Stunning Intraday Action

Apr 30, 2008: 8:33 PM CST

How did you do on today’s Fed day?  Days like this can remind us why volatile conditions can either be very rewarding or very draining for your account.  Let’s see what happened and where the dust settled:

On the intraday chart of the DIA, the Fed announcement (they cut .25 to 2.00%, as expected) came at 2:15 EST.  Initially, the market surged higher on sharply higher volume.  Then, traders changed their mind (they can do that, can’t they?) and then aggressively sold off the market into the close.

Newer traders who bought because they were told “Fed cuts are good for the market” were left confused by the swiftness and aggressiveness of the afternoon sell-off.

I make it a practice not to trade Fed days.  In the past, I’ve had software freezes where the program literally shuts down because it can’t deal with all the rapid price changes.  If you have a day-trading position on, you can imagine how stressful this situation can be.

I prefer to make smaller, more consistent gains rather than try to win big on what in essence is a random big luck of the draw.  Even in this case, if you wanted to get short, the initial up-impulse may have triggered your stop-out of the position, and it would have been difficult to get short with a good fill on the downside.  And there was no guarantee the downside would come as swiftly as it did.  My guess is that most at-home traders who played this move did so on the long (buy) side.

Where does this leave the Dow now?

We’re still above key support, but odds now favor some sort of downward reaction (retracement) against the recent upward sloping trend channel (gray dotted line).  Maybe somewhere around $126?  Key support looks good at that price zone, but breaking beneath $125 (and especially $124) could set up a highly probable test of the $116 lows.

With the Fed out of the way, it may be time to get back to some normal conditions.  Still trade with caution and learn from the lessons of today.

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How to Trade a Rectangle Consolidation

Apr 30, 2008: 11:11 AM CST

Rectangle consolidation patterns can lead to amazing profits and are relatively easy to recognize on a chart.  Let’s learn more about this chart pattern.

Eaton Corp (ETN) recently broke out of a rectangle consolidation pattern, which gives us an example of how we could trade such chart patterns.

Sears Holding (SHLD) broke a long-term rectangle that led to large gains in 2005:

The defining characteristic of a rectangle pattern is the ability to draw two clear parallel trendlines that are tested on both sides by price.  Volitility winds down during this time as the stock ‘builds a base’ for an eventual breakout.

The tight price in the pattern is said to be ‘in equilibrium’ or ‘in value’ as buyers and sellers generally agree that those levels represent a fair price and will trade at those levels.

Generally, volume falls as the pattern develops, but increases towards the end of the pattern and sometimes surges on the eventual breakout of the range.

Let’s look at how we might trade this pattern.

The Ideal Rectangle Consolidation Pattern:

Once you recognize a rectangle and can draw parallel channel lines, add the stock to your watchlist and keep your eye on it should it break out.

Alternately, you could aggressively place a buy stop above the upper channel and a sell-stop (to enter short) once price breaks the lower channel.  You’ll either need your program to place stops automatically, or you’ll need to enter them manually once the position triggers.  Alternately, you could place an “alert price” with any number of software or websites.

Let’s assume an upward break.  Place stops conservatively just beneath the upper trend channel (for a high reward/risk ratio), or aggressively place them beneath the lower trend channel (giving the market room).

I prefer to enter on a ‘throwback,’ which often gives you greater odds of continuation and gives you better fill and generally removes the urgency to enter (which leads to higher slippage and eliminates ‘chasing’ the market).  Throwbacks don’t always occur, and so you’ll need to see for yourself which tactic you prefer.

Generally, a conservative target would be the height of the rectangle added to the breakout price to establish an initial target.  Rectangles can be reversal patterns, and so you might sometimes want to use them to establish a position trade, but I prefer fixed targets when trading them.

It’s generally accepted also that the ‘longer the consolidation, the greater the eventual breakout’ so you can take the length (distance) of the rectangle into consideration when making price projections (some people turn the rectangle up – vertical – and then use that as a price projection).

