adam) initiates this DB pattern. The stock then
bounces high into a center retracement before falling into a gentle, rolling second bottom (Eve). Price
action finally constricts into a tight range before the stock breaks strongly to the upside.
Many times the top of Eve prints a flat shelf that marks an excellent entry point. Shelf resistance
typically develops right along the top of the center retracement pivot. The relationship between this
center pivot and current price marks an important focal point as the skilled trader closely watches the
development of a suspected double bottom pattern.
Since bottoms occur in downtrends, risk must be managed defensively. The greedy eye wants to
believe the immature formation and is easily fooled. Even spectacular reversals offer little profit if price
can't ascend back out of the hole it found itself in. When choosing stop and exit points, violation of a
prior low is the natural first choice. Make certain your entry permits you to exit for an acceptable loss at
this location. And don't stick around long. Price will gather downside momentum quickly at broken lows
as it searches for new support.
Successful bottom entry takes a strong stomach. Even when all the technicals line up, sentiment
will be highly negative at these turning points. The potential for short-term profit though is outstanding.
In addition to other longs ready to speculate on a good upside move, high short interest will fuel
explosive impulses off these levels. Perhaps for this reason alone, serious traders can't ignore double
bottom patterns.
The Big
W
pattern
can be
identified
in all
time
frames
and all
markets.
It is a
powerful
tool for
locating
bottom
trade
entry.
The Big W reference pattern maps the entire bottom reversal process. This signpost identifies key
pivots and flashes early warning signals. The pattern begins at a stock's last high, just prior to the first
bottom. The first bounce after this low marks the center of the W as it retraces between 38% and 62%
of that last downward move. This rally fades and price descends back toward a test of the last low. The
smart trader then listens closely for the first bell to ring. A wide range reversal bar (doji or hammer) may
appear close to the low price of the last bottom. Or volume spikes sharply but price does not fail. Better
yet, a Turtle Reversal prints where price violates the last low by a few ticks and then bounces sharply
back above support. When any or all of these events occur, focus your attention on the second leg of
this Big W.
Aggressive traders can initiate entry near the bottom of this second leg when the bell rings
loudly. The middle of the W now becomes your pivot for further execution. For price to jump to this
level, it must retrace 100% of the last decline. This small move finally breaks the falling bear cycle.
Enter less aggressive positions when this emerging second bottom retraces through 62% of the
fall into the second low. But sufficient profit must exist between that entry and the W center top for this
trade to work. Longer-term traders can hold positions as price pierces this pivot. Be patient since price
will likely pause to test support here.
Then expect another upward leg. Price at this level has a high probability of moving even higher. It
can easily retrace 100% of the original downward impulse, completing both the Double Bottom and Big
W patterns. This tendency allows for further entry at the first pullback to the center pivot after the next
break.
BREAKOUTS
Significant declines evolve into long bottoms characterized by failed rallies and retesting of
prior lows. As new accumulation slowly shakes out the last crowd of losers, a stock's character
changes. Prices push toward the top of key resistance. Short-term relative strength improves and the
chart exhibits a series of bullish price bars with closing ticks near their highs. Finally the issue begins a
steady march through the wall marked with past failures.
Stocks must overcome gravity to enter new uptrends. Value players build bases but can't supply
the critical force needed to fuel rallies. Fortunately, the momentum crowd arrives just in time to fill this
chore. As a stock slowly rises above resistance, greed rings a loud bell and these growth players jump
in all at the same time.
The appearance of a sharp breakout gap has tremendous buy power. But the skilled trader should
remain cautious when the move lacks heavy volume. Bursts of enthusiastic buying must draw wide
attention that ignites further price expansion. When strong volume fails to appear, the gap may fill
quickly and trap the emotional longs. Non-gapping, high volume surges provide a comfortable price floor
similar to gaps. But support can be less dependable, forcing a stock to swing into a new range rather
than rise quickly.
Fortunately this scenario sets up good pullback trades. The uptrend terrain faces predictable
obstacles marked by Clear Air pockets and congestion from prior downtrends. These barriers can force
frequent dips that mark good buying opportunities. The trader must identify these profitable zones in
advance and be ready to act.
Gap breakouts are
more likely to rise
toward higher prices
immediately than
simple volume
breakouts. Waiting for a
dip may be futile.
Extreme crowd
enthusiasm ignites
continued buying at
higher levels and
market makers don't
need pullbacks to
generate volume. If
entry is desired, use a
trend-following strategy
and manage risk with
absolute price or
percentage stop loss.
As trend builds momentum, surges register on technical indicators such as MACD and ADX. Volatility
absorbs each thrust and parabolic rallies erupt. Dips will cease during these runaway expansion moves
as price range expands bar to bar, often culminating in a second (continuation) gap and a final
exhaustion spike.
After rapid price movement, markets need time to absorb instability generated by that trend's
momentum. They pause to catch their breath as both volume and price rate of change drop sharply.
During this consolidation period, new price levels undergo continuous testing for support and resistance.
To the pattern reader, this range phenomenon reveals itself through the familiar shapes of Flags,
Pennants and Rectangles.
Relatively simple mechanics underlie the formation of these continuation patterns. The orderly
return to a market's mean state sets the foundation for a new thrust in the same direction. In a series of
sharp trend moves, congestion tends to alternate between simple and complex in both time and size.
Trade defensively when the prior pattern was both short and simple. Go on the offense after observing
an extended battle in the last range.
When examining continuation patterns, traders must pay close attention to proportionality. This
visual element will validate or nullify other predictive observations. Constricted ranges should be
proportional in both time and size to the trends that precede them. When they take on dimensions larger
than expected from visual examination, odds increase that the observed range actually relates to the
next trend larger in scale than the one being viewed. This can trigger devastating trend relativity errors,
in which positions are executed based on patterns longer or shorter than the time frame being traded.
All patterns must be evaluated within the context of trend relativity. The existence of any range
depends upon the time frame being analyzed. For example, a market may print a strong bull move on
the weekly chart, a bear on the daily and a tight continuation pattern on the 5-min bar, all at the same
time. A range drawn through one time frame does not signal similar conditions in the other periods that
particular market trades through.
TRENDS
The cult of Elliott Wave Theory intimidates the most experienced traders. But don't let wave
voodoo stop you from adding important elements to your chart analysis. Strong trends routinely print
orderly action-reaction waves. EWT uncovers these predictive patterns through their repeating count of
3 primary waves and 2 countertrend ones.
Wave impulses correspond with the crowd's emotional participation. A surging 1st Wave
represents the fresh enthusiasm of an initial breakout. The new crowd then hesitates and prices drop
into a countertrend 2nd Wave. This coils the action for the sudden eruption of a runaway 3rd Wave.
Then after another pullback, the manic crowd exhausts itself in a final 5th Wave blowoff.
Traders can capitalize on trend waves with very little knowledge of the underlying theory. Just
look for the 5-wave trend structure in all time frames. Locate smaller waves embedded in larger ones
and place trades at points where two or more time frames intersect. These cross-verification zones
capture major trend, reversal and breakout points.
For example, the 3rd wave of a primary trend often exhibits dynamic vertical motion. This single
thrust may hide a complete 5-wave rally in the next smaller time frame. With this knowledge execute a
long position at the 3rd Of A 3rd, one of the most powerful price movements within an entire uptrend.
While waves seem hard to locate, the trained eye can uncover these price patterns in many strong
uptrends.
Many 3rd waves trigger broad Continuation Gaps. These occur just as emotion replaces reason and
frustrate many good traders. Since common sense dictates the surging stock should retrace, many exit
positions on the bar just prior to the big gap. Use timely wave analysis (and a strong stomach) to
anticipate this big move just before it occurs.
4th Wave corrections set the sentiment mechanics for the final 5th wave. The crowd experiences
its first emotional setback as this countertrend generates fear through a sharp downturn or long
sideways move. The same momentum signals that carry traders into positions now roll over and turn
against them.
The greedy crowd ignites a
powerful December rally in
AMGN. Note the embedded
5 wave patterns, typical
with surging uptrends. The
3rd of a 3rd identifies the
most dynamic momentum
expected in a sharp price
move.
As they prepare to exit, the trend suddenly reawakens and price again surges. During this final 5th
wave, the crowd loses good judgement. Both parabolic moves and aborted rallies occur here with great
frequency. Survival through the last sharp countertrend adds an unhealthy sense of invulnerability into
the crowd mechanics. Movement becomes unpredictable and the uptrend ends suddenly just as the last
greedy participant jumps in.
When trend finally turns back through old price, skilled traders then use past action to identify
effective momentum and swing trades. Battles between bulls and bears leave a scarred landscape of
unique charting features. For example, gaps provide one of the most profitable setups in all of technical
analysis. Continuation gaps rarely fill on the first try, except with another gap. Use a tight stop and
execute your trade in the direction of support as soon as price enters the gap on high volatility.
Past breaks in support identify low risk short sales. The more violent the break, the more likely it
will resist penetration. Head & Shoulders, Rectangles and Double Tops leave their mark with strong
resistance levels. These patterns often print multiple doji and hammer lows prior to a final break as
insiders clean out stops at the extremes of the pattern.
Clear Air prints a series of wide range bars as price thrusts from one stable level to another.
Rapid price movement tends to repeat each time that trading enters its boundaries. Potential reward
spikes sharply through these unique zones. But watch out. Reversals tend to be sharp and vertical as
well. Tight stops are advised.
Pattern Cycles recognize that important features may not be horizontal. What the eye resolves as
uptrend or downtrend contains multiple impulses shooting out in many directions. The most common of
these is the Parallel Price Channel. Use these price extremes to enter contrary positions with stop
losses just on the other side of the parallel trendlines.
HIGHS
Short-term traders discover great rewards in uncharted territory. Stocks at new highs generate
unique momentum properties that ignite sharp price moves. But these dynamic breakouts can also
demonstrate very unexpected behavior. Old battlegrounds of support/resistance disappear while few
reference points remain to guide entry and exit. In this volatile environment, risk escalates with each
promising setup.
The final breakout to new highs completes a stock's digestion of overhead supply. But the
struggle for greater gains is far from over. Issues reaching new highs often undergo additional testing
and preparation before resuming their dynamic uptrends. The skilled trader can follow this building
process through the typical pattern development expected during these events.
Price may return to test the top of prior resistance several times. This can create a variety of
stepping or basing ranges before trend finally moves sharply upward. Other times, stocks will
immediately go vertical when new highs are printed. The challenge is to decide which outcome is more
likely.
Use Accumulation-Distribution analysis to predict whether new highs will escalate immediately
or just mark time. Price either leads or lags accumulation. When stocks reach new highs without
sufficient ownership or buying pressure, they will often pause to allow these forces to catch up. Other
times, accumulation builds more strongly than price. The initial thrust to new highs confirms this
accumulation. The breakout triggers a new round of buying interest and price immediately takes off with
no basing phase.
On Balance Volume and similar accumulation-distribution indicators are essential tools to
evaluate the strength of new high breakouts. Expect an immediate upward thrust when OBV draws a
pattern more bullish than the price chart. Alternatively, when multiple acc-dis readings show ownership
limping behind price, prepare for an extended basing period. And always use caution with NASDAQ
stocks. Their odd transaction reporting may lead to false OBV readings.
Final phases of congestion often print sharp initiation points for the breakout impulse. Locate
this hidden root structure in double bottom lows embedded within the congestion just prior to the trend
move. The distance between these lows and the top resistance boundary will yield price targets for the
subsequent rally. Barring larger forces, this new high breakout should extend no more than 1.38 times
the distance between that low and the resistance top before establishing a new range.
Once price clears a new high base, the bull impulse escapes the gravity of final congestion. This
often triggers a dramatic 3rd wave for the trend initiated at the congestion low. This thrust can easily
exceed initial price targets when it converges with larger scale wave movement. In other words, when
forces in the daily and intraday charts move into synergy, trend movement will inevitably be more
dramatic than anticipated.
When complex
basing occurs early
in a dynamic
uptrend, alternation
predicts major price
thrusts with few
retracements. This
CMGI parabolic
move supports that
theory. Note the
extended range at
the right shoulder
of the Inverse Head
& Shoulders
pattern, probably
driven by
inadequate
accumulation. Once
the building
process was
complete, price
ejected into an
astounding rally.
Measure ongoing new highs with a MACD Histogram or other widely used momentum indicator.
Whatever your choice, allow your math to support the pattern rather than the other way around. For
example, if an established trendline can be drawn under critical lows, key your trade timing off that line
rather than waiting for your indicator slope to turn up or down.
Effective trading of post-gravity impulses relies on the interaction between current price and
your momentum indicator. At new highs, prior support/resistance can't be used to predict swings.
Follow the MACD slope to flag overbought conditions favorable for ranges or reversals. Enter long
positions when price falls but the slope begins to rise. Or be conservative and wait for the zero line to be
crossed from below to above.
Patterns point to low risk momentum trades. Enter retracements to a trendline or moving average
and you'll ride the dips just as new buyers jump in. Short sales should be avoided completely when
momentum is high unless you're an experienced trader. Trying to pick tops is a loser's game. Delay
short sales until momentum drops sharply but price is high within its range. Pattern analysis can then
locate favorable countertrends with limited risk.
When a stock breaks to new highs, how long will the rally last? In physics, a star that burns bright
extinguishes itself long before one emitting a cooler, darker light. So it is with market rallies. Parabolic
moves cannot sustain themselves over the long haul. Alternatively, stocks that struggle for each point of
gain eventually give up and roll over. So logic dictates that the most durable path for uptrends lies
somewhere in-between these two extremes.
Overbought conditions lead to a decline in price momentum and illustrate one ever-present
danger when trading new highs: stocks may stop rising at any moment and enter extended sideways
movement. Watch rallies closely with your toolbox of technical indicators to uncover any early warning
signs for this range development.
The first break in a major trendline that follows a big move flags the end of a rally and beginning
of sideways congestion. Exit momentum-based positions until conditions once again favor rapid price
change. In this environment, consider countertrend swing trades if other forces favor success. But stand
aside once volatility slowly dissipates and crowd participation fades.
TOPS
No trend lasts forever. Inevitably, crowd enthusiasm outpaces a stock's fundamentals and rallies stall.
But topping formations do not end uptrends all by themselves. These stopping points may only signal
short pauses that lead to higher prices. Then again, they could be long-term highs just before a major
breakdown.
What hidden patterns can you use to identify and trade reversals before your competition sees
them? Successful short-term traders get in the reversal door early and allow the herd to trigger sharp
price movement. Familiar trend-change formations, such as the Head & Shoulders and Double Tops,
take so long to develop that many profitable entries pass before they finally signal an impending break
to the waiting crowd.
First Rise/First Failure offers traders an early method to identify reversals following new highs
or lows in any time frame. FR/FF identifies the first 100% retracement of a dynamic trend move within
the time frame of interest. In order for any trend to continue, price movement should find support near a
62% retracement, measured from the starting point of the last thrust that pushed price to the new high
or low. From this pullback, trend must base and test its extension before it can break out to further
continuation highs or lows.
Cross-verification rings a
loud bell. Note how the
uptrend line broke on the
same bar as the violation of
the 62% fib retracement
following this late 1998
AMZN explosion. The
familiar triangular shape of
First Rise-First Failure
makes identification easy
when flipping through
many price charts.
100% retracement violates the major price direction and terminates the trend it corrects.
Completion also provides significant support/resistance, where bounce trades can be initiated with low
risk. From this point, continuation trends may reawaken in the next larger time frame by a new break
through the 38% (prior 62%) S/R and continued push past the 62% retracement, toward a test of the
high/low extension.
Bounce reversals represent superb entry points when the 100% violation coincides with a 38% or
62% retracement of the next higher dynamic time frame. However risk: reward requires careful
measurement, as the trade may develop more slowly than expected. In other words, a successful
position must be held through expected congestion at the 38%-62% zone before it can access a
profitable retest of the double top/double bottom extreme.
Allow minor testing violations for all major Fibonacci retracements before taking positions.
Specialists and Market Makers know these hidden turning points and conduct stop-gunning exercises to
take out volume just beyond the breaks. And watch out for trend relativity errors. Bull and bear markets
exist simultaneously through different time frames. Limit FR/FF trades to the time frame for which the
retracement occurs unless cross-verification supports other setups.
Every popular topping formation has its own unique pattern features. But all tell a common tale of
crowd disillusionment. Whether printed in the manic highs and lows of the Head & Shoulders or the slow
capitulation of the Rising Wedge, the final result remains the same. Price breaks sharply to lower levels
while unhappy shareholders unload positions as quickly as they can.
Early in a rally, value and improving fundamentals attract knowledgeable holders. But as an
uptrend develops, the motivation for new participants becomes vastly different. News of a stock's rise
generates excitement and attracts a greedier crowd. These momentum players slowly outnumber the
value investors and stock movement becomes more volatile. The issue continues upward as this frantic
buying crowd feeds on itself well beyond most reasonable price targets.
Both fire and ice will kill uptrends. As long as the greater fool mechanism holds, each new long
allows the previous one to turn a profit. Eventually changing conditions force a final end to the upside
action. A shock event can suddenly kill the buying enthusiasm, forcing a sharp and immediate reversal.
Or the trend's fuel just runs out as the last interested buyer enters one last position.
Many traders mistakenly assume bulls turn into bears immediately following a dramatic, high
volume reversal. They enter short sales well before the physics of topping and decline rob the crowd of
its momentum. In fact, these early shorts provide fuel for the sharp covering rallies seen in most topping
formations.
Skilled traders wait and measure the process of crowd disillusionment before they enter large
short sales. Decline characteristics can be predicted with great accuracy using pattern analysis. While
they wait, the repeating character of the topping event provides a natural playground for swing
positions.
REVERSALS
No chart pattern better illustrates this slow evolution from bull market to bear decline than the
Descending Triangle. Within this simple structure, the trader examines how life drains slowly from a
dynamic uptrend. Variations of this destructive formation precede more breakdowns than any other
reversal. And they can be found doing their dirty deeds in all time frames and all markets.
But why does it work with such deadly accuracy? Most traders don't understand how or why
patterns predict outcomes. Some even believe these important tools rely on mysticism or convenient
curve fitting. The simple truth is more powerful: congestion patterns reflect the impact of crowd
psychology on changes in price and momentum.
Shock and fear quickly follow the first reversal marking the triangle's major top. But many
shareholders remain true believers and expect their profits will return when selling dissipates. They
continue to hold as hope slowly replaces better judgement. The selloff then carries further than
anticipated and their discomfort increases. Just as pain begins to escalate, the correction suddenly ends
and the stock firmly bounces.
For many longs, this late buying reinforces a dangerous bias that they were right all along.
Renewed confidence even prompts some to add to positions. But smarter players have a change of
heart and view this new rally as a chance to get out. As they quietly exit, the strong bounce loses
momentum and the stock once again turns and fails. Those still riding the issue now watch the low of
the first reversal with much apprehension.
Prior countertrend lows present trading opportunities for those familiar with double bottom
behavior. As price descends a second time toward the emotional barrier of the last low, traders step in
looking for a good DB play. Price again stabilizes near that prior value, encouraging new investors (with
very bad timing) to enter final long positions.
By this time, the stock's bullish momentum has slowly drained through the criss-cross price
swings. Relative strength indicators now signal sharp negative divergences as price continues to hold
up through this sideways action. Momentum indicators roll over and Bollinger Bands contract as price
range narrows.
The double bottom appears to hold as a weak rally draws a third high. But this final bounce fades
and traders exit quickly. Shorts now smell blood and enter initial positions. Fear increases and stops
build just under the double low shelf. Price returns for one final test as negative sentiment expands
sharply. Often, price and volatility then contract right at the break point.
SEEK sketches a perfect Descending
Triangle reversal and breakdown
following its 1998 rally. Sharp, parabolic
rallies often set the stage for dramatic
topping formations. Note how the
triangle is also a variation of the Adam
and Eve pattern.
The bulls must hold this line. However, odds have now shifted firmly against them. Recognizing the
imminent breakdown, traders use all upticks to enter new short sales and counter any weak bull
response. Finally, the last positive sentiment dies and horizontal support violates, triggering the stops.
Price spirals downward in a substantial price decline.
Stock charts print many unique topping formations. Some classics can be understood and traded
with very little effort. But the emotional crowd also generates many undependable patterns as greed
slowly evolves into mindless fear. Complex Rising Wedges will defy a technician's best effort at
prediction while the odd Diamond pattern burns trading capital swinging randomly back and forth.
Skilled traders avoid these fruitless positions and only seek profit where the odds strongly favor
their play. They first locate a common feature found in most topping reversals: price draws at least one
lower high within the broad congestion before violating a major uptrend. This common double top
mechanism becomes the focus for their trade entry. From this well-marked signpost, they follow price to
a natural breaking point and enter when violated.
Flip over the Adam and Eve bottom and you'll find a highly predictive structure for trading
reversals. This Adam and Eve Top provides traders with frequent high profit short sales opportunities.
Enter shorts on the first violation of the reaction low, but use tight stops to avoid turtle reversals. These
occur when sharp short covering rallies suddenly erupt right after the gunning of stops below a violation
point.
Each uptrend generates positive sentiment that must be overcome through the topping
structure. A&E tops represent an efficient bar structure to accomplish this task. The violent reversal of
Adam first awakens fear. The slow dome of Eve absorbs the remaining bull impulse while dissipating
the volatility needed to resume a rally. As the dome completes, price moves swiftly to lower levels
without substantial resistance.
Observant traders recognize the mechanics of Descending Triangles and Adam & Eve
formations in more complex reversals. The vast majority of tops contain characteristics of these
familiar patterns. Crowd enthusiasm must be eliminated for a decline to proceed. Through the repeated
failure of price to achieve new highs, buying interest eventually recedes. Then the market can finally
drop from its own weight.
DECLINES
As uptrends end, the same crowd that lifts price provides fuel for the ensuing decline. Longs get
lulled into a false sense of confidence as rally momentum fades and a topping pattern forms. As smart
money quietly exits, the uptrend hits a critical trigger point: the bulls suddenly realize they're trapped.
Seeking to protect profits, they start dumping the stock. Price fails and selling spirals downward through
wave after wave.
Common features appear through most price declines. Several false bottoms print and fail. Volume
repeatedly surges as losers unload positions and price carries well past downside target after target.
Then just as hope collapses, the stock makes a final, multiple bottom.
Pattern Cycles offer a superb way for the short-term trader to understand and capitalize upon this
repeating market behavior. Look no further than R. N. Elliott's work in the 1930s and you'll find the Five
Wave Decline. This structure for price correction is as powerful today as it was 60 years ago. And as a
parable for crowd behavior, traders can use it without understanding the broader Elliott Wave Theory.
The 1st, 3rd and 5th wave
impulses in EWT become
Top-1-2 in the Decline's
count. Connect the 3rd (1)
and 5th (2) waves with a
trendline. Ignore the 1st
(Top) wave, which the
trendline can violate in any
way it wants. The first
bounce after the (Drop) may
come close to that trendline
but will rarely violate it.
5WDs consist of three downward impulses and two corrections. The first impulse (Top) corrects
the uptrend that carries an issue to a new high. This Top begins the price failure that completes through
the second impulse (1): the technical breakdown of the stock. As with rising markets, this impulse can
be very dynamic. But in most declines, the worst is usually reserved for last. As this 2nd impulse
completes, a false bottom paints a comforting picture that slows the selling and brings in weak longs.
The selling then suddenly resumes and accelerates into a final 3rd impulse (2) that is so emotional that
prices violate set targets and reasonable support zones.
The emotion of this last wave extinguishes selling pressure, bouncing the stock. Rapid upward
motion ignites the first impulse of a significant countertrend. This strong rally then fails suddenly. As the
longs brace for more pain, the prior low unexpectedly holds. A new crowd then steps in and price
returns to the 1-2 trendline as a double bottom forms. The balance of power shifts and the stock breaks
through that line into a new uptrend.
The skilled eye can see 5WDs in all time frames, from 5-min to monthly bars. And the unconscious
crowd behavior represented by this fascinating pattern goes well beyond declining markets. These
volatile movements fit perfectly into the larger structure of herd mentality that drives Pattern Cycles
through their orderly and predictable process.
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We spend too much time looking for stocks to trade. Surprisingly, stock picking is
one of the easiest skills a new trader can learn (while actually taking a position is
one of the hardest).
The trick to finding good setups is scanning dozens of charts in seconds, instead of
hours. And this isn't as hard as it looks.
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First, let's talk about stock scanning. Chart database programs (such as Worden's
TC2000) feature advanced market scanning tools. With them, you can write
Boolean statements that will search quickly for your needle in the market haystack.
