Target versus “Target”
We got the correction I mentioned yesterday (or perhaps only part of it.) The potential WEDGE formation broke downwards as it should, but the movement towards the target (point #5) was not as direct as it is in most wedges. This five minute chart only shows yesterday’s wedge and its completion.
Pattern targets are best used to determine reward/risk measurements, and in this case I would not have taken the trade. But assuming an entry, what do you do about targets? Actually, you treat the trade just like any other, using trendlines, support and resistance, and Fibonacci measurements. Whether or not you get to the “official” target depends on trade management.
Today’s first move after a small gap was up to the day’s high at point “0.” After the trade triggers, a Fibonacci cluster develops at point “C.” Remember that Fib clusters require several measurements to show almost the same level. These were so close together that drawing multiple lines just makes the chart hard to read.
Point “C” is an 89% Fibonacci retracement of the move from “5″ to the top at “0.” It is also a 127% retracement of the move from “X” to “0.” And the third measurement is a Fibonacci extension; measure from “0″ down to “A” and you will find that it is duplicated by the distance from “B” to “C” — a Measured Move.
All of these targets are available an hour before we reach point “C”, so there is plenty of time to decide whether to take partial or full profits there. It all depends on your trading plan.
Did we reach the wedge target? Some would say we missed by over half a point because they are under the misconception that trading is always exact. I measure targets on wedges the same way I treat tests of top or bottom. If we get inside the range of the extreme bar at the beginning of the pattern, I count it as a hit. So as far as I am concerned the wedge pattern would have been a successful trade.
It’s All In The Angle
Both Tuesday and Wednesday had their best moves start right at the open, and since I’m not fond of entering at the open without a clear setup, I would have had trouble trading them. I’m not trading this week, but that doesn’t stop me from trying to figure out the charts.
On today’s 15 minute chart I’ve marked two patterns, one as a flag, and the other tentatively labeled a WEDGE. Whether you like trading patterns or not, there is some useful information in the angle of the congestion that followed the opening moves yesterday and today.
The flag sets a nice example. Perhaps you’ve heard the saying “the flag flies at half mast.” Points #1 to #2 represent the flag pole or “mast”, and points #2 to #3 are the flag. After the breakout above the flag, the next stop is at #4, repeating the distance of the original flagpole. It’s really just another example of a Measured Move.
The key is that a good flag will either be flat, or more often will lean against the trend set by the flagpole. In other words, it will create a pullback.
But look what is happening from points #5 to #6. The correction is leaning the wrong way. That is more likely to be a wedge formation, although with the low volume this week I’m not completely happy calling it that. But I wouldn’t be surprised to see a pullback here, even if the Santa Claus rally is going to continue.
If this is a wedge, it won’t be confirmed until the lower trendline is broken (although I know traders that will enter on the reversal of that “false” breakout at point #6.) And even then, the target would only be the level of point #5, which isn’t much room for profit.
Whether this actually works as a wedge or not isn’t the issue. In the short term, corrective action that struggles in the direction of the trend can show the market is losing momentum and is often a sign of weakness. But during low volume holiday periods anything can happen, so just trade what you see.
Here Comes Santa Claus
Well, we dropped about five points, gained it back, and then the big blue arrow tells it all. But I don’t think this picture is really worth 1,000 words, so I’ll keep this short. (That last drop all occurred after the stock market closed.) I didn’t see any trades I liked today.
I’m not sure how much posting I’ll do next week since we have company, but being the compulsive person I am, I’m sure I’ll put something up. For those of you keeping regular trading hours, we’ve finally reached the starting gate for the yearly Santa Claus Rally.
(If you want a break from the market but can’t keep away from your computer, check out my other site — www.OurWindowOnNature.com.)
According to Yale Hirsch who did the original research, the Santa Claus Rally occurs during the days between Christmas and New Years, and continues into the first two trading days of the new year. Popular culture has expanded this time period just like it has the holiday shopping season, but then popular culture doesn’t do any research.
Does it still work? From what I’ve read, about 65% of the time. But here’s a quote many overlook from Hirsh’s 1986 book Don’t Sell Stocks On Monday:
If Santa Claus should fail to call,
Bears may come to Broad & Wall.
With that encouraging thought, Happy Holidays.
For More Information:
Don’t Sell Stocks on Monday
Out of print, but still available if you’re willing to pay these prices. The second “used” copy is listed at $120!
Screening Trades
The last few bars yesterday broke out of a rectangle, but without any convincing volume. Remember that the most consistent pattern breakouts require volume to the upside and, although volume on down breaks is nice, it is not required.
Today’s first bar opened above the rectangle, but during the first three minutes shot down to tag the bottom of the pattern again, and then reversed back above it. Since the rectangle was only 1.8 points wide I wasn’t paying too much attention.
