Intraday Foibles

May 8, 2008: 1:45 AM CST

I was quite impressed by the strength of the bears in swiping the US Indexes lower on Wednesday, giving the bulls only a marginal chance for any sort of retracement.  I recommend saving today’s charts for the files under “strange price action” for future review.

Let’s look first at the DIA:

Price made its intraday high just above yesterday’s close, which formed a shooting star (bearish reversal) candle pattern.  After consolidating into the 11:30 time slot, the market broke to the downside and consolidated in a slightly rising formation (actually flat on the SPY) which broke sharply and quickly to the downside.

Bulls only neutralized selling pressure, and did not overcome it, as evidenced by the strange ‘flat-line’ price action into the 2:00pm hour before the bears took full domination of the intraday price action, pushing the indexes to new lows on surging volume before making one final push downward to close near the session lows.

In terms of ideal trades, one could have entered short on the shooting star candle at yesterday’s close at 10:30 and targeted the 200 period moving average.

One could have ‘gotten short’ again when the Bollinger Bands narrowed at 1:00 and entered playing for a breakdown in price with a stop above the key moving averages.

A second such trade could have been entered around 2:00 (actually any time before that once you recognized the price retracement and flat-line price action – akin to a rectangle).

Price breakdowns can give you large targets, and with the swift action, you may have been tempted either to take a small target or try to fade the action when you felt it ‘bottomed’ but momentum often precedes the price and the new momentum (and price) low at 2:30 was a clue that the actual price low was likely yet to come.  Indeed this was the case.

I focused on the rectangle consolidation patterns on the SPY chart below:

It’s unusual to have two rectangle consolidation zones back-to-back, and also unusual to see price form such a clean stair-step pattern without meaningful retracements against the prevailing trend.

File this day for your future reference and study price action to gain greater clues into your own interpretation.

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Indexes at Support or Resistance?

May 7, 2008: 9:24 PM CST

Are the Indexes at Support or Resistance?  Today’s action would lend to the “Resistance” camp, but let’s take a closer look.

Let’s start with the daily chart of the Dow Jones Index:

With this chart, I have Resistance plotted via two areas:

1.  The declining 200 day moving average

2.  The horizontal trendline via prior support/resistance

I have Support plotted also via two areas:

1.  Rising (up-sloping) trendline beneath price action

2.  The Rising 20 and 50 day moving averages

So which is it folks?

Let’s look at the S&P for a similar situation:

In this, I’m showing sort of a ‘rising wedge’ potential pattern.  Generally, rising wedges are bearish patterns, but it’s difficult to draw an exact converging trendline pattern that makes up the wedge.  It’s more akin to an upward sloping trend channel, but still a break beneath the lower trend AND the moving averages would be bearish and set up a potential retest of March lows.

Let’s pull the daily chart back just a bit and compress the bars to see how many valid trendlines we may be able to draw on the Dow Jones (and similarly in the S&P 500) Index:

At first glance, you may be asking what I have done on this chart.

I’ve drawn two (current) resistance lines (red) and two support lines (black).

Notice that three of these lines converge – along with the 50 day moving average – at or near 12,700.

There is a lot more going on than I’m showing on this chart, but even still, there are a variety of trendlines that can be drawn (not to mention Gann and Fibonacci retracements as well).

It’s best to keep your analysis simple, but it’s interesting to not how many seemingly ‘obvious’ chart points are setting up now.  It will be interesting to see and trade the resolution!

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Current Yield Curve Turns Bullish

May 7, 2008: 9:00 AM CST

Although it’s not discussed extensive, the Yield Curve has now normalized to levels that have historically preceded large bullish moves for the overall market. The last time this pattern occurred was in 2003.

Bill Luby at VIX and More recently identified this pattern as well with a good, brief analysis in his post “The Yield Curve looks like May 2003.

Let’s look at the current (and past) Yield Curves and see what may be in the cards for the broader stock market.

Yield Curve Basics

The Yield Curve refers to the different yield values on different fixed income vehicles, specifically the difference (plotted as a line graph) of the 3 Month, 2 Year, 5 Year, 7 Year, 10 Year, 20 Year, and 30 Year yields.

“Normal” Yield Curves form when the 3 month yields are far beneath the 30 year yields (which reflects normalized conditions) meaning you’ll take less income (yield) from a 3-month commitment (such as a CD or short-term T-Bill) than you will with a 30-year commitment (such as a bond). The value of yields increases at each successive type of vehicle.

A “Flat” Curve occurs when there’s little to no difference between short term and long term yeilds.

An “Inverted” Curve occurs when short term yields are higher than long term yields. In this case, it would be to your benefit to lock in your capital for short-term rates (perhaps 3 months to 1 year) at a higher yield than locking it up for 30 years. Also, on the other hand, higher interest rates on loans are more expensive for businesses which cut into profits.

