Five-Part Daytrading Course Kevin Haggerty
Los Angeles, California
Copyright © 2000, TradingMarkets.com, Kevin Haggerty
ALL RI ALL RIGH GHTS TS RE RESE SERV RVED ED.. No pa part rt of th this is pu publ blic icat atio ion n ma may y be re repr prod oduc uced ed,, st stor ored ed in a re retr trie ieva vall sy syst stem em,, or tr tran ansm smit itte ted, d, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher and the authors. This pub This public licati ation on is des design igned ed to pro provid videe acc accura urate te and aut author horita itativ tivee inf inform ormati ation on in reg regard ard to the sub subjec jectt mat matter ter cov covere ered. d. It is so sold ld wi with th th thee un unde ders rsta tand ndin ing g th that at th thee au auth thor orss an and d th thee pu publ blis ishe herr ar aree no nott en enga gage ged d in re rend nder erin ing g le lega gal, l, ac acco coun unti ting ng,, or ot othe herr professional service. Authorization to photocopy items for internal or personal use, or for the internal or personal use of specific clients, is granted by TradingMarkets.com, provided that the U.S. $7.00 per page fee is paid directly to TradingMarkets.com, 1-213-955-5777.
Printed in the United States of America
Table of Contents
Part One: How to Become A Winning daytrader · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · 1 Part Two: How to Select the Best Stocks to Trade Every Day Day·· · · · · · · · · · · · · · · · · · · · · · · · · · · 11 Part Three: Stacking the Odds in Your Favor · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · 22 Part Four: The Best Daily Setups to Trade · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · 34 Part Five: Trading in the Real World World·· · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · · 51
Five-Par FivePartt Day Daytr tradi ading ng Course By Kevin Haggerty
T
hroughout this course, I will share with you some of the important lessons I have learned about trading. Some of these lessons were taught to me by others, many I learned by myself, and a few of these were learned the hard way. My goal go al is to te teac ach h yo you u th thee es esse sent ntia iall to tool olss an and d st stra rate tegi gies es on onee ne need edss in or orde derr to ha have ve a ch chan ance ce of su succ ccee eedi ding ng at da dayt ytra radi ding ng.. Sincerely Kevin Haggerty How To Become A Winning Daytrader. During the first section Kevin will teach you what you need to know about becoming a successful daytrader. Proper psychology, the correct trading technology, money management and position size are just a few of the topics that he will discuss.
PART ONE: HOW TO BECOME A WINNING DAYTRADER In th this is fi firs rstt we week ek of ou ourr fi five ve-w -wee eek k co cour urse se on da dayt ytra radi ding ng,, we wa want nt to de defi fine ne wh what at th thee bu busi sine ness ss of da dayt ytra radi ding ng is an and d wh what at it is not. We will discuss the differences between professional direct-access daytraders, and those traders attempting to accomplish the same thing through online brokerage firms with internet ISP hook ups. The SEC has expressed many concerns regarding the explosive growth of online daytrading, and we will address their concerns in this first installment of the course. We will explain why daytrading is potentially a valid and rewarding busi bu sine ness ss,, bu butt at th thee sa same me ti time me,, we wi will ll mak makee yo you u ac acut utel ely y aw awar aree of th thee va vari riou ouss hu hurd rdle less yo you u mu must st ov over erco come me to su succ ccee eed. d. Successful daytraders must maintain a proper psychology, mental attitude and focus. In addition, you must work with superior technology, have sound money management strategies and develop a thorough knowledge of the markets. Of most importance, you must understand the risks involved in trading stocks. I realize that this information may be dry, but it is essential that you have this base of understanding before proceeding.
DAYTRADING DAYTRA DING DEFIN DEFINED ED The professional daytrader is a person who trades stocks in the office of a registered broker dealer. With the right amount of training, experience and proper communications, some of these traders will eventually trade remote from their homes. Registered broker dealer firms provide the direc Registered directt access communicatio communications ns (T1 lines) and electronic electronic execut execution ion equipment/software that puts these traders on the same execution access level as the Merrill Lynch’s and Goldman Sach Sa chs’ s’ss of th thee wo worl rld. d. Th Thee so soft ftwa ware re us used ed fo forr ex exec ecut utio ion n an and d mo moni nito tori ring ng th thee ma mark rket etss is of ofte ten n fa farr mo more re ad adva vanc nced ed th than an wh what at I’ve seen or used on major brokerage firms trading desks. Daytraders that work in this situation can compete on an execution basis with the NASD market makers and other electronic systems or ECN’s.
Daytra Dayt radi ding ng,, by de defi fini niti tion on,, me mean anss th that at yo you u en end d ea each ch da day y fl flat at,, me mean anin ing g yo you u go ho home me wi with thou outt an any y op open en po posi siti tion onss at th thee en end d of th thee tr trad adin ing g se sess ssio ion. n. Da Dayt ytra radi ding ng is no nott ta taki king ng ho home me 50 500 0 sh shar ares es of NE NEON ON at 44 on Ju July ly 6, 19 1999 99 (s (see ee nu numb mber er 1 on ch char art) t),, and watching it open on July 7, 1999, at 18 3/8 (see number 2 on chart). As you may recall, New Era of Networks, Inc. (NEO (N EON) N) an anno noun unce ced d a la larg rgee ea earn rnin ings gs sh shor ortf tfal alll af afte terr th thee cl clos osee on Ju July ly 6, 19 1999 99.. I us usee NE NEON ON as an ex exam ampl plee of th thee pr prob oble lems ms you can face by not ending each day flat.
NEON Daily Chart—6/15/99 to 7/9/99
In th thee ca case se of NE NEON ON,, yo you u wo woul uld d ha have ve lo lost st mo most st,, if no nott al all, l, of yo your ur eq equi uity ty an and d wo woul uld d ha have ve re rece ceiv ived ed a ma marg rgin in ca call ll th that at yo you u would be unable to meet. No, this doesn’t happen often, but it only has to occur one time to possibly put you out of business. The media then runs a story about the perils of daytrading which they, in reality, confuse with online broker bro kerage age tra tradin ding g whe where re the per person son jus justt gam gamble bled d and too took k a sho shot. t. That That kin kind d of tra trade de is not not wha whatt the day day-to -to-da -day y bus busine iness ss of trading is about.
ORDER EXECUTIONS AND ONLINE FIRMS For th For thee mo most st pa part rt,, on onli line ne br brok oker erag agee fi firm rmss ro rout utee cu cust stom omer er or orde ders rs to ot othe herr ma mark rkee- ma maki king ng br brok oker erag agee fi firm rmss or di dire rect ct tr trad ades es to the who wholes lesale ale mar market ket mak making ing bro broker kerage age fir firms ms suc such h as Her Herzog zog,, Kni Knight ght/Tr /Trima imark, rk, and She Sherwo rwood. od. In ret return urn for doi doing ng so, they receive payment for this order flow or, in some cases, share in the profits of the firm to which they are sending the orde or derr fl flow ow.. In my op opin inio ion, n, th this is is a ba bad d pr prac acti tice ce an and d is de detr trim imen enta tall to th thee be best st ex exec ecut utio ion n re rega gard rdle less ss of a fi firm rm’s ’s ob obli liga gati tion on to conduct regular and vigorous review of the quality of executions of orders sent to other market makers. The majority of these online firms are middlemen or conduits that just slow the process if you attempt to compete with profes pro fessio sional nal day daytra trader derss by att attemp emptin ting g to exe execut cutee con contin tinuou uouss day daytra trades des thr throug ough h you yourr onl online ine bro broker ker.. To the their ir cre credit dit,, mos mostt of these online brokers seek the active investor and don’t claim they can provide the professional platform that direct-access firms provide for daytraders.
SOME OF THE SEC CONCERNS YOU SHOULD BE AWARE OF The three leading online complaints to the SEC for fiscal year ending June 1999 were: 1. Difficulties in accessing accounts 2. Failures or delays in executing orders 3. Errors in processing orders
Concern # 1 Investors and traders must understand the issues and limitations of online investing. Demand has grow gr own n so qu quic ickl kly y th that at ma many ny fi firms rms ma may y ha have ve tr trou oubl blee st stay ayin ing g ah ahea ead d of th thee te tech chno nolo logy gy to ha hand ndle le th thee growth. You occasionally will experience delays on these new systems. In the meantime, you may have trouble getting online or receiving timely confirmations of trade executions. You should not always expect “instantaneous” executions and reporting. There can and will be delays in electronic systems. You should explore and understand options and alternatives to executing and confirming your orders if you encounter online problems. TRANSLATION: You can’t expect to succeed in daytrading if you are unable to enter a market or marketable limit
order and get an instantaneous execution and confirmation. If you thought you bought your stock at 50, but the price wasn wa sn’t ’t co conf nfir irme med d an and d th thee st stoc ock k is no now w tr trad adin ing g at 49 1/ 1/4 4 as yo you u re rece ceiv ivee a 50 co conf nfir irma mati tion on,, yo you u wi will ll re reac ach h yo your ur ri risk sk of ru ruin in leve le vell ve very ry qu quic ickl kly y an and d be ou outt of bu busi sine ness ss.. Th Thee in inve vest stor or th that at pa paid id 50 fo forr a lo long ng-t -ter erm m po port rtfo foli lio o do does esn’ n’tt ha have ve a pr prob oble lem, m, bu butt the daytrader that must keep losses to a 1/4 - 3/8 was unable to because of system delay. You must deal with a firm that has a trading order desk that you can reach by the phone under all conditions.
Concern # 2 The SEC wants all investors to be aware of how quickly stock prices can actually move, especially among the more volatile sectors like technology and Internet stocks. The price you see on the screen as you enter your order doesn’t necessarily mean that you will always be able to get that th at pr pric icee in a ra rapi pidl dly y ch chan angi ging ng ma mark rket et.. Yo You u sh shou ould ld ta take ke pr prec ecau auti tion onss to en ensu sure re th that at yo you u do no nott en end d up paying more for a stock than you intended or can afford. One way to do this is to use a limit order rather than a market order when submitting a trade in a fast moving stock. fast st ma mark rket etss an and d pe peak ak vo volu lume me pe peri riod ods, s, do don’ n’tt ex expe pect ct to da dayt ytra rade de th thro roug ugh h an on onli line ne br brok oker er wi with thou outt TRANSLATION: In fa substanti substa ntial al ris risks. ks. The There re hav havee bee been n som somee hor horror ror sto storie riess of peo people ple tha thatt pla placed ced mar market ket ord orders ers in fas fastt mov moving ing int intern ernet et sto stocks cks and hot IPO’s that got execu executed ted many poin points ts away away from from what they saw on their their screen screens. s. This This result resulted ed in major major finan financial cial losses to many of these people. You must understand the risk associated with trading in a fast-moving market. Before you attempt to daytrade as a business, you must grasp these execution skills and implement the necessary direct-access communications.
Concern # 3 Investors buying securities on margin may not fully understand the risks involved. In volatile markets, investors who have put up an initial margin payment for a stock may find themselves being required to provide additional cash (maintenance margin) if the price of the stock subsequently falls. This is where many newer daytraders run into problems. If the funds are not paid in a timely manner, the brokerage firm has the right to sell a securities position and charge any loss to the investor. When you buy stock on margin, you are borrowing money. As the stock price changes, you may be required to increase the cash investment. You should make sure that you do not over-extend.