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mindlessly executed. Nothing could be further from the truth. The best scans just
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Your two eyes are better tools for locating good trades than the most carefully
written market scans. The most effective formula will uncover a lot of useless
garbage but also let you find the real gems. So keep your search sloppy, and don't
try to optimize. Instead, put your resources into a fast computer that lets you flip
through your output at the speed of light.
Let's examine five visual aids to speed up your stock scanning. Train your eyes to
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look at charts in this way the next time you sit down to do your market homework.
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You don't want to ski on the Bunny Slopes. There's little profit for traders when
price rises or falls in a very gentle pattern. Real opportunity comes when strong
tension between conflicting forces gets released in a big move. Bunny slopes never
build that tension and should be avoided if you're looking for short-term gains. The
good news is it takes only a second to see this flaw on a price chart.
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Border Disputes happen between price bars and intermediate moving averages.
These conflict levels define important setups because so many players react to
these zones. Keep your eye on the interplay between price, the 50-day and 200-day
moving averages as you flip through your charts. No single pattern defines these
disputes, so stop and investigate when you see something interesting.
Davy and Goliath traps many traders. This trend-relativity error happens when you
see a great pattern, but miss the support or resistance that's going to screw it up.
Avoiding this error is simple. Look above and below the breakout price for the setup
that's catching your eye. Then do the math. How far will it travel before it runs into
the mean ogre?
Trend Mirrors tell you to look to your left before taking a trade. Mirrors show all the
past stuff that's going to affect price movement right now. One of the great trading
secrets is that price reacts a lot more than it acts. In other words, old debris in the
charting landscape generates most price swings. So look for all the past highs/lows,
gaps, volume spikes and candle shadows when you see an interesting setup in the
present.
If you have to look, it isn't there. The Bad Hair Day refers to a price chart that
makes absolutely no sense when you first look at it. So what do you do when an
oddball pattern catches your eye? You waste more time and try to figure it out.
When a chart doesn't slap you across the face at first glance, move on and find one
that does.
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A pattern is only as good as the price action that follows it. Many players get
caught up in the hunt, thinking all it takes to trade is a good setup. Unfortunately,
this approach is a great way to lose money.
Trade setups are predictive archetypes, nothing more and nothing less. Some
evolve with textbook perfection, while others show no regard at all for your expert
opinion.
Good trade execution is a three-step process. You find the pattern, you study how
price interacts with it, and you decide whether or not to pull the trigger. A good
percentage of setups never reach the moment of decision and should be
YOUR DAILY discarded without a second thought. Many traders have trouble with this limitation,
MARKET because they expect the markets to pay off like a racetrack, through a simple pickGUIDE
and-play strategy. In other words, they take positions the same way a gambler
bets on horses. But the markets don't work this way, and setups can't be treated
like tipsheets.
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When I post a new pattern, someone always asks when they're "supposed" to take
the trade. I tell them to take it when they get a buy or sell signal. Of course, this
makes things worse, because many folks don't know what signals look like. So
perhaps a little instruction is in order.
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Interactive The execution target defines where to buy or sell short. A good setup points to this
to
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price through support-resistance, pattern recognition and the reward-risk ratio. A
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couple of limitations affect execution targets, though. First, any external forces that Short-Term Trading
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possible a single tick will affect the calculated reward-risk ratio and bust the
and
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The execution zone stands between current price and the execution target. This is
an attention boundary for your trade entry. You shift focus toward the execution
and
target when price penetrates the execution zone. So where do you draw this
EVERY MARKET important interface? Place it at a distance that allows adequate time to examine
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whether or not to take the trade when price hits the target.
Use common sense to identify useful execution zones. Look at recent volatility and
measure a fixed distance from the target. Or locate the last support level your
setup must pass through before reaching the execution target, and place it there.
You have three entry choices on most trade setups:
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●
●
●
Enter in congestion near a breakout or breakdown.
Stand aside when the breakout or breakdown occurs, and wait for a
pullback.
Try to get in as a breakout or breakdown starts, and hope to get filled at a
good price.
Hard Right Edge
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Alan S. Farley
Each entry strategy fosters its own execution zone/execution target combination.
The key is to enter long near substantial support, or sell short near substantial
resistance. Of course, this is harder to do than it sounds. Emotions rise in moving
markets, and the decisions we take in the heat of battle may not be the best ones
for that setup. But that's part of the fun of swing trading.
Let's look at two examples.
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Genesis Microchip (GNSS) had a triple-bottom short setup last week. But bad
timing empties trading accounts on this volatile stock. So when was the right time
to sell it short?
Genesis printed a NR7 (narrowest range bar of the last seven bars) just before
collapsing into the mid-40s. This would have been an excellent place to enter, but
it would have required seeing the signal just before the close, and then jumping in.
The trader could also sell short the next morning when the stock gapped down, but
a bad fill would place the position at risk for a reversal or short squeeze. The third
method is still on the table. Genesis may still rally back to the breakdown level and
present a very low-risk entry.
Manhattan Associates (MANH) also set up an interesting short sale last week, but
the outcome was quite different. It sat near a double-bottom failure, but overnight
news gapped up the stock. Because the failure never triggered, there was no risk
from short entry choices two or three. But there was risk if a short position was
entered on the prior bar, in the bottom congestion.
The good news is this narrow zone triggered an exit signal as soon as the stock
gapped up above it. And the fill on a position in this quiet zone would make any
loss more palatable.
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TRADING WITH STAGE ANALYSIS
TACTICS
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Same as it ever was.
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What if you could just glance at a price chart and find good trades immediately?
It's not as hard as you think. Start by looking for recurring patterns and trends, and
then see where price is trading on this "pattern tree." It should tell you right away if
there's money to be made.
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Stage analysis defines your location within the market universe. Stan Weinstein
documented this powerful technique in his classic Secrets of Profiting in Bull and
Bear Markets. He described how market action can be broken into specific stages
of development.
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Each stage has its own characteristics and favors certain strategies over others.
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For example, uptrends are better for buying stocks, while downtrends are better for
selling short. It may sound simple, but many of us do exactly the opposite.
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I've reconfigured these mechanics into a concept called pattern cycles. These
focus on the cyclical aspect of stage analysis, and how traders use them to
capitalize on a wide variety of market flavors. Pattern cycles track markets through
repeating crowd behavior. They are evolutionary -- i.e., one phase naturally
progresses into the next. They signal the strategy that works best in the current
phase, and what to expect from the next one.
What are these repeating cycles? They follow the common TA language we've
learned over the years -- bottoms, breakouts, uptrends, new highs, tops,
breakdowns and downtrends. Each phase also defines a trend-range axis that
carries price sideways, upward or downward in a predictable manner.
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One overriding factor complicates market-stage analysis: It exists in more than one
time frame. In other words, markets will be at one stage on a weekly chart, a
different one on the daily chart and yet a third on the intraday chart. Traders must
deconstruct this trend relativity to achieve accurate price prediction, and take
advantage of a specific stage.
Trend relativity errors wash many traders out of the markets. We recognize a
stage and throw money at it. But we might forget a longer time frame that's moving
against our position. You can overcome these errors by defining holding periods
that align to the stages being traded. In a broad sense, this is the same process
that divides market players into scalpers, daytraders, position traders and
investors.
Opportunity peaks at the interface between different stages. Here are three
examples. Breakout trades appear where bottoms gives way to uptrends. Pullback
trades develop where price retraces to the edge of the last phase. Bursts into new
highs awaken an assortment of momentum trades.
Pick your strategies wisely. There's a time to buy breakouts and a time to sell
short. There's a time to press your positions and a time to take whatever the
markets give you. And there's definitely a time to chase momentum and a time to
trade pure price sensitivity.
Stage recognition errors hurt the investing public as well. Look at the multitude that
got crushed buying the dips when the markets descended from the bubble top in
2000. And in these bear market days, investors forget that bottoms take time to
develop, and returns need to be measured in years, not days.
Value investors enter the markets when bottoms are forming. Momentum traders
come in during strong uptrends and downtrends. But sadly, the public enters
during tops and climaxes. So whether you trade or invest, take the time to identify
current stages in your individual stocks and in the broader market. This ultimately
defines the best way to play your hand.
Remember that standing aside is a proactive strategy through certain stages. You
won't make money when market conditions don't match your holding period or
trading skills. Instead, sit on your hands and let the market come to you when the
cycles makes no sense. This requires discipline, but it will keep you in the game
for the long run.
Swing traders can take the next step and master a variety of stages. This lets us
capitalize on a broad range of market environments. We become breakout traders
when markets are on the move, but play the swing game when they're just
chopping around. Diverse skills enable us to sell short when markets decline, or
work the edges during extended ranges.
For restless souls like you and me, this opportunistic style offers a great way to
make our favorite hobby a full-time job.
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20 GOLDEN RULES FOR TRADERS
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Want to trade successfully? Just choose the good positions and avoid the bad
ones. Poor trade selection takes a heavy toll as it bleeds your confidence and
wallet. You face many crossroads during each market day. Without a system of
discipline for your decision-making, impulse and emotion will undermine skills as
you chase the wrong stocks at the worst times.
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Many short-term players view trading as a form of gambling. Without planning
Resources or discipline, they throw money at the market. The occasional big score reinforces
this easy money attitude but sets them up for ultimate failure. Without defensive
rules, insiders easily feed off these losers and send them off to other hobbies.
YOUR DAILY Technical Analysis teaches traders to execute positions based on numbers,
MARKET time and volume.This discipline forces traders to distance themselves from
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reckless gambling behavior. Through detached execution and solid risk
management, short-term trading finally "works".
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Markets echo similar patterns over and over again. The science of trend allows
you to build systematic rules to play these repeating formations and avoid the
chase:
1. Forget the news, remember the chart. You're not smart enough to
know how news will affect price. The chart already knows the news is
coming.
2. Buy the first pullback from a new high. Sell the first pullback from
a new low. There's always a crowd that missed the first boat.
3. Buy at support, sell at resistance. Everyone sees the same thing and
they're all just waiting to jump in the pool.
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4. Short rallies not selloffs. When markets drop, shorts finally turn a
profit and get ready to cover.
5. Don't buy up into a major moving average or sell down into one.
See #3.
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6. Don't chase momentum if you can't find the exit. Assume the market
will reverse the minute you get in. If it's a long way to the door, you're in
big trouble.
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7. Exhaustion gaps get filled. Breakaway and continuation gaps
don't. The old traders' wisdom is a lie. Trade in the direction of gap
support whenever you can.
8. Trends test the point of last support/resistance. Enter here even if it
hurts.
Hard Right Edge
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Alan S. Farley
9. Trade with the TICK not against it. Don't be a hero. Go with the
money flow.
10. If you have to look, it isn't there. Forget your college degree and
trust your instincts.
11. Sell the second high, buy the second low. After sharp pullbacks,
the first test of any high or low always runs into resistance. Look for the
break on the third or fourth try.
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12. The trend is your friend in the last hour. As volume cranks up at
3:00pm don't expect anyone to change the channel.
13. Avoid the open. They see YOU coming sucker
14. 1-2-3-Drop-Up. Look for downtrends to reverse after a top, two lower
highs and a double bottom.
15. Bulls live above the 200 day, bears live below. Sellers eat up rallies
below this key moving average line and buyers to come to the rescue
above it.
HRE SPOTLIGHT
16. Price has memory. What did price do the last time it hit a certain
level? Chances are it will do it again.
Technical
Analysis
Masters
17. Big volume kills moves. Climax blow-offs take both buyers and
sellers out of the market and lead to sideways action.
John Murphy
18. Trends never turn on a dime. Reversals build slowly. The first sharp
dip always finds buyers and the first sharp rise always finds sellers.
19. Bottoms take longer to form than tops. Fear acts more quickly than
greed and causes stocks to drop from their own weight.
20. Beat the crowd in and out the door. You have to take their money
before they take yours, period.
Exploiting Market Quirks
Reversals at the first test of a new high or low are common. Investors jump out at
double tops after missing the first exit while value players buy double bottoms.
Skilled traders also use this known reversal tendency to enter counter-trend
positions.
Markets invariably return to test prior support or resistance unless a natural barrier
(such as a continuation gap) stands in the way. Besides price and pattern,
common moving averages also provide classic swing reversal points.
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20 RULES FOR EFFECTIVE TRADE EXECUTION
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Execution can be the weakest link in an otherwise great market strategy.
After all, it's a lot easier to find good stocks than to trade them for a profit.
So how do we enter the market at just the right time and capture the big
moves we see on our charts?
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Here are 20 rules for effective trade execution. Try these out the next time
you're getting ready to pull the trigger.
1. Seek favorable conditions for trade entry, or stay out of the market until
they appear. Bad execution ruins a perfect setup.
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2. Watch the tape before you trade. Look for evidence to confirm your
opinion. Time, crowd and trend must support the reversal, breakout or fade
you're expecting to happen.
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3. Choose to execute or to stand aside. Staying out of the market is an
aggressive way to trade. All opportunities carry risk, and even perfect
setups lead to very bad positions.
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4. Filter the trade through your personal plan. Ditch it if it doesn't meet your
risk tolerance.
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5. Stay on the sidelines and wait for the opportunity to develop. There's a
perfect moment you're trying to trade.
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7. Take positions with the market flow, not against it. It's more fun to surf
the waves than to get eaten by the sharks.
and
8. Avoid the open. They see you coming, sucker.
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9. Stand apart from the crowd. Its emotions often signal opportunity in the
opposite direction. Profit rarely follows the herd.
10. Maintain an open mind and let the market show its hand before you
trade it.
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11. Keep your hands off the keyboard until you're ready to act. Don't trust
your fingers until they move faster than your brain, but still hit the right
notes.
Hard Right Edge
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Alan S. Farley
12. Stand aside when confusion reigns and the crowd lacks direction.
13. Take overnight positions before trading the intraday markets. Longer
holding periods reduce the risk of a bad execution.
14. Lower your position size until you show a track record. Work
methodically through each analysis, and never be in a hurry.
15. Trade a swing strategy in range-bound markets and a momentum
strategy in trending markets.
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16. An excellent entry on a mediocre position makes more money than a
bad entry on a good position.
17. Step in front of the crowd on pullbacks and stand behind them on
breakouts. Be ready to move against them when conditions favor a
reversal.
18. Find the breaking point where the crowd will lose control, give up or
show exuberance. Then execute the trade just before they do.
19. Use market orders to get in fast when you can watch the market. Place
limit orders when you have a life outside of the markets.
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20. Focus on execution, not technology. Fast terminals make a good trader
better, but they won't help a loser.
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EFFECTIVE TRADE MANAGEMENT
TACTICS
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Managing open positions is the most difficult task the swing trader faces.
Danger can rear its ugly head at any time and turn a healthy profit into a
nasty loss. Too often, we jump into a good setup, only to watch it fail
because of poor trade management. This is especially true with newer
traders who think the markets are little more than a pick-and-play game.
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Experienced players take the time to master the intricacies of the trading
day. This is a broad-ranging task that requires considerable devotion. But
the payoff is worth the effort because it keeps them out of danger and
protects their bottom lines. To get you started on the long road to effective
trade management, here are 20 ways to turn that great idea into cold, hard
cash.
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1. Decide in advance how actively you should manage open positions. The
pros watch every tick and act on short-term swings. Part-timers read the
morning paper and learn everything they need to know. Your own efforts
need to fall somewhere in between.
2. Choose your playing field wisely. Track the weekly price bars if you
invest; the daily bars if you're a swing trader; and the 60-minute bars if you
play hard in the intraday markets.
3. Outline a specific strategy to deal with overnight positions. Learn when
to stay put and when to jump ship ahead of key reports and news.
PICKS, CHARTS, 4. Set aside time and capital for unexpected opportunities. Fresh ideas
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show up all the time and demand your attention. Build a routine that filters
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these prospects quickly and efficiently.
5. Align your positions to current market conditions. Overall sentiment,
external shocks and volatility affect the success or failure of your trades.
and
EVERY MARKET 6. Trade with the buy- or sell-swing within the market. Most of the time this
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tracks a three-day cycle for swing traders and a 21-day cycle for position
traders. Find your place in the swing and take advantage of those who
execute against nature.
7. Have a proactive plan for the first and last hours of the trading day.
Newer traders should sit on their hands during this time, but the pros can
use it for most of their decisions.
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8. Become a student of time-of-day tendencies. Markets tend to trend
within narrow time windows, while fake-outs take control for the rest of the
day.
Hard Right Edge
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Alan S. Farley
9. Choose a set of averages and indicators you're comfortable with, and
then leave them alone. Learn to interpret conflicting information rather than
searching for the perfect indicator.
10. Track the Tick indicator closely and watch its short-term cycles. The
Tick has a life of its own, and it will save your neck if you let it.
11. Keep one eye on your positions and the other on the indices. When a
stock moves more sharply than an underlying index, it should continue to
do so. This becomes very important when the index starts to move.
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12. Follow round numbers on everything in the market. Watch how your
positions react to 10, 20 and 30. Round-number support and resistance
can be greater than old highs or lows.
13. Look for breakouts and breakdowns of the two-day range. This will tell
you if your stock is trending, or running in place.
14. Become a student of price gaps and categorize each one. Then tell
yourself what you'll do the next time your trade hits one.
15. Recognize when you're wrong and need to get out. Find the price that
ruins the trade, and don't outthink the market when it gets hit. The move
could be a fake-out or the start of something big.
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16. Don't overanalyze your positions. Let each one speak for itself. If it has
little to say, get out and move on to the next trade.
17. Become a tape reader. Look for early warning signs of a move against
your position or confirmation you did the right thing.
18. Trade small if you're new at the game. This will teach you important
lessons at a very low price when you make a mistake. Neophytes should
concentrate on learning how to trade and not worry about making money.
19. Increase position size during winning streaks because your
performance suggests reduced risk. Reduce position size during
drawdowns and wait for the clouds to pass.
20. Build a contrary relationship with the crowd. Your profit rarely follows
the direction of the herd, so stand against it whenever possible.
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The Swing Shift by Alan Farley
Editor/Publisher Hard Right Edge
Daily
Originally Published on RealMoney.com:
December 23, 2001
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20 RULES TO STOP LOSING MONEY IN 2002
1. Don't trust others opinions It's your money at stake, not theirs. Do your own analysis, regardless of
the information source.
2. Don't believe in a company Trading is not investment. Remember the numbers and forget the press
releases. Leave the American Dream to Peter Lynch.
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3. Don't break your rules You made them for tough situations, just like the one you're probably in
right now.
4. Don't try to get even Trading is never a game of catch-up. Every position must stand on its
merits. Take your loss with composure, and take the next trade with
absolute discipline.
PICKS, CHARTS,
SCANS, IDEAS & 5. Don't trade over your head If your last name isn't Buffett or Cramer, don't trade like them. Concentrate
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on playing the game well, and don't worry about making money.
6. Don't seek the Holy Grail There is no secret trading formula, other than solid risk management. So
stop looking for it.
7. Don't forget your discipline Learning the basics is easy. Most traders fail due to a lack of discipline, not
a lack of knowledge.
8. Don't chase the crowd Listen to the beat of your own drummer. By the time the crowd acts, you're
probably too late…or too early.
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9. Don't trade the obvious The prettiest patterns set up the most painful losses. If it looks too good to
be true, it probably is.
Hard Right Edge
Founder
Alan S. Farley
10. Don't ignore the warning signs Big losses rarely come without warning. Don't wait for a lifeboat to
abandon a sinking ship.
11. Don't count your chickens Profits aren't booked until the trade is closed. The market gives and the
market takes away with great fury.
12. Don't forget the plan Remember the reasons you took the trade in the first place, and don't get
blinded by volatility.
13. Don't have a paycheck mentality You don't deserve anything for all of your hard work. The market only pays
off when you're right, and your timing is really, really good.
14. Don't join a group Trading is not a team sport. Avoid stock boards, chatrooms and financial
TV. You want the truth, not blind support from others with your point of
view.
15. Don't ignore your intuition Respect the little voice that tells you what to do, and what to avoid. That's
the voice of the winner trying to get into your thick head.
16. Don't hate losing Expect to win and lose with great regularity. Expect the losing to teach you
more about winning, than the winning itself.
17. Don't fall into the complexity trap A well-trained eye is more effective than a stack of indicators. Common
sense is more valuable than a backtested system.
18. Don't confuse execution with opportunity Overpriced software won't help you trade like a pro. Pretty colors and
flashing lights make you a faster trader, not a better one.
19. Don't project your personal life Trading gives you the perfect opportunity to discover just how screwed up
your life really is. Get your own house in order before playing the markets.
20. Don't think its entertainment Trading should be boring most of the time, just like the real job you have
right now.
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CLEAR AIR
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Traders turn profits by anticipating price movement. Although this
sounds simple, many market participants don't understand how to locate
impending change. Stock prices move back and forth endlessly. But when
do these common swings represent good trades and when are they just
dangerous noise? One answer lies in the relationship between price and
time.
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The singular goal of trading can be defined as locating price
expansion just before it happens and taking a position to capitalize on
the event. When price moves a greater distance over a lesser period of
time, individual chart bars and candlesticks expand in length. This range
YOUR DAILY expansion signals those points of greatest opportunity for traders and
investors.
MARKET
GUIDE
Clear Air identifies horizontal chart levels where prior stock trends
exhibited sharp price expansion in either direction. The stronger the
CA event, the more likely that price will trigger volatility on the next pass.
This tendency allows traders to locate outstanding trades with little more
than quick visual scans of their favorite stock charts. CA prediction is
Featuring
simple: the more often those bars expand through the same levels, the
more likely expansion will continue.
Congestion limits volatility. Range expansion represents the state of
least congestion and greatest volatility. However, it cautions traders to
manage risk closely as opportunity and danger stand side by side.
Although price may have sharp momentum in one direction, defense
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Predicting natural swing points in pre-existing Clear Air utilizes only
known support/resistance and fibonacci retracement levels. Since
traders tap detailed price and volume from prior passages, those points
can be used for cross-verification to reduce risk. High probability setups
can be easily identified with natural entry and exit triggers.
Clear Air exists at new highs and lows as well as prior price breaks
and trends. But locating safe positions in this Clear Air requires detailed
fibonacci projections and may lead to conflicting outcomes. Only
disciplined traders should play on this dangerous field. Major breakouts
and breakdowns often print few congestion and swing points that traders
can use to identify support/resistance. And positions must be taken without
the benefit of information from prior passages through the same price
ADVANCED
TRADING
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Fibonacci and Clear Air
Apply a fibonacci grid after a Clear Air series to reveal hidden reversal
zones not apparent during the event. Try placing a grid over new sharp
expansion moves to anticipate where opportunities will emerge on next
retracement swing. When trading Clear Air, always rely on the chart in the
next smaller time frame to locate low risk entry and exit levels.
All original materials: © 2003 Brooke Publishers, Inc.
Comments: [email protected]
Leading & Lagging
Indicators
Stock Selection
& Risk
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Trading Tactics
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CUTTING LOSSES
TACTICS
TUTORIAL
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What elements of the trading game do you concentrate on each market day? Do
you push hard for the big gain but face big losses when the action suddenly turns on
you? Or do you slowly build up each profit and always watch defensively for a quick exit
when wrong? The path you take will define your success or failure as a trader.
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YOUR DAILY
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Our online trading course MASTERING THE TRADE uses the simplified table just
below to illustrate a few important observations about profit and loss. Most trading
strategies have a built-in success/failure rate. For example, scalping incurs a high %WIN
but a low AvgWIN. Alternatively, buying breakouts reflects a lower percentage of winners
but the average gain is greater. Regardless of how you trade, the market offers only three
ways to improve profitability (for any given number of trades):
●
●
●
Featuring
Raise your %WIN
Raise your AvgWIN
Lower your AvgLOSS
Day traders have fewer profitability options than position traders. Price tends to
move away from an entry point as a function of time. So individual day trading gains
(AvgWIN) are generally smaller than position trading gains. Very short-term time frames
also frustrate attempts to raise %WIN since day traders must be right immediately while a
position trader can wade through many whipsaws to get to a profit.
Interactive
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But day traders are in a much better position to control losses than position
traders. The price-time tendency now works to their advantage. In other words, incurred
losses should be smaller (on average) because the position is held a shorter period of
PICKS, CHARTS, time. This allows day traders to take their individual losses closer to -0- than position
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Manage the loss side of trades and you'll increase profits more quickly than
chasing gains. In preparing your exit, recall a valuable rule for optimal technical analysis
entry: execute your trade where price must move only a short distance to prove that you
are wrong. This frequently defines a strategy where you enter a promising position right
and
at support/resistance. If price goes through the line, exit immediately with a small loss
EVERY MARKET and get on to the next trade.
