AAPL Amazing Intraday Gap and Recovery

Jul 22, 2008: 10:52 PM CST

There’s so much to be said about Apple’s (AAPL) intraday performance today.  From the 10% gap down to a rally to close the day off just over 2%, Apple traders were in for an amazing ride.  Let’s look at the intraday and daily chart to see where this leaves us.

AAPL 5-min:

The bulls truly turned a bad situation around in a hurry.  I watched Apple fall after earnings were released yesterday and I figured we’d have a bad gap opening and I suspected there would be at least a 50% retracement of that gap.  I didn’t expect an almost full gap recovery situation!  I tip my hat to the bulls for finding deep value in the price plunge.

Apple reported record June earnings and Q2 profit over 30% greater than Q1, yet most of this was already priced into the stock, and traders punished Apple for lowered guidance in earnings ahead.  These kinds of situations are enough to make your head spin and give you extreme frustration as a newer trader.

“But they had record profits!  Why did their stock go down so much?!?”

To make your head spin even further, Wachovia Bank (WB) reported over $8 billion in losses in Q2, that it will be slashing its dividend, and that it will be laying off over 10,000 workers and it would be almost lunacy to think their stock ended the day well.  But it did.  Wachovia ended the day 27% higher – but these points are for another discussion.

With Apple, usually the best strategy to employ after a gap is to attempt at least initally to trade against the gap, playing for a partial or full fill.  I don’t like to fade equity gaps greater than 2%, but you just never know what will happen so it’s often best to employ a consistent strategy, even if you do so with a smaller than normal position.

Anyway, as the day developed, price initially found resistance via the 20 period EMA which was then broken (and turned into support) before finding resistance at the 50 period EMA, and once it was broken to the upside as well, the ’skies cleared’ and opportunities opened up vastly to the upside with renewed confidence.  I listed the “Highest Probability” trade as being the retest of the confluence of support coming from the 20 and 50 period EMA converging – it was a low risk, high reward situation that paid dividends for aggressive traders.

So where does this leave us on the daily chart?

AAPL Daily:

The downtrend is still officially confirmed, and price is ‘officially’ beneath all three key moving averages, including the 200 period (known as the “line in the sand”) but I’m sure Apple bulls take solace in today’s action.

67 million shares transacted today – while not a record, the activity was definitely impressive.

Let’s continue to watch this stock and how its movements may affect the broader stock market.

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Generate Your Own Equity Curve (Simulator)

Jul 22, 2008: 5:11 PM CST

TechnicalTrades.net offers traders an Equity Curve Generator algorithm/program for you to input parameters into the formula and randomly simulate outcomes that could be representative of your trading system.

Generally, the success or failure of a trader is due to study of the overall system they have developed personally, and diligent application of that system in the larger picture; individual trades really do not matter, especially when they become one point among hundreds of ’spots’ on an Excel Spreadsheet or some other graphical program that demonstrates equity curves or probability distributions.

There is a Catch-22 regarding evaluating your trading system: You must know a close estimate of your win/loss ratio as well as your % win (or probability of a winning trade) to evaluate your results over a long enough time frame, depending on how frequently you trade. In other words, you won’t truly know how your system performs until you gather sufficient data – trades – to generate a proper %win ratio and win/loss ratio.

One major solution to this dilemma is to run various parameters you think may be closest to your chosen system through an Equity Curve Generator algorithm. The above link provides such a simulation.

The page gives you instructions, but you need to know ( or “toy with”) the following:

1. Ave Win divided by Ave Loss (Win/Loss Ratio).
2. Win percentage

The Win/Loss ratio is derived from an average of each trade. Remember that to enter a ‘good’ trade, you should strive to make your profit target a key value larger than your downside (or protective) stop. You can set this ratio to be exactly 2:1, where your profit target will be exactly two times your stop.

In other words, if a stock trades at $50 and you believe you can get an upside target of $55, then you would place your stop at $47.50 ($2.50 less than the current entry). This is a bit mechanical, and doesn’t really test out in the real world, but it gives you an idea of how to achieve relative consistency with the win/loss ratio.

Keep in mind that most traders will tell you to strive for a 3 to 1 profit to loss goal on every trade, but sometimes this is impractical. Sometimes you may find a 1 to 1 profit to loss parameter to be acceptable, but you will need to consider the second variable – % correct – in order to evaluate this.

The Win Percentage (or “Win Rate”) tells you – on average – how many times you hit your profit target vs. your downside stop. In other words, how many times on average do you take some profit vs taking a loss due to a stop?