TRANSLATION: Don’t buy it on margin if you don’t have the allocated cash reserve to pay for it in cash. As
mentioned earlier, a simple margin example of a trade that recently occurred was New Era of Networks, Inc. (symbol NEON). The NEON example will highlight margin risk.
THREE TRADING EXAMPLES Examples: star arte ted d wi with th $2 $25, 5,00 000 0 of ca capi pita tall an and d hi hiss ru rule le wa wass to us usee ma marg rgin in,, bu butt fo forr no mo more re th than an th thee Trader Tra der A: st total capital of $25,000. CASH 7/6/99 7/7/99
Trade
B 500 shares NEON @ 44
$22,000.00
S 500 shares NEON @ 18 3/8
$9,187.50
LOSS
$12,812.50
STARTING CAPITAL
$25,000.00
TRADING LOSS
-$12,812.50
ENDING CAPITAL
$12,187.50
MARGIN $11,000.00
NEON an NEON anno noun unce ced d ne nega gati tive ve fi fina nanc ncia iall re resu sult ltss af afte terr th thee cl clos osee on 7/ 7/6/ 6/99 99,, an and d th thee st stoc ock k op open ened ed on 7/ 7/7/ 7/99 99 at 18 3/ 3/8. 8. Tr Trad ader er A said sa id en enou ough gh an and d ba bail iled ed ou outt wh whil ilee he tr trie ied d to fi figu gure re ou outt ho how w to ma make ke 10 100% 0% on th thee re rema main inin ing g $1 $12, 2,18 187. 7.50 50 of ca capi pita tall to ju just st get back to even.
Examples: Trader B: started with $11,000 of capital, was excited about the NEON story and decided to
maximize the position by utilizing the maximum regulation T-margin allocation which is currently 2:1.
7/6/99 7/7/99
Trade B 500 shares NEON @ 44
CASH
MARGIN
$11,000.00
$22,000.00
S 500 shares NEON @ 18 3/8
$9,187.50 LOSS
STARTING CAPITAL TRADING LOSS ENDING CAPITAL
$12,812.50
$11,000.00 -$12,812.50 -$1,812.50
Trader B went for the roses and got the skunk. No more capital, wiped out and owed money to the brokerage firm.
Trader A vs. Trader B Trader Trad er A ma made de a be bett tter er ma marg rgin in de deci cisi sion on th than an Tr Trad ader er B be beca caus usee he co coul uld d ha have ve me mett a ma marg rgin in ca call ll an and d st stil illl ha had d ca capi pita tall le left ft,, which was not the case for Trader B, who had a deficit capital position and had to ante up cash to the brokerage firm. As we progress in this course, we will discuss Trader A’s and Trader B’s understanding of money management, knowledge of the risks inherent in various types of stocks, and a trading plan that is geared to increasing capital rather than losing 50 to 100% on one trade or investment. Almost forgot, thank you for reminding me. There is a Trader C. Trader C: started with $15,000 of capital, carried no positions home overnight, took no more
than 1/4 - 3/8 point loss per trade, and takes trades in stocks that have a potential for 1 to 1 1/2 point profit. On 6/ 6/6/ 6/99 99,, Tr Trad ader er C ma made de th thre reee tr trad ades es in NE NEON ON,, pr prof ofit itin ing g on on onee ou outt of th thee th thre ree, e, ye yett us used ed co corr rrec ectt mo mone ney y ma mana nage geme ment nt.. 1. B 500 shares @ 42 1/8
S 500 shares @ 41 7/8
-$125.00
-1/4
2. B 500 shares @ 42
S 500 shares @ 41 11/6
-$156.25
-5/16
3. B 500 shares @ 42 1/4
S 500 shares @ 43 3/8
+$562.50
+1 1/8
+$281.25 Commissions
-$90.00 +191.25
NEON opened at 41 3/4 on 6/6/99 and closed at 45 1/4. This is just an example and not an actual trade, but it points out what wh at a go good od da dayt ytra rade derr is tr tryi ying ng to ac acco comp mpli lish sh.. Ke Keep ep you ourr lo loss sses es to a 1/4- 3/ 3/8 8 of a po poin intt and tr try y toma tomake ke 1 po poin intt if th thee trade allows you to manage it that way.
In da dayt ytra radi ding ng,, yo you u ar aree li limi mite ted d by ti time me an and d ra rang nge, e, so yo you u mu must st ma mana nage ge yo your ur av aver erag agee lo loss ss an and d si size ze wi with th di disc scip ipli line ne.. Tr Trad ader er C was correct on only one of three entries and still made a few bucks rather then being out of business on 7/7/99 when NEON opened at 18 3/8.
THE BOTTOM LINE The SEC says that while new technology available to retail investors may resemble that of professional traders, retail investors should exercise caution before imitating the style of trading and risks undertaken by market professionals. Strategies such as daytrading can be highly risky, and retail investors engaging in this activity should do so with funds they can afford to lose. SEC Cha Chairm irman an Art Arthur hur Lev Levitt itt sum summed med up his sta statem tement ent reg regard arding ing onl online ine tra tradin ding g by say saying ing to all investors, whether you invest online, on the phone, or in person—know what you are buying, what the ground rules are, and what level of risk you are assuming. TRANSLATION: If you expect to daytrade as a business, you need direct-access technology. Online brokerages are
not equipped to provide that necessary speed. Decide whether you are an active investor or a daytrader. Getting caught in the middle can be dangerous to your bank account. When you start any business, you must make a financial investment up front. It is no different in daytrading. You must decide what amount of money can you afford to loose if the business goes bad and still not have it affect your financial structure. The SEC has opened up the markets to investors at an unusual level, especially with after-hours trading coming, but they expect investors to be prepared for whatever level of risk you undertake.
DAYTRADING DAYTRAD ING TODAY Daytra Dayt radi ding ng to toda day y is at a hi high gher er fe feve verr pi pitc tch h th than an th thee ta take keov over er ma mani niaa of th thee 19 1980 80’s ’s.. De Deal alss we were re be bein ing g an anno noun unce ced d da dail ily y an and d speculating investors were buying stock on any viable rumor. Many of these people played the deals with options, but they had very little or no knowledge of option premium, time decay, implied volatility and the simple fact that most options expire worthless. There were some spectacular success stories, but in the end, far more horror stories as takeover mania crashed and burned. Enter the 1990’s and assets under management by mutual funds exploded. The public was in the market like never before. The seeds were now sown for daytrading to emerge as a viable business. The opportunity to succeed at daytrading is higher now than at any time during the past 25 years because of the following reasons: 1. Extended Bull Market 2. Momentum Investing 3. Deregulation of fixed commissions in 1975, which are still shrinking 4. SEC’s approval of futures on the S&P 500 and now on some other equity indexes. This is the
Holy Grail for a daytrader. Volatility—without volatility there is no daytrading. Program trading and the ability of large players to manipulate the equity futures, and thus the underlying stocks, create more frequent opportunities to daytrade stocks with extended average daily ranges. 5. SEC’s allowing direct access to the markets through ECN’s, DOT machines and many of the
other technologies that crop up every week. This has led to the evolution of online investing, which is still just beginning. After-hours trading will present even more opportunity along with the obvious risks of illiquid markets.
TECHNOLOGY You should view technology from the standpoint of what gives you the fastest reliable data and execution capability. You can’t compete with professional daytraders if you are using buy and hold equipment with delayed order entry. The various levels from best to worst are outlined and the list follows.* * Bec Becaus ausee the there re aremany goodcompa goodcompanie niess tha thatt pro provid videe the these se ser servic vices,I es,I wil willl not rec recomm ommend end any spe specif cific ic one oness to you you.. I adv adviseyou iseyou to sel selectthe ectthe one that fits your needs the best.
1. Trading in the office of a registered broker dealer • Communications: T-1 dedicated telecommunication line, backed up with same, or at a
minimum, dedicated ISDN lines for backup. • Software: Direct-access software that enables you to execute directly with market makers, ECN’s and a super-DOT link to exchanges for listed executions. These software packages like Redi Plus and Cybertrader have analysis modules which enhance trade selection and monitoring. The dedicated phone lines are provided by the Bell Atlantic’s’ and MCI’s’ of the world. 2. Trading in a remote location (office or home) and using a dedicated telecommunication
hookup such as a 56k-frame relay, ISDN, or in the case of very heavy volume traders, a T-1 is, of course, expensive. The 56k and ISDN are the most common and costs vary as to the distance dist ance and locat location. ion. Your prosp prospectiv ectivee direc direct-acc t-access ess firm will provide provide you with the necessary specs and cost. 3. Trading through a direct-access firm using ADSL technology is now becoming widely
available. This gives you data-transfer rates at 768 Kbps downstream and 384 Kbps upst up stre ream am;; th that at is ex exce cell llen ent. t. A us user er to told ld me sh shee do down wnlo load aded ed a 10 1000-MB MB fi file le in te ten n mi minu nute tes. s. Th Thee
cost is about $80 per month plus $249 for the DSL router which they give you free on a two-year sign up. If you are trading in a remote location with multiple users, you qualify for thee bu th busi sine ness ss ho hook okup up,, wh whic ich h is SD SDSL SL.. Fo Forr $2 $295 95 pe perr mo mont nth, h, yo you u ge gett 76 768 8 Kb Kbps ps do down wnst stre ream am an and d 768 Kbps upstream which is one half of a T-1 bandwidth. The better deal for $399 is 1.1 Mbps both ways, which is basically equivalent to a T-1. The hardware and installation are free. 4. Cable box or ISDN internet hookup using software provided by direct-access firms. This,
like level #3 above, is fast but subject to any ISP problems that are more frequent than the telephone company’s downtime. • Note: If possible, get two different internet service providers and two computers. You
should get uninterrupted internet service if possible. 5. Trading through a direct-access firm with a 56k-modem connection. You might get by with
this but you have to allow for the slowness that may occur if that is the type of trading you expect to do. • Note: When you use software provided by a direct-access firm, you should use, at a
minimum, a 350 MHz machine with a 128-MB of memory. You can lease this size and larger for $100–$125 per month and trade up if needed at the end of one year. Also, do yourself a favor and get two monitors—the bigger the better.
THE BUSINESS If you are to succeed at the daytrading business, you have to run it like one. At the end of the trading day you take no position home overnight. By adhering to this discipline you avoid the overnight risks that traders A&B both had with NEON. Daytrading is limited by time and the average range of the stock, but you will be in better position to control your risk and the size of your losses. This is the key part of the “traders equation”. The average size of a daytrader’s profit will be smaller than that of a short-term position trader because of time and range. Daytraders will be stopped out much quicker than position traders due to daily market noise such as programs and announcements from brokerage firms and the companies themselves. The most important thing you must manage mana ge as a da dayt ytra rader der is th thee si size ze of yo your ur lo loss ss.. Se Seco cond ndly ly,, yo you u mu must st ma mana nage ge a wi winn nnin ing g tr trad adee to ma maxi ximi mize ze th thee pr prof ofit it on ea each ch tr trad ade. e. Yo Your ur mo mott tto o wi will ll be beco come me “m “mak akee a po poin int— t—lo lose se a qu quar arte ter.” r.” An And d yo you u wa want nt to do th this is as ma many ny ti time mess as you can. Daytraders can maximize margin (Regulation T) EXAMPLE: $50,000 of capital with Reg. T margin of 2:1 can control $100,000 in stocks. You can liquidate your
position(s) and repeat the procedure time and again over the trading day. Proprieta Propri etary ry tra trader derss wor workin king g for an NAS NASD D bro broker ker dea dealer ler are all alloca ocated ted inc increa reased sed lev levera erage, ge, whi which ch var varies ies acc accord ording ing to eac each h firm. To qualify as a proprietary trader, you must be U-4 registered at the firm, pass series 7 and series 63 (or 62) and then pass the new series 55. This, of course, assumes you qualify as a trader. Daytrading margin of your full capital is certainly not as risky as overnight carry, but if they stop trading in a stock before you can liquidate your position and the news is bad, you might find yourself in the same position as trader B.