ADVANCED
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Risk Management
You have to be very, very good before you allow yourself to be bad. %WIN simply
measures your winners against losers. If you make money on 3 out of 4 trades, your
%WIN is 75%. See how the average loss changes from the 75% to 25% levels.
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AMZN's daily range expands over a 3-day holding period. This tendency of price to move
away from an entry point underscores a natural advantage the day trader has over the
position trader or investor. The shorter a position is held, the more efficiently losses can
be taken. Day traders must capitalize on this mechanism through quick exits on nonperforming entries.
All original materials: © 2003 Brooke Publishers, Inc.
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EFFECTIVE MARKET TIMING
TACTICS
TUTORIAL
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Many folks believe good chart-reading automatically leads to profitable trading.
Unfortunately, this isn't true. While technical analysis and trading are interrelated
skills, chart-reading requires no capital or emotional commitment. In contrast, reallife trading places both of these elements at risk in an unforgiving environment.
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I publish hundreds of trade setups each month. But none of these ideas will put
money in your pocket without good timing. It's a critical error to enter a trade just
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because it has a pretty chart. The opportunity comes only when you can discover
and capitalize on the setup's timing signals.
Wizards
Careful entry bridges the gap between the setup and the trade. This is the door
YOUR DAILY through which you take on monetary and emotional risk. There are many ways to
MARKET time the market, but three strategies work for most swing trades. First, enter a
GUIDE
breakout or breakdown after it's under way. Second, wait for a pullback and enter
near support/resistance. Third, buy or sell within a narrow range before the move
begins.
Featuring
Which is the best entry strategy for your next trade? Unfortunately, the right
answer is never the same twice. Don't try to render entry rules into simple
repetitive tasks. In truth, you need to plan each trade within the context of the
current market environment, reward-to-risk ratio and chosen holding period. This
extra effort is a necessity, not a luxury.
Interactive
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Let's examine these three entry strategies. Over time you'll learn how to pick the
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best one for the trade you're ready to make. Keep in mind that several different
PICKS, CHARTS, strategies might work with the same setup. The right choice could have more to do
SCANS, IDEAS & with intestinal fortitude than market timing.
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Buying a breakout or selling a breakdown is the only timing method employed by
most traders. Unfortunately, it's also the best way to wash out of the markets. This
entry technique is simple. Your setup breaks through support or resistance, so you
rush in to place a position. And then you pray.
This is a very risky way to enter the market. The trade looks great when it moves
in your direction, but what do you do if it reverses and takes off the other way?
Amazingly, most folks don't have a good answer to this important question. So
they freeze like a deer in the headlights when faced with the reality.
Chasing momentum can work if traders choose their plays wisely and pay close
attention to two important rules. First, always establish your risk before making the
trade. Choose a flat stop-loss percentage, or use a pattern in a lower time frame to
signal when the trade goes against you. Second, make sure the broader market
offers adequate support for your strategy. Momentum stocks benefit from
momentum markets.
What's your rush? Many traders believe they're too late when they stumble across
a breakout in progress. In fact, they're often too early. Many times you're better off
standing aside and waiting for the market to reverse, rather than jumping in with
the crowd. Pullback entry is a very powerful method because it uses the eager
capital of those who missed the first move. But the trick is to get into the trade
before they do, and let their enthusiasm carry you into a profit.
Pullback entry is very price-sensitive. If possible, place a limit order where you
expect the pullback to shift toward the breakout direction. This is actually easier
than it sounds. New trends frequently return to prior support/resistance before
momentum finally kicks in. So look at the chart and find where the initial breakout
took place. Pullbacks often move to these important levels like magnets.
Narrow range entry confuses many traders, but the theory is simple. Common
sense dictates the best time to enter a new position is just before a breakout or
breakdown. Narrow range uses characteristics of low volatility to identify when
conditions are ripe for a big move. The trader enters at a tight price level and waits
for a move to begin. The advantage is that the position can be exited for a small
loss if the market breaks the other way.
Congestion patterns, such as triangles, often look like coiled springs.
Paradoxically, this wound-up appearance predicts the return of rapid price
movement. Traders can use classic indicators, such as historical volatility, to
identify trigger points for this movement. But a better way is to locate narrow range
bars and declining volume right at key support/resistance levels. Enter the trade
here while everyone else gets ready to chase the breakout or breakdown.
Hard Right Edge Recommends:
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PRACTICE YOUR EXIT STRATEGY
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It's easy to get into the market, but what about getting out? Most traders don't have
an exit plan, whether their positions are turning a profit or going down in flames.
The truth is that a good exit will save your neck on a bad entry, and keep you in
the game longer than good stock-picking.
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Exit planning must deal with the good, the bad and the ugly. In other words, keep a
profit protection strategy to exit winning trades, a stop loss strategy to get out of
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bad ones and a fire drill in case disaster strikes. You'll need all three tactics in
every trade, because anything can happen once you hit the order button.
Wizards
Your holding period guides the profit side of the exit equation. Always seek the
YOUR DAILY reward target that matches your time in the market. In other words, trade the most
MARKET profitable move from your entry to the target within the time frame that you're long
GUIDE
or short the stock. This lets you apply both a time- and a price-based exit strategy
to your winners.
Featuring
A time-based exit strategy requires little interpretation. Focus on your holding
period's time window rather than the price action. Exit the trade immediately when
price hits the reward target at the right time. Exit the trade before price hits the
reward target if the window starts to close. The trick with time-based strategies is
to look for the best price available within the chosen window.
Interactive Most traders should start with a price-based exit strategy. For example, you enter
Trading
a long position, and it moves into a profit. It rallies at a moderate pace and hits
Picks
your reward target within the holding period. You exit the trade "blind" at the
PICKS, CHARTS, reward price. This means you take the money and go, without considering the
SCANS, IDEAS & current price action.
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Highly Effective
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Hard Right Edge
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You've just taken a nice profit in a perfect world, but how do you protect yourself in
the real one? Start by focusing on trends within shorter-term time frames. For
example, when trading a daily chart, manage profit and loss using a 60-minute
chart whenever possible. The shorter-term pattern will tell you when to move the
stop in order to protect profits, or when to exit the trade entirely.
Let's outline common stages for a long position that eventually reaches the reward
target:
●
●
●
Price moves into a profit.
Price reaches first resistance, and reverses.
Price finds support and rallies through first resistance.
This action/reaction continues until price reaches the target. In this scenario, trade
management requires a breakeven stop as soon as price moves into a profit. This
stop should be moved up after the first reversal, but stay below short-term support.
When price finally rallies above first resistance, move the stop just below this new
level. Continue the process until the position hits the reward target.
Profits are nice, but many trades go haywire right away. The exit strategy is very
simple in this situation: get out as soon as price breaks support on a long trade, or
resistance on a short sale. This may sound simple, but there are two problems.
First, many of us lack the discipline to take losses when they should be taken.
Second, many of us don't understand how to place stop losses in the first place.
Take your loss when the market says you're wrong. Every setup has a trigger that
violates the pattern you intend to trade. Identify this price in advance, and place
your stop just behind it. Remember that this magic number changes dynamically
with each new bar, so you need to adjust it often. But don't remove it under any
circumstances.
Do you get frustrated because your stops get hit frequently on good trades? The
fault lies in your analysis and trade management, not in the stops themselves.
Many traders believe they can improve their performance by placing stops where
they shouldn't go. Every stock will violate support/resistance up to a point before
reversing. Your analysis must consider the stock's underlying volatility, so the stop
can be placed outside this "market noise."
Finally, you need a way to deal with unexpected bad news. Start with a panic drill,
and practice it over and over again in your head. The exit strategy is simple: If you
can beat the rest of the crowd out of the door, act immediately. The after-hours
market can save you a fortune if you learn to use it wisely. If you can't escape right
away, watch price action closely and take your best shot. The market can do
anything it wants once bad news hits, and you may need to accept a large loss.
Sudden losses are a cost of doing business as a trader. Full disclosure rules and
external events will impact your bottom line from time to time. Reduce your risk by
choosing lower-volatility stocks to carry over longer time periods. Avoid holding
anything through earnings reports or terrorist threats. Remember, it's not hard to
rebuild profits after the unexpected takes a bite out of your bottom line.
Hard Right Edge Recommends:
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MASTERING REWARD/RISK
TACTICS
TUTORIAL
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Most traders ignore reward/risk ratios, hoping that luck will save them
when things start to go bad.
This is probably the main reason so many of them are destined to fail. It's
really dumb when you think about it, because reward/risk is the easiest
way to get a definable edge on the market house.
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YOUR DAILY
MARKET
GUIDE
The reward/risk equation builds a safety net around your open positions.
It's designed to tell you how much can be won, or lost, on each trade you
take. The secondary purpose is to remove emotion so you can focus
squarely on the cold, hard numbers.
Let's look at 15 ways that reward/risk will improve your trading
performance.
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1. Every setup carries a directional probability that reflects a specific
pattern. Always execute positions in the highest-odds direction. Exit your
trades when a price fails to respond according to your expectations.
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2. Every setup has a price level that violates the pattern. Only take trades
where price needs to move a short distance to hit this "risk target." Look
the other way and find the "reward target" at the next support or resistance
level. Trade positions with the highest reward target to risk target ratios.
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3. Markets move in trend and countertrend waves. Many traders panic
PICKS, CHARTS,
SCANS, IDEAS & during countertrends and exit good positions out of fear. After every trend
in your favor, decide how much you're willing to give back when things turn
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against you.
4. What you don't see will hurt you. Back up and look for past highs and
lows your trade must pass through to get to the reward target. Each price
level will present an obstacle that must be overcome.
5. Time impacts reward/risk as efficiently as price. Choose a holding period
based on the distance from your entry to the reward target. Then use price
and time for stop-loss management. Also use time to exit trades even
when price stops haven't been hit.
6. Forgo marginal positions and wait for the best opportunities. Prepare to
experience long periods of boredom between frantic surges of
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concentration. Expect to stand aside, wait and watch when the markets
have nothing to offer.
Hard Right Edge
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Alan S. Farley
7. Good setups come in various shades of gray. Analyze conflicting
information and jump in when enough ducks line up in a row. Often the
best thing to do is calculate how much you'll lose if you're wrong, and then
take the trade.
8. Careful stock selection controls risk better than any stop-loss system.
Realize that standing aside requires as much deliberation as an entry or an
exit, and must be considered on every setup.
9. Every trader has a different risk tolerance. Follow your natural
tendencies rather than chasing the crowd. If you can't sleep at night, you're
trading over your head and need to cut your risk.
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10. Never enter a position without knowing the exit. Trading is never a buyand-hold exercise. Define your exit price in advance, and then stick to it
when the stock gets there.
11. Information doesn't equal profit. Charts evolve slowly from one setup to
the next. In between, they emit noise in which elements of risk and reward
conflict with each other.
12. Don't be fooled by beginner's luck. Trading longevity requires strict selfdiscipline. It's easy to make money for short periods of time. The markets
will take back every penny until you develop a sound risk-management
plan.
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13. Enter positions at low risk and exit them at high risk. This often
parallels to buying at support and selling at resistance, but it can also be
used to trade momentum with safety and precision.
14. Look to exit in wild times in order to increase your reward. Wait for
price acceleration and feed your position into the hungry hands of other
traders just as the price pushes into a high-risk zone.
15. Manage risk on both sides of the trade. Focus on optimizing entry and
exit points and specialize in single, direct price waves. Remember that the
execution of low-risk entries into bad positions allows more flexibility than
high-risk entries into good positions.
Hard Right Edge Recommends:
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The Swing Shift by Alan Farley
Editor/Publisher Hard Right Edge
Daily
Originally Published on RealMoney.com:
January 14, 2002
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MEASURING REWARD:RISK
Why do great trade setups fail, while lousy ones move in our favor? The answer is
quite simple, yet frustrating. Trading is an odds game, in which anything can
happen at any time. Price will go where price wants to go, no matter how hard we
YOUR DAILY hit the books, study the charts or pray to the deities. So rather than searching for
MARKET the perfect trade, we're better off learning to control risk first.
GUIDE
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You've forgotten the nature of risk if you can answer "yes" to any of the following
questions. Do you still buy "how-to" books, even though you've traded for years?
Do you sit in bad losses because you hate to be wrong? Do you reject market
wisdom because you lost money trading it?
Featuring
Measure reward:risk before taking a trade, and let it guide your open position.
Your
Price close to good support identifies a low-risk long setup. Price close to
Original Guide
substantial resistance identifies a low-risk short sale. The distance between your
Interactive trade entry and the next obstacle within your holding period measures the reward,
to
Trading
Successful
and intended exit. The distance between the entry and the price that breaks the
Picks
Short-Term Trading
trade points to the risk, and unintended exit. Put the odds firmly in your favor by
PICKS, CHARTS, only taking trades with high reward, and low risk.
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The best swing trades exit in wild times, just as advancing price approaches a
strong barrier. Reward planning seeks discovery of this price before trade entry.
This profit target sits at a level where risk will increase dramatically when price
reaches it. Traders should exit immediately once this profit target is struck, or at
least place a stop that locks in profit, in case of a reversal.
Every setup has a price that busts the trade. The safest trades need only a small
move to signal a bad outcome, and the need to jump ship. This loss target
changes dynamically after entry. Consider the impact of the last price bar on
evolving reward:risk, and adjust the plan accordingly. Many traders find it difficult
to absorb new information quickly. So they're better off sticking with the original
plan, and using trailing stops to protect the position.
How do you know the price that kills the trade? You'll find it at the convergence of
support-resistance boundaries on your setup. These usually turn up through
combinations of violated moving averages, broken patterns and filled gaps. Every
situation is different, so finding the loss target may require all of your trading skills.
Exit swing trades to book profits, take losses or close mediocre positions. A good
exit is more valuable than a great entry. Emotions usually run high at both reward
and risk targets. So take a deep breath and clear the mind before closing out a
position.
Tips on Reward:Risk Management
●
●
●
●
●
●
●
Watch the clock and become a market survivor. Market cycles affect price
movement in many ways.
Exploit market quirks in your entries and exits. Events like overnight gaps
and options expiration can benefit positions, rather than hurt them.
Enter smaller trades when signals don't line up well.
Good timing on bad stocks makes more money than bad timing on good
stocks.
The best signals converge through many different types of technical
analysis.
Use common sense and good mathematics in your profit and loss
projections.
The most profitable entries and exits come when the crowd is leaning the
wrong way.
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OVERBOUGHT/OVERSOLD OVERLOAD
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Analysts love to show off by proclaiming that the markets have become
overbought or oversold. Unfortunately, few of us seem to understand what these
terms really mean or what we should do when these moments of truth arise.
Should we run for the hills because a market is overbought, or perhaps load up the
boat because it's oversold? And how do we know when one of our trades might fall
prey to one of these extreme conditions?
The best way to understand overbought or oversold markets is to study the nature
of supply and demand. At any given moment, a finite pool of buyers and sellers is
available to take action on a particular stock. The trading activity of this crowd
YOUR DAILY usually stays within fairly narrow boundaries.
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But imbalances develop over time and force one side to pull the trigger, sometimes
prematurely. This "uses up" that side of the market and awakens price mechanics
that favor the other side.
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Bollinger Bands offer an effective tool for measuring overbought/oversold
conditions. Notice how Nvidia (NVDA:Nasdaq - news - commentary - research analysis) triggers a short-term reversal each time price bars thrust outside the
extremes of the 20-day Bollinger Bands. These outer bands tell swing traders to
expect a reversal before real evidence appears on the price chart. This allows
them to take high-profit exits while the rest of the crowd is caught in the moment.
It's important to note that overbought/oversold markets are relative to a trader's
time frame. In the NVDA chart, some reversals were simple pullbacks in the
underlying trend, while others represented major market turns. It is vitally important
for traders to define their holding period before reacting to short-term price swings.
Major profits will be lost by planning the trade in one time frame but executing it in
another.
Stochastics represents the classic overbought/oversold oscillator. Unfortunately,
most traders don't understand how to interpret the information it provides. The
worst thing you can do is jump ship just because stochastics hits a high or low
extreme. Most swing-trading profits are booked in the early stages of overbought
or oversold markets. Of course, that's where most of the risk is as well.
Use simple double-top or double-bottom patterns to pinpoint reversals driven by
overbought or oversold conditions. The best signals come when stochastics
makes a lower high (or higher low) and expands in the opposite direction. This
type of pattern will often complete ahead of price change, and should be acted
upon without waiting for further confirmation.
A single price bar can change everything. Stocks trade with an average high-low
range through most market conditions. When this range expands sharply after an
extended trend, it issues a loud overbought-oversold signal.
What exactly does this mean? First off, when a price bar expands in a new
breakout, it's the beginning of something and not a reversal signal. But when a
stock ramps from one price level to another, and then pops an expansion bar, get
ready to close up shop in a hurry.
Traders must deal with the relativity of overbought/oversold markets. A longer-term
Wilder's relative strength index (RSI) really drives home this vital point. It captures
broad cycles of market movement, and it can stay at overbought or oversold levels
for extended time periods.
As with the stochastics indicator, hold your ground until RSI shows definite signs of
moving in the other direction. This usually comes when it drops below (lifts above)
the extension line. Even then, compare RSI with the price pattern to determine
whether a major turn, or simple pullback, is under way.
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Patterns appear at the end of thrusting price movements. They are characterized by
constricted swings between key support and resistance levels. Pattern development
completes when a new trend leg breaks through this wall into directional price change.
This new thrust may be in the same or opposite direction as the previous one. A pattern
between adjacent price moves in a single direction continues that trend. Alternatively,
when a breakout turns and retraces the last trend leg, the intervening pattern reverses
the prior move.
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You can categorize most patterns by their tendency toward continuation or
reversal. This familiar bias underlies the predictive power of these structures. By their
repeating nature, a well-marked chart landscape can be drawn to profit from the expected
YOUR DAILY breakout. Use classic observation and well-chosen technical indicators to examine
patterns as they develop. Their bullish or bearish nature can often be identified well
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before completion and exact entry points chosen where new price momentum will likely
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But sometimes patterns won't do what the crowd expects.
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One of the most powerful signals in pattern analysis flashes when a setup fails to
act according to its tendency. This pattern failure often triggers sharp price movement
in the opposite direction from the formation's natural bias. Have a contrarian entry system
based on this reversal waiting in your trader's toolbox. But first exercise sound risk
management as you recognize this event in progress and wait for ripe opportunity to
appear.
PICKS, CHARTS, Probability underlies all prediction. Through skilled observation or system-driven
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profit from it. But the most common price patterns often fail to act as expected. Look to
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in the low-odds, high-profit direction. One obvious example can be seen in the
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unexpected Tellabs rally after it drew a recognized reversal formation.
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The classic Head and Shoulders reversal has been subject to intensive study over
EVERY MARKET the last century. In fact, one popular investigation discovered this well-known pattern
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works only 79% of the time. While this figure lies well outside random outcome, it
illustrates just how wrong you might be the next time you sell short at the H &S neckline.
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Think Contrary
More
Leading & Lagging
Indicators
Sell short at
the Head
and
Shoulders
neckline?
That classic
TA advice
got traders
into major
trouble in
early 1999
on TLAB.
When price
rose
beyond the
level of the
right
shoulder,
the pattern
failed and
smart
traders
prepared
for low-risk
long entry.
The break
at the tops
of the head
and right
shoulder
signaled
confirmation
AND also
offered an
easy
pullback
trade.
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The Swing Shift by Alan Farley
Editor/Publisher Hard Right Edge
Daily
Originally Published on RealMoney.com:
December 20, 2001
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HOW TO PLAY 'FAILED FAILURES'
Twisted logic can devise very profitable trading strategies. For example, we're
taught early in our careers to buy breakouts and sell breakdowns. But market
contrarians pay their bills doing the exact opposite. They wait for a move to fail,
YOUR DAILY and then sell the breakout or buy the breakdown. These mind-bending tactics
MARKET don't end there. Many smart traders take it one step further and buy when the
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Let's back up and examine this way of thinking one step at a time. Most of us
follow a common path -- we pile into stocks because they break out of
resistance. But contrarians know exactly how you'll react when your pretty
breakout drops like a rock. So they guess where your stops are hidden and enter
short sales at the same price to capitalize on your misfortune.
Your
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Now twist your brain a little more and take this reasoning to the next level. The
Interactive stock breaks out -- you sit on your hands. The stock fails the breakout -- you wait
to
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and do nothing. But when the stock jumps back above the breakout price -- you
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friend Bo Yoder calls this action a "rinse job." Whether through manipulation or
mechanics, price gets drawn like a magnet through common support and
resistance levels. This whipsaw movement cleans out the stops before a market
ramps higher or lower. Not a pleasant experience when you're caught holding
the bag, but an excellent opportunity when you come off the sidelines.
and
EVERY MARKET
How does price action "know" where the stops are hidden? The answer is quite
DAY!
devious. Retail traders are well-versed in the basics of technical analysis. They
take positions using common methods already deconstructed by the smart
money. The result: Price passes through support and resistance far more easily
than in the past. But keep your chin up. Whenever someone comes up with a
new way to take your money, they also give you a new way to make it.
Let's look at failed failures on several stocks we've discussed in recent weeks.
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We made the case for a bounce play on Concord EFS (CEFT) on Dec. 10. Using
the intersection of two key Fibonacci retracements, we suggested Concord would
reverse near $29 and start a run back toward its high. But things didn't work out
that way.
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Four days later Concord gapped down through the entry target and made a mad
dash to the 50-day moving average. It tagged it early in the session and
reversed, closing back above $29. The next morning, price gapped above the
entry target and completed an "abandoned baby," a significant one-bar reversal
pattern. Concord then rallied to test the old high.
Fortunately, the gap down should have kept swing traders on the sidelines. Most
effective trading strategies limit entries after unusual gaps. But those already
positioned had stops in the middle of that rinse job because it looked like a safe
level on the price chart. There's a diabolical trading lesson here: Safe prices are
also the most dangerous ones. How twisted is that?
On Nov. 8, we looked at Oxford Health Plans (OHP:NYSE - news - commentary research - analysis) and made the following prediction: "The intraday bars of the
last two trading days draw a bullish pattern that looks close to breaking out."
As someone else around this organization likes to say -- Wrong! Oxford Health
decided to go in the opposite direction the same day the column was published.
Look at how the two-day rinse job filled the gap, before price jumped back into
the resistance line.
What happened next is even more interesting. Oxford spent a week gathering
into a tight little ball. In fact, the last bar before the breakout printed a "NR7," the
swing trader's term for the narrowest range bar of the last seven bars. This quiet
signal often precedes major price expansion and is a telltale sign of a market
ready to move.
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STOP LOSS QUESTIONS AND ANSWERS
TACTICS
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I get more questions about stop losses than about any other subject.
Clearly this strategy causes traders a lot of pain and confusion. Some of it
stems from the schizoid nature of our modern markets. But most of it
reflects an underlying weakness in trade management skills.
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What takes place at the end of a trade usually reflects decisions made at
the beginning. In other words, the best entries usually lead to the most
profitable exits. This is the most urgent wisdom I can give when it comes to
stop-loss placement.
We can spend hours deciding whether a stock is a good buy or a good
sell, but this emphasis is often misplaced. Over time, carefully chosen exits
are more important than great entries. You don't believe me? Just ask all
those folks who bought tech stocks in the late 1990s.
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I've compiled a question-and-answer session that addresses the most
important elements of stop-loss strategy.
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Question: Where do I place my stop loss when shorting a stock that gaps
down?
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Answer: The most obvious place is just above the price level where the
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to
gap would be filled. But that's a generic answer. It's more effective to place
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the stop loss on top of converging resistance, such as highs, Fibonacci
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retracements and moving averages. A bouncing stock will have a very hard
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Q: I'm getting stopped out of both my longs and my shorts in this market.
Are my stops too tight, or should I blame it in the choppy market?
A: There are many reasons why stops get hit too often. It's hard to tell
without knowing the specifics of each placement. This is a tough market,
and
EVERY MARKET and you often have only two choices. First, place a tight stop loss and
DAY!
trade the small swings to avoid all the choppy reversals. Second, back up
a giant step and trade the broader trend you see in front of your nose. In
other words, the market is only choppy if you're a daytrader or if you flip
positions every few days.
The trends are more obvious if your holding period is weeks or longer. But
longer holds have a disadvantage when it comes to stop placement. You
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have to take on greater risk with longer-term positions, because stocks will
wiggle around a lot more before getting from point A to point B.
