US Market Shocks, Awes, then Shocks Again

Jan 24, 2008: 1:49 AM CST

It is very difficult to remember a day as surprising as the intraday price movement on the major US Stock market as January 23, 2008. What’s surprising is that an almost identical pattern occurred… 24 hours earlier!

Let’s take a quick look at the S&P 500 index on the 5-minute chart for yet another perfect gap fade trade:

  1. “Fade the Gap”. Enter long (the SPY or DIA) to target yesterday’s close.
  2. “Gap Fill Reverse”. Exit original long trade and enter short to play for a target of the intraday price low
  3. Exit. This is actually just beneath the intraday price low, which served also as the absolute low of the day.

The pattern is similar on the Dow Jones Index and DIA (ETF).

Let’s look at the strongly developing momentum divergence on the 15-minute chart:

Notice the green line drawn beneath the final three swing lows in the oscillator, which served to create a divergence with the equivalent swing lows in price.

Divergence trades are often good for a small target only (such as the falling 20 period moving average), but extended (or prolonged) divergences can yield larger wins and often precede actual trend reversals.

Despite all the great news in the market, not every stock was spared the wrath of the bears.

Apple (AAPL) and Google (GOOG) fell in tandem today, with Apple plunging $16, creating a bearish development on its price chart.

If you can’t find today’s price on Apple on the above chart, that’s ok. It’s actually hidden behind a large volume red bar. The candle pattern is actually a hammer, coming after a strong price decline, which may prove to be bullish, and the sellers may have temporarily capitulated. Either way, a long trade in Apple is a countertrend and relatively risky move.

Notice the momentum divergence from December until January that preceded the price decline.

The market shocked with a major downside gap. Then “awed” us with an amazing recovery. Played to our expectations by trending lower in the day, then shocked us yet again with an amazing comeback rally to take the Dow Jones positive by almost 300 points today.

Market, is there anything you can’t do? Absolutely amazing!

3 Comments

3 Responses to “US Market Shocks, Awes, then Shocks Again”

  1. Stock Market » US Market Shocks, Awes, then Shocks Again Says:

    […] Here’s another interesting post I read today by Corey Rosenbloom […]

  2. LP Says:

    Have you figured out the Tight vs Loose stop issue in your trading? Will be interested to hear your opinion. As for mine (useless at best), I think it’s a wash. Tight stops give you more shares, maybe as much as 50% but you will lave 20% or so more losers. Loose stops will increase your winners by maybe 20% but you will have a dramatic shortage of shares.

    The question is what will your mind accept with degrading the other aspect of your system (like taking the trade). Also, I like mechanical entries but exits are a different story. However, I really do believe that individual wins and losses are random. So in this case Discretionary entries for the inexperienced can hurt a lot. You really don’t know which ones will be a winner or loser but you mind wants to be assured of a winner before you take the trade. A mechanical system just auto enters your edge, sizing your position and places a protective stop. Thus no blows but you could die a slow death.

    Exits are a beeyatch at best. There is no perfect exit. A discretionary trader may exit at what he/she think is the opportune time but later finds the stock continuing to move. The other problem is that many will only remember their better exits and think that the discretionary exit is best. I guess it would be one of those wonderful biases that get us in trouble.

    No magic, no grails. I do think that the only potential grail is strong and consistent risk / money management. However, most trades don’t take this seriously as they only concentrate on great entries.

  3. Corey Rosenbloom Says:

    Hey LP,

    I believe the type of trade taken warrants a specific strategy. For example, trend trades with high probability require looser stops because they are so obvious and traders cluster their stops at predictable levels and you need to overcome those zones, while lower-probability or precise trades (like a divergence set-up) require much tighter stops. Position sizing is another factor as well.

    You’re right as you identify the dilemma above.

    The more I trade and the more I study, I lean more and more to automated, mechanical systems. Edges play out over time, and we have to take every trade our system calls for, and there’s no way to know in advance what the outcome of any trade will be in the same notion that the casinos don’t know that they will win every game and don’t even care. You don’t see a dealer sizing up the cards and saying, “You know what? Let’s just re-deal, how about it? I don’t like the hand I have.” They take the cards, spin the wheels, throw the dice, etc because over hundreds of events, their slight edge will be realized.

    Similar edges are possible with trading, but we tend to foul them up when we try to predict what will happen next. Truth is that we can’t, from an individual trade’s perspective and this is very intimidating and discouraging for many newer traders (I have been there as well).

    I’m 100% in agreement with your last statement as well. If there’s something perfect, I haven’t found it and I doubt anyone has. We just take the trades that conform to our definition of an opportunity with edge and control our risk appropriately and not shoot for the stars or think we know the outcome at all on any trade. And we keep doing it over, and over, and over, and over.

    It’s such a hard business and as many times as I heard that, I never really realized it until about two years ago. This stuff is hard! It comes down to working through the hardships, learning as much as you can, and developing a system that works for you and your unique personality. Oh, and then testing and tweaking as the system breaks down with new market conditions!

    Ohhhh but you have to love this game to stay in it.

    Thank you so much for your thoughts and your comment.