Trading What I See

There are several types of trend day, some easier to trade than others. Let’s start with the overall picture (15 minute chart), and then look for potential entries on the trading chart.

After the gap opening the market pushed right through the 162% level of a larger A-B-C. Whether measuring external retracements of the first pullback or the “C” leg of an A-B-C, passing the 162% level is where I stop looking for a reversal setup.

The next stop is often the 262% Fibonacci level, and that’s where we reversed at the end of the day. We’re back at the top of the daily rectangle, where we reversed four days ago. Was this a Spring reversal? We exceeded the top price from the rectangle by one tick.

I would be cautious of a gap up tomorrow that quickly reversed, but a continuation of the closing pullback followed by an upside breakout with volume could head for the rectangle target over 30 points higher.

Did I just say we could go either way? Don’t I always? Let’s see what happens in the morning.

Now, how could you have caught this move? First remember the quote from Victor Sperandeo that I’ve used often.

If there is a gap, and it is going to reverse, it will do so 10 to 15 minutes after the opening 95 percent of the time.

By the first pullback this morning we had exceeded a potential 162% A-B-C which means you should expect continuation. We had also exceeded Trader Vic’s 15 minutes without a reversal. Two reasons to look for upside action, so what we needed was a usable entry.

For entries in a trend I usually look for a bounce off the bottom of a parallel trend channel, or a pullback to a Fibonacci level measured from a major pivot. It didn’t take very long to realize that neither of these two methods would work this morning. So instead, I used the opening price to start my measurements.

From “A” to “B” was a 62% retracement, but the next three hours progressed so slowly it made the trade seem like a mistake. Without any good basing points my procedure is to gradually move my stop up with each new pivot (yellow lines), with an exit shortly after “C=100%.”

After that slow 5+ point rally, I was surprised by the afternoon move and didn’t even consider an entry. But at least we are out of the sideways action of the last two days. Tomorrow we’ll see what happens with the rectangle.

I mentioned yesterday that I was not interested in the upside at this time. Today you see why. I can’t take credit for calling this drop — almost every technical analyst I follow was seeing the same thing. Our concern was that when “everyone” sees a pattern, the market will sometimes make several false breaks before the real move. Today was the real move.

Today should NOT have been a surprise. If you don’t understand what I meant yesterday when I said “This is a classic setup for additional downside action“, dig out your copy of Edwards and Magee’s Technical Analysis of Stock Trends (see below) and spend some serious time studying volume patterns. Here is what my copy says when you look up volume in the index:

(Volume is of the utmost importance in all technical phenomena. Each chapter takes up essential points in connection with volume; and all chart examples demonstrate volume action and should be studied with this in mind.)

I know some very good technicians that never look at volume — I don’t think they understand what they are missing. Personally, if we had failed to make a drop similar to this I would have been very surprised.

If you were expecting a down move at this time, today was fairly easy to trade. We started with a gap down to yesterday’s low and then moved sideways for two hours. During that time the market pulled back 50% of the distance from yesterday’s high, and then the rest of the day was down.

Whenever I see a very strong move (up or down) I draw a Fibonacci retracement of the first pullback. The three key Fib levels are 1.618, 2.618 and 4.236. When we broke through 1.618 without a pause, that indicated a strong move.

We then tried to bounce at the 2.618 level for an hour with no significant upside progress. That set up the expectation of more downside action, and the next important level is where we closed for the day.

As I said yesterday, I expect a re-test of the bottom. That would create a large A-B-C pattern on the daily chart, with “C” being 62% of “A.” But remember, that particular pattern has two lower targets, and there is no reason matching the earlier bottom has to be the end of this down move.

Edwards and Magee: Technical Analysis of Stock Trends

Some days when I’m not trading, I still can’t stop watching the market. Today was one of those days. Although yesterday didn’t have the range of a “real” trend day, a consolidation wasn’t surprising. Of course I had anticipated a reversal, but as you know, I trade what I see, not what I expect.

We made a sudden drop from the open, and although it reversed at a 78% retracement of yesterday’s last rally, I didn’t see a good entry. Then we broke out to a new high, but reversed back down. As I’ve mentioned before, under these conditions I will often set an alarm at the first hour’s high and low and work on other projects.