“Daytrade “Dayt rader’s r’s Equa Equation” tion” Maximum % of profitable trades + Maximum profit per trade – Small losses x Multiple trades = SUCCESSFUL DAYtRADER This eq This equa uati tion on is th thee re real al mo mone ney y ma mana nage geme ment nt of da dayt ytra radi ding ng.. Pl Plac acee it wh wher eree yo you u ca can n se seee it th thee en enti tire re tr trad adin ing g da day y to re remi mind nd you of the objective—make money while controlling risk.
MAXIMUM % OF PROFITABLE TRADES Daytraders, in an effort to keep losses small, will get stopped out often and this makes it hard to maintain a high percentage of profitable trades. Our trading plan is to select the most promising opportunities; that is the stocks which are most likely to move in the direction of the trend with maximum range. In or orde derr to ac acco comp mpli lish sh th this is,, yo you u wi will ll se sele lect ct fr from om th thee st stro rong nges estt of th thee in inst stit itut utio iona nall st stoc ocks ks th that at ha have ve pu pull lled ed ba back ck fr from om th thei eirr swing point highs or are coming out of consolidation in the direction of the trend (sells reversed). You will be even more profitable if you learn to recognize the dynamics of supply and demand and not just some shape of a pa patt tter ern n or a fo form rmat atio ion. n. Bu Buye yers rs an and d se sell ller erss ar aree co cons nsta tant ntly ly ma maki king ng de deci cisi sion onss an and d we we,, as tr trad ader ers, s, wa want nt to be on th thee sa same me team that is currently winning the war. We will cover these dynamics later in the course. Meanwhile, for practice when you are watching your stock(s), focus on: 1. Where the volume is trading, on the bid, midpoint or the ask. 2. What are the bid and ask doing—moving up or down? 3. Is the stock showing strong relative strength versus the day’s trend? 4. How does the stock react to programs? 5. Does the volume increase on up days and decline on down days (sells reversed)? 6. Where are the blocks trading, on upticks or downticks? 7. Is stock closing better or worse than its VWAP (volume weighted average price)? It is not a pattern or system that makes you profitable, but rather the dynamics that bring life to the stock’s pattern. I will cover all these topics in the upcoming weeks.
MAXIMUM PROFIT PER TRADE The stocks we look for must have room to run, which means an average daily range of two points or more. When you enter the trade, a good portion of the range should be available for profit. This is not a factor if your entry is above the previous close, but it can be if you are entering from a five-minute chart pattern. Most traders have a tendency to take profits prematurely as they get nervous when a stock makes its normal pullback. You haven’t traded if you haven’t experienced taking a quick 1/2-point profit and then watched the stock run another 1-1/2 points. You probably sat there frozen, unable to pull the trigger again as the stock made new highs. Managing your trade to higher profit levels after normal pullbacks is harder than it seems. You start thinking about the money, and your emotions get in the way. Part of yo Part your ur le learn arnin ing g pr proc oces esss is to un unde ders rsta tand nd th thee no norm rmal al ch char aract acteri erist stic icss of th thee st stoc ocks ks yo you u tr trad ade. e. Is it a 1/ 1/2 2 up up,, 1/ 1/4 4 ba back ck,, or 1 point up, 5/8 back? Once you understand the normal pattern of the stock, then you must decide by watching the dynamics of th thee st stoc ock k as it tr trad ades es to de dete termi rmine ne if th thee in intr trad aday ay tr tren end d ha hass ch chan ange ged— d—is is su supp pply ly de defi fini nite tely ly la larg rger er th then en de dema mand nd,, or is it ju just st backing off on light volume and small programs. Your decision will determine whether you hold or exit the trade. The better you get at understanding and recognizing the dynamics, the more proficient you will get at selecting stocks about to accelerate, which will help in maximizing the profit per trade.
SMALL LOSSES This is the part of the equation where you have the most control. If you can manage your losses, the profits will have a higher likelihood of happening even with average stock selection. It takes discipline and the proper mental attitude to determine your stop levels and execute the stop as planned. What usually happens to new traders is they determine, for example, a stop loss level of no more than $300 per trade. This can be .30 on 1000 1000 shs or 1 point on 300 shs. shs. It all depen depends ds on your money money management management plan and availab available le capit capital. al. Thee st Th stoc ock k ge gets ts to th thee st stop op le leve vell fo forr th thee tr trad ader er th that at is us usin ing g a me ment ntal al st stop op.. Th Thee tr trad ader er he hesi sita tate tess to pu pull ll th thee tr trig igge gerr be beca caus usee he sees se es a qu quic ick k up upti tick ck,, bu butt th thee st stoc ock k th then en ti tick ckss 1/ 1/8 8 be belo low w hi hiss st stop op le leve vell an and d is of offe fere red d th ther ere. e. Th Thee tr trad ader er fr free eeze zess an and d is no now w in a position of hope, which is forbidden territory for the daytrader. If you keep taking bigger losses than normal, you will
have to increase the profit on your winning trades and/or the percentage of profitable trades. It is easier to control your loss side than to accomplish both of those because as a daytrader, we must trade under the limitation of a shorter time period and range of the stock. (Repeated for a reason!) My advice to you is you will be better off if after you receive confirmation of execution, you immediately enter either a stop loss or a stop loss limit order to protect your exit from the trade. This takes the judgement out of your
hands and protects you from your emotional-self, which is almost always wrong. This one rule alone will go miles in improving your trading. The next most important thing to keeping your losses small is you don’t have to wait until your stop loss point is hit before you exit a trade. When you enter a trade, the market must prove to you the trade is correct by turning profitable within a short period of time. If the stock or the market dynamics change after your entry and appear negative, just get outt of yo ou your ur po posi siti tion on.. Do Don’ n’tt wa wait it fo forr th thee ma mark rket et to co coll llec ectt yo your ur $3 $300 00 by ta taki king ng ou outt yo your ur st stop op.. It is be bett tter er to ex exit it th thee tr trad ade. e. If you are correct, you save some money. You are better off entering the trade again as it turns around and trades up through your entry point.
MULTIPLE TRADES You don’t have to be a math major to figure out that if your percentage of profitable trades is positive, you want to maximize the amount of trades. A good example of this would be all the recent splits we have seen in many of the top institutional-trading institutional-t rading stocks such as GPS, EMC and DELL. Instead of average daily ranges of 3–4 points, they are now 1 3/4–2 1/4 points. This decrease in range size makes it tougher to get the 1–1 1/2 point profit from each trade, but you can take a larger amou am ount nt of 1/ 1/2– 2–3/ 3/4 4 po poin intt pr prof ofit itss an and d do it mo more re of ofte ten n be beca caus usee th thes esee ki kind ndss of st stoc ocks ks ha have ve wh what at I ca call ll an ex exce cell llen entt “Travel Range.”
A recent example of travel range is IBM on July 21, 1999 (shown on next page). The stock opened at 127 1/2, down 3/4 from the previous day’s close. We don’t include this gap down in our calculation. On the day, IBM ranged from a high of 129 3/4 to a low of 126 7/8, only 2 7/8 points.
THE TRAVEL RANGE Measur Meas urin ing g be betw twee een n in intr trad aday ay hi high ghss an and d lo lows ws as th thee da day y pr prog ogre ress sses es,, th thee tr trav avel el ra rang ngee fo forr IB IBM M th that at da day y wa wass 21 21.4 .47 7 po poin ints ts,, or 16.8% if you divide that by the opening price of 127 1/2. It had 11 moves of one point or more. After the opening at 127.50, the sequence is as follows from left to right: +.81
(-1.31)
+1.43
(-1.375)
+1.875
(-.68)
+1.50
(-1.6875)
+1.75
(-2.25)
+.625
(-.56)
+.56
(-1.06)
+.68
(-1.06)
+2.25
Yes, it wa Yes, wass a vo vola lati tile le da day y wi with th th thee S& S&P P fu futu ture ress an and d pr prog ogra ram m tr trad adin ing, g, bu butt th ther eree ar aree ma many ny st stoc ocks ks th that at ha have ve tr trav avel el ra rang nges es at leas le astt tw twic icee th thei eirr av aver erag agee da dail ily y ra rang nges es.. Do th thee ho home mewo work rk an and d fi find nd th thes esee st stoc ocks ks be beca caus usee wh when en yo you u do yo you u wi will ll re real aliz izee th that at stocks take on their own life because of such things as specialist tendencies, active options traders and market makers, programs and of course the institutions (The Generals). There is another group called the accelerators, which we will discuss in another chapter.
CONCLUDING REMARKS After reading this chapter ask yourself if you will do the following: 1. Understand the risks of daytrading. 2. Take no position home overnight. 3. Act on what the market is telling you and not what you hear or read. Free yourself of any
preconceived notions of imposing your will on the market. Cutt yo your ur lo loss ss on a po posi siti tion on wh when en th thee ma mark rket et pr prov oves es it no nott co corr rrec ect. t. Th This is do does esn’ n’tt me mean an yo you u wa wait it 4. Cu for your stop to get hit before you exit. 5. Work hard at developing a trading plan to select trades, manage trades and exit trades. 6. Select the technology and communications necessary for direct access execution. 7. Manage the “Trader’s Equation”. You must understand how when each part of this equation
change chan gess it ef effe fect ctss yo your ur pr prof ofit itab abil ilit ity. y. Ma Mana nage ge th thee lo loss ss si side de an and d yo your ur ha hard rd wo work rk wi will ll ta take ke ca care re of the profit side. Thesee ar Thes aree al alll cu cutt-an andd-dr dry y ru rule les. s. As bo bori ring ng as th they ey ar are, e, th they ey mu must st be beco come me th thee co corn rner erst ston onee of yo your ur tr trad adin ing. g. Yo You u ma may y wa want nt to re-read this chapter, as the next part will start in on the good stuff.
