Trading What I See

For those having trouble accessing the site yesterday, evidently the server holding Trading What I See was having high load issues. It took me several hours to post yesterday’s comments. When I checked, the web host was working on the problem. My access seems much faster today, so perhaps it is solved.
Lowell

Today the Russell 2000 had the fifth narrowest range so far this year — 5.9 points. And that range occurred right at the top of the daily rectangle. Actually this could be good news.

When price makes a continuous move from deep inside a pattern and then immediately breaks out, the odds favor a failure. Too much of the rally strength has been expended inside the pattern. However when there is a pause near a pattern’s edge, then a high-volume breakout is much more likely to succeed. But right now I’m waiting to actually see that breakout before I get excited on the upside.

Not much else to say on today’s action. We turned up at a Measured Move (C=100%) and developed a triangle formation. However the breakout had no volume behind it, and price reversed just above yesterday’s high before coming anywhere close to the triangle target. Not surprising with the lack of volume.

Another indication of the slow trading. The NYSE Tick ($Tick) never hit either a plus or minus 1000 today. I only watch the Tick at critical points, but most days one direction or the other will have some bias. And I would expect to see a high reading there when we finally break from this consolidation pattern. Maybe Monday.

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.

Another pullback day with weak volume, adding about two points to last week’s close. I pointed out some rectangle trades Friday, and said that I would be very cautious even if the pattern continued.

Today’s chart covers two sessions, and I’ve drawn several patterns on it. The blue lines are last week’s rectangle, which broke to the upside about 11:15 this morning (Pacific time.) The magenta trendline used Friday’s pivot connected to another at 8:00 today. We bounced twice more from that line.

The yellow lines are a sloppy triangle, with a parallel trendline that stopped this afternoon’s rally. The breakout shows a small volume increase, but that increase disappears on any longer term chart. I can actually see two additional valid ways I could draw that triangle, but they all break out at the same time.

With all of these patterns you might think I would be pointing out many profitable trades, but from my perspective it is the complete opposite. I don’t think any of these trades provided safe entries.

When I find too many ways to interpret a day’s chart I begin looking at longer and longer time frames. And I keep coming back to the daily chart that shows the heavy distribution that started February 27th followed by the weak pullback from the pivot bottom.

This is a classic setup for additional downside action. As a daytrader I’ll be quick to change my mind if we get some good upside volume. But for right now, I’m really expecting a downside break to at least re-test last week’s lows.

What started with a reasonable setup turned into a do-nothing session, with the narrowest range in about ten days. We began with a small gap below yesterday’s low, and almost exactly to a 127% external retracement of the rally from yesterday’s final pivot bottom. The first bar reversed the move and created a divergence in the Stochastic.

This type of setup often leads to a nice rally, but they are not supposed to retrace 89% as happened by the 7:30 pullback. They also don’t go back outside of the previous day’s range. From that point I became very cautious and just watched for the rest of the day.

By lunchtime it was obvious that the market was forming converging trendlines which can set up a WEDGE pattern. I like wedges for potential trades, but the best ones will form after an extended move. Today, with the small early range, I wanted the additional confirmation of a divergence on the pullback that occurred right at the point of the wedge. The pullback occurred, but the divergence didn’t.

By the time we got a triple top and a divergence I didn’t trust the pattern, although it finally retraced the entire height of the wedge to meet its expected target.

I was a bit hesitant from the start today, since my data provider showed the Russell trading for two hours Monday (with almost no volume) when the U.S. markets were closed. That means that I had to choose between drawing trendlines and Fibonacci measurements either using this additional data or ignoring it. Neither ended up giving good signals so stopping early, although frustrating, wasn’t a bad decision.

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 was a great day to practice drawing trendlines instead of trading. The range from high to low was 6.1 points — not just an NR7 day, but the narrowest day in weeks. When I find a day where I’m not happy with the setups, I’ll sometimes practice finding relationships I might miss on a more hectic day.

Today I didn’t have to look far. This is a five minute chart to show most of the last two days. I’ve drawn the trendlines in different colors to make it easier to see the parallel lines. The sequence for drawing parallels is always the same.

Find two pivots that seem important to you and draw your first line (points 1 to 2.) Copy that line to the pivot between those two points that is the farthest away (3) and extend it into the future. Pay careful attention if price approaches that line.

It doesn’t always work this well, but today it picked out two of the main reversal points almost to the tick. Although I have them listed as “targets”, perhaps that isn’t the best term. If you trade in multiple contracts (or shares), this is a logical time to take some profits. Price sometimes will break right through parallel lines, and of course, sometimes it doesn’t get that far.

Although I stayed on the sidelines today, do I see any potential trades (if you ignore the small range)? Look at the opening pattern. We had a gap down that immediately broke through yesterday’s low. Some volume. Some excitement. Here’s what I said last Thursday.

Any time you have a breakout failure, you must at least consider a potential trade in the opposite direction. Because if the change in trend continues, everyone that shorted that break has to cover their position.

The second bar (or the third bar on my 3-minute trading chart) gave a potential entry signal when it reversed. There was another potential signal at the magenta number 2. On the 3-minute chart the Stochastic oscillator gave a clear divergence as price couldn’t clear yesterday’s close (blue dotted line.) Small gains today, but even on small-range days chart reading works.

A range of 7.2 points on the Russell 2000 makes this a narrow range day. The question that often comes up after a day with limited movement is “What comes next?” Many say narrow range days are followed by wide range days. Sometimes. But perhaps not as often as traders think.

I don’t trade statistics as such, but I decided to do some checking. For a TREND DAY I required a range greater than 1.5 times the recent average, and for the open and close to be near the extremes of the range. (The distance between the open and close had to take up at least 80% of the bar’s range.) For a narrow range day I used Toby Crabel’s NR7 — the narrowest range in the last seven days.

On the Russell 2000, going back about 8 1/2 years, there were 150 trend days (about 7%) and 275 NR7 days. Unfortunately only 25 of the narrow days directly preceded a truly wide range day. Not as good a I had hoped, but still enough to think “possible trend” after a day such as this one.

But even on narrow days there are sometimes a few trades if you are patient. Notice the 10:00 trade where price pulled back to a Fibonacci cluster - an important Fib measurement from two or more different sources. Combine that with an overbought Stochastic and there were two reasons to at least consider the trade.