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Trading What I See

Great Trading,

Lowell

Another Context Lesson.

Early trading moved quickly to yesterday’s high and reversed. Then there was a drop to yesterday’s low, with no pullbacks in sight. I suppose I could have shorted the early peak as a test-of-top, but I didn’t. Then yesterday’s low provided enough support to run us back to re-test the high.

By the time we reached the intra-day high again it was starting to look like a large rectangle would form. But at around 8:50 Pacific time we broke out. Or did we? There was a beautiful divergence between price and the Stochastic oscillator that lead to the big move of the day. The reason seems to be a Philadelphia Fed announcement that was much worse than expected. The entry signal came a few minutes before the announcement.

But we didn’t know the news would be bad, so why would you really take the trade? Well, there was the divergence. And I just happened to be scanning several other markets at the time. Would it have helped to know that the NQ e-mini futures were making a lower high just then? What if I said that the ES e-min futures were just finishing a triple top? You say you want more? All making lower highs at that same moment were the YM e-mini futures, the NASDAQ Composite Index, and the SOX (Semiconductor Sector). Did I hear you say false breakout?

At 11:00 there was a nice pullback to resistance, combined with an overbought Stochastic, for a continuation move down. A trendline bounce gave you a nice exit.

Remember the context of your trade. Tuesday I mentioned the context of previous day’s trading pivots. Today it is the context of what the other markets are doing. Both are sometimes crucial to taking the correct action at the correct time.

Fed Day

One of these days I’ll convince myself to take Fed days off. I usually just watch and seldom make a trade. Today was no exception.

The morning started with a four point gap, followed by an eight point rally. With most commentators certain that Fed news would be No news, maybe today would be tradable. Wrong. The next three hours and forty-five minutes went sideways in a 4 point range. Then came the “excitement.”

Fifteen minutes before the Fed announcement, some traders tried to anticipate the news. Prices ran up to touch the daily high and then retreated. The report was released, and prices dropped to touch the daily low and then rallied. End result — we ended the day right at the center of the four point mid-day range. One of these days ….

One Day is Not Enough

As we watch short-term charts, it is too easy to forget the context of our trades. In this case, yesterday’s data. The first hour produced a narrow range, and many traders thought the market was already waiting for tomorrow’s Fed announcement. (Maybe I’m just projecting my morning thoughts.) But the major rule is “trade what you see – not what you think.”

The signals were there. At 8:15 (Pacific) we had a nice .618 pullback to a trendline created from Monday’s high to today’s opening bar. Stochastics were overbought, and there were three possible entries. (1) a break of the moving averages, (2) a break of the rising yellow trendline, and (3) a break of yesterday’s low (which was also the first hour’s low.) It was five points or more before the first pullback.

If you were expecting an even larger move, the divergence between 10 and 10:30 was a warning of potential reversal. The rest of the day was a climb back into the morning range.

Wedges and Targets

Wedge Patterns usually occur at the end of a move, but occasionally you will find a well-formed wedge in a sideways pattern. A wedge is created by a pair of trendlines that converge, and is similar to a triangle, except that both trendlines point in the same direction.

This pattern was quite well-behaved. Notice the three pushes to the upside. When you have a three-wave move, it is common for the first pullback to be .618% and the second .382%. The first pullback was accompanied by an oversold Stochastic. The second didn’t get oversold, but it was bouncing off a confirmed trendline.

Wedges are not the most reliable patterns, but this one gave several simultaneous signals that it was ending at point 5. First, it hit the upper trendline just as it reached yesterday’s high (green line.) Second, there was a well-formed divergence between price and the Stochastic.

The third piece of the puzzle is a Fibonacci extension measurement. Extensions are when you measure a move in one direction and compare it to the next move in the same direction. If you take the distance from point 2 to point 3 and multiply it by .618, you will get the exact distance between point 4 and point 5. Three reasons to short for a quick five point profit.

Why five points? Because the normal target for a wedge is its beginning. The actual bottom came about a half hour later, at another divergence. Notice that the bottom occurred at the precise time when the two trendlines crossed. It’s amazing how often that will happen, but like much else in the magic of market geometry, you can’t count on it. But you try and trade it when you see it.

False Breakout

Yesterday I mentioned the possibility of a breakout today, and it looked like it was happening — for a few minutes. We started with an almost five point gap on fairly good volume. Price opened above the highs of the last two days on the Russell, which has actually been the weakest of the indexes I follow. Three minutes later we were on our way down. Predictable? Not by me. But the move gave two different short sale setups within a few minutes of the open.