Rectangles have a minimum target of equaling their height after breakout, and in the Russell 2000, two points is the smallest size I will usually consider for a trade. It turned into a nice rally as I watched.
The pullback to point #1 is a type of trade I look for — a strong rally with a small pullback to the short moving average, in this case a Fibonacci 38%. The strength of the rally can override my normal expectation of a larger first pullback. Except there was one problem.
Because the market ran away from me, I was watching some other markets as I waited for the pullback. At point #1 both the SOX and the NQ were trading at yesterday’s lows. Maybe today the Russell is going to lead everything higher, but as a discretionary trader I don’t have to take every setup.
Often a correction will make a down-up-down pattern before completing, and at point #2 that’s what it looked like. If I can find another reason I will look for an entry trigger there. But wait! Now the ES and the YM futures have hit yesterday’s lows. The Russell is all by itself, oscillating around yesterday’s high. Something seems wrong here.
I have a rectangle marked through this topping area, but I couldn’t draw the lower boundary until after point #3. That was the release of the Philadelphia Federal Reserve report, showing the biggest drop in manufacturing activity in over three years. For my trading, all I care about is the time of the reports. It is the market’s reaction to reports that makes a difference, not whether they are good or bad.
Before the breakdown occurred, I decided that it looked like a valid rectangle (2.6 points wide), and both my moving averages had turned down so I considered point #4 a valid entry. After a hesitation at yesterday’s close (dashed blue line) we dropped through the rectangle target without a pause (yellow arrow.)
If you exited at the 2.618 Fibonacci measurement (taken from the top and bottom of the rectangle), point #5 could be another entry. It’s a low volume pullback to the fast moving average as the averages are pulling farther apart.
Has you noticed how flat the trading has been in the late afternoons? Six of the last nine days have ended with a long sideways move. I’m becoming very cautious about trades over the last several hours. Of course, now that I’ve written about it, it’s bound to change.
Profit, not Prophet
Wrong again, but all my trades today were profitable. I think there’s a lesson worth learning there. One of the reasons I don’t actually trade Elliott Waves is that the wave counts I see can turn into other wave counts that still make sense.
That’s the nature of the Elliott beast, but if you only use it as a guideline combined with other techniques, it can often give you pinpoint accuracy. But not yesterday. Let’s go over trading by the numbers.
Point #1 is the “top” I saw yesterday, with three Fibonacci measurements ending there. That pivot was the reason I came into today with a downward bias. After the first 3 minute bar, I placed an order for a short sale. As is often the case, my entry techniques offer a certain amount of protection when I am wrong.
I use an array of entries depending upon the situation, but let’s look at some possibilities that would be appropriate here. Sometimes I’ll enter at the break of a previous bar (that was the case today.) Other times I’ll use the short-term moving average (blue.) And there was a well established uptrend line from mid-day yesterday.
It doesn’t make any difference how strongly I believed the Elliott count at that point. I picked Trading What I See as the name of the site for a reason. I want all my actions to have criteria that I can explain. The opening bar wasn’t broken; the moving average wasn’t broken; the trendline wasn’t broken.
If any of those entries had triggered, I use front-end software that sets my exit stop the second the trade fills. I don’t even have to think about it, except to sometimes move the stop closer. Point #2 was a potential trade that I treated just like any other trade. When it doesn’t trigger I look on to the next possibility.
As pointed out several times in the last few days, when the 2.618 extension doesn’t stop price, look to the 4.236 extension. Once again, I “expected” a pause and probably reversal there, but that will never make me take a trade. But by point #3 there was a nice divergence with the Stochastic, and I made my first trade of the day as we broke the blue moving average.
And didn’t go anywhere (point #4.) After seven bars I covered half of my trade. As the blue moving average recrossed to the upside I covered the rest. First profit of the day — it was 40 cents after commissions.
It wasn’t long before we had a well-defined rectangle, but it is only a point wide. That means I’m not interested in trading the breakout at point #5. But watch what happens next. A pullback to the bottom of the rectangle. A poke through a declining moving average, and a reversal that breaks an established trendline. Point #6 is my kind of trade.
Where do we start looking for an exit. At both the Fibonacci retracements and Fibonacci extensions on the way down. I use them for taking partial profits or for moving my trailing stop closer. Point #7 is 262% of the measurement from points 3 to 4, extended from the top of the rectangle.
“Profit, not Prophet” is something I pasted on my computer monitor years ago as I was learning that predicting the market is a whole lot different from trading it. There really is a lesson in that.
Street Smarts - REVIEW
Street Smarts: High Probability Short-Term Trading Strategies
This is a book full of short-term trading setups, and I think it should be in every trader’s library. Linda Raschke usually gets all the credit for this book, but Larry Connors was the co-author, and they take turns explaining some of their best short term trading techniques.
