A Day of Structured Chaos

Nov 11, 2008: 5:54 PM CST

Whether or not you did well trading intraday today (Tuesday), you have to admit that it was a rather intensely difficult day.  Let’s see if we can discern order from the day’s seeming chaos and view the DIA (Dow Jones) 5-minute chart for insight.

DIA (Dow Jones ETF) 5-min chart:

Just like Monday, Tuesday’s action began with a large scale (greater than $1.00) overnight gap.  Generally, we have lower confidence (and profits) attempting to fade gaps of this magnitude, and sure enough, one would have been stopped out using virtually any stop-loss strategy on a supposed gap-fade play.  However, by 2:30, the market made a valiant attempt to fade the gap and rallied roughly $3.00 (300 Dow Points) to close the gap… yet it fell just short.  Despite the closeness of the gap, the day will be recorded as a “failed” gap-fade day.

Also, one of the main precursors for a “Trend Day” is an overnight gap that fails to fill.  On such trend days, one would expect price to open at one extreme and close towards the other extreme, provided there is no violation of the 50 period EMA which should always serve as a sort of active trailing stop.

Let’s walk through the day in terms of ‘obvious’ trade set-ups.  Following the gap and thrust down, there was a pullback to the 20 period EMA which fell just short at 10:30 which set-up an “impulse sell” or more aggressively a “bear flag” trade.  Price achieved the target, rallied once more to the falling 20 period EMA, triggering a short-sell (with tight stop) and then that trade also met its objective.

Astute traders noticed the developing triple-swing positive momentum divergence developing, but my main comment is to throw indicators out the window when you feel we have a trend day developing, and pay close attention only to the moving averages (and relation of price to them).

Price first breached the 20 period EMA to the upside, formed a higher swing low, and then burst strongly through the 50 period EMA, triggering any stop-losses being trailed by the possibility of a trend day.  I labeled this “Optimal Entry” because once price formed a higher low, broke above the moving averages (which had held as resistance) and then burst above the most recent swing high, that created the “Sweet Spot” Trend reversal trade which clued us in that the day’s downtrend had reversed officially to an uptrend.

A slight retracement down occurred and price completed a “Measured Move” to the upside, falling just short of filling the gap, though this area served as strong resistance.

Now in an uptrend, we should be looking to buy pullbacks in price.  The first opportunity came as price tested the (now) rising 50 period EMA, formed a rally… that quickly faded out in less than 30 minutes.  Price then swung down to take out any stops for ‘long’ trades before moving sharply to the downside… then reversing back to the upside into the close leaving both longs and shorts baffled and perhaps screaming “Foul!”

This was a hard day to trade.  Classic technical set-ups were both successful early in the day and failures later in teh day in their own regard.  The media is reporting that the late-afternoon surge… and fade… were caused perhaps by a BlackRock executive saying that the Bear Stearms mortgage portfolio might be worth more than originally expected… but that the economy clear was not out of the woods yet.

During holidays, volume typically is lower and price swings can develop suddenly and become very violent with less participation than on ‘normal’ days.  Today’s trading action was a testament to that fact.

Again, guard your capital and stay safe in these uncertain times.

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Originally published by Corey Rosenbloom at Afraid to Trade.

2 Comments

2 Responses to “A Day of Structured Chaos”

  1. Brian N Says:

    Hello Corey,
    I’ve been an avid reader of your blog since your appearance on The Disciplined Investor and appreciate your thoughts on the market, especially during these times.
    I’m curious why you use DIA instead of a normal DOW chart? Does it provide you better insight through the day or are the charts easier to post for your blog.
    Thank you for your time.

  2. Corey Rosenbloom Says:

    Hey Brian,

    Thank you for reading and for your question.

    I initially made the switch from individual stocks to ETFs then to the Dow/DIA and finally to the Dow-mini futures and that’s what made the most sense to me in terms of contract size, index value, point movement, etc.

    In regards to displaying charts, I love the way StockCharts displays their graphs over TradeStation, and I feel that the DIA reflects the price movement better than the actual $INDU or Dow Jones index, particularly because the $INDU does not report gaps while the DIA does. Plus, it’s possible to get a little better reading on volume/participation by viewing the DIA over the $INDU.