Don’t get over-eager – be realistic. Unless you are a position trader or investor, you’re not likely to get many 10 to 1 risk/reward ratio readings, or you might not even get many 5 to 1 (especially if you are a scalper or day-trader).

Also, be realistic in that ‘pure chance’ is a .5 % win (this translates to a 50% chance that a trade will succeed). I do not recommend you get into the simulator and type in anything above 75% unless you want to amuse yourself and see what the numbers would be like. There is too much volatility or things that you cannot predict in the market in a given position, and it is extremely difficult to sustain a high winning percentage for a long time. Realize that most professional active traders achieve in the neighborhood of 40% to 60% win ratios – let this be a sobering thought.

Visit the site and play around with these two variables (ratios).

The bottom line that you should learn from this exercise: You do not have to be perfect to make a lot of money in the markets. The key is consistently letting your average wins be larger than your average losses, among other considerations.

Have fun with this exercise!

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Gaming the Market

Jul 21, 2008: 8:42 PM CST

The author of the blog “Gaming the Market” informed me that his blog has moved and I wanted to provide the link to his excellent and developing blog.

“Gaming the Market” provides excellent analysis and detailed posting on information relating to the popular topic of “gaming the market.”  So far, the author has addressed short-selling, the plunge protection team (does it exist?!), insider trading, convertible arbitrage, options & stock movement, and more.

I was particularly interested in his recent post regarding the famous “Plunge Protection Team” (entitled “Front-Running a Systemic Crash“) where he discusses a variety of opinions and analysts’ statements regarding this mysterious force that may or may not exist.

Here’s a couple of teaser quotes:

“Ever notice how official speeches to prop up the US capital markets are timed right before a massive sell off? How about those last hour rallies when the market looks really bad?”

The blog then provides the full-text of Executive Order 12631: Working Group on Financial Markets and then discusses the “Treasury’s War Room.”

In other posts, he describes the mechanics of short-selling, why ’short-interest’ is not necessarily comprised entirely of ’short-sellers,’ and later discusses the “Short-Squeeze of the Century” (hint: It was in the 1800s and was comprised of activity on a given railroad stock – interesting historical read).

Be sure and stop by and check out some of his material.  I’m looking forward to learning more.

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Larger Divergences Form – Selling Ahead?

Jul 21, 2008: 2:28 PM CST

Today’s reversal in the indexes give us pause about the short-term continued bullish direction.  Let’s look at the multiple momentum divergences that have formed on the higher intrday time-frames.

DIA 30 minute chart:

On the 30 minute chart, we see the classic “Three Push” or “Three Swing” pattern, all three of which have formed negative momentum divergences.  Under the principle “momentum precedes price,” we can potentially anticipate a correction or ’sell-swing’ in prices in the short-term.

Negative momentum divergences often highlight the ‘loss of momentum’ on the side of the bulls/buyers, as higher buying pressure is slowly diminishing and ‘momentum’ or price acceleration declines.  An object in motion often slows before it stops and reverses, and prices in the market place often follow this pattern.

In addition to the momentum divergence, volume has been diverging as well.  Higher prices are not being confirmed by higher volume, and higher prices on lower volume is often seen as a sign of bearishness as well.

On the 15-minute chart, the divergences are a little clearer – though there are four divergences that have formed.

DIA 15 minute chart:

I would classify this as a “lengthy” momentum divergence, one of which is being made on lower volume (which is evident on the chart).

Recall that the recent rally has occurred under the backdrop of a confirmed bear market where the higher time frames are in confirmed down trends.  Any such rallies are classified as ‘counter-trend rallies’ and can often occur and end quickly with little warning in both directions.

Be safe out there, and don’t overstay your welcome in the postions you are trading.

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Finviz New Group Performance Tool

Jul 20, 2008: 9:41 PM CST

Finviz.com is a relatively new website you may not have discovered yet that offers a wealth of free information, ‘heat-maps,’ and screening tools for your trading needs.  I wanted to highlight a new feature, Finviz Group Performance, which gives a quick comparison across timeframes of how different sectors have performed.

Here is a sample of the 1-month performance:

You can see ‘at a glance’ which sector has put in the best and worst performance for the time period you’re viewing.  You can see the day’s, week’s, month’s, three month’s, six month’s, or year’s sector percentage performance.

Knowing which sectors have been making a comeback, or are showing continual strength, can give you clues about where to deploy swing trading capital and can assist in idea generation.

Study up on the concept of Sector Rotation Theory and how it can help you not only identify strong stocks in strong sectors, but also avoid weak stocks in weak sectors – and how it can help you identify the expected next sector to outperform based on the progression of the economic and stock market cycle.

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