Hard Right Edge
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Alan S. Farley
There's one more caution in regard to stop placement. Your stops have to
match your trading strategy. For example, if you're looking for a 3-point
swing, you have to stay out of the market until your risk (current price to
stop price) is a point or less. This goes back to the importance of picking
good entry points.
Q: My stops get hit all the time. What am I doing wrong?
A: Keep those stops away from the most obvious support or resistance
levels, such as round numbers. There's a lot to gain by pushing price
through these levels. It cleans out one side of the market and sets up a
vacuum headed the other way. It's one reason I'll actually sell short into a
breakout or go long into a breakdown. Keep in mind that many traders look
for price stretching through a barrier as a signal to go the other way.
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Q: Should I use a flat dollar or percentage stop loss?
A: I never use percentage or dollar stop losses, at least for the initial
placement. The first stop loss is always based on the price pattern and
where current action violates the trade setup. Of course, you need good
trailing stops once a position moves in your favor, and flat dollar strategies
have a useful purpose in protecting profits. But I would avoid percentage
stop losses in all cases.
A move of 5%, 10% or 50% says nothing about the current market or trade
setup. You could enter a position where a stock moves 11% every day on
average. So your 10% stop is at risk every day because of market noise,
rather than anything else. A percentage stop loss gives the illusion of
controlling risk without giving you the realization of what risk is in the first
place. Why is this important? Reward and risk are joined at the hip. If you
don't have one right, the other won't be right either.
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There is a definable risk based on the pattern and where you enter the
trade. Each trade has a different risk profile, and your trade entry tells you
how much it can wiggle but still get you to the goal. You need to include
this standard deviation in your stop-loss planning, or you'll take maximum
loss after maximum loss.
Q: I'm thinking about using time-based stops instead of price-based stops.
Do they work?
A: Time-based stops may work, but time cycles are 10 times harder to
manage properly than price. So your chances of being wrong with time
stops are about 10 times as great. You'll also experience major drawdowns
while you wait for your time to get hit.
Q: How can I protect my positions from gaps and sudden price moves?
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Sometimes they happen before I have a chance to set my stop losses.
A: Plan a fire drill and practice it in your head at all times. The fire drill is a
consideration for the worst-case scenario. Of course, we protect positions
with stops whenever we can. But things such as gaps and world events
can carry positions through them, and we need to know exactly what to do
when the market spikes. The only way to accomplish this is to visualize it
happening and to see how you really want to address it. Then you'll act
spontaneously when the time comes.
If a stock is set to gap through your stop loss when it opens, do you sell it
immediately or wait for a bounce? There's really no right answer. I usually
pull my stop and watch the first few minutes of trading. If the market
reverses, I try to close out on the bounce to a common retracement level.
Some midday panic situations are global, while others are sudden. Most
times, my preferred fire drill is to exit first and ask questions later.
Sometimes I'll see the futures go crazy and not know why. They may not
affect my individual positions at the time, but I'll often exit everything until I
can find out what happened. I still remember the futures going crazy on
Sept. 11, 2001. There was only a few minutes to jump ship before the
market was shut down for days.
Q: I'm placing very tight stops on every trade, but they keep getting hit.
What am I doing wrong?
A: Base your stops on the risk profile of the stock you're trading. You can't
trade a volatile biotech stock and expect to get away with a 15-cent stop
loss. But you might be able to do it with a slow moving REIT or paper
company. Look at total dollar exposure and the stock's volatility. Be
focused on exiting when you're wrong, wherever that is on the price chart.
The only way that makes sense with your stop loss is if your entry was
appropriate to the trade setup. You can also take another shot at a stock if
your stop loss gets hit or the stock recovers. These new positions should
move in your favor immediately, or you should jump ship again because
you were already wrong once.
Q: I want to hold on to a trade as long as the pattern stays intact. So I
place my stop loss just outside the edge of the pattern. But what do I do
when price breaks out in my favor for a bar or two and then falls back into
the pattern?
A: You need to exit right away after a false breakout or breakdown,
regardless of where you've placed your stop loss. The false move creates
overhead supply (or underlying demand in a short sale) and raises the
odds the pattern will break the other way. This is classic pattern-failure
dynamics.
Rigid stop-loss placement with global rules undermines good trade
management. Management is more important than knowledge and all the
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technical analysis in the world. You have to be a manager of your trades
and your trading style. That gives you the courage to re-enter good
positions when you get blown out of them, if and when conditions change.
Q: A stock breaks out and moves in my favor, but my stop gets hit most of
the time on a pullback. How can I avoid this?
A: This scenario illustrates the major problem traders face when they
chase breakouts. For example, you get a breakout and a strong move in
your favor. You're taught to protect profits, so you place a stop-loss that
guards some of the gains in anticipation of making more money when the
stock runs. But the nature of price mechanics suggests that after an initial
rally, a stock will pull back to test the original breakout level.
Both of your stop-loss choices have problems. First you protect profits with
a trailing stop, but you risk getting hit when price pulls back to the breakout
level. Second, you place the stop under the breakout level, but then you
turn a winner into a loser. This also adds risk, because pullbacks often
overshoot support-resistance just to get to the stops that are buried there.
The pullback from a rally is a two-edged sword, because it's a buy signal
and a stop-loss level at the same time. In other words, if I'm already
positioned I feel the need to sell, but if I'm not positioned, I feel the need to
buy. The solution is counterintuitive and simple. Train yourself to avoid
breakout entries and instead trade pullback entries.
Q: Should I lift my stop-loss when I know the stock will gap against my
position when it opens?
A: I usually lift the stop-loss, but every case is different. Watch the pre- and
postmarket trading, and see how much pressure the stock faces and
whether it's trading above or below major support-resistance. The ability to
hold higher price levels predicts that the stock will stabilize when the
market opens. Keep in mind that New York Stock Exchange stocks may
give few clues in extended hours.
When there's news that could affect the stock, I pull the stop loss and keep
the position through the open. Then I try to hold for the first 10 to 15
minutes to see if it reverses or runs. If the stock starts to run or breaks a
large support-resistance level, I get out immediately. The strategy can lead
to a larger loss, but it's a tradeoff, because the gap prints the high or low
for the day more than 70% of the time.
Q: Do market insiders see our stop-loss orders and purposely try to trigger
them?
A: Some brokers hold stops locally, while others send them out to the
"floor." But it doesn't really matter whether insiders see them or not
because they know where you'll place them, even if they're not physical.
Millions of traders came before you and applied the same logic to stop
placement that you do every day. So unless you find a more creative way
to accomplish this task, you'll wind up selling at the worst possible price
anyway.
Q: Once a trade turns profitable, when do I adjust the stop loss to ensure I
won't take a loss? And thereafter, if the trade continues in my favor, what
rule do I use for trailing stops?
A: I figure an amount of initial wiggle room based on my goals for the trade.
If the reward target is several points away, the stock needs to move around
a lot, and I don't want to get in its way. If it's a small trade, I don't want to
lose a penny after I get the first thrust away from my entry price.
The best strategy as the trade evolves is to use support-resistance on the
60-minute chart to move your trailing stop. For example, you get your rally
and the stock congests for a few bars. When price breaks even higher,
move your stop behind the last congestion pattern. This way, price needs
to break the smaller support before it hits your trailing stop.
Get more aggressive as the stock approaches your reward target. Shift
your strategy after the price passes 75% of the distance between your
entry and intended exit. At that point, there's no sense risking a bundle in
order to make a few pennies. Move the stop in close so any small reversal
takes you out of the trade.
Q: How can we trade profitably with stop-gunning games going on all the
time?
A: Stop-running or stop-gunning (both terms are used) occurs when a price
is pushed through support or resistance in order to trigger the stops that
are hiding there. After the stop supply is exhausted, the market bounces
back in the other direction, usually winding up where it was before the
exercise began.
You only have two choices if you're positioned before a stop-gunning
exercise. First, keep the stop-loss outside commonly targeted price levels.
This is tough to do because it adds a lot of risk to the trade. Second, keep
the stop loss in very close and take another position after the stop-gunning
is over.
Look to step into stop-gunning games from the sidelines rather than being
a sitting duck with a position bought or sold at a dangerous level. You can
often get dramatic fills with good timing during these games.
Q: Why do I always place my stop loss at an exact high or low?
A: You're describing a condition known as trader's disease. It's caused by
the market tendency to gravitate toward the price that causes the most
pain. Options traders are especially vulnerable to this affliction. It's not
really sinister, it's just the nature of the market.
Start by realizing that volatile stocks can't be traded with tight and scientific
stops, because all their support-resistance levels are channeled. This
pushes a stock back and forth through common stop levels but keeps the
ongoing trend intact. If you get up close to a price chart, you'll notice
there's large bar-to-bar overlap most of the time. This makes it hard to get
your move without getting shaken out.
Q: How can I keep my stop loss from getting hit all the time on Nasdaq
tech stocks?
A: Keep your size down when trading volatile stocks. Before you trade, ask
yourself how far that stock can move in its natural wiggle. This quick
analysis takes a long time to master and is complicated by the tendency of
market volatility to change from day to day. You can also avoid getting your
stops hit by picking lower-beta stocks to trade. This means avoiding most
four-letter stocks.
Q: When should I use a stop-limit order?
A: I never use a stop limit on anything. It's too easy for the stock to go right
through your price, not get filled, and trigger a deeper loss. When you want
out, you want out. When you need to get out, you need to get out.
A regular stop-loss order becomes a market order when price trades
through it. This gives you more control than a stop-limit order, as long as
you choose your stock wisely. Keep in mind the more volatile the stock, the
wider the potential loss will be on this type of order. When possible, pick
lower-volatility stocks that will hit your stop and trigger at that price, without
slippage.
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The Adam and Eve Reversal demonstrates the importance of the
center peak in the formation of Double Bottoms. A very sharp and deep
first bottom on high volume (Adam) forms this DB pattern. The stock then
bounces high into the center retracement and develops a longer and more
gentle, rolling second bottom (Eve) on relatively low volatility. Price action
then constricts into a tight range and the stock breaks strongly to the
upside.
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At times, the top of Eve is bound by a flat shelf that marks an
excellent entry point when broken. And similar to many of these subpatterns, shelf resistance is often located right along the top of the center
retracement pivot. This illustrates that the most important focal point
subsequent to any suspected double bottom is the relationship between
this center pivot and current price.
Less common than the A&E is its cousin, the Eve and Adam pattern.
Price first develops support near its low on relatively minor volume in the
signature rounded Eve curve. The market attempts a rally, which then fails
at common retracement levels. Fear ignites the crowd and price action
shifts into a higher volatility state. A sharp and violent drop ensues, hurling
the stock back toward its lows. A high volume Adam reversal-spike then
prints, often with a price extreme just below Eve's bottom. The subsequent
uptrend can skyrocket as the crowd sentiment shifts sharply back toward
the positive.
Since DBs occur in downtrends, risk must be managed defensively.
PICKS, CHARTS,
SCANS, IDEAS & The greedy eye wants to believe bottoms and easily fools better
judgement. Even spectacular reversals offer little profit if price can't ascend
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back out of the hole it found itself in. When choosing stop and exit points,
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violation of a prior low is the natural first choice. Make certain your entry
MORNING
permits you to exit for an acceptable loss at this location. And don't stick
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around long. Price will gather downside momentum quickly at broken lows
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as it searches for new support.
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Successful bottom entry also takes a strong stomach. Even when all
the technicals line up, sentiment will be highly negative at these turning
points. The potential for short-term profit, though, is outstanding. In
addition to other longs ready to speculate on a good upside move, high
short interest will fuel explosive impulses off these points. Perhaps for this
reason alone, serious traders can't ignore double bottom patterns.
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Eve's rounded
bottom takes longer
to form than the
sharp Adam spike.
Look for volume to
decrease as the
stock heals and
prepares for a new
uptrend. Adam and
Eve formations
aren't limited to
bottoms. Watch for
them at the end of
parabolic rallies.
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HRE SPOTLIGHT
Technical
Analysis
Masters
John Murphy
Eve and Adam
formations rarely
appear but are
highly profitable
when they do. The
emotional shift
within the crowd
from extreme
negative to extreme
positive ignites fits
of buying, powering
a stock out of its
bottom.
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ADAM AND EVE TOPS
TACTICS
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Stock charts print many unique topping formations. Some classics, such as the
Descending Triangle, can be understood and traded with very little effort. But the
emotional crowd also generates many undependable patterns as greed slowly
evolves into mindless fear. Complex Rising Wedges will defy a technician's best effort
at prediction while the odd Diamond pattern burns trading capital swinging randomly
back and forth.
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Skilled traders avoid these fruitless positions and only seek profit where the
odds strongly favor their play. They first locate a common feature found in most
topping reversals: price draws at least one lower high within the broad congestion
before violating a major uptrend. This common double top mechanism becomes the
YOUR DAILY focus for their trade entry. From this well-marked signpost, they follow price to a
natural breaking point and enter when violated.
MARKET
GUIDE
Do you recall the Adam & Eve Bottom, featured earlier? This unique formation
consists of a spiking first bottom, followed by a rounded second one. Flip the pattern
over and you'll find a highly predictive structure for trading these topping reversals.
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This simple Adam & Eve Top provides traders with frequent high profit short
sales opportunities. Note this classic pattern in Quantum's chart. Price never drew a
third high before entering a significant bear market. Successful A&E short sales can
be entered on the first violation of the reaction low, regardless of an underlying trend.
However, use tight stops to avoid "turtle reversals". These occur when sharp short
covering rallies suddenly erupt right after the gunning of stops below a violation point.
PICKS, CHARTS, Each uptrend generates positive sentiment that must be overcome through the
SCANS, IDEAS & topping structure. A&E tops represent an efficient bar structure to accomplish this
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task. The violent reversal of Adam first awakens fear. Then the slow dome of Eve
absorbs the remaining bull impulse while dissipating volatility needed to resume a
rally. As the dome completes, price moves swiftly to lower levels without substantial
resistance.
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Observant technicians will recognize the mechanics of Descending Triangles
EVERY MARKET
and Adam & Eve formations in more complex reversals. The vast majority of tops
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contain some characteristics of these familiar patterns. Crowd enthusiasm must be
eliminated for a decline to proceed. Through the repeated failure of price to achieve
new highs, buying interest eventually recedes. Then the market can finally drop from
its own weight.
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Quantum's
1997 multiyear high
breaks
down in a
dramatic
Adam
and Eve
Top. Look
for both
volume
and
volatility
readings
to decline
gradually
through
the
formation
of the
second
rounded
high. Most
times, this
"Eve"
consumes
more price
bars than
the
"Adam"
that
precedes
it.
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HELL'S TRIANGLE
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The classic Descending Triangle illustrates the painful rollover from bull
to bear market better than any other pattern. But why does it work with such
deadly accuracy? Most traders don't understand how or why patterns predict
outcomes. Some even believe these important tools rely on mysticism or
convenient curve fitting. The simple truth is more powerful: congestion patterns
in technical analysis reflect the impact of crowd psychology on changes in
price and momentum.
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Shock and fear quickly follow the first reversal marking a triangle's major
top. But many shareholders remain true believers and expect their profits will
return when selling dissipates. They continue to hold positions as hope slowly
YOUR DAILY replaces better judgement. The selloff then carries further than anticipated and
MARKET
their discomfort increases. Just as pain begins to escalate, the correction
GUIDE
suddenly ends and the stock firmly bounces.
Featuring
For many longs, this late buying reinforces a dangerous bias that they
were right all along. Renewed confidence even prompts some to add to
positions. But smarter players have a change of heart and view this new rally
as a chance to get out. As they quietly exit, the strong bounce loses
momentum and the stock once again turns and fails. Those still riding the issue
now watch the low of the first reversal with much apprehension.
Prior countertrend lows present trading opportunities to those familiar
with double bottom behavior. As price descends a second time toward the
emotional barrier of the last low, short-term traders step in looking for a good
PICKS, CHARTS, DB play. Price again stabilizes near that prior value, encouraging new
SCANS, IDEAS & investors (with very bad timing) to enter final long positions.
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By this time, the stock's bullish momentum has slowly drained through
the criss-cross price swings. Relative strength indicators now signal sharp
negative divergence but price continues to hold up well through this sideways
development. Momentum indicators roll over and Bollinger Bands contract as
price range narrows.
This double bottom appears to hold as a weak rally draws a third high.
But this final bounce fades and traders exit quickly. Shorts now smell blood
and enter initial positions. Fear increases and stops build just under the double
low shelf. Price returns for one final test as negative sentiment expands
sharply. Often, price and volatility then contract right at the break point.
The bulls must hold this line. However, odds have now shifted firmly against
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them. Recognizing the imminent breakdown, short-term traders use all upticks
to enter new short sales and easily counter any weak bull response. Finally,
the last positive sentiment dies and horizontal support violates, triggering the
stops. Price spirals downward in a substantial price decline.
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Anticipating Breakdowns
SEEK
sketches a
perfect
Descending
Triangle
reversal
and
breakdown
following a
1998 rally.
Sharp,
parabolic
rallies often
set the
stage for
dramatic
topping
formations.
Note how
the triangle
is also a
variation of
the Adam
and Eve
pattern
AND a 5Wave
Decline.
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THE LOWDOWN ON BOTTOMS
TACTICS
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Is this what we've been waiting for since the swan dive began in early 2000? Are
we finally at the bottom of this long bear market?
If the news is good, it could take months or years to answer that question. But we'll
find out quickly if this isn't the bottom, because the major averages will break the
lows and resume their selloffs.
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In either case, let's take a quick primer on what to expect "at the bottom." Perhaps
it will give us a clue about the end of our market misery.
YOUR DAILY Bottoms print as a result of market physics. Uptrends and downtrends exhibit
MARKET natural wave motion as they thrust forward, and they pull back to test gains or
losses. This action-reaction becomes very important at market turning points. It
GUIDE
implies that a reversal pattern will appear at some point in each trend. In an
uptrend, a lower high will eventually follow a higher high and mark a new top. In a
downtrend, lower lows will finally stop when price action prints a higher low. This
marks the birth of a bottom.
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There are many variations on the theme, including rounded bottoms, triple bottoms
and V-bottoms. The problem is, you never know what type you're in until after the
fact. The most common variation is the double bottom, in which a market prints
one higher low before rallying out of a base.
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Percentage profit potential peaks at the beginning of a new uptrend. So being right
at a bottom can produce a significant reward. But bottom-picking can be
dangerous business. Make sure to weigh all evidence at your disposal before
jumping into a falling market, and apply defensive risk management to ensure a
safe exit if you are proven wrong. For example, take losses immediately if the prior
low gets taken out.
Bottoms occur in downtrends. There's added danger because traders will often
believe a bottom before it's confirmed by the price action. Fast execution can cost
you a lot of money in this volatile situation. Less experienced traders should sit on
their hands and let others take the bottom bait. There will still be plenty of good
trades if and when the market moves higher.
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Spectacular reversals offer little profit if price can't climb out of the hole it fell into in
the first place. Keep a stop loss under the prior low, and consider an earlier exit
when the first bounce runs out of steam. Price can gather downside momentum at
broken lows as it searches for new support.
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Successful bottom-fishing requires a strong stomach. Negative sentiment infects
these turning points even when the technicals line up perfectly. Why are we so
attracted to these trades? Being right at a bottom offers a very high reward-to-risk
ratio.
Bottoms produce very strong market fuel. There are fresh longs ready to
speculate, and short-sellers who don't realize they're trapped. These two forces
combine to generate tremendous buying power that can trigger explosive moves.
For this reason alone, traders should consider the virtues of bottom-picking.
Market declines evolve into market bases characterized by failed rallies and
retracements to old lows. Bear markets end when strong hands finally shake out
the last losers.
So the time will come when price can rally to the top of resistance and keep on
going. Relative strength will improve at this major turning point, and charts will
print bullish bars with closing ticks near their highs. The averages will then start a
steady march through the wall, bloodied by previous failures.
Markets must overcome gravity to enter new uptrends. Value players build bases,
but they can't supply the critical force needed to fuel strong rallies. Fortunately, the
momentum crowd arrives just in time to fill this important chore. As markets rise
above resistance, greed rings a very loud bell, and growth players jump on board
all at the same time.
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THE BIG W
TACTICS
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Double Bottoms provide visual reference points that map the entire reversal
process. Once located, these signposts identify most key price pivots and flash early
warning signals when violated. The most common of these, The Big W, begins at the
last major high printed by a downtrending stock, just prior to the first bottom. The first
bounce after this low creates the center of the W as it retraces between 38% and
62% of that last downward move.
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This rally fades and price descends back toward a test of the last bottom low.
At this moment the trader listens closely for the first bell to ring. A wide range reversal
bar (doji or hammer) may appear close to the low price of the last bottom. Or volume
spikes sharply but price does not fail. Better yet, a Turtle Reversal develops where
YOUR DAILY price violates the last low by a few ticks and then prints a sharp move back above
support. Should any or all of these events occur, we mark the potential second leg on
MARKET
our Big W.
GUIDE
Featuring
Trade entry can be initiated aggressively near the bottom of the second leg if
the bells ring loudly. The top of the shorter move marking the partial retracement of
the last downward impulse (middle of the W) now becomes our main pivot price for
analysis and further trade entry. For price to successfully return to this point, it must
retrace 100% of the last fall (from the second low). This finally breaks the lower high,
lower low bear cycle. In strong DBs, price will quickly surge to this price right off the
second bottom.
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A less aggressive long position can be entered when this new impulse retraces
strongly through 62% of the fall into the second low. However, if a short-term exit
is desired, sufficient profit potential must exist between the entry and the pivot price
PICKS, CHARTS,
SCANS, IDEAS & for this trade to make sense. Longer-term traders can hold positions as price mounts
this pivot. At this point, it will often pause to test support. However, another upward
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Price returning to the height of the middle of the Big W has a very high
probability of surging beyond this point. Under normal conditions, it can easily
retrace 100% of the original downward impulse, completing both the DB and Big W
and
EVERY MARKET patterns. This tendency allows for further entry at the expected return test to the pivot
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point after the second surge has begun. The TIG chart provides an excellent example
of this second chance opportunity.
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Turtles and Trends
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In 1996,
propertycasualty
carrier TIG
Holdings
charted a
double
bottom
volatility
ride
uncommon
in
insurance
stocks. As
price
emerged
from a
small but
powerful
Turtle
Reversal,
it faithfully
completed
a classic
double
bottom
variation:
the outline
of the
letter W.
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BREAKOUT TRADING
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Significant declines evolve into long bottoms characterized by failed rallies and
retesting of prior lows. As new accumulation slowly shakes out the last crowd of losers,
a stock's character changes. Prices push toward the top of key resistance. Short-term
relative strength improves and charts print a series of bullish price bars with closing ticks
near their highs. Finally the issue begins a steady march through the wall marked by
previous failures.
Stocks must overcome gravity to enter new uptrends. Value players build bases but
can't supply the critical force needed to fuel rallies. Fortunately, the momentum crowd will
arrive just in time to fill this chore. As a stock slowly rises above resistance, greed rings a
loud bell and these growth players jump in all at the same time.
YOUR DAILY
MARKET
The appearance of a sharp breakout gap has tremendous buy power. But the skilled
GUIDE
trader should remain cautious unless the move is accompanied by heavy volume. Bursts
of enthusiastic buying should draw wide attention, which ignites further price expansion.
When volume fails to show, the gap may quickly fill and trap the emotional longs.
Featuring
Non-gapping, high volume surges provide a comfortable price floor similar to gaps.
But support may be more difficult to measure. And momentum can take longer to develop,
forcing a stock to swing into a new range rather than rise quickly. Fortunately this scenario
also sets up pullback trades as support forces profitable bounces.
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The uptrend terrain faces predictable obstacles marked by Clear Air pockets and
congestion from prior downtrends. These barriers force frequent dips that mark good
buying opportunities. The trader must identify these profitable zones in advance but also
PICKS, CHARTS, recognize that dips will disappear during the strongest rallies. Here price blasts through
SCANS, IDEAS & prior resistance as enthusiasm explodes.
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During uptrends, one goal is to locate runaway expansion moves. As trend builds
momentum, both gapping and non-gapping surges will register on technical indicators,
such as MACD or ADX. Short pullbacks should not violate the math of this developing
strength. As volatility absorbs each surge, more powerful rallies should erupt. During
and
these events, price range and volume will expand bar to bar, often culminating in a
EVERY MARKET second (continuation) gap and a final exhaustion spike.
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Leading & Lagging
Indicators
Gap
breakouts
are more
likely to rise
toward
higher
prices
immediately
than simple
volume
breakouts.
Waiting for
a dip may
be futile.
