Just after noon Eastern, the major US indexes complete the 1, 2, 3, Gap Fade tactic, which has been working extremely well over the last few months.

As a refresher, any time a gap occurs on (especially) the Dow Jones (or DIA) that is less than 100 points, the strategy that I find that works best is the following:

1. Enter short (if it is – as in this case – an upwards gap) and play for the target of yesterday’s close (with a stop about 30 to 45 points above your entry)
   
2. If the gap does fill (price returns to yesterday’s close) then flip your position and play for a retest of the gap opening price with a stop about 25 to 35 points below entry.
   
3. Exit at the retest only of today’s gap open price
   

Caveat, if your stop is hit on the initial gap-fade trade (or if price consolidates for over an hour or more) then flip your position and put on a larger position and play for a larger win (the underlying imbalance was so strong and is now expected to continue)

If your stop is hit on the second trade, there is no reason or justification to flip your position and play for a larger target to the downside. Take your stop and move on to other trades.

Let’s look at today’s action so far to see why this is a powerful and effective tactic:

I am using the DIA (Dow Jones ETF) on the 5-minute timeframe for this example.

Notice that price gapped up approximately 50 points ($0.50 on the DIA) and a short could have been entered either immediately or (conservatively) after a few bars to wait for confirmation.

Though price went against the position initially, it never reached your stop-loss level and immediately plunged on a failure test of the gap highs.

Price found support at the rising 20 period MA but found significant resistance at 13640 (or $136.40). Still, your target is yesterday’s close, which – not coincidentally – found support and could prove as today’s absolute low ticks.

When price retested yesterday’s close, enter a “long” buy position with a stop (in this case) beneath the rising 50 period moving average and play for a target of today’s gap open price (or even the intraday price high for aggressive traders) which was about 13650 ($136.50).

The target was recently achieved with little opposing force and the trade could have been exited profitably, and you captured profits on the three swings of the day so far.

Now we wait to see if continuation patterns form or momentum divergences form. Regardless, the pattern loses predictability at this point and other trades must set themselves up for entry.

Notice that the 1,2,3 Gap Fade Technique uses no indicators other than price.

Study for yourself to see if you would like to add this tool to your increasing trading toolbox.

Deere and Company (DE) has been perhaps an overlooked giant the last few years. While people have been focusing on high-flyers like Amazon (AMZN), Research in Motion (RIMM), Google (GOOG), and Apple (AAPL), Deere has been creating similar patterns and similar price appreciations.

Their 2 for 1 stock split earlier this week made the stock more attractive to the masses by appearing ‘cheaper’ and becoming psychologically a ‘better value.’ Nevertheless, the demand for stock in Deere and Company appears very high.

Let’s start with the amazing weekly chart:

• The moving averages are in the most bullish orientation (20 above 50 above 200)
• There has been, and continues to be a comfortable space between the 20 and the 50 (moving average)
• The large green arrows indicate the large price space between the key moving averages (very bullish)
• The small green arrows indicate textbook pullbacks to support at the rising 20 period moving average
• Price carved out a new momentum high with the amazing recent price swing following a test of support
• Price is (extremely) overextended and buying at this level probably is not the optimal strategy unless you’re a long-term investor
• The lower prices (due to the split) and supreme uptrend (tripling in value in two years) will likely create large demand for the stock, resulting in higher prices yet to come

The daily chart is a bit extended also at the moment:

• Notice the horizontal ’strong’ support line at $70.
• Price made an (obvious) new momentum high
• Price is at the upper boundary of a potential trendline and the Bollinger Band
• Price appears (gut feeling) to be cresting at the peak of the most recent wave and preparing for a temporary down-wave to retest at least $80.
• If price is too strong to retest $80 soon, look to establish a long position in this potential ‘run-away’ market
• The moving averages (no surprise) are in the most bullish orientation possible

Consider the fundamentals and news related items before considering long-term investment in Deere and Company, but from a technical standpoint, we have a candidate for a few trades due to the strong structure of the prevailing uptrend.