These are interesting patterns and can allow you to have a little fun when a stock breaks out of a consolidation area and makes a new run.  Not all rectangles ‘work,’ but they can offer excellent risk/reward characteristics that allow you to add a new tool to your trading arsenal.

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IBM Impresses Investors

Apr 29, 2008: 9:24 PM CST

IBM has been roaring its way to new highs recently to levels not seen since 2000.  Let’s see the chart of this impressive stock, which has made new highs as the stock market indexes fell in 2008.  In fact, its lowest point this year was early January!

Price broke above what can be considered a pennant, flag, or triangle consolidation pattern.  Either way, it resolved into a continuation pattern, as price was supported by the rising 20 period moving average.  The resolution was quick and forceful to the upside, which occurred on very high relative volume.

Price is currently retracing part of its gains, but it wouldn’t surprise me to see price support about the $120 level.  Momentum on this swing was a little lighter than on the previous swing (hence the divergence) but price built a base from early March until now for making a new run higher.

Let’s pull it back to the weekly chart:

There is a lengthy upward sloping trendline, which has been tested both the upside and downside.

Price now sits just beneath that line after the recent large upward move.  Momentum also made a new weekly high, and again there could be strong support from prior highs about the $115 to $120 level.

In this environment, I’m sure the buyers are happy to see a technology stock performing so well.  Continue to watch this stock.

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Transports Outperforming Dow

Apr 29, 2008: 11:46 AM CST

The DJ Transportation Index ($TRANS) is outperforming the Dow Jones index, which is an interesting development that has implications for Dow Theory.

Dow Theory stresses the ‘confirmation’ between the DJ Transports and the DJ Index itself (meaning both must make a higher high to signal a ‘Buy Signal’ and vice versa).

According to the theory, the Transportation Index has completed a higher high but is shy of its July 2007 closing high of 5,400 (which is 200 points away).

If you look back at a weekly chart, the Transports peaked a few months ahead of the market – so are they leading the market higher this time?

Some say that “the transports lead the stock market” which is a general occurence rather than a hard rule.

Nevertheless, the Relative Strength (bottom panel) is increasing as the Transports outperform the Dow Jones Index.

Also, notice how the Transports have supported on successive pullback to its 20 period moving average (the sign of a strong uptrend).

Notice also the ‘higher low’ that the Transports made in March when the Dow retested its January lows.  That was a positive non-confirmation of lower (Dow) prices.

It’s an interesting development that requires further analysis, so be sure to keep your eye on the Transportation index for more potential clues.

(Note:  Railroad stocks are keeping the index higher)

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The Disciplined Investor Podcast Series

Apr 29, 2008: 10:01 AM CST

Not long ago, I discovered Andrew Horowitz’s website The Disciplined Investor which probably has become most known for its Podcasts.

So far, Andrew has hosted 54 episodes and has addressed a wide variety of topics, including many interviews with fellow bloggers and financial minds in the industry.

Most impressive to me, he recently interviewed former Labor Secretary Robert Reich on Super-Capitalism, which touched on a broad array of interesting economic topics.

He has also interviewed

Brian Shannon of Alpha Trends (ep. 40)
Adam Warner of Adam’s Daily Option Report (ep. 50)
Tim Knight of Slope of Hope (and founder of Prophet.net – ep. 47)
Barry Ritholtz of The Big Picture (ep. 46)
Gal Arav, creator of NewsFlashr (ep. 50)

And many other individuals.

The podcasts themselves pop-up in iTues via this Subscribe link but you can also go to his website and download them via mp3 or for Zune as well.

Podcasts offer an alternative to websites, because they can be downloaded and taken with you wherever you go, be it in the car on the way to work, on the subway, or while exercising at the gym.

Andrew’s podcasts are professionally produced, with top talent interviews, and he is becoming a leader in the emerging financial podcast world.

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