Bulls on Fire – Midweek Chart Views

Jul 12, 2007: 7:32 PM CST

We’ve all read the headlines today – the Dow gained 280 points, a feat which hasn’t happened in four years.  The bulls mauled the bears today, and the buying pressure far outweighed the selling pressure.

All major indexes, with the exception of the Russell 2000 (Small cap) broke to new highs, the S&P 500 and Dow 30 made new all-time highs, and the Nasdaq made new six-year highs. All sectors advanced, as did all industries.  Today was an absolute rout for those who believe the market should be headed lower.

Words can’t describe the situation as well as a chart, and so without further delay:

The Intra-day Action of the DIA:

dia-intraday-j12.png

The Dow Jones itself:

dow-july-12.png

The Nasdaq (gap and run):

nas-july-12.png

The Russell (today’s “laggard”):

rus-july-12.png

The Dow had the ‘longest’ white candle, but only because the index does not record gaps like the Nasdaq and others do.  Today’s rally was driven by short-covering as well… panic covering, if I might add.

The Sector action was impressive, as well.  Materials experienced the largest gain, followed by Energy and Financials.

sectors-july-12.jpg

The large rally took many traders by surprise, myself included.  It’s extremely hard to capture a trend day, and you have to be either a very sophisticated trader to do so, or just very lucky.  As a trader, it’s so tempting to try to go countertrend, or to doubt market strength and attempt to fade it.

You can pick up subtle clues from the TICK and the TRIN, but it takes experiencing a few of these days to understand what to look for ‘in the air’ to see whether odds favor growing strength or waning strength as the day progresses.

I hope you did well today as a day-trader, or if you are a swing trader, I hope today put many of your positions in the green significantly.  Days like this have the potential to make or break an entire month for traders.  For outsiders, this business looks easy but for those of us who trade and analyze every day, we know that we ‘nickel and dime’ our way to profits and hold out for these types of days to make up for everything else.

Always know that days like this do happen, they can happen, and you can profit nicely from them.  Also realize that capturing such a day will take immense skills and study (and actual market experience/exposure).

It is also important to note that these days do not often repeat themselves exactly the next day.  In other words, you can’t watch the TV news and hear about such a day and then walk up the next day and extract magic profits.  Often, these days appear unexpectedly from low-volatility (or low attention) conditions.  In other words, what makes price continue is the fact that so many traders are thrown off balance and are scrambling either to enter or exit significant positions.

Anyway, take the time to study today’s action from as many angles as possible, document them, and use it as a reference.

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Link: 10 Principles of Short-Term Trading

Jul 12, 2007: 10:13 AM CST

Dr. Steenbarger at Traderfeed listed (and explained) Ten Principles of Short-Term Trading that are applicable to all types of traders.

Dr. Brett writes:

“There is much more to markets than your market, and there is much more to markets than price alone. Observing the dynamics of market behavior opens the door to strategies that exploit intraday and swing shifts in market direction.”

In addition, Dr. Brett provides a discussion regarding how to use imagery in achieving behavioral change.  He has discussed this topic both in his book Enhancing Trader Performance and in various other blog posts.

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A Little “Perversion” Trade

Jul 11, 2007: 8:39 PM CST

Have you ever been frustrated by a stock? Of course you have.

I like to keep a separate paper file of stocks that just blow people’s minds and expectations and generally defy all common expectations (from a technical analysis standpoint).

Not only is it a fun activity to me, but it helps me relieve stress when trades that I feel should work out, do not work out. These trades or positions trap so many people… and that is exactly why they work.

Here is a quick example of a “Perversion Reversion” over a longer time frame (disclosure – I had no position in this stock at any time):

fstr-july-10.jpg

Essentially, what I’ve done is enter the mind of a retail trader convinced that the price will plummet after the large, sudden decline at the beginning of March. Maybe the reason was fundamental, or earnings based, but either way, our hapless trader decided this stock was going to collapse because of all the bad news and so he (or she) loaded up short.

Price climbed and reversed higher, but the first test was the converging moving averages. “Of course, this stock will fall. It’s actually best to enter positions after a pullback – here’s my chance!!”

So instead of taking a stop, the trader loads up MORE shares short because this is – after all – truly a proper “Impulse Sell” trade that I discuss. I do, however, advocate usage of stops.

The trader receives temporary satisfaction as price does decline… but rises again. And then when price broke the 200 period moving average, it did so with a strong momentum impulse and new price and new momentum highs, along with a momentum (continuation) gap. Our trader should have covered.

