As mentioned previously, the classic technical analysis pattern of the “Broadening Formation” has formed on the Dow Jones Index, which has historically bearish implications.

Before we look at the charts, let’s define “Broadening Formation:”

Quote From Investopedia:

“A pattern used in technical analysis to predict the likelihood of a reversal in the direction of the current trend. It is identified by finding diverging trendlines that connect a series of widening peaks and troughs. The most common type of broadening formation is found at the end of a prolonged uptrend and is used to predict a move lower.

As the two trendlines diverge from the apex, the pattern resembles a reversed version of a symmetrical triangle. This pattern is considered quite rare, but the signal it generates is deemed to be very reliable.”

The default chart they use to define the pattern looks like this:

For more specific information, consult Thomas Bulkowski’s Encyclopedia of Chart Formations or Edwards and Magee’s classic text Technical Analysis of Stock Trends.

Broadening formations often represent struggles between large buyers and sellers and frequently represent inherent indecision in the market place. They may also represent large-scale campaigns of distribution by large funds as price swings unstably as volatility increases. It can almost ‘feel’ like those who are struggling to find balance in the market are slowly losing it with each price swing and eventually the system – stability – breaks down.

Let’s see if these definitions apply to the current market:

Weekly bar chart:

Notice the rampant increase in volume during the broadening formation pattern.

Not surprisingly, the S&P 500 Index is showing a similar pattern:

The NASDAQ is actually not showing a classic broadening formation, but is showing a sort of ‘backwards’ rising wedge pattern.

The rising wedge concept is detailed very nicely at StockCharts.com. Keep in mind this is a backwards version, which is more akin to the broadening formation.

The NASDAQ chart is still showing a broadening formation.

While patterns do not move stock prices, people do, patterns are actually representative of people’s (and funds’) actions in the market. Patterns are expected to capture the inherent psychology of market participants, and these patterns have been identified and tested through the years. No pattern is ever 100%, but arming yourself with as much information to make a decision as possible frequently is the best course of action.

Whether or not these patters resolve as the ‘textbooks’ indicate they should is to be determined, but at the very least (if you do not take bearish positions now) it is likely worth your while not to be initiating extremely large long positions that you hope will carry out for the next few years if these patterns do resolve as the textbooks would have us believe.

Be careful.

 

 

This week saw a precarious shift in the direction of the major US Indexes due to comments by Federal Reserve Officials who still have power to affect price swings in markets. The bulls scored a major victory but still have work to do to overcome the daily downtrend on most Indexes. Let’s look:

The Daily Chart of the Dow Jones Index shows a temporary downtrend, with lower highs and lower lows. The current structure has been broken with a higher swing high, but that high has taken us into key resistance, and a ‘down-swing’ is probably in order which would take us back to (at least) 13,000 to retest that level to see if price can make a higher low. Resistance is also coming in via t he declining 50 period daily moving average.

A recent price divergence with the momentum oscillator hinted that an ‘upswing’ was to come in price, which is exactly what happened. Divergences – especially those that occur at the bottom of the Bollinger Bands or Keltner Channels, often serve as high-probability events to return to the 20 period moving average, which is exactly what occurred here.

To be re-confirmed as an uptrend, price needs to swing down to make a higher low and then swing back up and take out the most recent higher high at 13,400. Until then, price is still in a ‘technical’ daily downtrend.

The weekly view shows an interesting picture:

Let’s look at this individually:

• There is a key momentum divergence forming, as price made a higher high, momentum made a lower high
• Volume is higher through the consolidation period… is this active distribution taking place?
• The momentum oscillator registered a key New Momentum Low not seen in over two years. Significant?
• Price carved a new price low following a new price high. Confusion?
• A Broadening Formation is clearly developing. Bearish implications?
• Price is currently trapped between the weekly 50 period (one year) moving average and the 20 period (four month) moving average.

Summary:

We see resistance on the daily chart from the prior ‘horizontal line’ support/resistance, and from the flat/declining 50 period moving average.

We see resistance on the weekly chart from a declining 20 period moving average.

Price on the daily chart has experienced an upswing and – in my assessment – odds favor a brief downswing in price to retest prior levels to see if a higher low can be established.

Remember, it’s often best to ‘play’ the market one day at a time and one swing at a time and not get too far ahead of yourself. If price breaks above these levels – which it can do – then it will do so against the odds as generated from a basic level technical analysis approach.

Study your own charts and identify potential conclusions from your own experience.

If yesterday was an ideal intraday trading environment, today was a relative nightmare. Such is the nature of the market to alternate between good periods and bad periods, trend and consolidation, favorable environments to unfavorable.

We recognize that the market adheres to the “Law of Alternation” in various aspects, and we can expect consolidation and ‘choppiness’ to take place intraday following a large ‘trend day’ the previous day.

Price must consolidate and ‘digest’ the gains made, and this usually takes place through seemingly ‘random’ and difficult to predict price movements that offer intraday traders few opportunities to capitalize on the small price swings and ‘back and forth’ or ‘back and fill’ conditions.

Today, I’ll be using the SPY (S&P 500 ETF) as the proxy for discussing the “Idealized Trades” for the day:

1. Gap-fade. The FIRST play of the day when there is a nominal gap is to position yourself to FADE the gap with a target of yesterday’s close (dotted purple line). This trade resolved extremely quickly and extremely well.
   
