Trading What I See

I don’t think today needs very much comment, but an example of a trading tip appeared during the first few bars this morning. Candlestick extensions above and below the day’s open and close have various names. Some call them wicks, some call them tails.

See how noticeable they are during the early trading. When a number of very long tails appear in both directions on consecutive bars, they are an early indication of market indecision and often lead to false moves or sideways action. When I see them, I am hesitant to trade. And today that served me well.

About the only good thing from a trader’s standpoint is that volatility runs in cycles. Excluding the explosive move after the Fed announcement, the last few days have been very flat. Either we will get some movement soon or I’ve mis-read the calendar and summer is here already.

When you are day trading, anything you can do to make decisions easier or faster is to your advantage. Even when swing trading, as you scan through chart after chart, being able to interpret the information quickly allows you to be more productive.

I received a question the other day about my colorful charts, since most candlesticks have one color for bars that close higher than the open and another color for the reverse. I’ll be away from my trading desk today, and since I’m able to schedule posts that appear at a later time, we’ll take a look at Dunnigan Bars.

William Dunnigan was a market newsletter writer in the 1950’s, and spent much time searching for a mechanical system for trading stocks and commodities. For mechanical trading you must carefully define everything, and for Dunnigan “everything” included different types of bars. In his book One-Way Formula for Trading in Stocks & Commodities he talked about Inside, Outside, Up, and Down bars (but only used the last two for his One-Way system.)

Although I’ve coded my own color bars in programs like Metastock, QuoteTracker, and Ensign, someone saved me the trouble in eSignal by writing an EFS (script) appropriately named Dunnigan_Bars. I just modified the colors to make it easier to read on my black backgrounds.

A green bar has both a higher high and a higher low. A red bar is the reverse, with a lower high and a lower low. These are what Dunnigan used in his system. But I’m at least as interested in the other types.

The magenta bar is an inside bar. Notice how it points out the small pullback in this nice downmove. Sometimes that’s the only opportunity for a pullback entry in a fast, sustained move. And the blue outside bars often appear at reversal points, where they turn blue just as the bar starts in the opposite direction.

If you use exceeding the previous bar’s extreme for an entry (as I sometimes do), you can tell the instant it happens without looking at the price scale. The bar will change color, often from magenta to red (or green) as in this downmove.

Like candlesticks, they don’t actually add information to the chart, but they make it tremendously easier to see what is there. You’ll see them on most of my posts.

After a slight continuation of Friday afternoon’s drop, the Russell 2000 began a laborous climb to precisely the 50% retracement level. From the looks of the action, there must have been a lot of people watching that number, for the market made three unsuccessful attempts to push through the 732 area.

If you were drawing trendlines on this short-term movement, you ended up with a rectangle, a chart pattern with a flat top and bottom. Notice the drop in volume during the pattern — this is typical of rectangles.

You could also consider this rectangle as just another congestion area. See how the upper and lower trendlines match the high and low of the first candlestick? There were 27 consecutive bars whose range was completely contained within that first bar. That is really congestion.

Unless a rectangle has a lot of room between its top and bottom, it is safer to wait for a breakout — or better yet, a breakout and a pullback, which occurrs over half the time. Today the direction was down, making the rectangle into a reversal pattern. The pullback actually moved back into the pattern for several bars, which caused me some concern, but the ultimate move was certainly worth the worry.

There was a second entry on a pullback to the short moving average. I took that trade, but was stopped out for a small loss when I moved my trailing stop too close. The final bottom occurred at a typical Fibonacci number. When a move is decelerating, the second impulse is often 0.618 times the length of the first. Perfect time for an exit.