The first setup is most easily seen on a longer term chart. While many watch an hourly chart, I don’t really like them. If you are trading stocks, there are 6 1/2 hours to the trading day. Index futures have 6 3/4 hours. In either case the last hour of the day is shorter than the rest. Am I being picky? Probably. For that general time frame I use a 45 minute chart for futures, and there are exactly nine of them in a trading day. (I used to use 65 minute charts for stocks. With computers, you can make the rules.)

The setup is from Victor Sperandeo. If you haven’t read Trader Vic — Methods of a Wall Street Master, you’ve missed a great trading book. The pattern is called the “2B.” I won’t go into much detail, but the essence is that a trendline break followed by a new high and a failure is almost a definition of a trend reversal. It’s easiest explained with a picture, so here it is. This pattern alone is worth much more than the price of the book.

The second setup, occurring at exactly the same time, comes from Larry Williams. He calls it the Oops! pattern. It requires a gap above the previous day’s high that can’t hold. In other words, it fails soon after the gap is made. And all the traders that took the breakout say “Oops!” He trades it as a one-day trade, holding until the next day’s open. We won’t find out until Monday if his trade works. I take my profits a lot earlier.

The Oops! pattern doesn’t really require a chart to understand, but you’ll still want to look at this one. Once you had convinced yourself that the true direction was down there were multiple patterns, Fibonacci measurements, and pullbacks for trade entry and exit. Too much to explain in one post, but this is what the Critical Bits Blog is all about.

No Question about Direction

The first hour’s range today managed all of 4.7 points. Actually the full day was wider — 6.1 points. As I mentioned Friday, I use the first hour’s range to stay out of trouble. I actually took a quick short sale during the early downchannel, but I exited for a break-even trade.

Watch for days when the first hour range is broken and then re-entered. These often lead to reversals or sideways days. I borrowed one of Dave Landry’s big blue arrows to point out today’s trend.

Nothing else to say today except remember that narrow range days lead to breakouts.

After a Trend? Consolidation.

Sometimes you get two Trend days in a row, but more often the next day is a consolidation. The first hour range was 5.1 points (just like Friday’s narrow range.) The 7:48 bar (Pacific time) created a double bottom that was also a Stochastic oversold condition. If you took that trade it would have been profitable, but was the exit going to be at the earlier high, or at the upper trendline already drawn? Notice it tried both.

It didn’t make any difference to me, since I didn’t really expect a breakout. I’m used to being wrong in my expectations about the market, but I don’t use them to trade – just to help decide whether I’m willing to risk an entry. Not shown on the chart is the July 5th peak just two points above a first hour breakout. That kept me watching.

Notice how price turns nicely at the trendline setups. At 9:15 it gives a profit-taking exit if you took the earlier trade, and at 12:30 it bounces off a parallel trendline (also at the first hour’s high) to go sideways into the close.

Trend Day – Catch it if you can.

For many of us, Trend Days are harder to trade than the normal up and down moves we encounter for most of the month. I sometimes spend trend mornings trying to find reversal points that never appear. And oscillators won’t give you an oversold condition until it’s too late. What’s a trader to do?

Reading the NYSE TRIN helps. (Numbers below 1.0 – and particularly
below 0.80 are bullish.) Because of the way it is calculated, the readings for the first half hour can be deceptive, but look at the 30 minute TRIN readings from this morning: .69, .74, .62, .62, .68, .79, .95. That last 95 reading came during the lunchtime consolidation.

The definition of a Trend Day might also help. For me, a Trend Day starts and finishes at the opposite ends of a wide range day. And they often have a nice consolidation pattern right in the middle. There’s a secret in that definition. If the consolidation pattern comes in the middle, you can make a profit even if you miss the first half.

The morning session made a well-channeled nine point move containing several nice pullback entries. Then came an hour and a half consolidation during lunch. If the pattern holds, there should be another nice move in the afternoon — and there was. Another nine points.

The trendline structure is also interesting. The first channel could have been drawn 36 minutes into the trading session. It held, and the bottom trendline provided pullback entry signals until the noon consolidation. And where did the market stop in the afternoon? The other side of that same line.

If you haven’t worked a great deal with trendlines you might be surprised to see that the afternoon pullback turned around at another parallel to the original trendline drawn early in the morning. It happens often enough that you should be watching.