PART TWO: HOW TO SELECT THE BEST STOCKS TO TRADE EVERY DAY STOCK SELECTION The st The stoc ock k se sele lect ctio ion n pr proc oces esss th that at I be beli liev evee is mo most st be bene nefi fici cial al to da dayt ytra rade ders rs is on onee wh whic ich h fo focu cuse sess on th thee pr prim imar ary y st stoc ocks ks th that at institutions depend on to outperform the S&P 500. These stocks demonstrate strong relative and absolute performance to the Index. Most of these stocks are in the S&P 500 index and have excellent liquidity. Our jo Our job b as tr trad ader erss is to id iden enti tify fy th thee st stoc ocks ks th that at th thee Ge Gene nera rals ls ar aree cu curr rren entl tly y ad addi ding ng to an and d ov over erwe weig ight htin ing g in th thei eirr po port rtfo foli lios os.. It is the herd mentality which creates the momentum that leads to many of the parabolic rises we have seen in this bull market. There is nothing better than getting good entry in strong momentum stocks that have pulled back, only to have the Gen Genera erals ls and mom moment entum um pla player yerss tak takee the them m up aga again. in. Als Also o hel helpin ping g thi thiss pro proces cesss are the “AC “ACCEL CELERA ERATOR TORS,” S,” whi which ch are the hedge funds, program traders and sometimes the specialists and option market makers. To better appreciate the stock selection process, I will try to give you some background on how a growth fund manager thinks and how he builds the fund portfolio.
HOW FUND MANAGERS THINK In or orde derr to be beat at th thee S&P 50 500, 0, in inst stit itut utio ions ns mu must st be in th thee ri righ ghtt se sect ctor or an and d in th thee ri righ ghtt na name mes. s. Th Thei eirr go goal al is no nott ju just st to mat match ch thee S& th S&P P 50 500; 0; th they ey wa want nt to be beat at it it.. In or orde derr to ac achi hiev evee th this is,, th they ey mu must st di diff ffer er fr from om th thee In Inde dex. x. To he help lp ac acco comp mpli lish sh th this is,, th they ey have built excellent internal research capabilities and, in addition, they have access to the best brokerage firm research thatt is ava tha availa ilable ble.. The There re are man many y tal talent ented ed ana analys lysts ts and por portfo tfolio lio man manage agers rs at the these se ins instit tituti utions ons,, so the there re isn isn’t ’t muc much h lef leftt to chance in the search for good companies. They get page-one information because of the millions of dollars they pay in commissions to the brokerage firms. Most gro Most growth wth fun fund d man manage agers rs are bot bottom toms-u s-up p sto stock ck pic picker kers, s, whi which ch mea means ns the they y clo closel sely y exa examin minee the bus busine iness ss pro prospe spects cts of each eac h com compan pany y and bui build ld the their ir por portfo tfolio lioss sto stockck-byby-sto stock. ck. The They y adh adhere ere to the fac factt tha thatt sto stock ck pri prices ces ten tend d to fol follow low ear earnin nings gs over time and to the extent that earnings forecasts are revised upward or downward, stock prices often will head the same direction. Most managers don’t try to predict near-term stock performance. Instead, they spend their time looking for companies that can grow earnings faster than the overall market and that are trading at attractive valuations. There are many factors that can make stocks rise or fall over the short term, but in the long run, earnings determine stock valuations. Therefore, a fund manager looking for the best chances of appreciation will choose those stocks that are fairly priced or undervalued. When mu When mutu tual al fu fund ndss re rece ceiv ivee ne new w mo mone ney, y, a fu fund nd ma mana nage gerr wi will ll of ofte ten n ad add d to ex exis isti ting ng po posi siti tion onss as lo long ng as th thee fu fund ndam amen enta tals ls remain solid for a particular stock. This assumes a stock still has strong relative and absolute performance to the S&P 500, 50 0, an and d it is th this is bu buyi ying ng th that at cr crea eate tess a tr tren end. d. A fu fund nd ma mana nage gerr wi will ll at atte temp mptt to bu buy y go good od st stoc ocks ks on pu pull llba back ckss an and d se sell ll we weak ak stocks on strength. Many of the momentum players just want to keep buying if the stock is up, but as soon as they have any sizable amount of shares offered to them by a brokerage firm’s trading desk, they might just disappear and turn seller themselves because the stock has reached a supply level and the stock can’t be pushed any higher until the seller(s) complete what they are trying to get done. The herd mentality prevails when it gets down to the high relative performance stocks such as we have seen in the tech te chno nolo logy gy an and d In Inte tern rnet et se sect ctor ors. s. A fu fund nd ma mana nage gerr ma may y th thin ink k th ther eree is a hi high gh de degr gree ee of ri risk sk in ce cert rtai ain n te tech ch st stoc ocks ks,, bu butt th thos osee companies may be producing fast earnings and helping the performance of the fund in the battle to beat the S&P 500. (So they might even stay too long.) This helps prolong the upside action as we get multiple upside breakouts after brief pullbacks. With a little help from momentum players, programs, hedge funds and the media hype that goes with these stocks, you are given many opportunities for strong daytrading action.
THE TH E AO AOLL EXA EXAMP MPLE LE A good example of this mentality is AOL, which was the largest contributor to several funds’ performance during the last part of 1998 and the first quarter of 1999. It had a parabolic move to the upside. Only those managers that had the stom st omac ach h to be bett on in inve vest stor or ps psyc ycho holo logy gy in inst stea ead d of vi visi sibl blee ea earn rnin ings gs go gott th thee fu full ll pe perf rfor orma manc ncee be bene nefi fit, t, bu butt ma many ny ju jump mped ed on the bandwagon at higher and higher levels afraid to be left at the gate. Surprisingly, even some value funds rationalized reasons to buy AOL. While arguing that AOL made sense for a value fund is a bit of a stretch, it does show how a herd mentality can drive a stock substantially higher. I hope those managers made good sales on the way down. If the fund managers decide to play the AOL game again, price and volume will let us know the “GAME IS ON.”
PORTFOLIO ADJUSTING Institutions are constantly increasing or trimming existing portfolio positions based on valuations, and they are also adding new positions or deleting underperformers from the portfolio. For example, a fund might have held a maximum of 10 million shares of AOL and because of the first-quarter froth and subsequent weakness, the fund may have cut back to 4 million shares. With the stock now down over 60% from its highs, fund managers might again decide to start adding to the position. Once the decision to add to a position is made, it often attracts the attention of other large players. This is what trend reversals are all about. Reversals like this usually take place around the 200-day moving average as more institutional players become confident that the move is for real. As the perception sinks in, the Generals jump aboard. Another example would be an institution that is taking a bearish top-down view of the market and now must realign its sector weightings. The theme would favor stable earnings, quality, low beta and yield, which translates to consumer staples—utilities, energies, and maybe gold. Energies and golds both usually do relatively well in a bear market. This defensive list of groups would be overweighed and sectors such as high-beta technology stocks would be underweigh underweighed. ed. This flow This flow of of mon money ey mov moving ing bet betwee ween n sec sector torss is very very vis visibl iblee bec becaus ausee mos mostt ins instit tituti utions ons are on the sam samee pag page. e. It’ It’ss just just tha thatt some are ahead of the pack. A good example of this is when many of the institutions loaded up on some of the techs during the market crack from July–October of 1998. Two other recent examples of money flows going into unloved sectors are the energies and basics during March and April 2000 (see charts later in chapter). The selection process will detect these moves based on price and increased volume, in addition to increasing relative strength. When stocks trend, they become tradable for daytraders as the many different institutional players get involved. Daytraders that select stocks from a matrix of high relative strength and earnings are, by definition, picking the stocks with the best technical and fundamental prospects to move significantly higher. The institutions institutions will have to own and over ov erwe weig ight ht ma many ny of th thes esee st stoc ocks ks if th they ey ar aree to be beat at th thee S& S&P P 50 500. 0. Th Thei eirr re rese sear arch ch an anal alys ysts ts wi will ll co cont ntin inue ue to be ou ourr re rese sear arch ch department. The following charts charts address the topics that I have just discussed. discussed. I provide brief analyses at the bottom of each chart chart that should draw together the various points I want to emphasize to you.
America Online (AOL)
WRB (Wide-Range Bar) breakouts on panic volume. If you did not get in at 1, the leftbehind portfolio managers entered at 2, afraid they would miss a further major move.
1. & 2.
3. This run up from an ascending triangle was again on a WRB, or Runaway Move as Mark
Boucher refers to in his course. He refers to them as a Thrust Breakout, Breakaway LAP and Breakaway GAP. This AOL example contains three favorite institutional patterns that they will aggressively attempt to breakout, market permitting.
Texas Instruments(TXN)
1. Breakout of nine-month base on good volume. This breakout was confirmed by S&P 500
trend (see Spyder Chart). Thee 10 10-w -wee eek k an and d 40 40-w -wee eek k EM EMA’ A’ss we were re bo both th ri risi sing ng an and d th thee 10 10-w -wee eek k wa wass ab abov ovee th thee 40 40-w -wee eek. k. 2. Th 3. The S&P 500 was also above its 10- and 40-week EMA’s. 4. TXN was now trending as it traded above both its 10-week and 40-week EMA. 5. TXN became a daytrader’s stock at this point, and now you start looking at your daily charts
for entry at inflection points which we will cover in Parts 3 and 4.
SPDRs SPD Rs (SP (SPY) Y)
1. SPY, which is a proxy for the S&P 500, broke out to a new level and is above the rising 10-
week and 40-week EMA’s. 2. The trend in both TXN and SPY were up. 3. You want to daytrade advancing stocks in an uptrending market.
Phix Semic Semicondu onducter cter Inde Index x (SOX) (SOX)
1. Positive Divergence preceding breakout 2 above 40 week EMA. 2. The breakout by TXN from a nine-month base was confirmed by the rising trend in SOX. 3. Five-month trading-range breakout preceded by rising lows in the range. The semiconductor
stocks sto cks ent entere ered d a pri prime me day daytra tradin ding g zon zonee aft after er thi thiss bre breako akout ut bec becaus ausee of the str strong ong mom moment entum. um.
Microsoft (MSFT)
1. Bre Breako akout ut of asc ascend ending ing tri triang angle le on a WRB (wi (widede-ran range ge bar bar)) wit with h exp expand anding ing vol volume ume.. (Se (Seee 3). 2. Bottom fishing as MSFT broke below and closed above 40-week EMA for the week and had
higher highs and higher lows the next two weeks (see 4 & 5). During this time, the Generals were adding to their positions. 6. GREAT DAYTRADING ZONE, MOMENTUM PLAYERS WERE IN BIG.
Caterpillar (CAT)
1. There was a rush to cyclicals such as CAT, DD, and AA as the Generals all jumped in at the
same time. 2. Volume had been building prior to WRB breakout. 3. Institutions love to break them out of the consolidations just above the 50- and 200-day
moving averages.
DuPont DuP ont (DD (DD))
1. Breakout above rising 50 and 200 EMA that is turning upward. 2. Breakout is on good volume.
KEY POINTS RE-CAP Before we identify and discuss the filters to select your daytrading stocks (same filters can be used for short-term position traders), let’s quickly recap some key points: We want stocks that have: • Strong relative and absolute performance versus the S&P 500 • Excellent liquidity, which means good volume and narrow spreads. • The best technical and fundamental prospects to move higher • Are members of S&P 500 or NDX 100 indexes, so we can benefit from the added volatility that program trading
provides. If the market shifted away from big caps, which is unlikely near term, we will make the same adjustments the Generals make to outperform the S&P 500. Uptren rendin ding g sto stocks cks (se (sells lls rev revers ersed) ed) are bet better ter day daytra tradin ding g sto stocks cks tha than n ran range ge bou bound nd sto stocks cks.. We wan wantt the mom moment entum um • Upt players on our team and as many accelerators that want to play the game as possible. • Stocks with volatility and good average daily range.
