A 1, 2, 3 Method for Quantifying Trade Ideas

Apr 7, 2007: 12:22 PM CST

Do you feel overwhelmed with opportunities when you complete an evening scan of your charts?

Adopt a simple quantification method to separate trade ideas into three categories for increased possibility of action, and decreased confusion.

This method assumes that you scan various charts either on the evenings or on the weekends, and are looking for key set-ups based on an individual trading system. This also assumes you find too many possibilities to narrow down into actionable trade ideas.

You will need to develop this idea as your own, but the guiding principles include ranking any chart patterns or trade set-ups into three categories:

Tier 1 Ideas:

Set-ups that you identify as triggering immediately, and you need to enter the trade the next day.

This might include pullbacks to key moving averages or support zones (in a trending stock), or rallies into resistance you identify that you want to enter a short trade. This also might be an indicator reading turning up out of oversold and indicating a direct buy signal ripe for the taking the next morning.

Tier 2 Ideas:

Set-ups you identify as forming and developing, and will likely trigger for entry within 2 – 5 days.

This is when you see a neutral reading in an indicator on its pathway to oversold (or overbought) that will soon signal a buy (or sell) signal related to your system. It might also indicate a trend thrust (impulse) you missed, but want to enter when the stock retraces to a set zone where you desire to be a buyer, and you want to enter the trade WHEN this happens.

Tier 2 Ideas are deserving to be in your watchlist with entry zones listed, or conditions listed that – when triggered – will move up to Tier 1 Ideas to be entered.

Tier 3 Ideas:

These would be general market structure identification where you would like to keep a stock in your watchlist to grab your attention when it sets up a trade entry signal based on your system. These might include strong stocks in strong sectors in an uptrend that are just now consolidating in range that offer no discernable trading opportunity, but you like the previous price action or the core fundamentals of the stock you desire to trade.

Your goal with these is simply to continue scanning them until they give buy signals based on your system. Just because a stock has a great story or good fundamentals does not make it a trade candidate until it signals a set-up based on your system/strategies. You should give these the least attention in your scans, but not drop them from memory or your watchlist because – in the future – you will anticipate trading this stock when it conforms to your system or signals.

It is not enough to keep one watchlist and believe that you will capture all the opportunities you are seeking. It is frustrating to keep a great watchlist and be overwhelmed by the possibilities and rush yourself into trades when you should have been patient and selected the best candidates for immediate price performance.

Dividing your opportunities into (at least) three watchlists – ranked by immediacy of possible price action – can help you narrow down to the highest probability moves while allowing yourself opportunities to enter new trades when they trigger should your tier 1 ideas result in a stop (or loss). This also keeps you engaged in the market and analysis, and continues to sharpen your skills.

Your goal in trading is to simplify the process and cut down on the multitude of decisions, so that you identify and execute the highest probability trades according to the system you have developed for yourself.

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Jobs Report Friday and Tactics

Apr 5, 2007: 9:00 AM CST

Following the surge Tuesday, the market is consolidating yet again, but this time the likely culprit is the upcoming holiday weekend (the Market will be closed Friday) and the release of the Jobs/Economic Report Friday morning. The report often swings the market quite forcefully in either direction, and for short-term traders, it is often best to go into this report flat.

If you are new to trading and are using charts and technical analysis only, realize that some days are better to flatten (exit) your positions and wait for a major report to pass and then enter after the report if the market continued in your direction (or at least stayed neutral in movement).

With the market so shaky (in terms of economic data), fundamentals and economic news tend to drive charts, not price patterns or indicators. At these times, you are most likely to see standard chart patterns and indicator signals fail (or become instantly profitable). What I am saying is that, although people move markets (by trading), there are various groups of traders, and the “big money” tend to establish/close positions based on larger economic macrodata and short term traders try to ride their coattails when they suspect their movement.

Now, with my warning stated, realize that with sudden (expected) volatility, the opportunity to profit is great with these opportunities. If you suspect you can predict the report and establish a position ahead of it, you can easily capture 100 or more Dow points (or actual dollars in stocks) within 30 minutes of the report’s release (including Federal Reserve Meetings/Policies).

Realize that trading this way (ahead of a report you anticipate) can easily equate to gambling, as there is little edge (repeatable profit over time) using this strategy. To play out your edge, it is best to take signals, but be aware of key days in the market where price will become suddenly volatile because of an announced report (this is akin to trading earnings releases in stocks – probably not a good idea for most people).

Be safe, know that we could see a major gap (in either direction) in the market ETFs and other stocks Monday morning, and be sure to enjoy the Easter weekend!

