Lehman Bros Breaks Significant Support

Jan 19, 2008: 11:58 AM CST

Lehman Brothers Holdings (LEH), a major financial company, recently ejected through a couple of technical analysis patterns worth noting that serves as an educational lesson on moving averages, patterns, support, and resistance. It would appear more downside is likely based on the recent break.

I must first state that technical analysis is more of an art than an exact science, but the principles can be effective in position entry, management, risk control, and price projection.

First, notice the rising trendline on the weekly chart from June 2006 until the break in July 2007. A triangle consolidation pattern formed at this time, which served as a key reversal pattern as buyers could not find the strength to drive prices higher.

Also, a momentum divergence formed from October 2006 until February 2007, when it was resolved quite violently to the downside (notice the swing highs were not confirmed by new highs in the oscillator).

Also, the February price swing set up new momentum lows, and based on the principle “Momentum Precedes Price,” we could have expected new price lows were yet to come following some sort of price retracement. The retracement came in the form of a triangle reversal pattern.

Upon the break of consolidation, following a simultaneous break of the 20 and 50 period moving averages (which can be expected to hold as reasonable support in an uptrend), the case began for a retest of the rising 200 period moving average, and a significant short-sell trade could have been initiated. At the minimum, traders should have exited any longer term holdings (long positions) in the stock at this break. The odds had shifted towards impending price weakness over further anticipation of gains.

A retest of the 200 period average came quite swiftly, and the retracements took price to key resistance now from the 20 and 50 period moving averages, which had re-oriented themselves into a downtrend style mode, where the 20 was beneath the 50. The trend was now confirmed as down, and price found resistance at the averages.

Notice how the 50 period average served has resistance (labeled) and the 200 period has served as support. That changed this week, with price plummeting and closing beneath the 200 period key average.

What may be setting up is some sort of perverse bear flag, which could take price $20 lower due to the inherent price projection of the “measured move” leg of the bear flag. Price could potentially reach $45 or lower as a result of the bear flag.

On the monthly chart, we see a triangle break in 2003 which led to a large ejection move to the upside.

A potential head and shoulders pattern may have formed, following one of the most pronounced momentum divergences possible (compare swing highs in price to oscillator highs).

Using technical analysis, one realizes that the odds had shifted for downside risk, and traders should not have been surprised by the swift downward price action.

Monthly support via the 20 and 50 period moving averages has been shattered, and price is now in a confirmed monthly downtrend, with odds favoring further deterioration in price.

Study the chart of LEH, as there are a lot of smaller lessons you could learn – also apply your own style of analytics to the price charts to see what conclusions you perceive.

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20 Ways to Stop Losing Money in 2008

Jan 18, 2008: 5:52 PM CST

Alan Farley (author of The Master Swing Trader, an essential book in my opinion) recently added an eye-opening article at the HardRightEdge.com site entitled 20 Ways to Stop Losing Money in 2008.

Farley begins the list with an admonition that hits you right in the face:

“The vast majority of retail traders lost money in 2007 and will lose money next year, despite ample doses of education, enthusiasm and brilliant ideas.”

With that being said, he launches into the top 20 ways to “stop the bleeding” for the new year.  I only wish he had listed 2008 ways for 2008!

Here is a sampling of the list:
“Don’t break your entry and exit rules. You made them for bad trades, just like the one you’re stuck in right now.”

“Don’t forget your discipline. Anyone can learn the basics of the trading game. Sadly, most of us will fail because of a lack of self-control, not a lack of knowledge.”

Don’t forget the plan. Remember the reasons you took a trade in the first place, and don’t get blinded by greed or fear when the position finally starts to move.”

Don’t fall into the complexity trap. Traders who can’t see the market are looking for it everywhere except in the price action. In truth, a well-trained eye will find more profits than in a stack of technical indicators.”

Check out the full post for more hard-hitting eye openers and tips.

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Market Returns to Date

Jan 18, 2008: 10:35 AM CST

We have seen a true “correction” via a 10% decline in price in the 13 trading days of 2008 so far, not including the peak to current decline from the October/November 2007 highs.

It’s always good to know where the markets are for the year, because so many intraday or swing traders can miss this aspect of analysis if they get too preoccupied with viewing many stocks in their research.

