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Trading What I See

Great Trading,

Lowell

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.

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 ….

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.

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.

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.

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.

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.

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.

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.