When I checked back later, what I saw was a series of reversals at nice Fibonacci retracements, but little range. Back to work. My next check revealed even more levels hit, and I just had to watch how long this Fibonacci Ping Pong could keep up.

Several times I though it had broken the pattern, but in each case it was a false reversal. Let’s start with the blue tops. Each blue arrow marks a pullback to a retracement of the day’s high - each at a standard Fibonacci level. Every level used measures from the lowest low so far in the decline. There is only one pivot without a direct hit. [Noticed after the post - the third blue Fib number should be 32%.]

The green lows, retracements of the low to high range, are even better. I didn’t mark it because the chart was getting too hard to read, but the first tiny reversal came when price hit the blue moving average — at exactly 38%. Then we ticked off the Fib number in sequence: 50%, 62%, 78%, and 89% — a catalog of the important Fibonacci numbers.

Since we then reversed back up, the yellow arrows are pullbacks to the 9:45 low, but if you checked you would find they also relate to the earlier low of the day. There were more Fib ratios in some of the moves, but just using the standard retracements that many traders follow was enough. Trading or not, a true Fibonacci Festival.

A strong move with few pullbacks works well for trend traders, but frustrates those of us who depend on clear pivot points and retracements. A consolidation period catches trend traders in whipsaws, but will often give reversal traders an extra edge. I suppose we just have to take turns, but today we seemed to have a combination of both.

Opening with a small gap, there were no large retracements until we entered the sideways pattern about lunchtime. I’ve talked recently about early pullbacks being near 62% and later ones closer to 38%, but the rally that started yesterday insisted on small pullbacks all the way up.

When all the early retracements are small, it may be an indication that either a TREND DAY is in the making, or at least that there are many traders afraid of missing a move to the upside. For me, that means looking for smaller pullbacks than normal, but only if I can find an entry with a very close stop.

At 7:30 this morning (Pacific time) there was finally a 38% pullback, and using the short moving average as an entry trigger, there was a reasonable trade to the blue parallel. That wasn’t the high for the day, but it was pretty close.

If it wasn’t so late in the rally, a return to the lower trendline would have given a potential entry, but notice how much price had flattened by the time we got there. We also didn’t get another 38% pullback until after the trendline was broken, and by that time the moving averages were intertwining.

If you keep drawing trendlines and parallels for channels you can see the drop in momentum as we end the day in a small rectangle. Today doesn’t exactly fit my definition of a trend day, but we did open at the low and close at the high.

If you look at a longer term chart (45 minutes or greater) you can see we have worked our way into a congestion area at the recent November highs. Only the Russell 2000 finished the day at the top of its range. Tomorrow could be interesting.

After yesterday’s TREND DAY down, some sideways movement today was not a surprise. And once again, drawing trendlines and channels gave some structure to the movement.

We started with a small gap down, bounced for two bars, and then dropped again. There was always the possibility of two trend days in a row, but remember my basic philosophy — I look for places on my trading chart where a reversal might occur, and then wait for some sort of trigger entry. And this morning’s bottom was such a spot.

A week ago Friday I posted charts from several timeframes, including one where I showed a channel inside a larger channel, with all the trendlines parallel. I make it a practice to look carefully at a daily chart before the market opens. On November 16th we turned down from the outer channel. This morning we bounced exactly off of the inner channel. Show that one to the non-believers.

Does that mean we are going back up? I have no idea. I just try to trade what I see.

After our bounce off the trendline we made a 78% pullback. A key point about first pullbacks — they occur before the crowd believes there has been a reversal. That’s why they usually reach or exceed 62% of the first rise.

There were several ways to be sure you didn’t enter too soon. The first green Dunnigan bar was a possible entry. So was the break through the short moving average. Either way, the move carried right to the blue parallel, where you expect either a pause or a reversal.

When there is a second pullback more traders are convinced that a new direction is in force, so they buy earlier. First pullbacks are often around a Fibonacci 62%. Second pullbacks are more likely to be 38%. And that’s where this one stopped.