Multiple Time Frames

Today there was a nice rally starting about 7:45 (Pacific). The question wasn’t whether you caught the beginning of the rally, but how soon you decided that the direction had reversed. There were four pullbacks before price topped about 10:15. All were tradable, but only after you saw the change of trend.

Although I trade a 3 minute chart, a 15 minute chart often gives me hints of potential turning zones. Not trading signals, but suggestions of what might happen. I watch for both equal moves and various Fibonacci relationships. When the 15 minute Stochastic became oversold about 7:30, this morning’s downmove looked much like what occurred late last week. A quick check showed a 12 bar drop matched by a 13 bar drop. The measurements were 9.9 points versus 10.4 points — only a 5% difference.

Buy? Not this trader. But the potential for a reversal from this level allowed me to consider each of the following pullbacks as possible uptrend entries on a 3 minute chart rather than as a continuation of the downtrend.  Notice how the equal moves produce a parallel channel.  Trendline traders could have caught this even without counting bars.

Is it still summer?

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Good Trading

Lowell
Everyone has been anticipating more trading action since the Labor Day weekend is finally behind us. As usual, “everyone” was wrong.

We started with a small gap to the upside, drifted down for the next 45 minutes, and that was pretty much the end of the trading day. First hour range: 5 points. Day range: 5.3 points. Toby Crabel once did a study of narrow range days. He popularized the NR7 (narrowest range in seven days) and the NR4. I wonder what he’d make of an NR88!

The real question, unless you’re a scalper, is how to avoid trading this type of day. One possibility is watching the first hour. If I can’t find a reasonable trade in the first hour and the range is quite narrow, I mark off the high and low and wait for a breakout. Unless you count the three-tick break at 11:00, it never happened. And I never traded.

Trendlines Rule

Today was contract rollover for the futures markets, and prices started off with a gap lower. Without a pullback, I just watched. At about 7:15 (Pacific) the market started a bounce, and I played this unsuccessfully as a pullback. As you can see it didn’t work.

Then the market started a series of higher highs and higher lows. Here’s where trendlines become valuable. The first trendline (yellow) was drawn from the blue #1 to blue #2. Then a parallel line (blue) was created starting at blue #3. When price touches this blue line there is a potential trade, which continued higher until the morning gap was filled.

Too many traders expect reversals when gaps are filled, so red #3 was a perfect exit point. Did I mention that price hit the yellow trendline then. I love confirmation of signals. We were in an uptrend there, so I wasn’t interested in a short sale, and price just drifted lower throughout lunch time.

At red #2 we have an oversold Stochastic signal, with a trigger as the moving averages are broken. This is probably the clearest trade of the day. The pullback was just over 50% (not shown). After price moved away from this bottom it was possible to draw the yellow trendline from red #1 to red #2. Then the blue parallel was drawn starting from red #3. And that’s where price reversed – not only at the trendline, but also inside the 127% – 161.8% retracement of the measurement from red #3 to red #2.

The Fibonacci measurements are not quite as precise as earlier in the week, but that danger zone is important to watch. And when price hits a correctly drawn parallel trendline, it’s time to take at least partial profits.

The rest of the day? It’s hard to find any clear Fibonacci or trendline setups. But that’s why we need multiple entry and exit techniques. In the market, nothing works all the time.

More Market Geometry

Gap Openings without pullbacks can be hard to trade, but with some patience and a ruler there were two possible entries. After many years of watching, I am still in awe of the power of parallel trendlines.

In each case, the lower yellow trendline was drawn first from two distinct bottoms. Then a parallel line was drawn from the top that occurred between those two bottoms. A sell signal was given when price hit the upper trendline and then fell through the short moving average.

I see the first trade as an acceptable risk, but not the second one. Notice where the measuring bottom occurred on trade number two – at precisely the 127% retracement of the mid-day pullback (from point A to point B.) I really expected a double bottom on that line. But this example shows why I consider the area from 127% to 161.8% of any retracement as a potential reversal zone. Price tends to pay attention to Mr. Fibonacci.

Pullback Entries and Fibonacci Exits

Yesterday was Labor Day, and although the markets were “closed” my data provider showed several hours of trading. Just enough that I didn’t trust my indicators for early action.