Use the Generals as our research department. Let them select the stocks—no one does it better. We will select those stocks to daytrade that are in the strongest uptrends and where we spot those situations when the buyers are more aggressive than the seller(s). In the final part of the process it’s what IBM is going to do in the next two minutes that matters most. Remember, though, that you don’t go to war unless you prepare for war. Understan Unders tand d tha thatt sto stocks cks wil willl pre presen sentt mor moree dyn dynami amicc sho short rt ter term m tra tradin ding g opp opport ortuni unitie tiess whe when n the they y are und under er or fai fairly rly val valued ued and they run out of buyers at the extreme valuations.
GENERAL FILTERS A. Skim In Inves vestor tor’s ’s Bus Busine iness ss Dai Daily ly (IBD) and Th Thee Wa Wall ll St Stre reet et Jo Jour urna nall for any stock specific
news or pending economic announcement. B. Review the market action of the prior day—which I keep by hand—it takes 10 minutes and
all the data is available from IBD. If you keep it by hand, you think about it, and you have records of how the market reacted at certain inflection points such as volume, breadth, moving average, swing point highs and lows. You would be amazed at how often markets repeat. This simple worksheet will be an exhibit in chapter 5 with a full month of data recorded for you. C. Check the earnings calendar for next four weeks and the brokerage firms’ upgrades and
downgrades. The site I use for this is www.dailystocks.com. This site is free, comprehensive and includes many other links of information and data you will find useful.
SPECIFIC FILTERS TRADINGMARKETS.COM Interactive RS Investigators Search This filter gives you the top relative strength stocks versus all other stocks from a universe of 5,000 most actively traded stocks. It is not the RSI (Wells-Wilder RSI) that measures the stock against itself, which we all use as a momentum indicator. The filter covers the past 12 months weighted more to recent action. If the stock has corrected sharply but still shows an RS of 98 or 99, it’ it’ss bec becaus ausee the 12 mon month th adv advanc ancee was sig signif nifica icant nt and the cur curren rentt cor correc rectio tion n is pro probab bably ly sma small ll in terms of percentage of the overall advance.
Search # 1:
RS value = between 80–99 Price Filter = more than 25 (only because of recent splits, the higher-priced stocks will give you better absolute move) Volume Filter = more than 400,000 shares The volume is what the stock traded that day, not the average daily volume of the stock. I prefer the stock to have an average daily volume of at least 500,000 shares for the past 30–50 days. The filter for 400,000 allows for a lower-thannormal volume day. Search #2: The second part of the filter is to run it again with RS values between 60 and 79.
This catches stocks that might be correcting back to their 50- and 200-day Exponential Moving Average’s (EMA’s), which present some good opportunities. After these corrections you will often see the Generals add good stocks on short-term market weakness and where the brokerage firms like to time their recommendations. Search Sea rch #3: The third part of the filter is to run it with the RS value between 90 and 99 and no other criteria. This gives
you the top relative strength stocks of the 5000-stock universe, regardless of price and volume. The fi The firs rstt th thre reee ex exam ampl ples es gi give ve yo you u an id idea ea of wh whet ethe herr a st stoc ock k is in a ru runa nawa way y mo mode de,, pu pull llin ing g ba back ck br brie iefl fly y fr from om sw swin ing g po poin intt highs, or consolidating after Wide Range Bar (WRB) thrusts or gaps. To understand the filters and which stocks are found, you must go through each chart so you get the feel for any lag in the filter. Search #4: If you decide to trade the 50-dollar-and-over big-cap stocks only, then a good filter to use is:
RS Value: between 80–99 Price Filter: more than 50 Value Filter: more than 750,000 Go to Stock Scanner to input the above parameters.
TRADINGMARKETS.COM ADX TREND FINDER If I had to choose one filter from TRADINGMARKETS.COM it would be this one: The higher the ADX, the stronger the trend up or down. When you combine ADX with Plus Directional Movement (+DMI) and Minus Directional Movement (–DMI) you will always discover a good trade opportunity. The ADX filter allows you a maximum of 10 values. For uptrends you set up +DMI > –DMI (reverse equation for downtrends). Search #1:
ADX Value 1 – 10 PX Filter more than 30 Vol. Filter more than 500,000 Trend Filter +DMI > –DMI The next step is to increase your ADX value by 10 until you run out of stocks (11-20, 21-30, 31-40 etc…), but everything else remains the same. Yes, I kn Yes, know ow th thee hi high gher er th thee AD ADX X th thee st stro rong nger er th thee tr tren end, d, bu butt yo you u ar aree fo forg rget etti ting ng ab abou outt di dire rect ctio iona nall mo move veme ment nt.. Of Ofte tent ntim imes es a stoc st ock k th that at ha hass ha had d a WR WRB B or ga gap p br brea eako kout ut wi will ll co cons nsol olid idat atee an and d tr trad adee si side dewa ways ys be befo fore re th thee ne next xt ru runa nawa way y mo move ve or re reve vers rsal al in tr tren end. d. Th Thes esee co cons nsol olid idat atio ions ns ar aree gr grea eatt sp spot otss fo forr th thee Ge Gene nera rals ls to sh show ow th thei eirr ca card rds. s. Ha Hall llib ibur urto ton n (H (HAL AL)) ga gave ve us a wa warn rnin ing g on Au Augu gust st 4t 4th h wi with th in incr crea ease sed d vo volu lume me th that at it mi migh ghtt br brea eak k ou outt of an as asce cend ndin ing g tr tria iang ngle le.. Th Thee ne next xt da day y we go gott go good od en entr try y at 48 1/8, and the stock traded to 50 7/8 before closing at 50 1/2. On August 4th, the energies all did well on increased
volume, which told us the Generals were working the floor and had to reach for stock. Baker Hughes (BHI), which you see on Search #1, has an ADX value of only 10, but is one of the top 10 stocks in percentage gained for the last six mont mo nths hs wi with th an 83 83.5 .5% % ga gain in.. We wa want nt to pl play ay th this is st stoc ock k as so soon on as we se seee a vo volu lume me si sign gnal al fr from om th thee Ge Gene nera rals ls wi with th a cl clos osee in the top part of its daily range. (Charts illustrating this follow). By st star arti ting ng wi with th a lo low w po posi siti tion on AD ADX X an and d wo work rkin ing g up upwa ward rd,, we ar aree su sure re to ca catc tch h al alll of th thee co cons nsol olid idat atio ions ns th that at us usua uall lly y le lead ad to excellent moves or the beginning of a trend reversal. When you look at the charts, start with the highest ADX values firs fi rstt be beca caus usee th that at’s ’s wh wher eree yo you u wi will ll fi find nd th thee 3 – 5 – 8 da day y pu pull llba back cks, s, WR WRB B Th Thru rust sts, s, an and d dy dyna nami mite te sh shor ortt te term rm co cont ntin inua uati tion on patterns. When you get to the lower ADX values, you pick up the consolidations such as the HAL and BHI. As long as +DMI is > than –DMI, all of the ADX values can find you an opportunity to monitor for a high probability trade.
Baker Hughes (BHI)
1. After a big, 5-wave down move, BHI forms a 1-2-3 bottom. 2. At B1, the Generals come for the stock in size, breaking it out of the ascending triangle,
ascending wedge, or whatever else you would like to call it. The key point is that at the B1 inflection point, BHI traded above the highs of the previous 4–5 weeks and did so on big volume. The “GAME WAS ON” at that point. 3. At B2, BHI makes a new high above swing point 2 after making a high low at swing point 3.
The stock trades and closes above both the 10- and 30-week EMAs. The trend at this point is up, and BHI becomes very tradeable regardless of whether you daytrade or position trade. 4. At B3, will BHI breakout of this consolidating range? I don’t know, but we will see the
Generals give us a warning before it does. (Note: As I am writing this, BHI breaks out of the asce as cend ndin ing g tr tria iang ngle le on go good od vo volu lume me at 11 11:3 :30 0 AM on 8/ 8/9/ 9/99 99 an and d is tr trad adin ing g at 35 5/ 5/8, 8, up 2 1/ 1/4) 4)..
Halliburt Hall iburton on (HAL (HAL))
1. (8/3/99) HAL closes in top of range.
range on good increase increase in volume. The Generals look like they 2. (8/4/99) Closes in the top of range want to break it out. Entry will be 48 1/8 on on 8/5. 3. (8/5/99) HAL opens at 47 1/2 and gives good entry at 48 1/8 and trades to high of 50 7/8 and
closes at 50 1/2. Volume is excellent. (8/6/99) Pullback day. (8/9/99) Surges to 51 3/4. Note:: This was good daytrade Note daytrade and also good position position trade.
HAL Volume Table Date
Open
High
Low
Close
Volume
9-Aug-99
49 49
51.75
49
51.4375
3,692,300
6-Aug-99
50.625
50.625
49.0625
49.3125
2,916,300
5-Aug-99
47.5
50.875
47.1875
50.5
3,880,300
4-Aug-99
47 47
48
46.8125
47.75
2,756,700
3-Aug-99
45.875
46.8125
45.8125
46.8125
1,619,000
2-Aug-99
45.875
46.4375
45.4375
45.75
1,813,000
30-Jul-99
46.5
47.4375
45.9375
46.125
1,308,100
CONCLUDING REMARKS After reading this chapter and working with the Filters, you will be on your way to gaining part of your edge, which is the selection of high octane trading stocks which have the following charactistics: • Strong relative and absolute performance versus the S&P 500. • Strong trending stock with high ADX and confirming directional movement. • High RS and EPS combination which puts you in the top momentum stocks. • Excellent liquidity and good average daily range.
By selecting stocks with the best technical and fundamental prospects to move significantly higher, you will often be trading stocks that are beginning or are in the explosive stage of their trend. The ke The key y to th that at mo move veme ment nt is fo forr yo you u to re reco cogn gniz izee ea earl rly y th that at th thee Ge Gene nera rals ls ar aree co comi ming ng fo forr th thee st stoc ock k an and d th then en ta take ke on only ly th thee well-planned entries you will learn or re-discover in parts 3 and 4.
PART THREE: STACKING THE ODDS IN YOUR FAVOR During part two, we presented a successful and proven method of selecting stocks to trade for any time frame. By selecting stocks with the best technical and fundamental prospects to move significantly higher, you will often be trading stocks that are beginning or are in the explosive stage of their trend. These stocks will be the ones needed by the Generals to outperform the S&P 500 and the same stocks that the momentum players will run and gun. Our selected time frame is daytrading, and in this chapter we will explain the various market and stock dynamics that willl hel wil help p you ide identi ntify fy whe when n the Gen Genera erals ls are act active ive,, whi which ch wil willl lea lead d to hig higher her pro probab babili ility ty tra trade de sel select ection ion.. Reme Remembe mber, r, we are talking about S&P 500, NDX 100 or any other high-volume liquid institutional stock. We are not talking about illiquid momentum OTC stocks with very little depth below the bid or offered side of the market.
ILLIQUID OTC STOCKS The patterns and trade recognition that you will learn in parts 3 and 4 don’t require you to be a pro at level II execution skills, which are much more involved than many trading firms advertise. If you expect to enter the daytrading business and an d st star artt tr trad adin ing g OT OTC C mo mome ment ntum um st stoc ocks ks wi with th sp spre read adss of 3/ 3/8– 8–1/ 1/2 2 wi with th bi big g tr trav avel el ra rang nges es an and d yo you u ha have ve no re real al ex expe peri rien ence ce in this trading business, I will sell you ice in January. You might as well donate the money to your favorite charity because 95% of you will lose. The only place you should attempt to learn those skills is at a direct access-trading firm and learning those skills takes time.
