Trading What I See

When you start the day with a large gap, it pays to check your longer term charts for reversal levels. In this case the daily chart shows that this morning’s plunge reversed within two ticks of the January 9th pivot bottom.

The daily also shows a nice wedge formation created over the last six weeks. Wedges are supposed to retrace their height quickly — however doing it all on Tuesday was certainly a surprise.

Besides matching the 1/9 low, today’s bottom pivot was also a 162% external retracement of yesterday’s range, giving several reasons to look for a reversal at that level. The question is whether you are willing to step in front of that kind of momentum.

There are several problems with trading this type of volatility. One is the size of the physical bars. Recent ranges have averaged around one point — near today’s open on the 3 minute timeframe it was over three points. This means that if you are using bar highs and lows as basing points, your risk on each trade has increased greatly. Of course so have the moves, as shown by the almost 17 point move in fifteen minutes this morning.

In order for me to find an entry with limited risk I had to look at a 1 minute chart, and even then I decided to pass the trade. Later in the day, when things calmed down, price kept missing potential Fib turning points. After all the nice setups this past week, today just didn’t match my trading style. But as a day trader, there is always tomorrow.

For some reason my data provider (eSignal) always includes several hours of holiday trading in their feed, and although I can screen it out in the S&P Futures, it still shows up in the Russell 2000. If you can ignore the “extra” bars on the chart, this morning’s bounce came at a logical Fibonacci level.

Without the extra data the trendline (from the 15 minute chart) would hit at a slightly different level, and perhaps there would have been a divergence in the Stochastic — there was in the shorter Stochastic I was watching at the time.

We opened with a small gap and a 15 minute drop (A), made a three bar pullback (B), and bottomed (C) with a slight penetration of a trendline that started from the February 12 low. The bottom was a precise 78% retracement of the rise from the low on Friday.

Whenever I have and A-B-C move (down-up-down) I take the distance from X to A and multiply it by Fibonacci ratios to get 62%, 100%, and 162%. These numbers are subtracted from the pullback (B) to give potential turning points for the move.

If the move is strong it will carry to 162% or further. If it is an average move, it will stop at 100%. And if it turns at 62%, you are more likely to get a good reversal. Trendline support, a 78% retracement, and an A-B-C that turned at 62%. We got a much better reversal than I expected. There was no reason to exit until we got to the rectangle area at lunch hour.

I don’t trade rectangle breakouts unless there is a nice volume increase, but the pattern on this one looked good. A breakout at about 11:00 (Pacific) followed by a pullback to the support at the top of the pattern. The first target on a rectangle is when price duplicates the width of the rectangle. That was the high of the day.

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.

Today had some indexes breaking out, the DOW to a record high and the S&P to a six year high. The Russell 2000 tried with a nice early rally, but then went flat in a narrow range for the rest of the day.

Unless you are trying to catch very small moves, today would have been full of whipsaws as you kept expecting the market to continue (or reverse) the early trend. And looking at the wrong indicator can give you signals that are not reflected in price.

You’ll usually see a Stochastic oscillator at the bottom of my charts, and I use it for both timing and directional information. The Stochastic is what is called a “normalized” oscillator, meaning that it will keep going back and forth between zero and 100, even if the price swings become very small.

That works well if the market is moving in tradable swings, but can give you a false impression of what is happening in a narrow sideways market. Look at the Stochastic (bottom) with the MACD (Moving Average Convergence Divergence) oscillator above it.

The MACD is constructed by taking the difference between two moving averages. Compare its rise and fall with the separation of the moving averages I keep on my price chart. (It won’t match exactly, because the moving average lengths are not the same.) After you’ve watched them long enough, you can actually get equivalent information from either, but some find the MACD easier to read.

The MACD is not “normalized,” meaning it has no arbitrary limits to its up and down moves. But this also means that, being smoother, it sometimes gives you less detailed information. That’s why many traders like to keep an eye on both types of oscillators.

Their differences are most apparent when the market is going sideways. When the market becomes less and less volatile, the MACD starts to stay very close to the zero line, while the Stochastic keeps giving overbought and oversold signals.

After todays early rally, the sooner you decided there was no tradable movement the better. And using the MACD (or carefully watching the moving averages) was the easiest way to stay out of trouble.

Contract Rollover for futures can distort trading data, and for the Russell 2000 today was the day. Not the last day the December contract can be purchased or sold, but the day all the short-term traders switch to the March contract.

For those of you not trading index futures, the contracts expire four times a year, and as you can see from the bottom of today’s chart, there is a sudden change in the volume pattern as everyone starts trading the new contract.

I track this by having the volume from both the old and new contracts showing in my brokerage program, and as soon as the new contract starts trading more than the old, I make the switch.