(Bonus quote from Yahoo Market News this morning: “The market went up on fumes this week,” said Philip S. Dow, managing director of equity strategy at RBC Dain Rauscher. “Nobody has any wild expectations to the positive for the jobs report. But, barring some kind of negative report, I still think we’ll see the market tread water.”)

Might I add: If the expectations are so negative, and if the report surprises to the upside, then the market will likely rally hard and gap up strongly Monday (a warning to the shorts). There is no way to know what will happen until it happens, but don’t let it catch you off guard.

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Link: Various Countries’ First Quarter Market Returns

Apr 4, 2007: 12:16 AM CST

TickerSense recently posted the First Quarter Stock Market Returns sorted by Country, and the good news is that the United States is in positive territory for the first quarter.

The bad news is that 65 (of the 87) countries (75%) beat the US stock market (S&P 500: up 0.18%) in the first quarter.

Topping the list: Zimbabwe at 600%. Can you imagine what it would be like to have your investment grow 6 times its initial value in 3 months? The only problem is that inflation grew at 1,000%, or 10 times your initial investment, so actually, your money would be worth less now than then, ironically.

It is always worth studying global markets, or at least giving international markets at least a cursory glance. How can it help? As globalization takes hold, the world is becoming more interconnected, where events (especially tragic events) that affect certain economies can now affect major economies across the globe.

Be aware that the United States is one nation among many, and we Americans tend to forget other economies are growing more rapidly than our own, and conditions overseas definately affect us at home. Investors are wise to study international trends and markets.  China’s Shanghai SE Composite rose 19%.

Check out the link and the TickerSense site. By the way, in the TickerSense Poll, bulls and bears (sentiment) are tied at both 30.30%.

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Dow Breakout of Range

Apr 3, 2007: 10:44 PM CST

We finally got the range expansion as expected in the major market indices, and the market has broken (again) to the upside as was also forecast, especially in light of the rampant negativity on the general state of the market. Is it surprising that, with all the negative sentiment around, the market rose yet again today?

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From a technician’s standpoint, we are still in a confirmed uptrend, and thus higher probability plays come from trading the upside, especially given the recent pullback into “support”.

Viewing a swing chart of the Dow and S&P 500, we see the market may be making a new swing higher, as confirmed by the recent new momentum high in the oscillator. This would hint that new price highs are yet to come. I can see the market testing the upper limit on the Keltner Channels (about 12,650 on the Dow and 1,455 on the S&P). The “Impulse Buy” setup has already achieved its objective, with entry near moving average support and first target being the most recent swing high).

dow-swing-ap3.jpg spx-apr3-swing.jpg

When the fundamentals or the news/commentators are telling you one thing (that the market will go down and the economy is heading into a recession) yet price and chart analysis tells you another, a dichotomy exists, and it is difficult to anticipate the next move with confidence, given so many conflicting signals. StockBee recently posted a timely post regarding “Methods Trump Markets” that addresses the issue of headlines/conventional wisdom already being reflected in the price of stocks.

A great quote from the post: “While majority are busy waiting for the doom to take the market down, the market acts contrary to expectations and offers bullish opportunities.”

Also analyze the Swing Chart of the S&P on the weekly time frame (notice the momentum divergence as price creeped higher and the eventual correction):

spx-swing-weekly.jpg

This is where trading your own system and not being influenced by others becomes crucial to success as a trader.

Despite the volatility that occurred at the beginning of the month, price still is making reliable swings and allowing for opportunity, provided you have a system and emotional stability (confidence) to take advantage of the movement and not get carried away with outside analysis or second opinions of your own analysis.

 

 

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Dow… still trapped. Someone save it?

Apr 2, 2007: 10:22 PM CST

I am sounding like a broken record, yet so is the market.

We have reached a clear equlibrium point and soon price will break one way or the other out of the consolidation we are experiencing. Remember, the longer the consolidation, the larger the move, yet it is difficult to predict which direction price will eject when it is trapped in a range.

Gutsy traders can take a position now and place clear stops if wrong… or you can place a buy (or sell/short) stop to draw you into the market when this range breaks. Either way, my prediction is for a clean, clear break out of the recent indecision zone.

The “Mighty” Dow is still Trapped

dow-apr2.png

The Nasdaq is also Trapped.

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If you must take a position, go Long SPY (S&P) with a tight stop should it break below moving average support.

spx-apr2.png

Sometimes, the best play is to wait for the market to tip its hand and then enter, but beware a “wash and rinse” which means the market may thrust initially in one direction, then shake back and take out the weak hands and stops, and then rally (or fall) hard in the original direction. Beware this, to those who keep stops too tight to the market.

 

Either way, be prepared and best of luck, regardless of your trading style.

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