LIQUID BIG-CAP STOCKS There is excellent volatility and momentum in the big cap liquid OTC names that you can trade just as you would IBM in the New York Stock Exchange. You don’t have to be concerned with SOES and SelectNet, which are shadows of what they were when the OTC daytrading business heated up. The market maker requirements are 100% (and 100 shares only) in favor of the market maker. The expansion of ECN’s has helped, and hopefully will continue to help, expand liquidity, improve execution speed, and remain relatively inexpensive.
HERD MENTALITY Sooner or later every stock runs out of gas, or in other words, the rubber band has stretched the limit. Brokerage firms never sell, they just hint at it. Fear of heights and not booking profits start the ball downhill, then the herd mentality sets in and you get a severe correction, as we have just witnessed in AOL. Once it starts, there are opportunities on the short side for daytraders, which we will illustrate in weeks 3 and 4. I strongly recommend that as an individual trader or investor that you never take a naked short position home overnight. If you feel that strongly about shorting an institutional stock, you should do it in one of the following ways with options: 1.) Long Put; 2.) Bear Spread (Put or Call); 3.) Put ratio backspread, which has limited risk and unlimited reward; 4.) Synthetic Straddle, which would be long calls/short stock or long stock/long puts. The synthetic straddle is for traders that want to trade the position by making adjustments according to the deltas of the options. This course is not about options, so unless you are educated in options, don’t utilize them in your trading plan unless you understand everything about their usage.
SHORT-SELLING RISKS Why do you think so many short-selling funds have gone belly-up or have suffered drawbacks so large that money has run to the exits from these funds? Also, there are many institutions and hedge funds that can’t wait to squeeze an obvious short or sector when the opportunity presents itself, and it usually occurs when your short looks perfect. With limited funds and experience, are you ready for that kind of risk and exposure? Forget about it. Get an education in options where you can define or limit your risk or just stay with intraday shorts.
Every day, institutions, hedge funds, momentum players, program traders, specialists and market makers are making deci de cisi sion onss to bu buy y or se sell ll st stoc ocks ks fo forr va vari riou ouss re reas ason ons. s. Ot Othe herr th than an th thee ve very ry fe few w ne neut utra rall da days ys,, ei eith ther er th thee se sell ller erss or bu buye yers rs ha have ve the upper hand on a given day(s). As daytraders you don’t pick a stock’s direction (which is chance at best), you get on the trade as the stock changes direction which is considerably different.
INDIVIDUALS VS. INSTITUTIONS As a daytrader, you have the least amount of information of any of the players involved in the stock. The institutions buying and selling the stock that day know what they want to get done. The brokerage firms that are talking to these specific accounts are trying to generate commissions by getting a good piece of business done. They know to a great extent what the institutions are trying to buy or sell and at what levels. Once the institution gives a brokerage firm the orde or derr to to,, in th this is ca case se,, se sell ll st stoc ock k (A (AOL OL), ), th that at or orde derr is pa pass ssed ed al alon ong g to th thee fi firm rm’s ’s in in-h -hou ouse se fl floo oorr br brok oker er or to an in inde depe pend nden entt floor broker who is called a two-dollar broker. As th thee br brok oker erag agee fi firm rm is wo work rkin ing g th thee AO AOL L se sell ll or orde derr fo forr th thee in inst stit itut utio ion, n, th thei eirr sa sale less tr trad adin ing g de desk sk is ma maki king ng ca call llss to va vari riou ouss kinds of institutions trying to find buyers for AOL which would help the seller and also generate more commissions. The information flow now includes the institutions that gave the sell order to the brokerage firm, the floor broker on NYSE NY SE,, th thee sp spec ecia iali list stss on NY NYSE SE wh who o no now w kn know ow th ther eree is an in inst stit itut utio iona nall AO AOL L se sell ller er,, an and d th thee va vari riou ouss ki kind ndss of in inst stit itut utio ions ns that were called by the brokerage firm that was trying to leverage the AOL sell order. The institution that initiated the AOL sel selll ord order er is als also o get gettin ting g cal calls ls fro from m oth other er bro broker kerage age fir firms ms reg regard arding ing dif differ ferent ent sto stocks cks and pos possib sibly ly AOL AOL.. All of the these se instit ins tituti utiona onall pla player yerss hav havee var variou iouss lev levels els of inf inform ormati ation on reg regard arding ing the sup supply ply/de /deman mand d lev level el of AOL tha thatt day whi which ch cou could ld influence their trading decision.
ORDER FLOW CHARTS; TRACKING THE GENERALS We are going to assume that the institution that initiated the AOL sell order received a call from other brokerage firms that there was another seller of AOL in the market. The order flow chart will give you a thumbnail sketch of the information flow that takes place between buy side, (institutions) sell side, (brokerage firms) and the NYSE floor, or in the case of a Big Cap OTC stock, possibly a major market maker. As a daytrader you don’t get that information so you must understand and be able to identify the dynamics which tell you that the Generals are active in the stock and whether it is a high probability trade.
ORDER FLOW CHART This order flow chart gives you a good basi basicc idea of how how the the info informati rmation on flow flow might might infl influence uence the inst institut itutional ional urgen urgency cy to buy or sell a stock.
Flow Summary • Institution A gives sell order to broker A. • Broker A sends order to NYSE floor broker for execution. • Floor broker works with specialist to execute order. • Broker A is calling other institutions trying to find a buyer for AOL. Sometimes the other institutions might be a
seller of AOL, but won’t tell broker A if they are working their order with, say, broker B. • Broker B and the other brokerage firms are calling Institution A during normal course of business about stocks
they have to buy and sell. Broker B tells Institution A that they are a large seller of AOL. Institution A doesn’t respond because it is working a sell order with Broker A. Brok oker er B an and d th thee ot othe herr br brok oker erag agee fi firm rmss ar aree al also so ma maki king ng ca call llss to ma many ny of th thee sa same me in inst stit itut utio ions ns th that at br brok oker er A ca call lled ed • Br as a seller of AOL. Get the picture? Everyone now knows there is more than one institutional seller in AOL, and unless some buyers show up, the sellers will probably have to give up some price to get their orders completed. The following charts illustrate how to effectively select key inflection points for short sales in a stock that has lost momentum and sellers obviously are stronger than sellers (buys reversed).
AOL Cha Chart rt 1
1. Parabolic rise by AOL after breakout of Cup-and-Handle pattern at 91 3/8. A negative
divergence developed on this momentum player induced move to top. help lpss to ut util iliz izee a cu curv rved ed tr tren end d li line ne fo forr pa para rabo boli licc mo move vess wh whic ich h ar aree us usua uall lly y br brok oken en by th thee fi firs rstt 2. It he WRB reversal day as you see above. After momentum fades on a parabolic move, there are usually some outstanding shorting opportunities for the daytrader. In th this is ca case se we sa saw w a ne nega gati tive ve di dive verg rgen ence ce,, br brea eaki king ng of pa para rabo boli licc tr tren end d li line ne,, an and d WR WRB B re reve vers rsal al da day y on st stro rong ng vo volu lume me th that at followed a mini blow-off top. AOL was now on your short side radar looking for a good entry point.
AOL Cha Chart rt 2
(In the following discussion, please refer to this volume table). 4/5/99
A: WRB to a new high.
4/6/99
Day 1: WRB to new high on strong volume, but but closes below the the midpoint of daily range.
4/7/99 Day 2: Big reversal day on WRB. 20.625 20.625 points, which is the largest range of recent data. Volume is heavy as AOL closes below the open, below previous low and in bottom 30 percent of its range. It also closed below parabolic trend line. The close below the low of the previous Day 2 also confirmed change of direction and defined Day 1 as a swing point high. 4/8/99 Day 3: Gave Gave you a good short sale entry below 152 which was Day 2 low. low. Stock traded down to 148 before reve re vers rsin ing g an and d cl clos osin ing g in to top p of ra rang ngee at 16 160. 0.50 50.. Ho How w di did d yo you u ma mana nage ge yo your ur tr trad ade? e? In yo your ur tr trad adee pl plan an yo you u ma mark rked ed th thee 14 148 8 level as another possible short sale entry point. Days 4, 5, and 6: Gyrated up and down in a fairly narrow range, but you must notice they couldn’t close above Day 3 close or high. Their opens and/or closes were all within Day 3’s daily range. We have a consolidation that has now deve de velo lope ped d be belo low w th thee hi high gh,, an and d we kn know ow th that at we pl plan an to se sell ll sh shor ortt br brea eaki king ng 14 148 8 lo low w if AO AOL L re reso solv lves es to th thee do down wnsi side de.. 4/14/99 Day 7: Also closed closed within the the daily range of Day Day 3, but this close on a WRB at bottom of its range range at 150.875 raised our short trade entry point to 150, which is Day 7’s low. We st stil illl wi will ll en ente terr a sh shor ortt sa sale le be belo low w 14 148, 8, bu butt th thee Da Dayy-7 7 ba barr to told ld us to en ente terr fi firs rstt at a mo move ve be belo low w 15 150. 0. If yo you u lo look ok cl clos osel ely y at Da Dayy-7 7 ba bar, r, yo you u wi will ll se seee th that at it cl clos osed ed be belo low w th thee lo low w of th thee la last st th thre reee da days ys an and d be belo low w la last st se seve ven n cl clos oses es.. Th This is to told ld yo you u th thee highest probability was down. 4/15/9 4/15 /99 9 Da Day y 8: Yo You u ge gett a tr trad adee th thro roug ugh h en entr try y be belo low w 15 150 0 as th thee st stoc ock k op open ened ed at 15 152. 2.75 75 an and d we went nt so sout uth h to a lo low w of 13 135. 5. You Yo u co coul uld d ha have ve ad adde ded d to yo your ur po posi siti tion on as st stoc ock k tr trad aded ed be belo low w 14 148. 8. AO AOL L cl clos osed ed th thee da day y at 14 143. 3.87 875. 5. Yo Your ur ne next xt en entr try y po poin intt is 1/8 below 135. 4/16/99 Day 9 : Inside day closes closes at absolute absolute bottom of of its range at 139.75. Momentum Momentum is still down, so you you decide to ente en terr sh shor ortt 1/ 1/8 8 be belo low w 13 139. 9.75 75 on Da Day y 10 10.. Th Thee cl clos osee is be belo low w th thee op open en,, be belo low w pr prev evio ious us cl clos ose, e, an and d at bo bott ttom om of ra rang ngee af afte terr sharp drop told you the sellers were still in charge. 4/19 Day 10: AOL opens at 142, gives you entry entry at 139.75 and and an add, if so so wanted, trading below 135. The stock hit intr in trad aday ay lo low w of 11 112 2 be befo fore re cl clos osin ing g at 11 115. 5.87 875. 5. Th This is wa wass se sell llin ing g cl clim imax ax vo volu lume me fo forr AO AOL, L, as it ra rall llie ied d th thee ne next xt da day y on 42 42.7 .7 million shares.(see table) After a parabolic rise AOL lost momentum. Institution A started to sell stock as did Broker B’s seller, and then the process starts to feed on itself as portfolio managers rushed to the exits in fear of not booking profits at windfall prices. There was, without much doubt, some able hedge funds that with a particular options strategy were able to accelerate the stock move down and capitalize on the herd mentality. As a daytrader, you were still able, without the same information, to trade in the correct direction by reading the stock. You were were able to enter enter trades trades at high high-prob -probabilt abilty y inflectio inflection n points points on the dail daily y chart that indi indicated cated the the ease of movement movement was down. When you can combine this with solid intraday patterns, you will get better at this business. The change in direction or reversal indicators we observed can be found on intradaytrading charts as well. On Ch Char artt II we di disc scus usse sed d th thee in init itia iall th thre reee en entr trie iess th that at sa saw w AO AOL L hi hitt a lo low w of 11 112. 2. Th Ther eree we were re se seve ven n mo more re go good od sh shor ortt-sa sale le entries from the daily chart after AOL rallied to almost 90% of the 175.50 high, which is quite common for right shou sh ould lder er to tops ps,, wh whic ich h yo you u se seee wi with th AO AOL. L. I ma mark rked ed th them em on th thee ch char artt an and d al also so id iden enti tifi fied ed th thee re reve vers rsal al da day y pr prec eced edin ing g en entr try. y.