“Gaps always get filled, so there’s no point at covering at these higher prices… I’ll wait.”

Of course, price does pull-back just a bit, but before long, it’s off to the races. A new and confirmed (short-term) uptrend has developed, and shorts have lost the advantage (or edge).

Still, our trader – convinced from a story he heard on TV or read on a website – holds on to his shorts (short position, that is). He was extremely happy when price ‘plummeted’ at the beginning of June, but other clearer-headed traders saw this as a natural pullback and took advantage of the lower prices and technical support to enter (or add to) positions. Needless to say, price rose quite strongly following a successful test of the 50 day moving average. Our trader was still short.

So now the trader sees a “Bollinger Band fade” trade and remains short. “Price has to fall – there’s a 90% chance, now!”

What is he not seeing?

  • A confirmed uptrend
  • New momentum highs
  • New price highs
  • Confirmation of new highs through volume
  • Any other bit of information that contradicts his initial reasons for entry

Poor trader… literally POOR trader. It’s good to have opinions and it’s good to act on them, but always be open to new information and set stops when you enter and honor them. Never ‘fall in love’ with a fact or a reason, statement, opinion, or position. The only truth is the market.

You trade differently than this trader… don’t you?

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Market Fades – Natural Pullback?

Jul 10, 2007: 8:14 PM CST

Today’s market action shouldn’t have surprised active traders.  Why?  The indexes were showing short-term overbought conditions as well as an overextension in oscillators, combined with the testing of a newly established trading range (upper boundary).  Volatility bands also showed odds strongly favored a retest of the midlines.

It is frustrating for new traders to accept the reality that has been summarized in the statement: “The market takes the escalator up and the elevator down.”  What this means is that losses tend to accelerate more rapidly (sometimes even in one or two days) than market gains, which often happen over small ‘chunks’ over many days.

dow-july-10.jpg

I have added a bit of trendline analysis to the Dow chart above.  The Dow hit upper resistance at the formerly established rising trendline which was violated at the end of June.  Just like support/resistance, trendlines, once violated, tend to serve as the opposite force – this is a good educational example of this phenomenon.

We are also seeing a marked sell divergence in momentum and price, indicated by the falling trending in the 3/10 oscillator.  Keep in mind that the market has rallied sharply since March, and a pause or correction is healthy and expected.

nas-july-10.jpg

The Nasdaq is showing a similar pattern, with the exception that the index made new price highs as well as new momentum highs.  A natural pullback is expected.  Shorting the market at the doji which formed at July 8th’s close was a very high probability trade:

  • A doji shows indecision, and often leads to short-term reversals of momentum
  • A test of the upper Bollinger Band in a range-bound environment signals a near 90% chance of a decline in price
  • Price-based oscillators (stochastic/RSI – not shown above) were showing overextended buying readings
  • Price was clearly extended above the rising 20 period moving average

The day’s market decline from overbought technical conditions was attributed to ‘jitters’ in the Retail Industry and fears over declining earnings.  Also, Chairman Bernake recently stated that “Inflation will be less sensitive to energy prices” which should be comforting to investors.  A reminder – inflation pressures can take hold very rapidly with exogenous shocks, such as key embargoes or attacks on supply.

Keep vigilant  and keep studying.

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Link: Using the VIX as a Timing Tool

Jul 9, 2007: 7:54 PM CST

Bill Luby at the VIX and More blog posted a three-part resource and his thoughts regarding how to use the Volatility Index as a market timing tool.

Specifically, he discusses how he uses its readings to trade the S&P 500 exchange traded fund SPY.  His concluding thoughts caught my attention:

“…I have increasingly become convinced of its applicability in this area [the VIX’s use as a market timing tool].”

You may also find it useful if you trade options along side ETFs and stocks, as knowing how to analyze the volatility index properly indicates to you how ‘fairly’ options pricing currently exists – essentially when there is greater ‘fear’ in the overall market (as evidenced by rampant put buying), options premiums will rise accordingly.

Some traders use strategies to sell specific options or spreads when fear (volatility) is high because they assume volatility cannot stay elevated, and it should reverse at least to normal or a bit below normal (in which case, it will be advantageous to execute option buying positions).  This also is a method that can be devised to be relatively ‘delta neutral’ if executed properly.

Many people have said it before and I agree:  It is far easier to predict volatility (cycles) than it is to predict market/stock direction.

Either way you feel, it always helps to check on the most recent trend of the VIX to see what the majority of traders are ‘betting’ on a large scale.

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