You’ve probably heard of Linda’s Holy Grail setup, and this is the book that made it famous. It is one of the most well-known (but not necessarlly well-traded) short term methods for playing pullbacks in very strong trends. Like all good trading setups, Linda gives you the exact settings for entry and exit, while using the Average Directional Movement indicator (ADX) to define the trend.
Like many of the strategies in the book, the Holy Grail (and most of the others) works on almost any market and in any time frame, whether you are a day trader or only look at charts on a weekly basis. The 25 chapters have over a dozen devoted to single techniques, with several that cover trade management and general market indicators. And as Linda points out in the introduction:
All you need is one pattern to make a living! Learn first to specialize in doing one thing well. We know two traders who do nothing but trade the “anti” pattern from a five-minute S&P chart.
That resonates with me, because one of my main entry techniques almost always triggers at the same time as an Anti pattern. The Anti is one way of defining a trend, and then trading pullbacks against it. The Holy Grail is a slightly longer term method of doing the same thing.
But a good trading toolkit will have more than just pullback patterns. Turtle Soup attempts to catch trend changes just as they happen. Momentum Pinball looks at the changes in direction in the three day market patterns identified in the Taylor Trading Technique. And Historical Volatility Meets Toby Crabel show one way to take advantage of the NR7 narrow range days.
Originally aimed at Swing traders, there are a number of the techniques that I use in my intraday trading from a three minute chart. Besides my version of the Anti, I’m constantly looking for Three Little Indians showing an exhaustion pattern with three symmetrical peaks. Or an 80-20 pattern that occurs at pivots.
And this is where I first ran across the Wolfe Wave pattern which, although I don’t trade it the way Bill Wolfe teaches, sometimes provides the overall structure giving definition to my own trades.
No matter what your trading style this is a book worth reading. You’ll probably find that you keep going back to it until certain sections become second nature, giving you a both a trading edge and a better understanding of the markets.
For More Information:
Extensions Inside Extensions
Fibonacci Extensions are one of my most useful tools. I use them to help me decide where prices may turn and, just as important, where I expect prices to continue. Today we had a series of Fib extensions inside a larger extension pattern.
First, a disclaimer. Although I traded some of the smaller patterns today, I didn’t recognize all of the internal relationships until tonight’s analysis. And although I’ve used standard Elliott Wave labels because they fit so well, I’m not really an Elliott trader. (Note that some letters are lower case and some in capitals.)
We gapped down this morning, opening below yesterday’s low. After a fast drop to the level of the December 1st pivot bottom, we reversed and climbed back to more than fill the gap. My first thought was “Oops!” If you are not familiar with this, it is a Larry Williams pattern that plays reversals of gaps. Point “a” would be a buy signal.
I don’t trade the Oops! pattern by itself, but that signal gave me an upside bias. But only until 8:00, when we reversed from point “c”. The reason was the extension level that we reached. Let’s go over extension measurements again, using this first rally as an example.
An extension measurement takes the distance of a move in one direction, and applies several percentages of that distance to the next move in the same direction. In other words, we would compare the distance from “X” to “a” with the distance from “b” to “c”. In a normal movement the second length will end up at either 62%, 100%, or 162% of the first length. This time it was 62%.
If the Oops! pattern were going to work I would have expected at least a 100% extension, also called a Measured Move. When that didn’t occur I became very cautious. That doesn’t mean I quit trading — just that I no longer had an upward bias.
The movement down from “A” to “B” subdivided into a smaller a-b-c , although the Fib relationships were not as exact as I would like to see. Then we had another movement upwards, shown as the white line from “B” to “C.” This is not a simple up-down-up movement, but what Elliott practitioners call an Impulse move. And it ends at a closely packed Fibonacci Cluster.
If you measure from “B” to “1″ and then add the Fibonacci ratios of that distance to point “2″, it gives you the top of points “3″ and “5.” If you measure from point “2″ to point “3″ and use the ratios from “4″ it also gives you point “5.”
Now let’s take a larger look. Measure from point “X” to “A”, apply the Fib measurements and add them to point “B.” Once again you come up with the level of point 5, the entire pattern making up a large A-B-C. Three Fibonacci Extensions all pointing directly to the same level. And that’s where we turned down.
Whether you use Elliott Wave counts or just Fibonacci measurements like I do, the 791.50 level from this afternoon looks like an important number. Remembering that I don’t trade Elliott by itself (BIG DISCLAIMER), that A-B-C pattern looks just like an Elliott correction in a down move. I wouldn’t be at all surprised to see a drop tomorrow back below point “X.” But all that means to me is that I start tomorrow with a bias of down.
For More Information: Probably the best way to learn Elliot Wave
Robert Prechter’s Elliott Wave Principle