AOL Volum Volume e Table Table Date
Open
High
Low
Close
Volume
26-Apr-99
151
162.5
150.625
162
23,110,600
23-Apr-99
146.75
147.25
141.6875
147
17,139,800
22-Apr-99
150
153
144
148.6875
25,234,900
21-Apr-99
130.5
144.5
127.9375
142.75
25,476,300
20-Apr-99
115
130.25
113
128.6875
42,672,800 Rally
Day 10
19-Apr-99
142
143
112
115.875
55,669,900 Selling Climax
9
16-Apr-99
146.5
148.75
139.75
139.75
18,969,900
8
15-Apr-99
152.75
152.75
135
143.875
40,297,400
7
14-Apr-99
162
163.375
150
150.875
18,062,200
6
13-Apr-99
158.5
164.25
156.75
159.3125
16,414,300
5
12-Apr-99
152
159.8125 151.0625
157.875
21,168,100
4
9-Apr-99
159
165.25
157.875
159.9375
16,286,400
3
8-Apr-99
158
161.25
148 14
160.5
30,784,500
2
7-Apr-99
170.125
172.625
152
158
33,010,300
1
6-Apr-99
164.875
175.5 17
162.75
167.5
34,484,700 High
A
5-Apr-99
152.25
167
152
166.9375
26,786,900
1-Apr-99
152.6875 153
144.0625
150
22,138,400
CHART SUMMARY When you analyze a potential trade, you are simply looking at the supply/demand situation of a stock. Is it higher highs and an d hi high gher er lo lows ws or lo lowe werr hi high ghss an and d lo lowe werr lo lows ws?? Di Did d th thee st stoc ock k cl clos osee ab abov ovee or be belo low w th thee mi midp dpoi oint nt of it itss da dail ily y ra rang nge? e? Wa Wass the close in the top or bottom of its range? If it is to change direction, it must trade above or below the previous periods high or low, regardless of time frame. The longer the time frame, the more significant the move. As in our AOL example, the Generals can’t hide. In this case, AOL ran into trouble on day 1 making a new high and just barely closing above the A day’s high and close. Day 1 closed below the midpoint of its range on heavy volume, which indicated the stock might change direction. On day 2 the stock made a significant reversal as it closed below its open and well below thee Da th Day y 1 lo low. w. It re reve vers rsed ed on he heav avy y vo volu lume me,, cl clos osed ed in th thee bo bott ttom om 30 pe perc rcen entt of it itss ra rang ngee an and d al also so to took ok ou outt mo most st of th thee A day WRB move to new highs. The se The sell ller erss we were re cl clea earl rly y in ch char arge ge as th thee Da Dayy-2 2 ra rang ngee ex expa pans nsio ion n on a re reve vers rsal al da day, y, wh whic ich h wa wass a wi wide derr ra rang ngee th than an an anyt ythi hing ng prec pr eced edin ing g th thee 17 175. 5.50 50 hi high gh,, wa wass te tell llin ing g yo you u th that at th ther eree wa wass si sign gnif ific ican antt se sell llin ing g an and d se sell ller erss we were re gi givi ving ng up lo lots ts of pr pric icee to ge gett it done do ne.. Al Alll of th this is,, an and d th thee br brea eaki king ng of th thee cu curv rved ed tr tren endl dlin inee sp spok okee of a ch chan ange ge in tr tren end d an and d st stro rong ng in inst stit itut utio iona nall pa part rtic icip ipat atio ion. n. Day 7 clearly defined a further downside move when it closed below the low of the last three days and below the last seve se ven n cl clos oses es.. Th Thee mo more re lo lows ws or cl clos oses es,, th thee hi high gher er pr prob obab abil ilit ity y of a mo move ve in di dire rect ctio ion n in th thee cl clos ose. e. At th this is po poin int, t, th thee se sell ller erss were getting more anxious because that 148 low was staring them in the face. Also, any of the accelerators that were in position to attack the sellers were salivating. The hedge funds with married puts and the specialist if he were short and in position to run the obvious 148 inflection point and stops. Any option players that were set up to put pressure on AOL and benefit from a significant move below 150 could also help to accelerate the downmove. Go back and read this example several times so you start to think of what you are seeing. It’s not about memorizing a pattern. You could look at ten identical head-and-shoulders tops, but each one tells a different story based on many of the thin th ings gs we ha have ve po poin inte ted d ou outt in th thee AO AOL L ex examp ample le.. Wh When en yo your ur sk skil ills ls im impr prov ove, e, yo you u wo won’ n’tt ev even en be th thin inki king ng pa patt tter erns ns an anym ymor ore, e, just direction and the balance of buying or selling pressure. After all, we only have to be right for several minutes.
Biogen Chart (BGEN) I have included the Biogen (BGEN) chart as it includes three different buy situations. BGEN had made a 60.25 all-time high hi gh on 4/ 4/8/ 8/99 99,, co corr rrec ecte ted d do down wn to 45 45.1 .125 25 on 4/ 4/26 26/9 /99 9 an and d wa wass tr trad adin ing g ba back ck up ov over er it itss 10 10-, -, 50 50-, -, an and d 20 2000-da day y EM EMA’ A’s. s. Th Thee pull pu llba back ck to th thee 20 an and d 50 da day y EM EMA’ A’ss go gott my at atte tent ntio ion. n. Th They ey ar aree of ofte tent ntim imes es ex exce cell llen entt en entr try y po poin ints ts in up up-t -tre rend ndin ing g st stoc ocks ks (sells reversed). Shorter pullbacks of 3-, 5-, 7- and 8-days often provide the strongest trades. TRADE A Day 1—After a 5-bar (daily) pullback, BGEN re-crossed the 50 day EMA and closed at 54 1/16, at the top of its range
and ri and righ ghtt at th thee 10 da day y EM EMA. A. Th Thee st stoc ock k ha had d ma made de a sw swin ing g po poin intt hi high gh of 58 1/ 1/8 8 (S (S1) 1) on 1, 1,78 787, 7,00 000 0 sh shar ares es an and d pu pull lled ed ba back ck on average volume of less than 600,000 shares. The BTK (Biotech Index) had the same pattern as BGEN and with increasing RSI.
Trading-plan entry point was 54 1/4 on Day 2, which was 1/16 above Day 1’s high of 54 3/16. Day 2—BGEN opened at 54 1/8 and got good entry at 54 1/4 and stock traded to a high of 56 1/4. TRADE B
After a 3 bar thrust move from our Day 2 trade BGEN hit 60 3/16, just under the 60 1/4 high, then consolidated for 7 days. (Sound like a familiar number?) All of either the opens or closes of the seven bars were within the range of the S2 swing point bar. Day 1—After two bottom-range closes on average volume of approximately 740,000, BGEN gives us an excellent
outside reversal day on 1,029,500 shares and closes 1/8 under the top of the range at 59 5/8. This told me that someone was anticipating a breakout to new highs above 60 1/4. Trading-plan entry point for day 2 was 59 7/8, or 1/8 over outside-days high of 59 3/4. Day 2—This was a second entry after getting stopped out, but it proved successful as BGEN traded to a high of 66 1/2
on 3,914,500 shares. (More about reversal days in the pattern chapter next part.) Once again, you saw that expansion in rang ra ngee on Da Day y 1 wi with th an in incr crea ease se in vo volu lume me an and d cl clos osee in th thee to top p of ra rang nge. e. Yo You u ha had d to se sens nsee th that at if we ha had d a de dece cent nt ta tape pe on Day 2, that the Generals would take it to new highs, but it wasn’t an easy entry. The stock traded down to 58 3/8 before recrossing entry point. It happens often.
TRADE C
After the big WRB move up on Day 2, BGEN went sideways for 10 days. This is very normal after these kinds of thrusts. Day 1—BGEN closes in top of range on move that doubled the previous day’s light volume. Day 2—Stock has a higher high, higher low, and closes in top 30% of its range just below the day 1 close. This was
enough action to plan entry the next day for a possible run to new highs again. The momentum players love this kind of play. Day 3—BGEN opens at 66 3/8, ticks to 66 1/4, and then takes off. We enter at 67 1/4, which is 1/8 above Day-2 high.
Stock trades to high of 69 11/16. Now, I ca Now, can n dr draw aw so some me li line ness ov over er th thee pa patt tter ern, n, an and d we ca can n ma make ke it a sy symm mmet etri rica call tr tria iang ngle le,, tr trad adin ing g ra rang nge, e, or wh what atev ever er ot othe herr names you can think of, but who cares? You saw enough on Days 1, 2 and 3 that told you to get on the same jet as the Generals.
BGEN Volum Volume e Table Table Date
Open
High
Low
Close
Volume
15-Jul-99
66.375
69.6875
66.25
69.1875
4,036,500
D ay 3
14-Jul-99
66.9375
67.125
64.25
66.1875
2,022,600
D ay 2
13-Jul-99
65.125
66.8125
62.8125
66.75
2,432,100
Day 1 Trade C
12-Jul-99
65.5
65.875
64.5
64.5625
1,114,900
9-Jul-99
67.375
67.375
64
64.875
4,406,100
8-Jul-99
67
66.5
66.5
66.6875
5,207,100
7-Jul-99
62.8125
65.25
61.625
64.9375
2,475,300
6-Jul-99
65.5625
65.625
62.0625
63.0625
2,322,600
2-Jul-99
67.375
67.5
65.5
65.8125
1,202,300
1-Jul-99
64.6875
67
63.25
66.6875
1,796,800
30-Jun-99
64.25
65.5625
62.375
64.3125
2,154,400
29-Jun-99
59.875
66.5
58.375
63.6875
3,914,500
D ay 2
28-Jun-99
57.1875
59.75
56.1875
59.625
1,029,500
Day 1 Trade B
TRADE ENTRIES The information-flow network is always in motion. The other part of the network is the brokerage firm analyst contact with wit h the mon money ey man manage ager. r. Som Somee acc accoun ounts ts are on pag pagee one and mig might ht get som somee ear early ly per pertin tinent ent res resear earch ch inf inform ormati ation on abo about ut earnings, products, etc. which could influence their trading decision on any given day. Once you select your entry point from the daily chart, you must make a decision based on intraday market dynamics whether or not to enter the trade. The different entries you will be using are as follows: 1. Stock trades through your entry price. 2. Gap open (sell reversed) and pulls back to entry price.
