Trading Wednesday’s Trend Day

Jul 16, 2008: 8:28 PM CST

How might we have identified and taken advantage of today’s developing trend structure?  Let’s take a couple of perspectives.

First, we, along with many other traders, have been expecting some sort of ‘oversold technical bounce,’ meaning odds were increasing for some sort of ‘snap-back’ rally, similar to the visual concept of a rubber band being stretched.  Such a rally is never guaranteed, but was expected – it was this structure that we were watching the daily charts, waiting for a possible ‘index burst’ to occur.

Trend days occur when continuity of thought on both sides of the market dominate the day’s trading.  For example, assume that in this case, short-sellers may have had significant profits on their positions and would be eager to take those profits at the eariest sign of market strength.  Buyers, seeing rampant weakness in the indexes, may have been waiting for the first sign of strength to ‘snatch up’ deeply discounted value stocks, and were waiting for a signal to engage in potential ‘bottom fishing’ tactics.

Today, both realities commenced with the short-sellers covering (adding buying pressure) and the buyers… well, buying.  Trend days result when one side of the market dominates the other.

Let’s look at some of the opportunities in the Dow Jones ETF – the Diamonds (DIA):

The day began with an overnight gap (up) that was almost instantly filled (remember the first play of the day when there’s a gap is to ‘fade’ the gap and target yesterday’s close).  With this complete, the next trade is often to play back in the same direction of the gap and play at least for the intraday high (which was achieved very quickly).

Price found resistance at the 200 period MA, and a flag-style retracement occurred which set-up a potential ‘bull flag’ trade which met its objective very quickly.  At this point, it was still uncertain if a trend day would develop, but the picture was becoming clearer with each new bar – the measured move took price above its key moving averages, and a key test set-up.

The “Make or Break” test occurred just before noon when price retraced back to the confluence of its key moving averages – if price broke this level, we would return back to the value area established lower, and perhaps retest yesterday’s close to see if sellers were still present.  If price continued its momentum higher, odds are short-sellers would exit their positions and buyers would be inspired with confidence to continue trading long (buying).

As such, a great ‘bracket’ trade was established (playing off the reaction or success/failure of the test, rather than trying to predict what was about to happen – either move would set-up a good trend move or ‘swing’).

The bulls won and at this point, a core trade could be established long, with aggressive trades taking place at any retracement to the key 20 period EMA – this was the successful structure and trading tactics of the day… but the picture was not clear until half of the day was over that it was safe to play for a larger, aggressive target.

The price structure of the NASDAQ ETF – the QQQQs – was similar to that of the DIA:

I highlight two bull flags that set-up on the day – yes, they look perfect in hindsight, but the more you see these patterns and the more ingrained they become, the more confidence you will have in recognizing them in real time and then taking appropriate action.

Odds now favor higher short-term prices on the major indexes, and the fact that Financial stocks surged so much today (some of which surged more than 10% in a single day) adds bullish fuel to the fire – it’s difficult now to be a (short term) shorter!

The ensuing rally will be classified as a ‘counter-trend reaction’ against the prevailing down-trend, yet there are still opportunities to capture this up-swing either in the index ETFs or in potential indivual stocks.

5 Comments

5 Responses to “Trading Wednesday’s Trend Day”

  1. Panamon Says:

    Agree with your analysis. Considering MACD divergence in QQQQ and decreasing volumes in the uptrend at the end of the day, I guess we can expect a bloodbath in the next few days, maybe even today (July 17)… What do you think?
    Ciao,

    Panamon Rn+

  2. learner Says:

    how do you know when to enter the trade for a bull-flag? e.g. in the QQQQ chart, how do you know the length the flag will make. at 10:00 am it was 5 candles, at approx 1:00 pm it is 9.

  3. Corey Rosenbloom Says:

    Panamon,

    I wouldn’t say that – during a strong trend, in which one side of the market absolutely dominates the other, there are no ‘swings’ in price. If there are no swings, then there are no oscillations in the indicator because the 3 and 10 period moving averages remain constant and equi-distant.

    During a strong trend move, it’s best to ‘throw out’ virtually all indicators except moving averages (for trade entries). During consolidation periods, it’s time to throw out moving averages in favor of oscillators. Nothing seems to work in all market environments.

    Great question!

  4. Corey Rosenbloom Says:

    Learner,

    The simple answer is that you don’t know when it will break, and so you identify and draw the trendlines when you feel confident they are forming and then wait for a break above the upper line to place entry and place a stop beneath the lower line.

    Generally, a flag will retrace 50% of the prior move (Fibonacci) so if it goes beyond that, I have less confidence in taking a trade. Also, the ‘flag’ should have a roughly 45 degree angle to increase confidence.

    The key (or entry) in both instances was not the final large white candle INSIDE the pattern, but the large candle that broke out of the pattern – that triggered entry. Of course, if you wanted an aggressive entry, you certainly could have entered before the price confirmed the break but in general, aggressive entries drop off your odds of a successful trade.

  5. Anonymous Says:

    Panamon,

    It looks like the volume in the Qs was increasing by today’s end. Do you mean a bloodbath for the shorts?

    Marc