Today was spent testing the extremes of yesterday, starting with a run to the high, and then a drop to the low. Highs and lows from several previous days should be watched closely and often become new pivot points. But except for the first reversal, we either went slightly too far or didn’t quite reach these levels. Yet I still have them labeled as tests.

As I said in the November 21st post

my definition of a Test is when the present bar goes anywhere into the range of the bar being “tested.”

Using this rule, the yellow arrows show what I consider a test, and I trade them exactly as I would an equal top or bottom. In other words, that is a point where I am looking for a potential entry signal in the opposite direction. In each case, the Stochastic oscillator made a nice divergence for a tradable entry.

Of course as soon as we moved away from the Test of Bottom, I drew the blue trendline. And the blue parallel. And at 10:30 (Pacific) we got a Test of Top, an 89% Fibonacci retracement, a rejection from the parallel, and a Stochastic divergence. You know I love multiple signals.

While many people trade multiple markets or multiple stocks, when I am working on a very short timeframe I feel more comfortable concentrating on one. But that doesn’t mean that I ignore all the rest. On intraday moves, my market (the Russell 2000) sometimes leads the others, and recently it has been lagging. But overall, your best trades will occur when the markets are moving together.

How can you keep an eye on other markets without becoming distracted from your own? My solution is to standardize my charts so the important things stand out. I use two monitors during the trading day, but that doesn’t mean I am limited to two screens full of data. With a mouse click I can bring up a general market layout to see what is happening elsewhere in the trading world.

First the standardization. On my markets page each of the six charts has a green line showing yesterday’s high, a red line for yesterday’s low, a thin blue line at yesterday’s close, and two moving averages. All six of the charts are linked, so by simply typing in a number (3, 15, etc.) they will all switch to a different timeframe. The bars are color-coded (see Dunnigan post) so I can instantly see the direction of the last bar. And in the bottom pane is a modified MACD to show the overall trend.

In addition to the major futures markets (NQ, ES, and YM), I have a chart for the semi-conductors (SOX) and the two parts of the S&P 500 (the large cap and mid cap sections.) Although this is a screenshot from the end of last week, look at the information available at a glance.

The DOW futures (lower right) are above yesterday’s high (green line), while the midcaps (upper center) are still trading below yesterday’s low. All the other charts are inside yesterday’s range. Quite often, just watching the OEX and the MID charts, you can get a feel for the strength of a rally or decline. If they are moving together, there is momentum. If they are fighting each other, there is more likely to be congestion.

Seeing how price and the two moving averages are acting gives you another clue to trending or non-trending motion. Notice how easy it is to see that the SOX are the most congested at the present moment.

On a shorter timeframe, look at the colors of the last few bars. The mid-caps are rallying — trying to catch up (many green bars), while the other markets are going sideways (magenta or alternating red and green bars.) And the MACD at the bottom is oscillating in smaller and smaller moves as option expiration day expires in a sideways motion.

I keep this chart hidden to avoid being distracted from my interest in the Russell, but when I’m trying to get a feel for the markets, or just before initiating a trade, I’ll take a quick look at these charts. Never for signals, but for the context to know what to anticipate from my own trades.

It’s important to study and understand the moves of the markets you trade, because there are often idiosyncrasies that may not apply to another trading vehicle. That’s one reason I try to carefully analyze the Russell 2000 each day after the close, looking for repetitive patterns. Sometimes these patterns can give you a real trading edge.

Yesterday, after falling for most of the day, the Russell made a nice reversal during the last hour. The bottom was a Measured Move, two thrusts in the same direction that end up being the same length. This is shown by the green “X to A” and “B to C” moves. (I’ll use different colors to cut down on the confusion.)

I’ve pointed out Measured Moves before, but here’s an interesting twist. Today’s magenta “X to A” move is precisely the same length as the green “X to A” from yesterday. It’s almost the same for the “B to C” moves. Four consecutive downward moves of approximately equal length, and two of them occur in a downtrend and two in an uptrend.

Out of curiosity I just checked the previous three days, and found six moves of almost exactly this amount. Then I remembered something I learned some years ago from a trader named ral (Russ Lockhart) about what he called his Box Point Calculator.

It was part of a spreadsheet where you entered the most recent pivot point, and it displayed a series of numbers that were multiples of 4.4 points above and below that pivot. (This was for the S&P Futures.) The two important levels were 4.4 points and four times that interval (17.6 points.) My first thought was “that’s too simplistic to be worth anything.” Then I tried it on a chart, and the first big move was exactly 17.6 points.

I’ve never looked for anything like this on the Russell, but there are lots of useful ideas that are hard to explain. The Measured Move is one of them. Yesterday we had one near the close. Today there is the series marked in magenta, and overlapping that, another shown in blue, all with two consecutive moves of the same length. I use these all the time in my trading.

Maybe there is a “Russell Standard” move that would be worth watching. If anyone is interested in a research project, the magic number might be 3.8.