Extreme
crowd
enthusiasm
ignites
continued
buying at
higher
levels and
market
makers
don't need
pullbacks to
generate
volume. If
entry is
desired,
use a trendfollowing
strategy
and
manage
risk with
absolute
price or
percentage
loss stops.
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BUYING THE PULLBACK
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Buying the pullback makes good sense after a strong rally, but it's a great way to lose
money if you jump in too early or too late.
How can you find perfect timing when it comes to this classic play? The key lies in reading
the clues of the charting landscape. It's natural for markets to correct after big rallies. This
countertrend move lowers the emotional fires and sets up the ideal conditions for a swing
back to higher prices.
But any pullback can turn into a reversal and trap your position in a downward spiral. So
let's look at the types of pullbacks we want to buy and those that should be avoided at all
costs.
YOUR DAILY
MARKET
Volume presents important evidence about a stock's intentions when it starts to pull back.
GUIDE
Look for selling to contract when bars test lower prices. The most bullish volume shows a
steady downslope in the histograms under the price bars. This suggests shareholders are
hanging tough because they believe in higher prices. Alternatively, big red volume spikes
show fear and may signal important tops.
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Don't trade a pullback against a gap. There are two types of gaps you need to worry
about. The first shows up on a high-volume move near the end of the rally. This
corresponds with an exhaustion gap that warns traders a reversal is near. It also marks
resistance after a stock finds support on the pullback and starts to rally again.
Second, don't buy into a gap down when the stock is pulling back unless it gets filled the
same day. This is a tough one because falling stocks often find support right after the
longs give up and sell into a gap down opening. The problem comes when the gap
doesn't fill by day's end. This prints a bearish reversal on the price chart and attracts more
selling.
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The simplest entry comes from a pullback into a strong support level. Trend lines, old
highs and Bollinger Bands ease selling pressure, and allow buyers to carry the market
back in the other direction. The biggest problem with these falling-knife entries is usually
psychological. The trader loses confidence while watching the intensity of the selloff and
fails to act when it's time to pull the trigger.
A trip down to the 50-day moving average offers an excellent opportunity for dip buyers
who want to hold positions for a few days or a few weeks. This price zone usually marks
strong support after a rally. A market pulling back here also suggests early dip buyers got
beat up on the ride down.
Pullbacks tend to feed on traders who buy too early. In other words, they buy and the
market drops, stopping them out and forcing prices even lower. This downward spiral
continues until prices reach a large pool of buying interest. This fresh demand often sits
right at the 50-day moving average.
Many traders use Fibonacci retracements to uncover hidden support on a pullback. But
this is a lot harder than it looks. Stocks commonly drop to three different retracement
levels, and you can lose a lot of money when you pick the wrong one. Fortunately there
are ways to focus in and locate the most likely support level.
Put the odds squarely in your favor by standing aside until price reaches a deep
retracement that corresponds with other types of support. This means the safest strategy
is to focus on the 62% retracement and look for intermediate averages or old highs at the
same prices.
This process is called cross-verification. It works because it's self-fulfilling. Different
traders look for different types of support in various pullback scenarios. Finding
convergence of multiple support types at narrow price levels taps into this broad set of
buying signals.
The intraday chart holds the key to pullback profits. Often, it's hard to make sense of a
market pulling back on a daily chart. Fortunately trends evolve in all time frames, and
traders can use the intraday chart to uncover hidden support and resistance levels.
Focus on the 60-minute chart because this gives you many days of intraday price bars to
work with. Pull one up when you see a correction in progress, and start searching for
common patterns, such as bull flags or double bottoms. These inflection points reveal lowrisk entry prices for positions taken in much longer time frames.
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CATCH THE DOW AND ELLIOTT WAVES
TACTICS
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Dow Theory hasn't missed a beat in over 100 years. So what does the mind of
Charlie Dow have to offer modern traders?
One of Dow's powerful concepts is the three-waves principle. Decades after Dow
first wrote on the subject, R.N. Elliott took up the cause to create his unique Elliot
Wave Theory. So let's combine their work, and see what these guys taught us a
few dozen years before we discovered the markets were a good place to hang out.
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Dow's three waves were built on the concept of the primary trend. We all know
what Charlie was talking about here. The primary trend is the major market
direction over years or decades. This is how we determine whether we're in a bull
market or a bear market. Dow determined this primary trend by looking at longterm price patterns and seeing the obvious.
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Elliott used his five-wave trend to reach the same conclusions. He noted that the
primary trend was composed of three waves moving in the major direction and two
waves moving against it. Furthermore, each primary wave hid a smaller wave
structure that exposed the true nature of price direction. For example, Elliott
commented that failures exhibited a rollover of certain waves within this fractal
structure and gave rise to trend reversals.
Hard Right Edge
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In Dow's world, a market printing higher highs and higher lows revealed a primary
bull trend. Conversely, a market printing lower highs and lower lows revealed a
primary bear trend. Elliott had no problem with this view, but he added a few twists
of his own. For example, he pointed out how certain phases of a primary trend
showed very limited counter-waves and rarely pulled back until the entire wave set
was completed.
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Three-wave principles get more interesting when Dow and Elliott describe
characteristic crowd behavior in each of the waves. Let's examine these through a
bull market cycle.
The first wave triggers value buying by patient investors who anticipate better
economic conditions and long-term growth. This occurs during the same period
that sentiment records its lowest readings and experts tell everyone in sight to stay
away from the financial markets. Value investors wake up from this gloom and
realize that the fear-filled talk hides a nascent recovery. They buy aggressively
from distressed sellers and nurture a sustainable bottom.
Elliott noted that this first wave shows very gradual price improvement and turns
back on itself frequently to test lower levels. He also points out that this wave
takes a long time to complete and gives a true bottoming appearance to the chart.
The good news is that the market eventually triggers enough momentum to carry
price up to much higher levels.
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Bullish evidence begins to mount in Dow's second wave. Improved corporate
earnings, increased employment and unexpected innovation characterize this
midpoint of a broad bull move. Less demanding investors now enter the market
because they see better times ahead and want to participate. They build goodsized portfolios and start to follow the markets with great interest.
Elliott sees this wave as the most dependable phase of the entire bull cycle. Price
movement advances rapidly, with less overlap from day to day. Small gaps appear
between bars as investors buy high and look to sell higher. A sharp advance often
triggers right in the middle of the wave, when a burst of enthusiasm forces a wide
continuation gap. This powerful move often marks the exact middle for the entire
three-wave event.
Danger signs grow during Dow's third wave, but they're hard to accept because of
an outstanding market environment. Record earnings and full employment lead
the media to proclaim an era in which the sky's the limit. Joe Sixpack now joins the
hunt as the public forgets about its losses from the last bear cycle. This broad
market participation starts a buying panic. At this very moment, the smart-money
investors who bought at the bottom begin to unload their positions into the hands
of the waiting public. The market eventually runs out of gas and prints a long-term
top.
The last wave in Elliott's world can show a parabolic spike, or a failure move
before it gets under way. This dichotomy points out the danger the public faces
when it enters the stock market in force. Elliott noted that the large-scale reversal
off this last wave may be very deep and painful. As we now know from personal
experience, this rapid selloff addresses the many sins common to all bull cycles.
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RECOGNIZING FALSE BREAKOUTS AND WHIPSAWS
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Swing traders encounter false breakouts and whipsaws throughout their careers.
That shouldn't be surprising, though, because all we're doing is playing an odds
game.
Even a perfect setup can fall apart for no reason and with little warning. This
reminds us that risk management is mandatory if we want to trade successfully.
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Breakouts occur in zones of conflict. Both sides of the market are very passionate
at these turning points, but no one knows how much force is required to carry price
into a sustainable trend. So any position you take near a breakout level carries
considerable risk, no matter how perfect a pattern looks.
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Price can respond in different ways to breakouts. First, it may carry through
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successfully to higher levels. Second, it may generate whipsaws that force losses
on both sides of the market. Third, it may trap buyers in a false move and start a
trend in the opposite direction. Each of these outcomes requires careful trade
management.
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A successful breakout occurs in three phases. It begins when price breaks through
resistance on increased volume. We'll call this the action phase. Price expands a
few points or ticks, and then reverses as soon as buying interest fades.
This starts the reaction phase. The market sells off and spawns the first pullback,
where fresh buyers see a chance to get in close to the breakout price. If all
systems are go, a second rally kicks in and carries price above the initial breakout
high. This marks the resolution phase.
The three phases of a successful breakout depend on certain volume
characteristics. Demand must exceed supply during the initial breakout. Volume
should "dry up" when it pulls back in the reaction phase. And new buyers need to
jump in to ensure a successful resolution phase. Whipsaws and false breakouts
result when these supply-demand dynamics fall out of balance.
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What exactly are whipsaws? Simply stated, they're choppy price swings back and
forth through common support or resistance levels. Natural tug and pull generates
most whipsaws.
But hidden hands also manipulate price through common stop levels in order to
generate volume, and intentionally wash out one side of the market. Whatever the
source, whipsaws are responsible for many of the losses in a swing trader's
portfolio.
Whipsaws emerge when a breakout can't generate an efficient reaction phase.
This failure may or may not trigger a major reversal. The pullback shakes out weak
hands and forces price back into resistance.
But there's usually a healthy supply of buyers throughout the choppy movement.
These bulls step in repeatedly to support the market. A successful breakout can
begin quickly after a whipsaw fades out. The loss of volatility actually triggers a
buying signal on many trading screens. This starts a bounce that generates the
momentum needed to carry price up and beyond the last high.
Major reversals occur when price action traps one side of the market. Many
traders wait to enter positions at key breakout levels. Once these folks execute
their trades, they're at the mercy of the market.
In other words, their profits depend on others seeing the breakout and jumping in
behind them. False breakouts occur when this second crowd fails to appear.
An overbought, one-sided market can drop quickly below a breakout level. This
throws all the traders who bought the breakout into losing positions. Without the
support of fresh buyers, a stock can fall from its own weight. Each incremental low
triggers more stops and increases fear within the trapped crowd. Momentum
builds to the downside, breaks key support and invites fresh short-sale signals
from a whole new batch of traders.
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MORNING GAP STRATEGIES
TACTICS
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Having trouble with those irritating morning gaps? You're not alone. Many of us
spend hours working on new setups, only to watch them go up in smoke overnight.
But there's no need to throw out all of your hard work just yet. You can do a quick
analysis, adjust your trading strategy and get into a good position well after the
crowd pulls the trigger on a gap play.
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Many traders still place market orders before the open and walk away.
Unfortunately, this is a sucker move that yields the worst fills imaginable. Take a
few extra minutes to plan your gap entry, and you'll get much better prices. No,
this isn't a daytrading column, although it will benefit anyone who plays in the
intraday markets. It's for swing traders trying to fine-tune their entries and get
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Stand aside at the open, and use the third-bar swing to find the best gap entry.
This is a dependable reversal or expansion move on the five-minute chart,
occurring 11 or 12 minutes into the new trading day. This phenomenon is a relic of
the old 15-minute quote delay. In past years, painting the tape before retail
investors could access stock prices ensured a few extra pennies for market
insiders. Because retailers were the last "paper" in the door, natural forces would
then take over and trigger reversals or breakouts. Although real-time market
access has grown substantially, this third-bar swing still shows its face on many
days.
Let the stock draw the first three five-minute bars, and then use the high and low
of this "three-bar range" as support and resistance levels. A buy signal issues
when price exceeds the high of the three-bar range after an up gap. A sell signal
issues when price exceeds the low of the three-bar range after a down gap. It's a
simple technique that works like a charm in many cases. If you use this technique,
though, a few caveats are in order to avoid whipsaws and other market traps. The
most common is a first swing that lasts longer than three bars. If an obvious range
builds in four, five or even six bars, use those to define your support and
resistance levels. Also consider the higher noise level in five-minute charts. A
breakout that extends only a tick or two can be easily reversed and trap you in a
sudden loss. So let others take the bait at these levels, while you find pullbacks
and narrow range bars for trade execution.
Gap location is more important than the gap itself. Does the opening bar push
price into longer-term support or resistance? A strong up gap may force a stock
through several resistance levels and plant it firmly on top of new support. Or it
can push it straight into an impenetrable barrier, from which the path of least
resistance is straight down.
Three-bar range support and resistance often need to complete a testing pattern
before they will yield to higher or lower prices. This comes in the form of a small
cup and handle, or an inverse cup-and-handle pattern. Simply stated, price
reverses the first time it tries to exceed an old high or low, but succeeds on the
subsequent try.
Price gaps generate other action levels as well. The most obvious is the support
line in an up gap (or resistance line in a down gap). We'll call these "reverse
break" lines. Violation of the reverse break can trigger price acceleration toward
the gap fill line. These market mechanics make perfect sense: everyone who
entered a position in the direction of the gap is losing money once price moves
past the reverse break line.
The gap fill line marks support in an up gap and resistance in a down gap. In other
words, the odds favor a reversal when price reaches it. Paradoxically, this is a
terrible place for swing traders to enter new positions. The reverse break line will
resist price from re-entering the three-bar range. In fact, price bouncing like a
pinball from the fill line to the reverse break line and back to the fill line sets off a
powerful trading signal in the opposite direction. It predicts the demise of the gap
and a significant reversal.
The flip side of this reversal is a failure of a failure signal. In other words, price
overcomes resistance at the reverse break line and retests the high of an up gap
(or low of a down gap). The ability of price to retest these levels issues a strong
signal to take positions in the direction of the gap.
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Gaps are shock events that jolt price up or down and leave an "open window" to
the last bar. Market folklore (such as the infamous "gaps get filled") seems to
offer guidance, but in reality it has little value. After all, many gaps never get
filled. So how can we use these one-bar wonders to make good trades and
increase profits?
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The first thing to do is figure out what kind of gap you're dealing with. It should
fall into one of these three categories:
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Breakaway gaps appear as markets break out into new trends, up or
down.
Continuation gaps print about halfway through trends, when enthusiasm
or fear overpowers reason.
Exhaustion gaps burn out trends with one last surge of emotion.
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Certain trades work best with each gap type, so proper identification is extremely
important. Use relative location and key characteristics to place them into the
right category. There is also a psychological aspect to recognizing the correct
gap. Breakaway gaps "surprise" because they appear suddenly on charts you've
ignored. Continuation gaps "frustrate" because they pop up where you think price
should reverse. Exhaustion gaps "relieve" because they print after you hold on
for too long.
Trade the trend on the first pullback to a breakaway or continuation gap. In other
words, buy the decline after a rally, or sell the rally after a decline. The odds
favor a reversal back in the primary direction, even if these gaps fill. However,
the pullback trade often requires great patience. Markets retest breakout gaps
right after they occur, but many bars can pass before price returns to test a
continuation gap.
Use the continuation gap to target major reversals. The first test usually occurs
after closure of the exhaustion gap. But you can't trade it if you can't find it, so
here's a trick: Wait until you can count three price moves, up or down. Then
place a Fibonacci grid across the entire trend and look for a continuation gap at
the 50% level. If you find one, place a limit order within the gap and wait for a test
to occur. The retracement should provide enough support or resistance to force a
reversal. Once the gap is filled, place a trailing stop and keep it close behind
current price action.
Modern markets fill many continuation gaps for a bar or two before they reverse.
If you're a defensive trader, place your order within this extreme price level.
Many times you won't get filled, but you'll save yourself whipsaws from entering
too early. Keep in mind the filled gap presents low risk only when volume
remains flat and price doesn't gap back through the old gap to get there.
Exhaustion gaps print blowoffs that end a trend. This last burst of energy can
occur on high volume, but the lack of it doesn't change the outcome. Exhaustion
gaps fill easily, with price often heading lower in a hurry. After this reversal, use
multiple time frame analysis to plan your next move. For example, an exhaustion
gap may also print a continuation gap in the next larger time frame. Be patient if
this sounds confusing. Seeing this three-dimensional landscape requires a sharp
eye and a lot of charting experience.
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TREND, DIRECTION AND TIMING
TACTICS
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It's easy to chase your tail before making a new trade. In fact, most of us don't
know what to look for before we commit our capital. Simply stated, each
opportunity should speak for itself. The best way to decide whether a given trade
does that is to first answer a few basic questions:
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What is the trend or range intensity?
What is the direction of the next price move?
When will this move occur?
Concentrate on the three Cs to find the answers you need to make the trade.
Recognize trend-range intensity through time-frame convergence. Predict price
YOUR DAILY direction through the will of the crowd. And align market timing through range
MARKET contraction.
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Markets alternate between up-down trends and sideways ranges. This is true in all
time frames. Price movement swings through synergy and conflict as trends
collide or converge. The strongest trends emerge when multiple time frames stack
up into directional movement. The most persistent ranges appear when
multilayered conflict stalls price change.
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Use moving average ribbons (MARs) to study trend intensity. These handy tools
illustrate complex relationships through simple interactions. Start by finding where
current price sits in the ribbons. Since price always moves toward or away from
underlying averages, each new bar reveals characteristics of momentum, trend
and time. Tie MARs together in a logical way. For example, use 20-, 50- and 200day averages to view distinct short, intermediate and long-term trends.
The interplay between averages exposes market phases and trend acceleration.
Look for a bear market when MARs flip over and the 200-day MA sits on top. Look
for the bull to return when it crosses back and each MA lines up, from shortest to
longest. Expect choppy action when averages criss-cross out of sequence. Price,
for example, can bounce like a pinball when it gets caught between inverted
averages.
Volume defines the crowd. Studying market volume has two primary functions.
First, it gauges the strength of ownership and the passion of the owners. Second,
it filters the crowd's divergent impulses and predicts their herd behavior. Capture
this vital information with a simple volume histogram (preferably color-coded) and
an accumulation indicator such as on-balance volume (OBV). Volume is
deceptively simple. The lack of a clear relationship between price and volume
undermines accurate prediction. Volume leads the crowd as often as it lags, but
always makes perfect sense in hindsight. Examine price action closely before
timing trades to a volume pattern. And move quickly to other opportunities when
the crowd gives mixed signals.
Range-bound markets lower volatility and dissipate crowd excitement. Eventually
congestion reaches a balance point where a new trend can begin. This cooling-off
phase sounds simple, but it's very hard to trade profitably. Declining volatility
fosters crowd disinterest, profit taking and indecision. The chart draws a series of
narrowing range bars (the distance from bar high to low). Then a new trend
explodes just when everyone turns their backs, but most miss the trade because it
gathers no crowd until it passes.
Find the narrowest range bar of the last seven bars (NR7) to locate this sudden
congestion breakout. Its predictive power lies in the location where it appears.
NR7s work best right in the middle of congestion, or when price pushes repeatedly
against a major barrier. When the signal works, it works fast and triggers a major
price expansion without a pullback.
How do you trade an NR7? Place an entry stop just outside both price extremes at
the same time, and then cancel one order after the other executes. Then place a
stop loss at the location of the cancelled order. This takes advantage of the small
pattern, regardless of the way it eventually breaks out.
You can answer the three questions with a single price chart and a few good
indicators. This way you'll know what to do next with very little effort. Get on board
quickly when everything converges and points to an impending move. Multiple
signals reveal crowd forces that converge into intense breakouts or breakdowns.
These focused time-price zones line up with the right answers at the right time.
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TREND WAVES
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The cult of Elliott Wave Theory intimidates the most experienced traders. But don't
let wave voodoo stop you from adding important elements to your chart analysis. Sharp
uptrends routinely print orderly action-reaction waves. EWT correctly recognizes these
predictive patterns through their count of 3 primary waves and 2 countertrend ones.
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Wave impulses correspond with the crowd's emotional participation. A surging 1st
wave represents the fresh enthusiasm of an initial breakout. The new crowd then
hesitates and prices drop into a countertrend 2nd impulse. This coils the action for the
sudden eruption of a runaway 3rd wave. Then after another pullback, the manic crowd
exhausts itself in a final 5th wave blowoff.
YOUR DAILY Traders can capitalize on trend waves with very little knowledge of the underlying
MARKET
theory. Just look for the 5-wave trend structure in all time frames. Locate smaller waves
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embedded in larger ones and place trades at points where two or more time frames
intersect. These cross-verification zones capture major trend, reversal and breakout
points.
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For example, the 3rd wave of a primary trend often exhibits dynamic vertical
motion. This single thrust may hide a complex 5-wave rally of the next smaller time
frame. With this knowledge execute your position at the 3rd of a 3rd, one of the most
powerful price movements within an entire up trend. While waves may appear difficult to
locate, the trained eye can uncover these price patterns in many strong up trends.
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Many 3rd waves trigger broad continuation gaps. These occur just as emotion
replaces reason and frustrate many good traders. Since common sense dictates the
PICKS, CHARTS, stock should retrace, many exit positions on the bar just prior to the big gap. Use timely
SCANS, IDEAS & wave analysis (and a strong stomach) to anticipate this big move just before it occurs.
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4th wave corrections set the sentiment mechanics for the final 5th wave. The crowd
experiences its first emotional setback as this countertrend generates fear through a
sharp downturn or long sideways move. The same momentum signals that carry traders
into positions now roll over and turn against them.
As they prepare to exit, the trend suddenly reawakens and price again surges.
During this final 5th wave, the crowd loses good judgement. Both parabolic moves and
aborted rallies occur here with great frequency. Survival of the last sharp countertrend
adds an unhealthy sense of invulnerability into the crowd mechanics. Movement becomes
unpredictable and just as the last greedy participant places a bet, the uptrend ends
unexpectedly.
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SPECIAL REPORTS
in the
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Trading for a Living
Waves within Waves
More
In 1996, Worth
Magazine
declared that
Isis
Pharmaceuticals
would be the
next Microsoft.
That was all the
greedy crowd
needed to hear.
A powerful rally
exploded and
prices doubled
in the next
month. Note the
embedded 5
wave patterns,
typical in
surging
uptrends. The
3rd of a 3rd
identified an
excellent
momentum
trade.
Leading & Lagging
Indicators
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& Risk
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The Swing Shift by Alan Farley
Editor/Publisher Hard Right Edge
Daily
Originally Published on RealMoney.com:
January 8, 2002
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HOW YOU COULD HAVE SEEN IMCLONE'S IMPLOSION COMING
Warning: This will be an "I told you so" column. We're going to look at a recent
horror story and see why you should have bailed out by now. If it hits too close to
home, you might want to move on and read something a little more pleasant.
YOUR DAILY We're taking no prisoners today.
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The RealMoney staff love to flutter their wings about the latest blowups. But I have
a confession to make. I think the companies we chatter about are extremely
boring.
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Enron? That's an extinct bird, isn't it? And although I think Halliburton is a beautiful
actress, she doesn't look that good in asbestos.
Your
My problem with companies like Enron and Halliburton is they don't have four
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letters. After all, the Nasdaq is where I spend most of my time. It's also where
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other traders hang out, because of the direct-access systems. So how about a little
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more gossip about OTC bloopers, screwups and nose dives?
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knife-catchers step in to call a bottom, they wake up the next morning with long
blades planted firmly in their backs.
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It's easy enough to see where the five-month ImClone rally ended. After all, that's
why they call it a broken trend line. Now this routine event isn't the end of the
world. Broken rallies often lead to sideways markets, not death spirals. But
sideways isn't nearly as good as up, so we'll mark the breakdown as Warning No.
1.
Warning No. 2 comes just two bars later, when the stock breaks the 50-day
moving average on strong volume. Definitely not good news if you own the stock.
In fact, it gives investors a very good reason to sell. The stock then waves another
red flag. Price bounces back to the 50-day moving average from below but fails to
break it for four sessions. Hear that ominous sound? Warning No. 3 just rang a
very loud bell.
OK, this is getting serious. The selloff expands out of the failed test and closes at
the low -- right at the 100% retracement of the last rally. This level should provide
strong support and stop the selloff. So how come day-traders didn't step in and
bounce the stock before the close? Members of the jury, I give you Warning No. 4.
Armageddon strikes the next day. Price rips a 19% gap on high volume and
breaks the 200-day moving average. Enter Warnings No. 5 and No. 6. I wish that
was the end of the story, but it isn't. While the gap does great technical damage on
the daily chart, watch what happens when we zoom out and look at the long-term
chart.
Warning No. 7 nails the coffin shut. The gap triggers the failure of a multiyear
channel breakout. This opens the door for a trip all the way back to the lower $20s.
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10 COMMON PITFALLS OF SELLING SHORT
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A pro recently joked the bear market will end when Joe Sixpack quits his
job so he can sell short for a living. Of course, it was Joe who led the
charge in the bull's final days, and got his head handed to him for the
effort. In other words, it will be time to go long in a big way when the public
finally gets around to selling short.
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Short selling is the hottest game in town these days, for obvious reasons.