For 2008, the NASDAQ has fallen 11.5%, Russell 2000 also 11.16%, but the Dow Jones and S&P 500 (not geared to overly volatile or small-cap stocks) have only declined 8.3% and 9.2% respectively.

Typically, we can expect this sort of pattern because the NASDAQ stocks are overwhelmingly comprised of ‘risky’ or volatile technology-style stocks that move up and down faster than the broader markets.

The Russell 2000 is comprised mainly of smaller capitalization stocks which also tend to be more volatile.

Traders/investors purchase such volatile companies when they expect long-term upside in the market (so they can ‘beat’ the market) and bail out of these stocks in droves when they expect longer term weakness in the broader market (so they don’t lose money faster).

Keep in mind that the Dow Jones is comprised of 30 stocks only, but they are larger capitalized “Blue Chip” companies that have been around for decades and are generally more stable and defensive.

The S&P 500 is comprised of 500 stocks that are expected to reflect the broader market in terms of capitalization, industry, sector, etc.

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Thoughts on Frustration in Achieving Trading Success

Jan 18, 2008: 10:16 AM CST

I wanted to provide some additional personal insights to a blog post by Toni Hansen recently entitled “Frustration in Achieving Trading Success,” which included personal statements of similar difficulties her journey to trading success.
I do recommend the entire post, but I wanted to highlight a few quotes for you:

“I think that nearly every single one of us has had to deal with that point in time where we have asked ourselves if it was worth it…. I know very few traders that are “a natural.”

Spot on. I think I’ve asked myself that question five times now. You get really down after a particularly horrid trade, or a series of smaller trades and you wonder why you’ve chosen this type of endeavor. It is SO much more difficult than the books and advertisements would have us believe. The ones who succeed are actually the ones who keep persisting despite doubts.

“With time though, as long as you [are] not flipping back and forth between strategies, then that comfort level will develop and you’ll find yourself not hesitating or making as many incorrect decisions.”

Early on, following my major trading loss, I jumped from strategy to strategy, book to book, seminar to seminar, and found that the more information I learned, the more hesitant/doubtful/scared I became.

I think at one point I had about 5 indicators on the screen and refused to enter a trade until all of them lined up. And when they all lined up, I’d look at the higher (or lower) time frame and decide that the other time frame had some sort of contradictory signal and I would sit aside.

I discovered the basics – trends, Dow Theory, price patterns, momentum etc – and committed to a specific strategy at the exclusion of all others. That helped build a solid, less volatile track record which also increased confidence in taking trades, and I stopped blaming myself (which was very difficult) when trades didn’t work. I realized truly that losses were necessary, did not mean I was less of a person, and that sometimes losses can provide information that the market is undergoing a change I need to be aware of.

“I remember that the one thing that always drove me insane was that I would find 6 or 7 great setups in a day and take 2 which underperformed and for whatever reason I simply could not pull the trigger on the others, even though I saw them develop and was convinced they would work. It was almost as if I could not take something that looked perfect and was settling for mediocre.”

I think Toni summarizes the entire “intermediate beginner’s” syndrome in that sentiment there. It’s not like I didn’t recognize set-ups when they occurred, but I would second-guess and decide to “let this be a time for me to see what happens” rather than participate and try to profit from the opportunity.

When one or two opportunities would have resulted in profit, I would force the next two or so trades and – you guessed it – end up with losses. That further complicated the process, in that I was seeing clear and profitable opportunities but every time I joined the market, I would lose or receive sub-par results. Even on the trades I won, I would take less profit than the signal (or target) afforded, afraid that the trade would reverse at any moment and my profit would be gone.

It took a while, but what really helped was learning from errors and studying why I did what I did and focusing on personality/psychology/risk etc. Also, it helped immensely to categorize and annotate each trading day for a variety of stocks to see intraday patterns (or daily chart patterns) in a series of files I called “Ideal Trades of the Day” based on my perception of opportunity and understanding of market/price principles.

By physically seeing trades from start to finish, complete with stops and targets, and seeing how many worked out had the “thrill of the order entry screen and rapid price movement” been removed, I began to rise above the fog of war to see the charts and the patterns more clearly.