Today was a great example of using Fibonacci for potential exits. At 8:00 am (Pacific) there was a pullback trade using a Stochastic oversold signal. At the time we were below both of my moving averages, so I used a break of those averages as my entry. Measuring the retracement of the pullback gave a zone of potential reversal between the 127% and 161.8% Fib levels. This doesn’t mean automatically exit – just watch price action in this important zone. But notice the precise reversal.

10:30 gave a pullback short signal, although the Stochastic never reached overbought. However I place a lot of emphasis on my moving averages, so I cautiously took the trade as the shorter moving average was broken. And once again measured the pullback to find the danger zone and another reversal. Again at 161.8 percent. They don’t always work, but you’d better believe I mark them on my charts.

Every other day …

Echo, echo, echo …. This looks much like a repeat of Monday’s (8/28) action. A quick, tradable pullback followed by a day of sideways oscillation. The range was a little wider, and if you play divergences it was possible to catch several of the swings.

The pullback over the first 30 minutes gave a tradable entry as the moving averages showed a strong uptrend from yesterday. A very clear stochastic pattern marked this second rise through yesterday’s high (green line.) Five points later, and the moving averages start intertwining for the rest of the day.

At 9:30 (Pacific) there was what I call a weak divergence for another long entry. [Weak because price didn't make a lower low.] I wouldn’t take the stochastic signal half an hour earlier because it was below both moving averages. For that I will usually wait for a divergence.

The new high at 10:30 came on lower volume and with another stochastic divergence. By the time you get the bottom at 11:45 you could have recognized the pattern as a rectangle, and it bounced to the top of the range in a straight line. Once again, the clearest and best trades are coming in the first hour. Tomorrow and Friday may be non-events as everyone heads out for the last three-day weekend of the summer.  I think I’ll join them and post again next Tuesday.

Reports drive the markets

Fibonacci ratios often mark the end of moves, but the problem is seeing the possibilities in time to take action. Often a move will retrace more than 100 percent, and if so, the most likely turning points will be either 127% or 161.8% of a previous move. Or in today’s case, of a previous range.

Yesterday spent over five hours in a sideways pattern that was finally broken this morning. Where did the breakout fail. At exactly 27% above yesterday’s range (127% measuring from the bottom of the range.) It tried twice to break that level, reversing when the Consumer Confidence report was released. (No, I didn’t see this measurement in real time, but that’s why I study these charts every day after the market closes. Over time I catch more of them.)

I don’t tend to trade reports, but after the news pushed the market down there was a pullback entry (marked in yellow.) The trade was only slightly profitable, but look where it stopped. At 161.8% of the pullback. When it couldn’t push lower that was a good time to take at least partial profits.

Then the market waited for the Fed report which, as usual, caused prices to whip back and forth a bit before deciding to move higher. Once again there was a pullback entry if you were patient. No, I don’t see a Fib ratio there, but believe me, I looked. That’s the way to learn.

Bet you can’t take just one.

One-a-day may be the best prescription until after next weekend (Labor day). It seems as if every other day has a single good trade. And of course Friday brought down the average. Fifteen minutes into today’s session set up a nice divergence trade. But unless you use something as sensitive as my moving averages, by the time you identify a trend, it’s too late.

I’ve put ADX on the chart, and it was just over 20 as the first trade triggered. But from my point of view, an ADX of 20 has to be rising to call a trend. This one was flat. I missed that first trade, not because of an ADX reading, but because I was so sure today would be as flat as Friday.

By the time we got to the next three pullback or divergence trades, my moving averages said FLAT. Good thing, too, because the trades had quite small gains, and I almost always lose money on those. Happy to be flat all day long. (Actually, I really would have liked that first trade.)

Lazy, Hazy Days of Summer

This morning I was sure I had identified a Triangle pattern that immediately broke to the downside. Fortunately I require more for an entry signal. Sometimes the lack of a trigger is the only thing that saves me from a bad trade – prices quickly reversed back up through the “triangle.”

After what looks like a nice volume breakout, prices reversed again, back into yesterday’s ending consolidation pattern. At 8:30 came the only entry signal of the day. But it’s Friday. And it’s late August. And my longer moving average is flat rather than down. Pass on that.

That’s when I drew the two orange support/resistance lines on the chart, and decided I wouldn’t trade until they were broken. That only happened during the last hour of trading, and if you’ll notice by the volume decrease, everyone had gone home. Guess it’s weekend already.

Some days you just watch.