But it's still not easy to make money selling first, and buying later. In fact,
most of us can look at plummeting charts for hours, and still jump in at
exactly the wrong time. This is one of the great truths of short selling.
Let's examine 10 common pitfalls of this classic trading strategy. After you
review this list, you'll understand why the practice can cause so much pain.
Keep in mind the bear environment actually makes short selling more
difficult at times, because the market loves to punish the majority.
1. Choppy Sloppy -- This bear market shows tremendous overlap in daily
price range for equities and indices. In other words, pick out today's high
and low for a particular instrument, and tomorrow's market will probably
trade through a portion of that range. Why is this a problem for short
sellers? It undermines logical stop placement, and makes good entry
prices harder to find.
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2. Duck, Duck, Duck, Goose -- Price doesn't go anywhere most of the
time, even in a bear market. The real declines tend to occur quickly, and in
PICKS, CHARTS, sudden bursts. This means you need to wait around for a seller's market to
SCANS, IDEAS & tap you on the shoulder, and/or get burned because your timing isn't
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3. Too Many Bozos on This Bus -- Short selling makes a terrible group
sport. Many stocks carry high short interest and attract frequent squeezes,
regardless of how rotten the chart looks. And you're the most exposed
playing the same tech stocks as everyone else.
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4. Misguided Missiles -- So you think you're a wizard when it comes to
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resistance levels? Well, think again, Merlin. Support-resistance is threepresents
dimensional, and price often goes further than you expect, up and down.
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This means you'll find yourself shorting into bear rallies that keep on going
for a New Generation
up, and up, and up. Until you give up and cover.
5. Tummy Bumpers -- Short sellers are their own worst enemies, and
your stomach is the culprit. It twists and turns when it sees your short-sale
tick up, one penny at a time. This particular agony is not the same as
watching an investment take a dive. Our sense of gravity helps us
rationalize those events a whole lot better.
Hard Right Edge
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6. Monkey See, Monkey Die -- It's often too late to sell short by the time
you see a selloff gather steam. Those shorting from higher levels are
already looking to cover by the time you think it's safe to sell short. They
add buying power to the market when they close their positions. That's why
you'll sell the bottom, and get crushed on a short squeeze.
7. Fear of Fleckenstein -- Sure it's the end of the world, but how does the
chart look? You may hate a company and think it's going to hell, but you're
going to lose money if the chart doesn't agree with you. You can't turn a
profit by selling stories short. You need a stock to do that.
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8. Tom and Jerry -- That cheese sure looks appetizing, but did you notice
the spring-loaded mousetrap? The most obvious selling spots routinely
trigger the most violent squeezes. This forces us to find the less-traveled
path if we're serious about selling the market.
9. The Unbear Market -- This is a bear market, right? You may not be so
sure if you look at the weekly charts. Many stocks and futures have gone
sideways for the last 9 months, not straight down. This indicates a balance
of buying and selling power, rather than a one-sided rout.
10. Calendar Cramps -- Short sale profits depend on the time of the
month. Positions entered around option expiration get burned because of
all the put/call unwinding. And buying power can surge near month's end,
especially during window-dressing season. This can make a falling market
float like a butterfly for a week or two.
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All original materials: © 2003 Brooke Publishers, Inc.
Comments: [email protected]
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FIVE WAVE DECLINES
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As up trends end, the same crowd that lifts price provides fuel for the
ensuing decline. Longs get lulled into a false sense of confidence as rally
momentum fades and a topping pattern forms. As the smart money quietly
exits, the up trend hits a critical trigger point: the bulls suddenly realize they're
trapped. Seeking to protect profits, they start dumping the stock. Price fails and
selling spirals downward through wave after wave.
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Common pattern features appear in most price declines. Several false
bottoms print and fail. Volume surges repeatedly, as losers unload their
positions onto the waiting value crowd. Price carries well past downside target
after target. Then just as hope collapses, the stock makes a final, multiple
YOUR DAILY bottom.
MARKET
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Pattern analysis offers a superb way for the short-term trader to
understand and capitalize upon this repeating market behavior. Look no
further than R. N. Elliott's work in the 1930s and you'll find the Five Wave
Decline. This structure for price correction is as powerful today as it was 60
years ago. And as a parable for crowd behavior, traders can use it without
understanding the broader Elliott Wave Theory.
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5WDs consist of three downward impulses and two corrections. The first
impulse (Top) corrects the up trend that carries an issue to a new high. This
Interactive Top begins the price failure that completes through the second impulse (1): the
technical breakdown of the stock. As with rising markets, this impulse can be
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very dynamic. But in most declines, the worst is usually reserved for last. As
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this 2nd impulse completes, a false bottom paints a comforting picture that
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SCANS, IDEAS & slows the selling and brings in weak longs. The selling then suddenly resumes
and accelerates into a final 3rd impulse (2) that is so emotional that prices
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violate set targets and reasonable support zones.
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The emotion of this last wave extinguishes the selling pressure, bouncing
the stock. This rapid upward motion ignites the first impulse of a significant
counter trend. This strong rally then fails suddenly. As the longs brace for more
and
EVERY MARKET pain, the prior low unexpectedly holds. A new crowd then steps in and price
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returns to the 1-2 trendline as a double bottom forms. The balance of power
shifts and the stock breaks through that line into a new up trend.
The skilled eye can see 5WDs in all time frames, from 5-min to monthly
bars. These volatile movements fit perfectly into the larger structure of greed
that drives the cycle of trend through an orderly and predictable process. And
the unconscious crowd behavior represented by this pattern goes well beyond
the financial markets.
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5WD Trendline Rules
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The 1st, 3rd and 5th wave impulses in EWT become Top-1-2 in the Decline's
count. Connect the 3rd (1) and 5th (2) waves with a trendline. Ignore the 1st
(Top) wave, which that trendline can violate in any way it wants. The first
impulse after the (Drop) may come close to that trendline but will rarely violate
it.
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All original materials: © 2003 Brooke Publishers, Inc.
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SELLING DECLINES
TACTICS
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How can we profit from the pain of other participants as stocks fall? Where
should short sales be entered to capitalize on their fear? And how can we shift trading
strategies as the new uptrend takes over?
Answers to these questions can often be found by watching the countertrend
rallies between dynamic falls. Hidden rules of proportion guide Five Wave Declines.
One general tendency expects the first corrective wave to drop about 38% of the next
larger up trend, while the second falls to 50% and the final thrust all the way down to
62%. However, 5WDs will sometimes correct 100% (or more) of the first wave, creating
a classic double top.
YOUR DAILY Selling short during 5WDs is more difficult than you might expect. The down
MARKET
trendline consists of only two points unless the first Top lines up with the subsequent
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two impulses. So you may not know a trendline exists until several entry points pass.
Fortunately this barrier also marks the highest level the first post-bottom (Drop) rally
should reach. This pinpoints a good trade setup when price gets close enough to the
line. However, the reward potential is smaller than during other declines and selling
short is now a countertrend entry.
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The best short sales in the 5WD pattern arise from natural breakdown points, as
impulses violate prior support. Frequently this requires foregoing entry on the very
first impulse since this wave can complete with little or no selling pressure. This
changes dramatically during the 2nd and 3rd falls when the crowd becomes highly
emotional.
PICKS, CHARTS, The 5WD trendline becomes a signpost for long trades that follow the first
SCANS, IDEAS & breakout through it. Immediately buying the break works exceptionally well on clean
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gap moves. Pullback entries routinely appear after breakouts as price returns to test
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the trendline from above. But watch out for very weak breakouts. Stocks may use this
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side of the trendline to initiate a new downward impulse, with price gently sliding along
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Downtrends do not easily give way to new uptrends. While a break of the 1-2
EVERY MARKET
trendline marks the completion of the Five Wave Decline, subsequent price movement
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may not generate much momentum. Long entries initiated at the trend break can be
very successful but a defensive posture is warranted. At these times, remember the old
traders wisdom: the bigger the move, the broader the base. Bottoms can take time to
form.
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Reading The Breakdown
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The 2nd
downward
impulse (1)
of 5WDs
often begin
close to the
same level
as the 1st
decline
(Top). This
sketches
the classic
double top
breakdown
pattern.
Short sales
can be
initiated at
the first
violation of
the prior up
trend. But
the danger
of a short
squeeze
remains
high during
this early
stage.
Subsequent
breakdowns
are not as
deadly to
short
positions as
a new bear
mentality
weakens
rally
attempts.
Leading & Lagging
Indicators
Stock Selection
& Risk
More!
All original materials: © 2003 Brooke Publishers, Inc.
Comments: [email protected]
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SURVIVING BEAR MARKETS
TACTICS
TUTORIAL
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From the Release THE MASTER SWING TRADER
© 2000 McGraw-Hill and Brooke Publishers. All Rights Reserved.
Modern participants have rarely faced severe bear market conditions. Most players wrongly believe that
profits will continue even in a major decline as long as they just flip their long strategies upside down. But
worldwide bear markets present difficult conditions for most short-side participants. Trend-following tactics
often fail as sudden squeezes offer no escape and induce heavy losses.
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Resources
A special personality marks each secular bear market. Inflation or oil prices may drive some while
overheated economics or asset overvaluation awakens others. But bear markets all display one common
characteristic: they make it much harder to turn short-term profits than typical bull markets. Swing traders
should prepare for the next downturn now so that they survive and profit while waiting for better conditions.
YOUR DAILY
MARKET
Pattern Cycles suggest effective short sale tactics during individual stock bear markets. But volume
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drops sharply through most phases of a broad worldwide bear depression. This induces illiquidity and
dangerous trading conditions. Spreads widen and slippage increases for both entries and exits. Opportunities
vanish as good short sale inventories dry up at many broker-dealers. Reliable information disappears and
good sources close shop due to a lack of interest.
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Bear markets appear through many time frames. They can represent grand bear markets, cyclical bear
markets, intermediate-term corrections or minor downswings. Minor downtrends can last a few minutes or
days. Longer ones may persist for several months. Grand bear markets can span decades and embed multiple
cyclical bull-bear swings. These cyclical swings pose the greatest threat for modern swing traders. Historically
this particular bull-bear cycle lasts about 4 years, with 25% (or 1 year) of that time spent in active bear
conditions.
Cyclical Price Declines
Bear Market
Percent Decline
1973-1974
59%
1983-1984
31%
1987-1988
35%
1989-1990
33%
1998
29%
Months to Recover
48
18
20
7
2
Bears shake out the market infrastructure and realign prevailing psychology. The actual price decline
often takes up only a small percentage of the time that downtrend conditions persist. As with stocks, indices
fall faster than they rise and the selling spasms tend to end quickly. The rest of the time the market meanders
back and forth on low volume while it tries to heal. This offers another clue why trading during these times can
be very difficult. The typical bear market doesn't end in the high volume capitulation that marked volatile
corrections in the 1990s. It slowly heals as value investors start to move back into positions. Most other
participants will have little interest in the financial markets by that time.
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The media conditions traders and investors to believe that a simple 20% retracement off the index
highs constitutes an active bear market. This comforts many participants, the small drop in their portfolios
giving them battle credentials. But technical and psychological damage mark bear conditions with far greater
accuracy than flat percentages. This type of pain has rarely been experienced over the past two decades.
A bear market corrects the excesses of a specific market uptrend. It retraces according to classic
Fibonacci mathematics. When the prior rally displays a moderate advance, the bear market may not need a
great pullback to correct the imbalance. But when a market rally extends to historical levels, conditions favor a
very deep pullback that may take several years of basing before a new and sustainable uptrend can begin.
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Long-Term Price Recovery
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Oxford Health Plans collapses into a multiyear bear market. But most of the selloff takes place during only 5
weeks of market action. Unfortunately, the stock needs far more time to recover from this severe decline. After
more than 2 years of basing, OXHP finally gathers enough new interest to test the initial breakdown.
Swing traders should act defensively through cyclical bear market conditions unless the intraday
charts signal opportunities. Rallies and selloffs that print in this time frame offer excellent short-term setups.
Tighten the holding period and step into as many positions as the temporary market environment allows. Try to
anticipate where short covering rallies will likely erupt. Get in on the same side as the professionals and use
the short seller's panic to turn a profit. Then find natural reversal levels and flip back to the short side after the
squeeze completes.
As a bear market evolves, follow the daily chart for key turning points and act defensively at all times.
Wait for favorable reward:risk and avoid being tossed around by the frequent swings of investor hope and fear.
These cyclical events complete through the same mechanics as individual stocks and futures. Look for a
double bottom or the Big W to signal the end of a major selloff. Track the growth of accumulation and renewed
interest through long periods of basing. These emotional periods offer excellent long-term profits for those with
precise market timing. But as with other falling knives, entry requires execution against popular sentiment.
Watch the technicals closely and act only after cross-verification favors the next bull phase.
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SURVIVING THE CHOPPING BLOCK
TACTICS
TUTORIAL
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Retail traders abandoned the markets in the last three years, and there are few signs
they'll return anytime soon. The latest numbers from the discount brokerage houses
confirm that the exodus continues unabated, and this marks a sea change in the way
market survivors will do business.
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You know these former traders very well. They're the relatives who whispered hot tips in
your ear during weddings, and next-door neighbors who rode Cisco (CSCO:Nasdaq Resources
news - commentary - research - analysis) to the sky and back down again. They're also
the daytraders and board slugs who thought the market was printing money with their
names on it.
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YOUR DAILY Recently, RealMoney's James De Porre pointed out how trading now pits professional
MARKET against professional. He rightly wondered how the new playing field might reduce or
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eliminate the edge that's kept us in the game through these hard times. I thought I'd add
my two cents and outline my take on this market.
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Some believe technical analysis has failed in this brave new world, but that's not quite
true. In fact there's a real disconnect when it comes to understanding the power of the
price chart and its many limitations. Technical analysis gives traders a map of the market,
but it can be a poor buying or selling tool. In other words, it shows the price levels where
trading decisions need to be made, but it doesn't always tell you what those decisions
should be.
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Classic books tell us to buy breakouts and sell breakdowns. This strategy still works
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during big trends, such as active phases of rallies or selloffs. But traders don't have the
PICKS, CHARTS, luxury of waiting for these relatively brief intervals. The vast majority of the time, modern
SCANS, IDEAS & markets are caught on the chopping block, rather than going directly from one price level
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Let's look at the chopping block, because it will be the main venue for pro-vs.-pro battles
in 2003. Conflict or indifference characterizes these extended periods, forcing traders to
outwit each other with contrary strategies and time frames. These tactics include fading
breakouts, reversing overnight momentum and defying common wisdom on things like
gaps and trendlines.
The chopping block will drive you crazy if you think technical analysis is a simple recipe
book. The whole point is to shake out traders who bury their noses too deeply in patterns
and indicators. The funny thing is these whipsaws actually prove the value of technical
analysis rather than undermine it.
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Many professional traders will buy breakdowns just to catch you in a short squeeze. Over
the months, I've documented other fading games such as rinse jobs and pattern failures.
This odd way of doing business becomes the rule rather than the exception during the
chopping block. To survive in this hostile environment, you need to recognize when price
is caught in this stage and when it's ready to change gears and head for higher or lower
ground.
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Memorize the chart above, because it's important for your survival. Almost every "real"
trend begins after an opposite breakout or breakdown in the futures markets. When a
chopping block develops, step back and outline its dimensions. Then wait for support or
resistance to break, and watch what happens next.
The rally or selloff out of a chopping block draws in momentum traders who see the same
thing you do. But the real signal comes on a clean break in the opposite direction. You
may not realize it at the time, but you're witnessing the first primary wave in a new trend.
Why does the market move in this diabolical manner? It goes back to our common view of
technical analysis. Support and resistance levels are nothing more than pivot points in the
chopping block. Smart traders line up against those unfortunate souls who follow the book
when they buy breakouts or sell breakdowns.
I know what you're thinking: All I have to do to make money is trade the opposite direction
and join the fade. But just reversing gears won't work, because time traps are set against
you as well. In other words, the breakout may go up for a day and squeeze out your short
position and then drop back into the block the next morning or the next week.
How do you profit in this environment? You only have two choices. First, trade at the
edges of the block after the endless games shake out everyone else. Second, play the
fading game well. Take a step back and learn how to read price and time traps.
The first thing you'll notice is how the market draws pretty pictures through sentiment and
price action. Then look for an ambush once the majority believes the illusion and takes
new positions.
At the start of each day, ask yourself what price action would undermine the most traders.
Often that's exactly what will happen in that session. For example, how many times have
you been caught buying an opening gap after a rally, only to watch it fade and reverse
into a selloff? It's called a bull trap for a reason.
Does this contrary thinking sound like a lot of work, just to make a buck? Well, yes and
no. It does require a different skill set from the one you were taught during the long bull
market. But it's the only way to survive if you want to trade in the big leagues.
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All original materials: © 2003 Brooke Publishers, Inc.
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Short-term traders often focus on large elements of the pattern cycle
and miss important signals buried within intraday price movement.
This relativity error forces them to wait on the sidelines until these major
swing points are reached and participants from broader time frames enter
the game. Rather than wait, traders can locate good setups by reading
reversal and breakout patterns within very short periods of cyclical market
movement.
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Chart analysis works best when several time frames are combined to
identify important swing points and breakouts. But once the shortterm trader identifies the broad framework of support and resistance,
YOUR DAILY profits come from predicting how the next few minutes or hours of market
action will play out.
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Let's trade through a small pattern cycle following a powerful Intuit
(INTU) rally.
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As INTU slowly pulled out of a 9-month base in mid-October, few
realized it was headed into a quick price triple. Typically, short-term
traders become aware of dynamic rallies very late in their development.
The majority then engages in momentum strategies to chase the big
move. But risk is very high at this stage of the broader pattern cycle. As
stocks go parabolic, traders get caught in sharp downdrafts that empty
pockets as quickly as they are filled.
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Smart technicians use major reversals, such as the one INTU printed
at 60, to signal the start of predictable swing trading conditions. The
downswing generates fear and provides a perfect environment for welldefined pattern and support-resistance formation. But don't rush into
poorly defined entries. Be patient and wait for the right opportunities to
develop.
While good short sales print on the downdraft, we'll concentrate on
going long with the uptrend. A large crowd always misses the boat on
strong rallies and sees any pullback as a good entry. Our first job will be to
wait until a bottom pattern prints and then join them. This can occur in a
few minutes but routinely takes several days to form on a typical 15-min or
60-min chart.
We are fortunate with INTU. The appearance of a symmetrical triangle
quickly defines a possible bottom and clear breakout point. Note how our
bottom support line actually violates the 11/30 low. The markets rarely
offer perfection on very short-term patterns. Traders must be skilled
enough to draw useful trendlines based on limited and conflicting
information. If we have done our drawing well, the gap on the morning of
the 2nd will be immediately recognized as a breakout from that triangle
and completion of the bottom reversal pattern.
The market does not give away its gifts easily. Traders that buy the
INTU morning gap face considerable whipsaw action until the lunch hour.
Note the common 3rd bar reversal just 10 minutes after the market opens.
This sets the stage for traders to apply a simple 1st hour range breakout
strategy and look for an entry just above the reversal high.
The pattern also offers swing traders safe entry on both the first test
of the morning gap and the double bottom test later that morning.
However those that enter at bottom support then risk considerable profit if
they choose to hold to new highs. Exit this classic swing trade just before
the top of the first hour range and consider the setup for a new breakout
trade on its own merits.
The safest breakout entry takes place just minutes before the move
above the morning highs. But how will the trader know to buy? A welltrained eye recognizes the small cup action of the tall bar just prior to the
breakout. The morning pattern gives up its secret here, leaving the smart
trader with 2-3 minutes to enter quietly at the bid through a favorite ECN.
Also note the small ascending triangle just above the breakout point. New
breakouts typically pause for 4-6 bars before momentum shoots out in a
tall candlestick.
The next morning opens with a powerful opportunity for traders. It
takes very strong demand to break the rising trendline of a price channel.
For this reason, channel breaks often produce very tall price bars
immediately following the initial signal. Note how much of the break takes
place in the first 30 minutes of trading. This offers a very small window for
the trader to get on board safely.
INTU pattern cycles shift back and forth through charts of different
time frames. If you get lazy and only focus your attention on a single
segment, your level II screen may flash a breakout but you won't
understand the source or reason. Without the right information, odds
increase that you'll jump in at the wrong time and buy a top or sell a
bottom.
Good traders know when to stand aside. As INTU approaches 60, long
side trades become very risky. But after the strong momentum of the
opening move, shouldn't we expect another long thrust after a short
pullback? At this point, our strategy relies on the broader pattern cycle to
provide our guidance. Looking back, we realize that price has returned to
the beginning of the original reversal and stands right at a potential double
top. Smart traders never buy into a double top.
But we should not sell short at this level either since the uptrend
remains well intact. Our best tactic is to pause and let the market tell us
what will happen next. Through the balance of the session, INTU sketches
a narrow consolidation flag. Here at the end of the week, the broad 60-min
chart resembles a classic cup and handle pattern.
Should we now buy or sell? Let's wait for Monday and see what the
market tells us to do.
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All original materials: © 2003 Brooke Publishers, Inc.
Comments: [email protected]
20 Golden Rules
for Traders
Trading Tactics
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BID-ASK
TACTICS
TUTORIAL
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Interpreting the bid/ask spread requires different skill sets than reading changing
prices on the ticker tape. This poorly understood supply/demand engine compresses and
expands constantly, responding to shifting market conditions. But most spread movement
reveals nothing more than pure noise and has little directional value. While scalpers can
use these frequent choppy periods to grab quick profits, technical traders should stand
aside and wait. Directional signals will erupt from the spread regularly and allow them more
rewarding entries.
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Bid/ask is a highly efficient market distribution mechanism that presents a constant
moving target for traders. There are 6 components to predicting price from the spread:
strong ask, neutral ask, weak ask, strong bid, neutral bid and weak bid. Follow the tape with
YOUR DAILY a focus on these forces and you'll access excellent short-term momentum data. When
MARKET conditions create volatility or imbalance, the spread widens and price tends to surge farther
on fewer shares. While this movement can be nerve-wracking, it also provides most of the
GUIDE
profit potential the day trader is likely to encounter.
The electronic markets operate differently than the listed exchanges. NASDAQ Level I
shows only the best bid/ask underlying their competitive market maker system while Level II
lists all the players chasing the inside price. A single specialist and several third party
Featuring
exchanges direct all the action on the NYSE. The size of available shares shown on the
tape tends to be accurate on the listed exchanges. But NASDAQ size remains highly
deceiving. While the drab 10x10 mystery lots of prior years are gone, both execution and
bid/ask displays are marred by exchange rules designed to profit insiders and hurt both
Interactive
investors and traders.
Trading
Picks
Although the marketplace ultimately decides price direction, specialists and market
PICKS, CHARTS,
SCANS, IDEAS & makers constantly use their inside knowledge to trigger volume and profit their own
accounts. Specialists have the little black book that shows the location and size of all stop
PROFITS
orders. Market makers have a similar advantage with Level III. In the absence of more
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pressing market conditions, insiders will always push price in the direction they expect the
MORNING
most volume or one that will set up their own accounts for the most gain.
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A quiet neutral, neutral-negative bid/ask or high volume, high negative bid/ask can
and
EVERY MARKET both provide favorable trading environments for the short-term trader ready to go long.
DAY!
In neutral markets, cash waits for opportunity and price can jump quickly when it appears.
And wide, highly negative bid/ask spreads in very active markets often signal a short-term
bottom and offer quick bounce profits.
Serious traders also watch tick, breadth and index to predict the impact of the ticker
tape. Use these measures to locate convergence-divergence with individual price action.
For example, index movement provides highly accurate prediction on short-term direction
for many individual stocks. Use them to filter entries during corrections and to locate key
reversal zones. Avoid long positions when an underlying index violates key support, even
when the tape is improving.
Strategies
from
Today's
Most Successful
Market Players
SPECIAL REPORTS
in the
Wizards Den
Trading for a Living
Leading & Lagging
Indicators
Stock Selection
& Risk
Tale of the Tape
Even with
the
tremendous
variety of
available
information,
watching
price
pulses on
time and
sales
remains the
single most
accurate
method for
short-term
price
prediction.
The
emotions of
fear and
greed
reveal
themselves
more
clearly in
this rapid
pulse than
in any other
reading of
the ticker
tape.
More!
All original materials: © 2003 Brooke Publishers, Inc.
Comments: [email protected]
20 Golden Rules
for Traders
Trading Tactics
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EXTEND YOUR ADVANTAGE IN EXTENDED HOURS
TACTICS
TUTORIAL
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The trading day doesn't begin at 9:30 a.m. New York time, nor does it end at 4 p.m.