The next signal, whether or not you took the last rally, was what I introduced as a Wyckoff Spring. We broke to a high and immediately reversed, accompanied by a divergence in the Stochastic. But then notice how the move down forms a converging trend channel. To me that is a strong warning.

There were several potential bad reversal entries as we dropped through the lunch hour, but converging lines tell me to wait for multiple signals before an entry — like perhaps a nice divergence at the same time we hit a Fibonacci number. Have you noticed that the Russell seems to like 78% during congestion periods?

The rest of the day is a Measured Move, with the first rally matched by the second. If you caught the pullback, your exit was probably the parallel trendline which came a little earlier. Tomorrow we’ll find out whether the daily internal channel really holds, or if this was just a bounce in a larger downtrend.

The market moved upwards quickly after the open, and that was not quite what I had expected on Election Day. Between 6:45 and 7:00 I called a top three times. But over the years I have learned to wait for setups, and none of mine appeared. None, that is, until the market started retracing the early move.

First let’s look at why this didn’t turn into a TREND DAY. It could have, with that directional morning move, but let me quote something I said from an earlier trend day on September 12th.

… 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 equivalent readings for this morning are: .88, 1.24, 1.23, 1.21, 1.13, 1.06, 1.04. Remember that readings above 1.00 tend to be bearish. The market can go up with large TRIN readings, but it’s telling you that volume is not supporting the rise.

Once you decided that a trend day was unlikely, the movements after 8:00 made some sense. There was a pullback from the peak to point #1 and then a rally. The drop after point #2 matched the first drop, with a little extra push into point #3. Many call that a Measured Move — I call it a 100% Fibonacci extension. Either way, it means that a move in one direction is matched by the next move in the same direction.

When the market pulls away from point #3 you can draw the first trendline (#1 - #3), and the parallel from point #2. There is a short sale setup at point #4 when hitting the parallel line coincides with the Stochastic reaching overbought. Then we have another Measured Move — this time matching the #2 - #3 distance and ending right at point #5.

The next pullback at #6 doesn’t reach overbought or hit the top of the trend channel, so you either missed that nice trade or had to find another entry technique. But notice what happens when we get to 100% of the #4 - #5 distance. The market tries to stop.

As I mentioned a few days ago, when the second move in a series doesn’t stop at the 100% extension, watch for a move to 168%. And that’s where we reversed. At least temporarily.

Here’s another Fibonacci extension tip. I use extensions to judge the direction of a slightly longer trend that the one I am watching. Using just the 62%, 100%, and 162% measurements I look at each “2nd” move — for example the “b” to “c” move as shown at the right of today’s chart. If the move goes to 162% of the original move, I consider the next longer trend to be up, and will probably buy retracements. If it only matches the first move, then the next longer trend is probably now sideways.

But if the extension move only reaches 62%, I’ll assume the next longer trend is still down, with the potential for a further move lower. Move “c” only reached 62% of the first move off the bottom, and that lead to exceeding the previous intraday low.

Last night I was actually discussing how long it had been since the last TREND DAY. Not that I expected one today — I just realized that, at an average of three per month, we were probably overdue. Did it help? Not at all. The first half of trend days always give me trouble.

For years, I could count on losing money on trend days. I would spend the morning trying counter-trend trades, and by afternoon I was afraid to enter because we were “too high” or “too low” and sure to reverse. Finally some kind soul explained to me that many trend days have a characteristic shape. I’ve mentioned this several times over the last few months. For example on September 12th I said:

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.

Today’s morning drop was 12.2 points, and although it started a bit later than normal, the pause in the middle was still there. Win or lose during the morning session, if you finally recognized the trend day by the end of the pause, there were still 11 points before the bottom. It’s unlikely you could catch it all, but over 8 points came after the breakdown, and there wasn’t a retracement to take you out. The market was even nice enough to give a little pullback for an entry.

It seems to me as though trend days have fewer channels and fewer good Fibonacci retracements, but I’ve never tried to quantify that. But when you are aware of the typical trend day pattern, an entry in the afternoon can make the day profitable.