It’s time to take a brief technical look at the stock market and see what’s happened and what may lie ahead.

From the top (using the Dow Jones Industrial Average), we are in a daily downtrend and are threatening to be in one on the weekly charts.

Prices have risen in the previous upswing to form a much more bullish posture than otherwise could be, and this could signal better times ahead.

Recall we have the potential “Santa Claus” rally ahead, which could take place around the Christmas holidays at the end of December, but keep in mind such a rally is never guaranteed.

• Price sits currently (intraday) at the key horizontal line which has provided both support and resistance
• Price managed to break above the 20, 50, and 200 period moving averages in two swings
• Price found recent support at the convergence point of the 200 period and 20 period moving averages
• We can expect – in the short term – that these levels (should they be retested) could hold again as support
• Price made a positive momentum divergence, which hinted that a rally (upswing) was ahead. It is now complete.
• To reverse the trend back to “up” on the daily chart, price would need to make a higher low then swing back above the recent higher high.

On to the weekly chart:

• Broadening formation (bearish) still developing
• Price crossed the weekly 20 period MA (bullish)
• Price found support just beneath the weekly 50 period (one-year) moving average (bullish)
• Momentum is making lower highs and lower lows (bearish)
• Volume is confirming downswings (sell-offs) which is bearish
• Price made a new momentum low (bearish)

Combine your analysis of the broader US Indexes with other interrelated markets such as the Bond and Commodity market to get a more holistic image of what the current conditions are at the moment.

Tread cautiously!

The TyroTrader presented interesting thoughts in “Society and Trading” which questions how much social support you receive from your friends and family while pursuing a career as a retail trader.

He references Nassim Talib’s book Black Swan and addresses differences between a society in which everyone works diligently day by day to make a decent but not extravagant salary with a separate society in which there are some ’superstars’ who seem not to work at all yet make disproportionately more than others in the society.

Tyro takes this comparison into a personal challenge and addresses some of the difficulties at-home full-time traders face from others who feel they are not contributing to society or earning a decent wage.  He then asks what your support structure is like and challenges you to think about some of these concepts in his post.

Read the post for more information and the complete though process and see how it applies to your situation.

Ford Motor Company (F) recently completed a compressed Head and Shoulders pattern that exceeded the price projection inherent in the pattern.

The Head and Shoulders pattern in Technical Analysis consists of an initial swing (left shoulder) that results in a second higher swing (head) and terminates with a failure swing (right shoulder) that takes price beneath the support zone known as the “neckline” which can be absolutely horizontal or slightly slanted.

Although this head and shoulders pattern in the Ford example is not a classic or textbook pattern because we normally expect these patterns to form AFTER a sustained uptrend, as these patterns are often of the major reversal type.

Let’s look:

The initial condition – left shoulder – completed mid-October and then price swung up to complete the ‘head’ section before creating a failure swing-up in early November.

Keep in mind that there is no way possible in technical analysis to forecast which price swings will complete themselves into head and shoulders patterns, and the pattern is absolutely undiscernable until the final failure swing around November 12^th is completed.

It is at THIS POINT that you can enter a trade to take advantage of the pattern, its implications, and measuring rule (price target). The target is traditionally the same distance from the top of the head (top of the highest swing) back to the neckline, and from this projecting price by that same amount lower. I have highlighted these with green lines. Notice that the objective was not only achieved but exceeded.

Even though price continued lower, it was still better to play for a small target with this and most patterns in technical analysis, as the ‘window of opportunity’ or ‘forecast zone’ lasts for a very limited time.

For educational purposes, I have also highlighted a positive momentum divergence in August that preceded a large volatility move up which created the eventual head and shoulders pattern.

While no pattern is perfect, it helps to study as many patterns as possible to see how you interpret them and whether you feel comfortable incorporating them into your growing trading arsenal.