Thousands of shares pass hands in the pre- and postmarkets, outside of normal business
hours. Trading is tough enough when everyone else is doing it, so why get up early or
stay late?
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The bottom line is that you'll make more money and take smaller losses if you play well in
the extended hours.
The pre- and postmarkets opened to the retail crowd during the height of the bubble. In
prior years, trading outside the exchanges was limited to Instinet. The senior ECN
(electronic communications network) was a private club back then, with participation
YOUR DAILY limited to institutions. That changed when Island ECN offered the little guy a cheap way to
MARKET trade into the dinner hour.
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At one time, it was assumed world markets were headed into 24-hour nirvana, where
liquidity would follow sunrises around the globe. The bear market ended that pipe dream,
as volume dried up in the extended hours. Now, three years later, only liquid stocks and
big news attract enough interest to light up trading screens before and after the bell.
Featuring
But these times of day still offer tremendous opportunities. One after-hours strategy
Your
unloads long positions at higher prices after a rally or covers shorts at lower prices after a
Original Guide
selloff. This is also a great time to pick up new positions, before the regular crowd bids
Interactive them up or down.
to
Trading
Successful
Picks
Short-Term Trading
I use the pre- and postmarkets more now than at any time in the past. The extended
PICKS, CHARTS, sessions are thinner these days, but they've also become the amateur hour. You can buy
Highly Effective
SCANS, IDEAS &
Market Strategies
and
sell
at
amazing
prices
if
you
pay
close
enough
attention
to
news
and
sentiment.
This
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and
is especially true after one side gets trapped when the closing bell rings.
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Last Thursday the markets closed at new lows after many players expected a bounce.
Minutes after the closing bell, Macromedia (MACR:Nasdaq - news - commentary research - analysis) was being offered at 35 cents below the final print, and there was no
news. This stock just broke out a week ago, and I'd been watching it for a pullback play.
So I immediately stepped in and took those shares. It opened unchanged on Friday and
kept going higher throughout the day.
Traders can sell short Nasdaq stocks without an uptick during these sessions. There's a
lot of money to be made when your sale matches up with an overeager buyer. The
danger lies in taking a position at the wrong price, because it could open much higher the
next day. Often I'll send the short position back out after I get a good fill, hoping to flip it to
weaker hands rather than waiting for the opening bell.
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ECN hours vary, but most trading takes place from 8 a.m. to 9:30 a.m. and 4 p.m. to 6:30
p.m. Eastern time. I'm always up and active before 8 a.m. because those first trades can
be way off the mark. It's amazing how greed and fear impose their will on weak-minded
traders. Somehow I feel it's my duty to take their shares and teach them a valuable
lesson.
A good practice is to keep one eye on the 24-hour Globex market during the extended
sessions. Get this data at the Chicago Mercantile Exchange site if you don't have a better
source. Overnight futures charts provide a set of support-resistance pivots, because many
stocks move in tandem with the Nasdaq 100 or S&P 500 futures before and after regular
market hours.
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Extended hours can be very risky if you don't do your homework. Pick your spots
carefully, or you'll find yourself in hot water when the market opens. Illiquidity often
translates into a very wide bid-ask spread during this time. This built-in disadvantage
demands an intuitive sense of support-resistance levels, as well as fast access to
breaking news.
It's important to know the difference between hidden size and amateurs making bad
decisions. Take a little stock, even 100 shares at a time, and see if it reduces the offer
showing up on your trading screen. If the offer drops down, take all the stock and see if it
goes away or refreshes. When big shares turn against you, get out immediately and look
for a better opportunity. The best strategy is to trade with the hidden size and against the
amateurs.
All direct access brokers offer pre- and postmarket trading. Some discount brokers let you
do it, and some don't. If you're not sure about your broker, head over to its Web site and
read the fine print.
The counterparty to your trade may bust it when it's too far away from the closing print.
This falls under the category of an erroneous fill, and it can be contested by the wounded
party. Island ECN considers a trade 20% outside the market price as an erroneous fill, so
don't get giddy when you buy a $10 stock for under $8. This is especially true if the stock
opens unchanged in the next regular session.
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All original materials: © 2003 Brooke Publishers, Inc.
Comments: [email protected]
20 Golden Rules
for Traders
Trading Tactics
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PULLBACK DAY TRADING
TACTICS
TUTORIAL
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A stock you follow takes off and trends sharply. But you miss your entry and watch in
frustration as it clears one hurdle after another. Finally it stops and reverses. As it pulls
back on your 5-min chart and Level II screen, you have to decide whether or not to join
the action.
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Predicting price movement when an intraday trend pulls back requires both skill
and patience. Some corrections persist or roll over into ranges that empty trading
accounts. But others quickly bounce and take off to new highs. How can you tell which
outcome is more likely?
The first pullback from a breakout has high odds of rapidly ejecting in the
YOUR DAILY direction of the new trend. But watch the depth of the correction. If it breaks through
MARKET
several minor support levels before reversing, sellers will likely emerge when price tests
GUIDE
the short term high. This common scenario will still produce good trades. With enough
reward between your entry and the short-term high, you can place a sell order 1/16th or
1/8th below the top and ride the bounce into a quick fill.
Featuring
Use a 6-Out rule to measure trend pullbacks. Start your count with the first bar lower
than the parabolic extension of the trend. Watch for a pullback at the same angle as the
trend itself or in a tight sideways pattern. The next trend leg should begin no later than
the 6th congestion bar.
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Why does this work? Many day traders set their short-term chart indicators to periods
that measure 5 to 8 price bars. 6 bar corrections will often reflect short-term support at
these common settings. If price does not eject, the next bar can signal a trend change
PICKS, CHARTS, and trigger waves of reflex selling by this fast-finger crowd.
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Keep in mind that markets often move in 1-2-3 patterns. Countertrends follow a
natural tendency to pullback, bounce and then pullback again before finding support.
Traders often fool themselves by jumping on the first bounce rather than waiting for the
corrective move to unwind. The deeper a stock corrects, the less likely it will take out the
old trend high and break into another wave. For this reason, only tight and small 1-2-3
patterns signal new trend movement.
Use a short-term oscillator, such as Stochastics, to measure an intraday rally's
duration. After each price thrust, odds decrease that the trend will continue. Oscillators
measure the depth of this overbought condition and provide early warning when a
pullback lasts too long. Set these indicators to watch the same signals that other traders
use to make their decisions. Then plan your trades to step in front of their reactions.
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HARD RIGHT EDGE
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TRADING
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Strategies
from
Today's
Most Successful
Market Players
SPECIAL REPORTS
in the
Wizards Den
Trading for a Living
Pullback Support
More
Leading & Lagging
Indicators
Moving
averages
and
Bollinger
Bands
measure
how far
price
should
pull back
before
reversing
in the
direction
of the
trend.
Notice
how this
NXTL
intraday
trend
repeatedly
bounces
at the 8
bar MA.
Trends
tend to
find
support at
similar
levels on
each
correction.
Use
Moving
Average
Rainbows
to identify
the right
settings
for each
unique
pattern.
Stock Selection
& Risk
More!
All original materials: © 2003 Brooke Publishers, Inc.
Comments: [email protected]
20 Golden Rules
for Traders
Trading Tactics
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TALE OF THE TAPE
TACTICS
TUTORIAL
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It's time for a rude awakening. The years you spent studying technical
analysis may not make you a good trader, and all that hard work may not
yield a decent return. So what did you miss when learning to play the
game? You forgot to master the art of tape reading.
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YOUR DAILY
MARKET
GUIDE
Let's be fair. Traders get a lot of mileage by studying the charts. But to
carry your game further and trade like a pro, you have no choice but to
master the ticker tape. And it's not easy, because there's no definitive book
or formula on the subject. The reason is sobering: Reading the tape must
be learned through personal experience and long observation.
Accomplished tape readers spend hours staring at the numbers and
watching the tempo of the market day.
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Price and Volume
Follow the numbers and see how your knowledge grows. You'll access a
market pulse hidden to other traders. To get you started on this long and
winding road, here are a few tricks to the secrets of the tape.
Featuring
Let's start with something simple. Price and volume give tape-readers 90%
Your
of the information they need to trade the market. To tap into this vast
Original
Guide
wealth, study the tape with one eye on the clock. Swings and reversals
Interactive
to
tend to occur in predictable cycles. For example, watch for the "three-bar
Trading
Successful
reversal" at about 11 minutes into the new session. Follow the tape in
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Short-Term Trading
whatever direction price moves at the open, and see how momentum
PICKS, CHARTS, fades at the critical time. Then jump in and execute a trade to take
Highly Effective
SCANS, IDEAS & advantage of the reversing tape.
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Here's a tape trick to get a read on the crowd's excitement level. Place a
65-day average volume next to your real-time daily volume for your favorite
stocks. Those trading through their averages flag impending breakouts and
breakdowns. This side-by-side analysis works best when a stock moves
and
against the broader market. For example, it heads up on a down day and
EVERY MARKET
trades over 50% of the average in the first hour. You're getting a powerful
DAY!
clue it will lead the market, especially at broad turns.
Tape Reading Tricks
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Epics are written about Nasdaq Level II. But the tale of the tape often gets for a New Generation
lost in LII mumbo-jumbo. Many tape-readers use Level II as a contrary
indicator. For example, execute trades against big size on Island ECN, and
with small size on Redibook or Instinet. Another trick is to ignore the
market makers and ECNs lined up on either side of the spread, and track
only the depth of their interest (i.e., how far down the sell side, or up the
buy side they stay in the market). Also see who moves in to fill the gap
when the spread opens more than 10 to 12 cents. That's the side with the
most motivation, and the one that will likely move price.
Market wizard Larry Pesavento points out a powerful tape-reading tool
called the opening price principle. Through years of observation, he
discovered how the opening serves as a pivot through an entire session.
He instructs traders on how to read tape when price returns to retest the
opening. Always keep the opening next to the current ticker. If price
retraces to that level during the session, follow the tape to see how it
reacts. Then use opening price breaks and reversals as trading signals.
Hard Right Edge
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Alan S. Farley
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It's 3 o'clock ... do you know where your stock is? Tape-readers pay close
attention to the relationship of current price to the daily range. Real-time
quotes refer to this ratio as the "percent in range." This simple number will
track the progress of a long watch list in seconds. For example, there's an
hour to go and the market is down. Most of your list is scraping the bottom
third of the daily range. But one or two stocks pop "100%" on the "percent
in range" quote. Those stocks are breaking to new highs, while the rest are
doing nose dives. You've just uncovered the strongest names on your list,
and the ones ready to make you money.
Hard Right Edge Recommends:
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All original materials: © 2003 Brooke Publishers, Inc.
Comments: [email protected]
7-BELLS SCANS
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20 Golden Rules
for Traders
Trading Tactics
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TAPE READING
TACTICS
TUTORIAL
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Have you learned to read the tape yet? Take the first step and memorize key price
levels on your favorite stock charts. Then watch the ticker or LII screen closely when
price approaches these critical points. Price action zones trigger both volatility and
volume. Observe how the tape reacts and see if you can predict key reversals before
the crowd does.
Wizards
Traders can now access four levels of ticker tape information. In the past,
Resources professionals relied on the manual ticker, an early version of the scrolling CNBC
display. Real time services then introduced single-issue Level 1 packages that updated
the inside bid/ask. As processing power grew, vendors added historical time and sales
grids that featured all trading activity in a spreadsheet format. Recently, Level 2
YOUR DAILY NASDAQ has revolutionized trade information with a complex display of the key
MARKET players that make a market in each stock.
GUIDE
Featuring
Always look outside the tape flow before execution. Time of day, market sentiment,
characteristics of a particular stock and chart support/resistance affect the importance
of tape transaction signals. Keep in mind that all skilled tape reading relies on one key
mechanism to locate profitable signals: market makers and specialists use their
knowledge of the order book to move their markets in whatever direction yields the
greatest volume. They will routinely manipulate trader emotions against the order flow
to shake them out of their positions.
Interactive Market players keep one eye on their markets and the other on external
conditions that affect prices. Quiet times (lunch hours, holidays) offer prime
Trading
conditions to gun key support and trigger common stop locations. And during long
Picks
periods of little interest, price can reach important levels on very little volume. At these
PICKS, CHARTS,
SCANS, IDEAS & times, insiders will test the breakout waters to see how much new trading interest they
can generate.
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Although each issue has its own personality, most emotional market behavior
unfolds in a straightforward manner. Price will respond with sharp movement in the
direction of the impulse but then pause and test demand with short pullbacks. These
countertrend movements highlight the real challenge for tape readers. Volume can dry
and
EVERY MARKET up at any moment and for no apparent reason, trapping one side in a sudden reversal.
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Level II Screen
More information does not necessarily improve trading results. NASDAQ Level II
provides detailed data on market makers and the depth of their markets. Unfortunately
such information may focus the trader on the process rather than the result. The final
resolution of this price competition often triggers more valuable signals for profitable
execution.
Strategies
from
Today's
Most Successful
Market Players
SPECIAL REPORTS
in the
Wizards Den
Trading for a Living
Leading & Lagging
Indicators
Stock Selection
& Risk
More!
All original materials: © 2003 Brooke Publishers, Inc.
Comments: [email protected]
20 Golden Rules
for Traders
Trading Tactics
NEW TO TRADING & TECHNICAL ANALYSIS?
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BOLLINGER BAND TACTICS
TACTICS
TUTORIAL
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From the Release THE MASTER SWING TRADER
© 2000 McGraw-Hill and Brooke Publishers. All Rights Reserved.
Bollinger Bands draw their power through two important characteristics. First, they
exhibit an underlying trend-range axis just like price or moving averages. Second, they
constrict or expand as they move. The interaction between these two forces draws unique
patterns as bars unwind through its boundaries. Candlesticks work especially well with
bands. For example, a Doji that strikes through a constricting band effectively signals a shortterm reversal.
BBs bend and twist in response to price movement. These undulations predict how far
trends should stretch before central tendency forces them back toward a central axis.
YOUR DAILY Complex relationships develop between price-band direction and price-band constriction. For
example, a trend tends to pause when constricting bands oppose it. It takes great skill to
MARKET
predict the bands' ultimate impact on price but is well worth the effort. More than any other
GUIDE
tool, BBs pinpoint hidden swings and telegraph whether the profit door lies open or closed.
Featuring
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Bands may swing through relative highs or lows and then pull back into proportional
retracement to start another trend thrust. Or they can enter extended ranges that
meander back and forth without direction. Movement frequently stops dead in its tracks when
price rises into a falling band or drops into a rising one. Sideways bands can appear in both
rangebound and trending markets. Price often fails to reach new high or low territory until
bands expand to clear the path. In many ways, Bollinger Bands predict time better than they
predict price.
Buy Signal
PICKS, CHARTS, The top Bollinger Band rises toward a test of the intraday high as Worldcom drops. This
SCANS, IDEAS & sharp divergence signals the eventual breakout after price finally reverses off of the bottom
PROFITS
band. Watch band slope closely when bars return to test important highs or lows. It often
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reveals the time and force needed to push price through a S/R barrier.
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Your
Original Guide
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Successful
Short-Term Trading
Highly Effective
Market Strategies
and
3-D Charting Techniques
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More Info
and
EVERY MARKET
DAY!
McGRAW-HILL
PUBLISHERS
presents
Trading Skills
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Generation
Hard Right Edge
Founder
Alan S. Farley
More
ORDER NOW!
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Complete 7Bells Scans
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Info
The skilled eye watches constricted bands in real-time to estimate the buying or
selling force required to push them out of the way. They work extremely well during the
second test of an important high or low. When markets finally break out, expanding bars
often shoot into the band's edge where congestion forms a flag until the BB allows further
movement. Bands constrict tightly around narrowing price in sideways markets. Apply NR7
methodology here to anticipate an impending positive feedback event.
Bollinger Bands signal early warning of trend change. Sharp price movement forces
bands to expand outward. When these active markets finally turn sideways, the bands slowly
tighten and roll toward price. Time passes and the BB door closes on rapid vertical
movement. Experience enables the swing trader to quickly estimate the time required before
bands will tighten and plan accordingly.
Strong buying or selling may push price well outside a band. A tall bar can even print
completely through the barrier in extreme conditions. General tactics suggest that violent
reversals often follow these major band violations. But trading against these events carries
risk since markets can print a short series of these volatile bars before the reversal takes
place. Also note that this price action rarely occurs during intraday markets, except at the
open.
Reduce risk by dropping down to the next lower time frame and waiting for a reversal
there before executing a countertrend position. Odds also improve if the thrusting bars
run into other forms of S/R that allow cross-verification for the entry level. Stay defensive
during the trade. Once price returns within the band's limits, the underlying trend can
reappear quickly unless the pullback generates other reversal signals. Look for Dark Cloud
Cover or a similar candle pattern that fills any gap created by the bar outside the band. This
complex setup can produce windfall profits if managed properly.
Swing traders work the quiet middle ground of Bollinger Bands for consistent profits.
Build strategies that enter countertrend positions at one band and exit at the other. These
swing setups face far less whipsaws than breakout entries at band extremes. Keep in mind
that the center band presents a natural profit obstacle that needs special consideration when
calculating reward: risk. Make sure a safe exit near this center point still produces a decent
profit for the trade.
Multiple Support-Resistance
A broad range sets up profitable swing conditions for KLA-Tencor. This 13-bar Bollinger Band
combines with simple horizontal S/R to uncover natural reversal zones at band extremes.
Enter a countertrend position when the prior bar prints a candlestick reversal outside the
band line. Wait for a break of the center band if no clear signal arises. Exit if price does not
expand quickly in the other direction or if the signal fails and the candle shadow gets taken
out. Watch S/R closely for positive feedback that will eventually carry price out of the
sideways market.
Use multi time frame Bollinger Bands to avoid expensive trend relativity errors. Look at
the same market through 3 different time frames. This corresponds to one above and one
below the chart that aligns with the holding period. Each setting produces a different range of
band extremes and relative price location within the indicators. Match reward: risk to the
central time frame but observe all intervening S/R on the other charts. Consider whether the
holding period allows enough time to mount barriers and reach targets at other band levels.
Keep in mind that all bands change dynamically in response to price. This allows
continuous feedback that shifts target values with each bar. Experience with this powerful
indicator helps swing traders anticipate how it will move. The longer that price travels
sideways, the tighter the bands become. Trend change for the bands themselves first begins
with a turn by the band closest to the prior price trend. For example, when an uptrend prints
along a top band, expect this side of the indicator to turn down before its twin when price
moves into a range or downtrend.
Combine Bollinger Band study with momentum-based indicators. This helps filter
directional movement from rangebound markets and improves trade timing. Add MA Ribbons
to price and display the MACD Histogram across the lower pane. Price often remains well
within band constriction during the early phases of new positive feedback events. As these
indicators show rising momentum, shift attention to natural pattern/band breakout levels and
look for entry within narrowing bars.
Hard Right Edge Recommends:
Low Commissions/Excellent Service:
We Strongly Recommend CyberTrader as your
professional trading solution.
All original materials: © 2003 Brooke Publishers, Inc.
Comments: [email protected]
20 Golden Rules
for Traders
Trading Tactics
NEW TO TRADING & TECHNICAL ANALYSIS?
Click Here
FIVE FIBONACCI TRICKS
TACTICS
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Fibonacci jumped into the technical mainstream late in the bull market. Futures
traders had it all to themselves until real-time software ported it over to the equity
markets. Its popularity exploded as retail traders experimented with its arcane math
and discovered its many virtues.
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Fibonacci ratios describe the interaction between trend and countertrend markets -38%, 50% and 62% retracements form the primary pullback levels. Apply these
Resources
percentages after a trend in either direction to predict the extent of the countertrend
swing. Stretch a grid over the most obvious up or down wave, and see how
percentages cross key price levels.
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YOUR DAILY Convergence between pattern and retracement can point to excellent trading
MARKET opportunities. Keep in mind that retracements work poorly in a vacuum. Always
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Discord between retracement and the underlying pattern generates noise instead
of profit. Move on to a new chart when nothing lines up correctly. This divergence
generates most of the whipsaw in a price chart. Alternatively, strong phasing
between Fibonacci and pattern exposes highly predictive reversals at narrow price
levels.
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First Rise/First Failure marks the first 100% retracement of a trend within your time
frame of interest. It provides an early reversal warning after a new high or low. The
100% retracement violates the major price direction and terminates the trend it
corrects. From this level, the old trend can reestablish itself if it breaks through the
old 38% level. More often, traders will use that level to enter low-risk positions
against the old trend.
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Parabolic movement tends to occur between the 0%-to-38% and 62%-to-100%
Fibonacci levels in all trends. This tendency offers a great tool for finding the big
moves when looking for trades. Watch for congestion to form at the 38% or 62%
level. Then use a simple breakout or breakdown strategy when price moves past it.
The next thrust can be dramatic, with price moving like a magnet back to an old
high or low. Of course, the strategy only works when you can find these levels in
advance.
Continuation Gap Extensions
You can often target the exact price a rally or selloff will end at by using the
continuation gap as a Fibonacci extension tool. Identify the gap by its location at
the dead center of a vertical price wave. Then start a Fib grid at the beginning of
the trend and extend it so the gap sits under the 50% retracement level. The grid
extension points to the terminating price for the rally or selloff.
Overnight Grids
Find an active stock and start a grid from the high (or low) of a session's last hour.
Stretch the grid to the opposite end of the next morning's first hour low (or high).
This defines a specific price wave traders can use to uncover intraday reversals,
breakouts and breakdowns. The overnight grid also offers a way to trade morning
gaps. The gap will often stretch across a key retracement level and target low-risk
entry on a pullback.
Second High/Low
Many traders can't figure out where to start a Fib grid. Here's a trick to help you
place it where it'll do the most good. The absolute high or low in a price wave isn't
the best starting point for a grid most of the time. Instead, look for a small double
bottom or double top within the congestion where the trend began. Swing one end
of the grid over this second high (or low), instead of the first. This will capture a
specific Elliott Wave that conforms to the trend you're trying to trade.
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FUN WITH FIBONACCI
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12th century monk Leonardo de Pisa, better known to his friends as
Fibonacci, discovered a fascinating mathematics sequence that appears
throughout nature. Beginning with a simple 1 + 1, the sum of the last two
number sets that precede it creates another Fibonacci value:
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1+1=2 1+2=3 2+3=5 3+5=8 5+8=13 8+13=21 13+21=34 21+34=55 etc, etc.
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For reasons that remain unknown, major ratios drawn from these numbers
describe a predictable interaction between trend and countertrend
movement in markets. The most important ones to remember are 38%, 50%
and 62%. Applying these percentages to trending price predicts the extent of
YOUR DAILY retracement contrary to the underlying trend, as well as how far a new high or
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low will travel. For traders, these hidden points represent invisible
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Fibonacci numbers closely relate to Elliott Wave theory. However, using
them requires only a short primer in that arcane study. At the minimum,
develop the basic understanding that primary trends travel in 5 waves (3
forward and 2 backward) while countertrends move in 3 waves (2 forward and 1
backward). That's all you need to easily manipulate Fibonacci price grids.
Grab some charts and a good charting program. All good technical analysis
software has this Fibonacci function. For example, both SuperCharts and Real
Tick allow custom entry of all major points. Lay Fib lines over the extremes of
dynamic trends using the Fibonacci Grid. Or just take a calculator and measure
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Placed correctly, you'll notice that most markets swing off Fibonacci
ratios as they move from support to resistance and back. Once you get the
knack of it, you'll see that trends in all time frames have common elements and
similar proportionality.
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a market at major ratios while standing aside as price hovers between key
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Fibonacci
defines
trend
movement
over broad
time frames
as well as
very short
ones. On
this weekly
chart of
CPQ, note
how the
38%, 50%
and 62%
retracement
of the strong
1997 rally
have
defined the
broad base
under
construction
for almost
two years.
Retracement
science
works in
bear
markets as
well as bull
markets.
Major
market
plunges
frequently
recover 50%
or 62% of
the last
selloff
before
continuing
the decline.
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MOVING AVERAGE CROSSOVERS
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Let's talk about the Golden Cross and the Death Cross. No, we're not opening a
deck of cards and telling your fortune. These colorful terms refer to patterns you
probably use every day in your trading but don't refer to by these names. Along
with its many cousins, they comprise a whole division of technical analysis. You
might know them better as moving average crossovers.
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Moving averages emit vital market data, but all of them exhibit one common
limitation: They lag current events. By the time a 20-bar average curves upward to
confirm a trend, the move is already underway and may even be over. While faster
incarnations (such as exponential averages) will speed up signals, all of them ring
the trading bell way too late.