It still took time, and I’m still improving each day and each week, and I know that 100% consistency is an unrealistic goal, but I try to take perhaps 75% of the ideal set-ups I see and reward myself when I do so. I’ve stopped berating myself when I miss out or hesitate and have learned to trade more relaxed and removed from the money.

That’s also what struck me is seeing actual money vanish before my eyes. Sometimes turning off the “actual dollar gain/loss” window of your account can help, provided you focus on the charts and perceived price opportunities.

Realize you’re committed for a lengthy but rewarding endeavor and don’t give up when doubts creep in. Take some time off if need be and re-focus, but always come back.

And do try to have fun along the way!

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The End of an Era

Jan 17, 2008: 6:29 PM CST

Folks, this may be it – the day when people realized that the ‘easy-go-lucky’ days of the market are behind us and harder trading and investing days are likely ahead.

While there are no guarantees, the odds have now shifted so that the ‘path of least resistance’ is now down on all respective time frames for the US Stock Market.

The Internet Business Daily put it best by stating in their January 16th edition, “The market is now guilty until proven innocent.”

I don’t intend to discuss the finer points of economic theory or fundamental data here, but I will show you some quick charts and why the bias has now shifted to the downside:

First, the Monthly Chart:

With the horrendous and clear break of the 20 month moving average, it appears that the market will end January solidly beneath this crucial zone, the last time it was breached this bad was early 2001 before a bottom was formed in mid-2003.

The S&P 500 Monthly chart shows a similar recent pattern, with the only exception being that the Dow stocks are higher today than they were prior to the 2001-2003 bear market while the S&P index is now beneath that zone. This means that had you bought stocks in 2000, you would have lost money on balance by 2008. That’s not a pretty picture to paint or an easy sell to clients.

Moving on to the weekly charts:

Traders, the weekly chart looks absolutely awful. One can see a potential head and shoulders reversal, broadening formation reversal, diamond reversal, consolidation breakout – you attach whatever significance or term you want to the recent price action and it all points “down.”

A retest of the 200 period weekly average seems to be a virtual certainty (though nothing is in the market), which is actually about 35 S&P points lower (the Dow looks similar in price patterns).

A bounce off this level, or some sort of bounce seems likely, but my guess is larger funds and late-comers will see the bounce as an opportunity to rid themselves of stocks at more favorable prices, rather than a “great and momentous” buying opportunity.

I circled the upcoming “Death Cross” of the 20 and 50 period moving averages. This lagging sell-signal could trigger more selling.

On to the dailies:

The market sliced through the October lows, making new near 52-week lows, after breaking out of a triangle consolidation pattern and forming a bear flag down.

I am not thrilled to announce that the moving average orientation has now turned to the most bearish position possible, with the 20 beneath the 50, with both being beneath the 200.

Momentum precedes price from shorter time-frames to the larger (longer) time-frames, and if the trend is clearly confirmed as “down” on the daily charts, and the moving averages exhibit this bearish orientation, it won’t take long for the same pattern to occur next on the weekly, should the downtrend continue as appears likely.

There’s 101 other ways to analyze the market, but I try to keep things simple and grasp the bigger picture when I can.

Please be careful and realize that it’s better to be in cash or bonds rather than try to hand-pick stocks that are bucking (beating) the overall market’s trend. Don’t be a hero. Trade in the direction of the major indexes and you will find greater success. If you don’t feel like you can trade stocks short, buy bonds or bond ETFs. Nothing mandates you to be long US Stocks unless you happen to be a specific type of fund manager.

At the same time, now is NOT the time to “get short” the market. We are already extremely oversold and odds favor a short-term bounce. If you’re underwater, it might be a valid idea to wait for a bounce to get out of any positions in which you’re panicked. Realize also that you have to be able to sleep at night, and if lightening your position a bit will help, then by all means do it. I don’t recommend rushing out and betting the farm that the market will go down either. Practice sound, detached risk control. TraderMike may have captured the essence of this thought perfectly with extremely clear/simple charts in his recent entry for January 17th, 2008 market recap.

chicagoline.jpg
(Here is a picture I took of the beautiful Chicago skyline to let us know that it’s not all bad out there)

Stay protected and live to trade another day if you believe further downside risk is ahead.

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