Tuesday’s action provided yet another fascinating example of classic trade set-ups and low-risk, high probability opportunities in the intraday DIA chart.  Let’s see this “Trend day that almost wasn’t” and also look at a bull flag, Bollinger Band Squeeze-Play, and a successfully filled morning gap (I should have titled this post, “The Day that Had it All.”)

DIA 5-min chart for December 30, 2008:

Starting at the beginning, we had an overnight gap-up that was quickly filled, complete with upper-shadow bearish candles that preceded the retracement.  Price then pulled back sharply to a major ‘confluence support zone’ formed by yesterday’s close (the target for the gap-fill… where shorts would be covering) and the rising 20 period EMA.  A bullish hammer candle formed which was followed by a narrow-range doji before price preceded into a fresh impulse move into new highs… albeit on a negative momentum divergence.

Oh, the retracement off the morning highs also came off a New Momentum High (NMH) which set-up the “Impulse Buy” trade I discuss frequently.

Price then formed three doji (consolidation) candles before retracing comfortably back to the rising 20 period EMA, forming parallel trendlines which set-up a possible Bull Flag trade… which met and exceeded its “Measured Move” target into fresh intraday highs (and the top of the Bollinger Band… on another negative momentum divergence).  I found the morning price action so interesting that I broke character and posted an intraday analysis before the day was half over!

It was at this time that I called the price action to be most likely a Trend-Day and suggested that any retracements be bought.  The “line in the sand” to determine whether or not a day will unfold as a pure trend day is the rising 50 period EMA, which – if tested – is expected to act as strong support.  Failure to hold the “50″ would call the trend day theory into question, and two closes beneath the 50 would – in my book – officially invalidate the trend day, triggering stops (though some prefer to trigger stops at one bar beneath the EMA, or if price breaches the 50 at any point).

I don’t prefer those strategies – though I used to employ them – and today’s price action explains why.  In the current environment, price swings tend not to ‘respect’ classic (or expected) boundaries comfortably (or as ‘nicely’ as they have in the past) which means our stops and turning points (in our analysis) must be wider to accommodate for this change in volatility.

That being said, traders who realized this and capitalized on it were able to hold on to their positions, albeit literally by a hair, and play for the full potential if the trend reaffirmed itself, which it ultimately did around 3:30.  Traders who played ‘conservatively’ (as I am accustomed to do – erroneously) and utilized ‘tight stop’ strategies missed the end-of-day move completely.

Foregoing this whole “tight stop vs loose stop” debate, price formed its final trade set-up of the day, which was a breakout from consolidation play (rectangle pattern) or more specifically a breakout from a “Bollinger Band Squeeze” play which satisfied its target nicely (exit at close of day).

Take a moment to go over today’s market action and highlight your own patterns and build experience while the market is closed so that you can internalize these patterns and react better when the market is open.

Corey Rosenbloom
Afraid to Trade.com