When the Russell 2000 starts trading less than 10 points a session I find it pays to become extremely selective. Going back five days we have had ranges of 9.70, 9.40, 10.90, 6.80, and finally yesterday’s 16.60. Maybe things are looking up.

Maybe they’re not. All I could see today were several pullback trades with whatever small trend there was at the time. I use two moving averages to help define a trend. Since I like Fibonacci numbers, my short average is a 13 period simple moving average (sma) and the longer one a 34 sma. If price is under both, I consider the trend down. Reverse that for uptrends.

I wasn’t comfortable with the early reversal, but there was a short entry about 8 o’clock (Pacific) and a long entry about 11:00. I actually got stopped out on the short before it moved. Should have watched the nice yellow trendline. Call the day a scratch. Which is probably not too bad since we are back below a ten point range, and finished up near yesterday’s close.

Breakout/Fakeout

This morning was an excellent example of why even day traders need to do some planning before the market opens. And how a little math will improve your bottom line.

The market opened almost unchanged, and then had a small surge to the upside. Considering the small ranges of the past two days (an inside day following an inside day) a breakout was not unexpected. But would it carry through?

The reversal occurred at a 127% retracement of yesterday’s range. [5-minute chart to show two days.] Most who use Fibonacci retracements seem to think they stop at 100%, but after the market completely reverses a move it sometimes goes just far enough to convince traders we are exiting a range. And as everyone jumps on board (look at volume), the market turns around. 127% is a typical reversal point.

Does that mean you should sell at that level? Of course not. Sometimes it goes to 162%. Sometimes it actually continues. But the break back through yesterday’s high (green line) or through yesterday’s close (blue line) said get out of long positions and consider going short to get into the best move of the day.

Wolfe Wave

Although I’ve never actually traded a Wolfe Wave, I easily recognize them after the fact. But today I called this one right at the top. (Called it, but didn’t trade this one either.) The numbers on the chart are not Elliott waves, but the tracks of the Wolfe.

I first ran across this pattern in the Linda Raschke/Larry Connors book Street Smarts, but for more details check out Bill Wolfe’s web site. There are a lot of definitions of a “Wolfe” wave on the web, and mine is my own interpretation, but when they work they are impressive.

Look for three waves in one direction where point 4 pulls back into the area of the first wave. As in this example, the 5th point often overshoots a bit, so the entry is when price comes back down through the trendline. The key is the target, found with another trendline from point 1 through the bottom at point 4. Expect a reversal when price gets there.

In today’s market not only did we hit target, but a Stochastic divergence gave the signal for another entry. Do Wolfe Waves always work this well? Does the market hand out free money? But I think I’ll spend this evening building a better Wolfe trap.

If it doesn’t work the first time …

Today started with a four point gap on the Russell, and it looked like we were on our way down. The first pullback gave a reasonable Stochastic entry, but reversed after two bars. Fifteen minutes later there was another potential short, this one accompanied by a nice Stochastic divergence.
I took the first entry and passed the second. I know that second entries are often necessary to catch market moves, and sometimes I even convince myself in time to take the trade.

There was another potential entry (long) just before 9 am Pacific time (lunchtime back East.) I can see it as another divergence now, but it was not strong enough to convince me at the time. To take a divergence trade I want a strong pattern, or for the divergence to be the confirming factor on another trade entry.

Notice the yellow line drawn half-way between today’s high and low. On a do-nothing day the market will often set a range and then spend the rest of the session oscillating around the center point.

Two non-standard trades

There were two interesting trades today – one early and one late. Interesting because neither are my regular entries.

The morning started with a gap that couldn’t hold. My oscillator was showing a divergence from yesterday, but by itself I wouldn’t trust it. However the drop began by crashing through my two moving averages. This provided a quick exit point if the move did not continue. But it did, and nicely.

After a boring mid-day there was a breakout (11:30 Pacific) followed by a 38% fibonacci pullback that also stopped right at the resistance zone built up during the day. This did not give me the Stochastic oversold reading that I usually require (14/3/3 – not shown), but once again the fast moving average gave a close exit point if the trade went wrong.

If it can’t go up …

Several nice signals today. At lunchtime (9 am Pacific time) there was a nice pullback to the 38% Fib level. Then the market tried to make a new high for an hour and a half. By the time it finally succeeded, a divergence pattern had developed in the 5/3/2 Stochastic.

A new high that can’t even hold for a single three minute bar is a pretty good indication we are going the opposite direction – right down to yesterday’s close.