Typically, “Normal” or steep yield curves precede bull markets (as the Fed controls shorter term rates easier than longer term, and lower rates are beneficial for consumers and businesses).

You can learn more about these conditions at a variety of web links, including an explanation from Fidelity Research.

Let’s look at the current “Yield Curve” courtesy StockCharts.com:

Let’s look at the “Yield Curve” in March 2003 and put it into perspective relative to the S&P 500 in 2003:

To flip the perspective, let’s look at two “Inverted” Yield Curves in 2000 and 2007:

Now, let’s look at the most recent “Inverted” Yield Curve which permeated throughout most of 2007 (before the “fall”):

Are bullish times ahead? Uncertain, but the conditions – at least from the yield curve – are more favorable than they were thanks to the Federal Reserve aggressively slashing interest rates to stimulate the economy.

Continue to watch this for more insights and potential clues for the future.

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Tuesday Intraday Index Fun

May 6, 2008: 5:58 PM CST

Wow!  What an interesting day it was for active traders.  Yet another gap was filled and a sort of unexpected trend day emerged.  Let’s look!

Dow Jones ETF (DIA) 5-minutes

Today opened with a sharp intraday gap down, which spent the first 10 minutes continuing downward.  I prefer to wait for 3 bars (15 minutes) before entering a gap-fade trade and I have increased confidence of a fill when the gap is less than $1.00 (100 Dow points).  Today’s gap was just over $0.50.

I typically place a stop 1/2 the distance to my target, which is always yesterday’s closing price.  As I showed earlier today, the odds favor a gap fill, but the odds of filling decrease along with the size of the gap.

Nevertheless, this is always the first trade to place with a decent gap-fill fade trade.  The trade achieved its target with only a small pullback just after 11:00am.  It would have been fine to exit the trade at a 50% retracement, which corresponded with the falling 50 period moving average (or at least take ‘half off the table’).

Strong-willed traders held on for the full fill, which typically produces a powerful retracement (or reversal) back IN the direction of the gap.  When this doesn’t happen, it often signals a more powerful trade (or signal) in the opposite direction, which was the case today.

Price supported at yesterday’s close (purple spotted line) and then rose to form a momentum divergence which then pulled back again to yesterday’s close and the rising 50 period moving average.

If you expected a trend day based on the price action up to this point, this would have been an ideal point to add to a core trade or go on leverage with a high-probability scalp trade.  Price gave you this scalp before faltering and closing near (or just on) the highs of the day.

Bears were strongly discouraged today as bulls claimed yet another victory.  The market is clearly climbing the proverbial “Wall of Worry.”

For reference, here is the action on the S&P 500 ETF – SPY.

As I always recommend, print out the daily action and locate the key trades you feel provided excellent opportunities via your understanding of price action and market structure.  Annotate the chart by hand to get a better feel of price action and incorporate these patterns into your experience so you can recognize them better in real time.

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Smaller Opening Gap Statistics

May 6, 2008: 11:36 AM CST

Today marked yet another opening gap that filled in the major US Stock Market Indexes. Gaps are one of my favorite opening patterns to play because they can provide a dual edge for traders. By ‘dual edge’ I mean they can provide a higher % win rate and also generate more profits when correct than losses when incorrect. Let’s look at the statistics for smaller index opening gaps and then view a chart of the whole spectrum.

Previously, I examined Large Opening Gaps on the US Indexes (specifically the DIA, or Dow Jones ETF) from January 3rd 2000 to the present (n=2,065 trading days) and found the following:

37% of DIA gaps (n=121) greater than $1.00 filled (which generally creates a negative edge depending on your stop-loss strategy)

44% of DIA gaps (n=16) greater than $2.00 filled (which creates a positive edge if your stop is around $0.50 to $1.00 or less on losing trades)

67% of DIA gaps (n=3) greater than $3.00 filled (which creates the dual edge concept)

But what about smaller gaps?

60% of DIA gaps (n=1,087) of at least $0.25 filled (again, creating a potential dual edge)

57% of DIA gaps (n=839) of at least $0.35 filled (potential dual edge)

52% of DIA gaps (n=507) of at least $0.50 filled (slightly with a dual edge)

43% of DIA gaps (n=237) of at least $0.75 filled (eroding the dual edge concept)

38% of DIA gaps (n=188) of at least $0.85 filled

The following chart shows $0.05 increments and the corresponding percentage of gaps filled for each gap:

(click for larger image)

The % of gap fills decline as the size of the gap increases, but around $1.50, the trend reverses (due to the fact that fewer gaps occurred at these levels which skews the percentages).

Keep checking back for more insights about the classic Gap-Fade strategies and other statistics and charts from previous decades on how this strategy performed.

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