2. Play the Gap trade. After a gap is faded, the SECOND play is always to position yourself in the direction of the initial gap, as this is a “momentum retracement” trade. The initial gap serves as a momentum impulse and the best trade will come following (or on a retracement) of that impulse. The target would have been the price of the gap itself or just beyond, which – also – was achieved extremely quickly (probably too quickly to have profited much, though)
   
3. I drew #3 only to serve as the target for the “impulse gap sell” trade, which was met and exceeded. There is not a trade at this level (exits do NOT equate to fresh entries)
   
4. When price breaks above the 50 and 20 period moving average, we can assume a brief trend could be in place and we could buy pullbacks to the 20 period MA, which would have worked extremely well at both #4 pullbacks
   
5. There’s my favorite pattern YET AGAIN. It’s the classic “Bear Flag” or “Lightning Bolt” pattern as I have highlighted it. While the initial impulse move down can NOT be forecast, the equal (or measured) move down CAN be forecast if price retraces shallowly into a classic bear flag pattern, as it did so nicely here. Enter short at the break of the flag and play for a “measured move” which was greatly exceeded.
   
6. Momentum Divergence. Price made a swing low but the 3/10 Momentum Oscillator FAILED to make a new low (it made a higher low) which set-up a potential countertrend divergence play. The target would have been small (retracement to the 20 period moving average only) and it would have required a tight stop. The target – the 20 EMA – was achieved rather rapidly.
   

I define the rest of the day as “Intraday Trader Hell” due to the extreme nature of price to trade one way, reverse instantly, trade another way, reverse instantly, and chop all participants up mercilessly.

In reality, the day wasn’t that bad for 5-minute chartist and shorter time-frame traders, but the last hour’s action was one of the worst I’ve ever seen.

Use your own charts to annotate the day they way you saw it in terms of ‘idealized trades’ and be honest about stops and targets.

Dr. Steenbarger at the TraderFeed blogspot recently posted his observations on “Questionable Things I Hear from Traders,” and he detailed each of these concepts.

I wanted to highlight his entry, and call attention to a few of the points and make you potentially self-aware in your own trading experiences.

He advises against perfectionism, something with which I struggle in my own trading, and notes that it doesn’t take ‘clairvoyance’ to be a successful trader.

He recommends that you trade passion for concrete goals and hard work – positive thinking cannot make you a successful trader, but diligent work can increase your chances.

He then addresses some hard truths about trading, and concludes by asking you to take a hard look if you ‘quit your job to trade full time.’ While it can be done, it’s superior to have a track record prior to leaving the arena of steady paychecks for uncertain outcomes (one of the hardest realities I had to address in the beginning).

“…trading is a craft. It’s something you hone over time. It’s not a place to act out one’s wildest fantasies or basest fears.”

Study these seven ‘common sayings’ and see if you find yourself uttering any of them on a consistent basis, and if so, see why doing so may be inhibiting your results as a trader.

Yesterday’s price action exhibited textbook characteristics of a ‘trend day,’ and analyzing the action can help you spot the conditions that lead to a trend day earlier and trade more effectively as a result.

First, let’s discuss what a trend day is and how we might detect it early.

We define a trend day as an occurrence where price opens at one extreme and moves in levels or steady waves to close at the other extreme. Trend days are often marked by higher overall volume.

The initial price movement in the first hour and a half can give you early indications that price will begin at one extreme and move in a reliable wave-like fashion and close at the other extreme.

If the initial 30 minute or one-hour range bar is significantly greater than those of previous days, and volume is notably higher during this period than previous days, then you have your first clues that the remainder of price action could unfold in a ‘trend’ fashion.

If the TICK is extremely one-sided and there is a large reading (or trend) in breadth (Advancers – Decliners) for the day, then those can serve as clues as well that a trend day is more likely.

Also, if the previous day was a “NR-7″ or Narrowest Range of the Last Seven Days, or was an inside day (the day’s range was completely inside the previous day’s range), then odds increase for (but do not guarantee) a trend day.

Let’s drill down to the intraday price action of November 28^th, 2007 using the DIA as a proxy:

Notice that I have ‘thrown all indicators out the window’ and focused on pure price action. Oscillating indicators such as the RSI, Stochastic, MACD and others tend to fail the most in strongly trending markets due to the fact that there are extreme readings and no true ‘waves’ or oscillations in price.

In a trending environment, it is best to use moving averages only (or perhaps the ADX indicator as a crutch) and trade retracements to key moving averages.

The initial oval I have drawn, and the breakout from the oval on higher volume is your first clue that the day could unfold as a trend day. The only caveat is that the previous day was also a trend day, and the odds decrease when the previous day was a trend day as well.

As price swung out of a weak retracement, price consolidated at Dow 13,200 (understandably so) and formed a rectangle where price pulled back to the 20 period simple moving average (very faint dotted line in chart). Price then broke above $132.00, but it was during the ‘afternoon lunch period’ which typically shows consolidation and low volume.

Around 1:00, price completed a mini-bull flag and retraced comfortably to the rising 20 period EMA, setting up a key trade with very minimal risk. Price then ejected up from that point and later formed a more reliable (truer) bull flag which also pulled back to the rising 20 EMA and then resolved nicely to the upside.

Although price broke the rising 20 into the close, it found support at the rising 50 period, which could have set up a trade into the close.

Early identification of a trend day will allow you to put on a leveraged core position and trade (swing) around it – in this way, you will maximize profitable intraday opportunities.