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Multiple moving averages overcome many flaws of the single variety. They're
especially powerful when used in conjunction with price patterns. For example,
pick out a long-term and a short-term average. Then watch price action when the
averages turn toward each other and cross over. This event may trigger a good
trading signal, especially when it converges with a key support or resistance level.
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Averages display all the common characteristics of support/resistance. For
example, one average will often bounce off another one on a first test, rather than
break through right away. Then, like price bars, the odds shift toward a violation
and crossover on the next test. Alternatively, when one average can't break
through another average after several tries, it sets off a strong trend-reversal
signal.
Different holding periods respond to different average settings. One-to-three-day
swing trades work well with averages that maintain a 3x to 4x relationship between
shorter and longer periods. This allows convergence/divergence between different
trends to work in the trader's favor.
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For example, the daily chart may show a strong uptrend, while the 60-minute chart
begins a deep pullback. A 40-day average will stay pointed in the trend direction
for a long time, but a 13-day average (3x13=39) will turn down quickly, and head
straight for the longer average. The point where they intersect represents a major
support level.
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Crossovers mark important shifts in momentum and support/resistance regardless
of holding period. Many traders can therefore just stick with the major averages
and find out most of what they need to know. The most popular settings draw
charts with a 20-day for the short-term trend, a 50-day for the intermediate trend
and a 200-day for the big picture.
Long-term crossovers carry more weight than short-term events. The Golden
Cross represents a major shift from the bears to the bulls. It triggers when the 50day average breaks above the 200-day average. Conversely, the Death Cross
restores bear power when the 50-day falls back beneath the 200-day. The 200day average becomes major resistance after the 50-day average drops below it,
and major support after breaking above it. When price gets trapped between the
50-day and 200-day averages, it can whipsaw repeatedly between their price
extremes. This pinball action marks a zone of opportunity for swing trades.
Crossovers add horsepower to many types of trading strategies. But try to limit
their use to trending markets. Moving averages emit false signals during the
"negative feedback" of sideways markets. Keep in mind these common indicators
measure directional momentum. They lose power in markets with little or no price
change.
For years, technicians have tried to filter crossover systems through trendrecognition formulas in order to reduce whipsaws. You can try this for yourself, or
just look for price patterns that tell you the crossovers are worthless.
Persistent rangebound markets limit the usefulness of all types of average
information. All moving averages eventually converge toward a single price level in
dead markets. This flatline behavior yields few clues about market direction. So
stop using averages completely when this happens, and move to oscillators (such
as Stochastics) to predict the next move.
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TRADING THE 50-DAY MOVING AVERAGE
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Seats on the 50-yard line give football fans the ideal place to watch a game unfold. It's no different when
traders focus their attention on the 50-day moving average. This neutral ground between bulls and bears
offers a perfect view of the market's playing field. This column has looked at the 50-day moving average
many times. In May, I showed how to use it as a buy signal on pullback trades. Last September, I examined
the market mechanics behind this versatile tool. And a year ago, readers discovered how crossovers
between the 50-day and 200-day averages signaled new bull or bear market impulses.
Let's explore how the 50-day fits into a broader trade analysis and why I place the indicator (or its intraday
cousin) on every chart I view. Keep in mind that these examples aren't stock picks yet, so don't flame me if
they don't act a certain way.
YOUR DAILY I spend weeks watching a chart until the price sets up perfectly at the 50-day average. If I've done my
MARKET homework, the trade entry will come at the ideal time, rather than at the ideal price. For example, a pullback
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Traders must choose between an ideal price and ideal time in most of their entries. Ideal price means
entering into high volatility when price gets stretched to an extreme. Ideal time means standing aside until a
pattern sets up for the move. Trading by price reduces risk but requires more patience. Trading by time takes
on higher risk in exchange for the likelihood of an immediate move.
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Juniper Networks had a great run off its October low. It hit a high at $15 three weeks ago and started to pull
back. Notice how it gapped down through the 50-day moving average on June 24 and then filled the gap. The
question is whether there's a buying opportunity now that it has bounced off support.
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Aggressive traders might enter near the June 24 low, assuming the 50-day average would hold and set up a
decent rally. That level represents the ideal price at the moment. But the ideal time hasn't come yet, because
there's no way to tell if the selloff is over.
The pattern shows a three-stage correction with a selloff, bounce and second selloff. Markets like to correct in
threes or fives, but the chart doesn't tell us which type to expect. It makes sense to wait for the pattern to give
us a buy signal. This won't come until lower highs of the correction are broken to the upside. That would
signal the ideal time to enter a long position.
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The Altera correction started out the same way as Juniper. It did a 1-2-3 selloff to the 50-day moving average
and bounced. But then it rolled over and broke support in a third leg down. This gives traders valuable but
conflicting information. It completes a wave-set that often precedes a strong reversal. But the last leg broke
intermediate support at the 50-day average.
The conflict sets up two interesting trade possibilities. The first is a 50-200 "pinball" play. Notice how the June
27 bar rallies back to resistance at the 50-day average and sells off. This level provides the ideal price for a
short sale down to the 200-day average. The trader would then cover the short position at the average, hence
the "pinball" designation.
The second trade is more potent but requires ideal timing. We know the decline may be over, giving us an
ideal price to go long. But we have no buy signal, so it's risky to enter the market. If we're lucky, a signal
comes when price remounts the broken 50-day average.
This small rally triggers a "failure of a failure" that traps short-sellers and forces them to cover at a loss. This,
in turn, lifts our long position into a substantial profit.
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Sometimes the ideal price and ideal time line up perfectly. This means the pattern points to a reversal or
breakout at a very narrow price zone. This rare confluence can set up very profitable trade entries. For
example, look at the current selloff in Goldman Sachs. It charged out of a long base in late May and rallied up
to $92. Then it turned tail with the broad market and headed back down.
The 50-day average is rising up to greet the falling price at the same level as last month's breakout. This tells
traders to look for a high-volatility reversal at this support. The turnaround would fulfill ideal price, because
support should hold on the first test. It also fulfills ideal time, because the selloff could transform into a V-type
move back to the high.
There is endless debate about which calculation to use for the 50-day moving average. The most common
math just takes the last 50 bars and divides by the total. Not exactly rocket science. Technicians have
tweaked the output in many ways over the years, trying to build a better mousetrap.
The most popular variation is the exponential moving average, or EMA. This version addresses a doublecount error in the original calculation and produces a reading that responds more quickly than the original
math. Since the early bird tends to get the market worm, the exponential average is now the most popular
choice in the professional community. It's also the way I look at the market. I noted previously that the chart
examples represent works in progress, i.e., they're not stock picks that readers should run out to buy or sell
immediately. They're developing setups that are intended to highlight the mental work flow that traders must
go through to find good positions.
Price action at the 50-day average flags many short-sale opportunities. Keep in mind that it's best to stay with
the trend when taking trades off this indicator. This means waiting until price breaks below it on strong
volume then rallies back to test it from below. The subsequent reversal should set off sell signals across all
kinds of trading platforms.
Whole Food Markets gapped down on heavy volume in early May. Notice how it already tested and failed the
average after the initial selloff. The stock then continued to decline, breaking several trendlines and the 200day EMA. Now that it's stabilizing at lower prices, there may be another rally back to the 50-day EMA.
This could set up a better short sale than the initial failure. The stock now has less sponsorship because of
the significant decline. The chart also shows a confluence of the 50-day and 200-day averages, as well as
the last broken trendline. Seeing these elements converge at a narrow price level is just what the short-seller
is looking for to enter a new position.
Genzyme's interaction with the 50-day average is obvious from a quick glance at the chart. Over and over
again, it drops just below the average, sits there for a few bars and makes another run at the highs. How
does a trader find the ideal time to go long and not miss the next run-up?
The 50-day average works well in combination with relative strength indicators, such as Wilder's Relative
Strength Index. The GENZ chart shows a 14-day RSI, smoothed by seven-day periods. This is the setting I
use for all my end-of-day analysis. This popular reading reduces noise and makes indicator reversals less
susceptible to whipsaws.
Notice how the RSI turns up ahead of each rally off the 50-day average. This shows the stock "healing" after
each pullback and attracting the interest of fresh buyers. The stock returned to the average about six bars
ago, but relative strength is still pointed down. This divergence warns traders to stand aside, because the
bounce is not likely to start in the next few bars.
I use the 50-day average on all my intraday charts. Well, it's actually a 50-period average based on the length
of time each bar represents. For example, this Yahoo! chart shows a 50-bar, 60-minute exponential moving
average. Intraday averages work exactly the same way as their daily cousins, with one important distinction:
There's a lot more noise in the intraday markets.
This means price can jump across the average several times, although support or resistance may not be
violated. Using the indicator for short-term analysis requires a good read of the charting landscape. In this
time frame, the best signals come when price sells off from a much higher level or rallies from a much lower
level into the average.
Yahoo! shows how the best time to enter a trade often comes many bars after price hits the average for the
first time. Try waiting for the next pullback to the average before entering a long position. This last decline
wakes up the double-bottom crowd and often revs up enough momentum for a strong rally.
Traders need to know when to ignore the 50-day average. The rule of thumb with moving averages is that
they work well in trending markets but poorly in sideways markets. But this can be confusing with longer-term
averages, because using them requires looking at the big picture.
IBM shows a strong rally between October and December of last year. But it's been going nowhere since that
time. Notice how the 50-day average has been crossed or hit at least eight times in the last six months.
Signals taken because of this price action were doomed to failure, because the average lost its predictive
power in the long-term sideways market.
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I used to think only price bars could predict the future. I started as a novice,
experimenting with every indicator in the book. I could never get the markets to
match my mathematics, so I finally gave up and became a pattern reader. In fact,
my early writings are so pattern-centric they appear intolerant of all other trading
techniques.
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I've had a change of heart in recent years because of a tool that's saved my neck
on a ton of trades -- the overused and underappreciated stochastics.
What exactly is the stochastics oscillator? It may seem like a simple question, but
the answer isn't. The term describes a mathematical process that has an infinite
YOUR DAILY progression of random variables. Let's dumb it down a bit. Stochastics measures
MARKET how a market closes each price bar relative to its range over time.
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This is urgent information for all types of traders. Scalpers use it to read the tempo
as money flows through their one-minute charts. Investors use it to identify cycles
as weekly stochastics alter the balance of power. But this valuable tool won't give
up its secrets easily, and it requires thoughtful interpretation.
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The settings you choose don't matter because stochastics print valid patterns with
any set of inputs. Different settings will emit different levels of "noise" in the
subsequent output. For example, notice how the five-, 13- and 21-day settings on
the PetsMart chart affect crossovers at key turning points.
The approach here is to match your inputs with your trading style. For example,
daytraders capitalize on subtle shifts in market direction and will benefit from shortterm settings. On the other hand, long-term settings help position traders avoid
false signals.
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Many traders get fooled when stochastics flip to an extreme because they look for
a reversal instead of trend continuation. Ironically, the most dynamic price
movement often takes place right after these levels are breached. So how do you
avoid bad signals and use stochastics for its intended purpose? Look at the unique
patterns.
The stochastics middle ground tells you the trend is your friend. Watch when the
fast line pulls away from the slow line in this zone. This reveals increasing
momentum in the direction of the short-term trend.
How can you use this information? Look to buy on the dip (rising) or sell on the
bounce (falling) as long as the indicator doesn't roll over. One effective variation of
this pattern is a 1-2-3 move where the indicator thrusts out of one extreme, pulls
back a little and then thrusts again.
Take advantage of the price surge when stochastics break into an overbought or
oversold level. Watch for the fast line to thrust away from the slow line right here.
This tiny signal often corresponds with a final burst of buying or selling before a
market reverses or goes flat. It corresponds with the profitable fifth wave parabola
in Elliott Wave Theory.
Stand aside when stochastics flatline across the top or bottom of the indicator plot,
but act quickly when they start breaking in the other direction. This Mesa reversal
signal is often timed perfectly with the break of a key support or resistance level.
One problem is you can't tell how far a move might carry from the indicator alone.
Look at the price pattern to find natural targets for the subsequent swing.
My favorite oscillator patterns are double-tops and double-bottoms. As with price
bars, I look for a lower second high to signal a top, and a higher second low to
signal a bottom.
Be patient when this pattern develops and let the lines drop away from extreme
levels to confirm the signal. This pattern is similar to the Mesa reversal described
above, but with one key difference -- it often triggers more follow-through on the
subsequent pivot because it reflects more underlying divergence.
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Voodoo trading could add a lot to your bottom line. W.D. Gann, R.N. Elliott and
other cultists spent years studying the market's mystical side, trying to figure out
how obscure ideas could tap hidden profits. Magic numbers, astrological dates
and prayer wheels have all been enlisted in the search for that elusive trading
edge.
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Most traders believe Fibonacci fits in the category of market witchcraft, but this
arcane science has a basis in fact. A 12th century monk known as Fibonacci
discovered a logical sequence that appears throughout nature. Beginning with 1 +
1, the sum of the last two numbers that precede it creates another Fibonacci
number. For example: 1+1=2, 1+2=3, 2+3=5, 3+5=8, 5+8=13, 8+13=21,
YOUR DAILY 13+21=34, 21+34=55, etc.
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Major ratios between Fibonacci numbers identify expected retracement levels, as
markets pull back after rallies or selloffs. The most common Fib retracements are
38%, 50% and 62% of the principal price movement. These are price levels where
many traders expect important reversals and bounces. For obvious reasons, these
also represent entry signals in many short-term strategies.
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Fibonacci patterns and the Elliott Wave are kissing cousins. According to Elliott,
major rallies or selloffs occur in three primary waves, with two countertrend waves
in between. These waves are often boxed into major retracement levels. Go back
and look at my article "Mind the Gaps." Notice how Fibonacci retracements can
also define levels where markets jump from one price to another.
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Markets swing off common retracements as they move from support to resistance
and back. But these dynamics have become harder to trade in recent years. The
popularity of Fibonacci as a technical tool is the likely culprit. Many smart players
now trade against key retracement levels because they know weaker hands will
jump in at these prices. For example, they will sell support just because of
expectations of a bounce at that price level.
But Fibonacci applications still have tremendous value for swing traders. The trick
is to use an original approach. First, never trade a retracement level in a vacuum.
Look for other forms of support or resistance to show up at the same price level.
For example, when you see a 50-day moving average, an intermediate high and a
trend line converge at a 62% retracement, the odds for an important reversal
greatly increase.
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You can also learn to trade the Fibonacci whipsaw. Stand aside when price pulls
back to a deep retracement level. Let other traders take the bait and get shaken
out when price breaks through the number. Then let the market reverse and jump
back across the retracement level. Use this crossing as your entry signal. The
markets usually punish only one side of the action at a time.
Apply less common retracement strategies to avoid the crowd. H.M. Gartley
described little-known Fibonacci relationships in his 1937 book "Profits in the
Stock Market." The Gartley Pattern relies on a 78% retracement, and represents
another way to capitalize on those caught in a 62% whipsaw. This classic setup,
first described almost 70 years ago, works just as well now as it did during the
Great Depression.
You can also trade Fibonacci extensions, instead of retracements. Market wizard
Larry Pesavento highlights a Gartley variation he calls the Butterfly Pattern. This is
a complex formation, which carries price 27% past a 100% retracement before it
reverses. Got that?
The combination of all these waves and ratios can certainly be confusing. But one
of the joys in applying complex Fibonacci math is its ability to confuse most
traders. After all, the markets rarely reward the trading style of the majority.
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20 Golden Rules
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MASTERING THE MOMENTUM TRADE
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Pattern Cycles generate powerful strategies to capitalize on changing
conditions and major turning points. But most traders fall into the momentum
game and never learn other tactics. While the greedy eye sees rising trends with few
pullbacks, most still lose money chasing a hot market. They realize too late that
momentum demands precise timing and strict emotional control.
Greed-fear exerts tremendous force during dynamic price movement and
clouds careful preparation. Ironically initial gains can be dramatic for new
momentum traders. Beginners luck and fearlessness combine to make those first
weeks or months very rewarding. But results often change quickly. Momentum
traders at all levels lack sound risk management.
YOUR DAILY
MARKET
Focus on the big gain dulls awareness of the big loss. Market insiders adjust
GUIDE
quickly to the momentum crowd and generate sharp whipsaws to shakeout the weak
hands. Confused participants start buying tops and selling bottoms with regularity.
Or they abandon their rules and try to survive by holding old winners through violent
selloffs and waiting for a bounce.
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Sharp trends print wide range bars and many gapping moves. This volatility
increases risk and inhibits safe entry-exit planning. Swing traders rely on supportresistance to define execution and reward targeting. Momentum markets often
display no common landscape features at all. This requires entry without a clear
violation level that proves that the setup was wrong. In this blind environment,
arbitrary stop losses may be the only way to keep the speculator out of intense
danger.
Momentum trading can be mastered. Three disciplines will break destructive
habits and reprogram trading for success:
●
●
●
Abandon the adrenaline rush: Forget the excitement. Profit depends upon
detached and disciplined execution.
Learn the numbers: The nature of price movement must be ingrained
deeply enough to allow spontaneous decision-making during the trading day.
Cross-verify: Objective measurements must filter unconscious bias.
Reduce momentum risk through 3-D charting. Identify reward for the time frame
of interest. Confirm that the stock shows no important divergences that may signal
the end of the move or an impending reversal. Then guide execution and position
management through the chart in the next lower dimension. When a strong trend
explodes on the daily view, use a 60-min bar to pick out low risk entry and define
natural exit points. For intraday positions, control the 5-min bar breakout by using a
1-min chart to locate the natural swings.
Successful momentum strategy requires solid tape reading skills. Demand on
the time and sales ticker reveals the inner workings of rapid price movement. Both
retail (small lot) and professional (large lot) traders need to participate in a sharp
trend or it will fail. Watch the crowd's response to support numbers very closely. If
you can't feel their urgency to get on board, perhaps it isn't there. When the action
pushes into uncharted territory, use round numbers to gauge demand. Multiples of
10 present strong resistance in place of classic support levels. Understand the
motives of the big players that drive fast markets and ride their coattails to gain a
needed edge. And if you see big lots move against a rally, be prepared to join them.
Time of day tendencies create profit and danger zones. As the market opens,
overnight imbalance and fresh retail cash trigger volatility that resolves through price
change. Insiders guide stop gunning exercises and fade trends through the lunch
hour's negative feedback. The final hour arrives, just in time to resolve many
complex themes with sharp breakouts or breakdowns. And through it all, intraday
buying and selling oscillates in an orderly 90-min cycle.
Riding Intraday Swings
Intraday
volatility
shakes out
day
traders
during a 3hour, 16point
NXTL rally.
Short-term
price
movement
responds
to
numerous
intermarket
cycles that
ensure a
bumpy rise
for the
momentum
crowd.
Technical analysis uncovers momentum secrets as it exposes insider
deception and herd emotions. Verify all shock events through both patterns and
indicators. Proper application will reduce entries associated with false breakouts and
invoke natural risk management. Always trade by the numbers and not the news.
Use their cold logic to painlessly exit momentum positions and move on quickly to
the next opportunity.
Physics teaches that an object in motion tends to remain in motion. Profits
depend on this well-understood mechanism. Moving averages set to multiple time
frames reveal trend velocity through their relationships with each other. Measure this
acceleration-deceleration with a classic MACD indicator or apply MA Ribbons to see
if they spread or contract over different time periods. For obvious reasons, always
seek acceleration cross-verification before momentum trade execution.
Swing traders apply original tactics to each phase of the Pattern Cycle. At new
highs, they execute momentum setups that rely on sound risk management. When
market conditions change, they move swiftly onto fresh ideas that reflect the new
inefficiencies. Always opportunistic, they seek the next profit like the predator looks
for vulnerable prey.
Momentum strategies fail through most market conditions. Stocks trend only
15% to 20% of the time. Constricted ranges bind price during the rest of its
existence. Trading longevity requires diverse skills through both trending and
congested markets. Be flexible enough to shift from one strategy to the other as
feedback loops alternate between positive and negative. In other words, adapt
tactics quickly to changing market conditions rather than wait for those limited times
when the environment favors the hot stock.
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MOMENTUM CYCLES
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Neophytes quickly fall under the spell of fast moving markets. However, trading
momentum is far more difficult than most participants admit. When the emotional
crowd ignites sharp price movement, greed clouds risk awareness. The
inexperienced trader reacts foolishly and chases positions just behind the big
volume, where odds of a reversal quickly increase.
Prices rarely move in a straight line. As shocks destabilize a market, counter force
emerges to restrain price back toward its stable state. An inevitable backward
reaction follows each forward impulse. Burning the fuel of the crowd's money,
markets seek equilibrium before proceeding with the next price thrust.
YOUR DAILY Unskilled traders fail to consider this cycle when entering momentum trades.
MARKET
They blindly execute positions with a common and dangerous strategy: market
GUIDE
entries on accelerating thrusts. Lacking trailing stops and effective risk management,
both good and bad positions bleed money as sharp countertrends destroy profits. As
these inevitable reactions wind down, losses escalate as blind fear chooses the exact
turning point to finally get out.
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Consider both action and reaction when developing effective momentum
trades. This demands complex planning and detached execution. One successful
strategy requires trading opposite to natural bias: entries on counter trend reactions
and exits on accelerating thrusts. This aligns positions to the underlying trend but
against the current crowd emotion. Entries into accelerating momentum can also
work when tight stops are placed and the trader exits into further acceleration. This
eliminates risk associated with the inevitable pullback.
PICKS, CHARTS,
SCANS, IDEAS & Choosing the wrong action-reaction trigger produces frustrating results. Every
PROFITS
trader knows the pain of executing a low risk entry, riding a profitable trend, then
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losing everything on a subsequent reaction. Avoid this experience using clearly
defined tactics to minimize emotional momentum trading. Supplement this discipline
with multi-trend technical analysis and cross-verification to identify profitable swingpoints and locate natural escape routes.
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Riding the Wave
Markets inhale and exhale as dynamic trends evolve. Reaction follows impulse as
momentum seeks stability in preparation for new price change. Smart traders read
this continuous cycle through the wave motion in bar charts.
Leading & Lagging
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All original materials: © 2003 Brooke Publishers, Inc.
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When a stock breaks to new highs, how can you tell how long the rally will
last? In astronomy, scientists understand why the star that burns brightest
extinguishes itself long before one emitting a cooler, darker light. So it is with
market rallies. Parabolic moves cannot sustain themselves over the long haul.
Alternatively, stocks that struggle for each point of gain eventually give up and
roll over. So logic dictates that the most durable path for continued uptrends lies
somewhere in-between these two extremes.
Resources
New high trends may end in a few bars or last for years. But as impulse and
reaction carve out the uncharted territory, familiar features start to emerge.
Elliott's Rule of Alternation offers one important lesson when rallies thrust
YOUR DAILY upward into new prices. He notes that congestion patterns formed between rally
MARKET
impulses tend to alternate between simple and intricate shapes. And complex
GUIDE
congestion takes longer to resolve than simple reactive movement.
Featuring
Overbought conditions lead to a decline in price momentum and illustrate
one ever-present danger when trading new highs: stocks may stop rising at
any moment and enter extended sideways movement. Watch rallies closely with
your toolbox of technical indicators to uncover the early warning signs for this
range development.
The first break in a major trendline that follows a big move flags the end of
Interactive a rally and beginning of sideways congestion. Momentum-based positions
Trading
should be exited until conditions once again favor rapid price change. In this
Picks
environment, consider countertrend swing trades when other forces favor
PICKS, CHARTS, success. But stand aside as volatility slowly dissipates and crowd participation
SCANS, IDEAS & fades.
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Traders avoid unnecessary losses when they stay prepared and recognize
the type of range being drawn after an extended rally. Observant chartists
quickly discover that the second corrective range of a dynamic uptrend tends to
carve out the more complex formation. This suggests the basing process often
found right near old highs will complete more quickly than expected.
No trend lasts forever. Inevitably, crowd enthusiasm outpaces a stock's
fundamentals and the rally stalls. But topping formations do not end uptrends all
by themselves. These stopping points may only signal short pauses that lead to
higher prices. Then again, they could be long-term highs just before a major
breakdown.
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Rule of Alternation
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When complex basing occurs early in a dynamic uptrend, alternation predicts
major price thrusts with few retracements. This CMGI parabolic move supports
that theory. Note the extended range at the right shoulder of the Inverse Head
and Shoulders pattern, probably driven by inadequate accumulation. Once the
building process was complete, price ejected into an astounding rally.
Leading & Lagging
Indicators
Stock Selection
& Risk
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All original materials: © 2003 Brooke Publishers, Inc.
Comments: [email protected]