3. Second entry. This is when you enter a trade, get stopped out and enter again if the stock
trades back through your entry price. The market and stock dynamics must look good to take the trade. Remember, you don’t necessarily have to get stopped out to scratch a trade. The dynamics are changing all day based on this information flow. If the market doesn’t prove your yo ur tr trad adee co corr rrec ectt in a re reas ason onab able le ti time me fr fram ame, e, or in th thee ca case se of bu buys ys,, if yo you u se seee se sell llin ing g pr pres essu sure re get the upper hand, get out of your position. You can always re-enter if the dynamics change. We are always looking to enter the stock where we can identify the aggressive buyers or sellers. Not all stocks exhibit this, but when the institutions are aggressive and they have competition on the same side of the trade, the identification process is much easier. A neutral stock is a dead stock until trading decisions are made to change the supply-demand equation. First, I will show you a simple table that I use to monitor the market dynamics. Second, I will cover some of the telltale indications of strong-stock dynamics. We will finish up with how specialists and market makers interact with the stocks.
MARKET DYNAMICS This is a table to use so you can monitor changing market dynamics during the day. I keep this every 15 to 30 minutes depending on activity in market. A top-to-bottom explanation of headings is as follows: SPU: Near term S&P 500 future which is now the September contract. SPX: S&P cash index. TICK : Net difference of all NYSE stocks trading on plus or minus ticks. I always keep an S&P 500 futures intraday
tick by tech chart with the NYSE tick chart right below it. If you see the futures making lower lows and the NYSE ticks showin sho wing g pos positi itive ve div diverg ergenc encee and mak making ing hig higher her low lowss (se (sells lls rev revers ersed) ed),, loo look k for ent entry ry in sto stocks cks sho showin wing g pos positi itive ve rel relati ative ve intraday strength. PREM: This is the difference between the S&P Future that you are monitoring and the S&P Cash Index. I use Track
Data Fast Trac and can set the spread on my screen. If you don’t have that on your system, you can just eyeball the two and subtract. A-D: This is the net difference between the advancing and declining stocks on the NYSE. UVOL: Up volume of stocks on NYSE. DVOL: Down volume on the NYSE. DOW: Dow Jones 30 stocks. Net change. NDX: NASDAQ 100 stocks. Net change. BD: 30-year treasury bond. Net change. SOX: Semiconductor stock Index. MSH: Morgan Stanley High-Tech Index. DRG: Drug Index RLX: Retail Index BKX: Banking Index XOI: Energy Index USX: Oil Service Index
RUT: Russell 2000 Small Cap Index
These are the major sector indexes, and you can add indexes at the bottom if they are active, such as FPP, XBD, etc.
Market Table This is actual market data for 8/19/99 9:45AM to 11:00AM EST. This is the table that monitors overall market dynamics. 9:45
10:00
10:20
10:30
10:45
11:00
SP’U
–10
–10
–10
–8
–14
–14
SPX
–11
–12
–12
–10
–16
–16
TICK
–482
–474
–528
–172
–181
–470
PREM
3.85
3.80
3.85
3.70
3.75
3.60
–1032
–1014
–958
–908
–1035
–1098
UVOL
13
26
44
48
51
58
DVOL
41
61
93
99
126
149
DO W
–91
–84
–79
–71
–105
–97
NDX
–21
–27
–33
–28
–45
–44
BD
–9
–5
–9
–8
–5
–6
SOX
–
–
–
–
–
–
MSH
–
–
–
–
–
–
DRG
–
–
–
–
–
–
RLX
–
–
–
–
–
–
BKX
–
–
–
–
–
–
XOI
–
–
–
–
–
–
OSX
+
+
+
+
+
+
RUT
–
–
–
–
–
–
A-D
This table takes less than 45 seconds to complete. You round off numbers for the S&P Futures, all the averages and the volu vo lume me fi figu gure res. s. Yo You u us usee ex exac actt nu numb mber erss fo forr TI TICK CK,, PR PREM EM,, AA-D, D, an and d BD BD.. Fo Forr th thee se sect ctor ors, s, th they ey ar aree ei eith ther er pl plus us or mi minu nus. s. At th thee bo bott ttom om of th thee sh shee eet, t, I ma make ke no note tess on wh whic ich h st stoc ocks ks ar aree sh show owin ing g st stro rong ng or we weak ak in intr trad aday ay re rela lati tive ve st stre reng ngth th an and d lo look ok for set ups on the 5 minute charts. You sh You shou ould ld al also so ma make ke no note te of an any y ke key y ma mark rket et ne news ws th that at sh shou ould ld ge gene nera rate te a re reac acti tion on an and d ob obse serv rvee ho how w th thee ma mark rket et re reac acts ts to the news. Startt to us Star usee th this is ta tabl blee on a da dail ily y ba basi sis, s, an and d yo you u wi will ll st star artt to se seee th thee re rela lati tion onsh ship ipss de deve velo lop. p. Is it ju just st pr prog ogra ram m se sell llin ing g se seei eing ng that th at th thee se sect ctor orss ar aree al alll pr pret etty ty st stro rong ng an and d th thee br brea eadt dth h is st stil illl go good od,, or ar aree th thee Ge Gene nera rals ls in th ther eree se sell llin ing g be beca caus usee up up-v -vol olum umee / down-volume ratio keeps getting worse with all sectors turning minus? There are many market clues that you will only start to understand if you keep the table. After a period of time, your market feel will improve ten-fold, and this will improve your entry into good trades. You will observe that trending dayss wil day willl all hav havee sim simila ilarr tra traits its,, as do the ove overre rreact action ion day dayss tha thatt als also o pro provid videe goo good d opp opport ortuni unity. ty. The neu neutra trall day dayss tel telll you little by flat averages, but maybe breadth, volume or certain sectors will provide pertinent information. Note: I used 26 boxes for the table so you can record the market every 15 minutes if needed.
STOCK DYNAMICS Once you have located your stocks to trade either from the daily chart or from the 5-minute bar intraday chart, you are watching how those stocks are trading. Remember, we want to enter trades with the Generals on our side. It is not always so clear cut because there is so much noise on an intraday basis. You can enter a trade, get lucky, and have a big buy program kick in along with institutional buying and you feel smart in addition to making a profit. The problem is that it works the other way just as often. Option market makers are constantly buying or selling stock to hedge position risk, and programs go both ways. The specialist might have an axe to grind. Upstairs position traders might be working down a long or short position, and portfolio managers are making daily trading decisions at different levels. There is no crystal ball, so as daytraders, you must go with the flow. This means you can make all the correct decisions for entry into a trade but might not get proven correctt becaus correc becausee of the the const constant ant intr intraday aday nois noisee that stop stopss you you out once or even even twice befor beforee your stock trend trends. s. When When that happens, most daytraders don’t re-enter the trade and miss the major move that day. Stocks Stoc ks wi will ll st stil illl re reac actt to th thee ma majo jorr su supp pply ly/d /dem eman and d pr pres essu sure re wi with th mi mino norr in inte terr rrup upti tion onss by pr prog ogra rams ms or so some me of th thee va vari riou ouss noise mentioned above. We want to recognize which side is stronger before we enter the trade. Since we are in a bull market, we will assume we are buying stock. There are very simple and easy-to-see dynamics, but you must adhere to them with discipline in order to be successful. 1. Did the stock open up on the day? 2. Is it trading above the open? 3. Is it trading above the VWAP? This is the volume weighted average price on the day.
Several quote vendors such as Track Data, Bridge, and Bloomberg have this information. These are the only vendors I have used, so I am not aware of who else provides this information. When the buy When buying ing pre pressu ssure re is neu neutra tral, l, or may maybe be the there re is one goo good-s d-size ized d ins instit tituti utiona onall buy buyer er tha thatt has no real competition, then the buyer will try to scale down the order. If the market is soft and the buyer is getting enough stock, then we won’t notice the buyer. If the market firms up or another buyer or two show up, we would probably see some buying pressure build. No inst in stit itut utio ion n wi will ll pa pay y up fo forr st stoc ock k un unle less ss th they ey ar aree ab able le to ge gett vo volu lume me,, bu butt th they ey mu must st pa part rtic icip ipat atee if volume starts to trade. When the stock is trading above the VWAP, it means the buying pressure is stronger, buyers are competing for stock, the market is probably advancing, option market makers are probably buying stock to hedge short calls, and if the specialist is on the right side of inve in vent ntor ory, y, it me mean anss an up st stoc ock. k. Wh When en al alll th thes esee in ingr gred edie ient ntss ar aree pu putt to toge geth ther er an and d th thee st stoc ock k is at a ke key y in infl flec ecti tion on po poin intt on th thee da dail ily y or in intr trad aday ay ch char art, t, th then en da dayt ytra rade ders rs ha have ve a go good od sh shot ot to ma make ke money. 4. Is the volume trading on the bid side, or is it trading at the midpoint or offered side?
We are buyers today in the stock, so we want to see it trading on the offered side (ask) or at leas le astt th thee mi midp dpoi oint nt.. Th This is te tell llss us th thee bu buye yers rs ar aree ag aggr gres essi sive ve,, an and d it is a se sell ller erss ma mark rket et.. Al Alll of yo you u who have direct-access software have time and sales tickers that are dynamic and that you can load with stocks you are monitoring. This is an absolute necessity if you are entering off intraday patterns or retracements. 5. Where is the volume trading? Bid, midpoint or ASK?
Bridge Brid ge an and d Bl Bloo oomb mber erg g al also so pr prov ovid idee th this is in info form rmat atio ion. n. Tw Two o st stoc ocks ks co coul uld d cl clos osee in th thee to top p of th thee range, but one might be due to late program trades, and the other because 75% of the volume was on the ASK side where there were multiple buyers.
6. Watch where the blocks are trading (5000 shares or more). This will precede range
expansion. 7. Where is size reflected? Bid or Ask? In OTC stocks you won’t see this nearly as often as on
the NYSE. 8. Is the Bid and Ask moving higher? 9. Are the other stocks in the group behaving in a similar fashion? It is always better to buy
strong stocks in a strong group. Five-pArt daytrading coursending stocks above the open for buys (sells reversed) either on continuation or pullback entry. Oftentimes, programs are very helpful on pullback buys or shorts as they give you entry at good levels, but you mustt be fas mus fastt to exe execut cute. e. Als Also, o, you wil willl get som somee gre great at opp opport ortuni unitie tiess whe when n sto stocks cks rea reach ch cer certai tain n sta standa ndard rd dev deviat iation ionss bas based ed on the implied volatility of the stock for one day. We will explain this opportunity in part 4.
NYSE SPECIALISTS Specialists interact all day long with the order flow. If you are not talking directly to the floor, you have no way of knowing when the specialist is involved. They are very regulated in how they can interface with the order flow, unlike the large OTC market makers that can still sell short on minus ticks. If you are a wholesaler, you get to talk to the buy side, the sell side and you see order flow from many retail firms because they pay for it. The NYSE specialists are down there to make orderly markets, but you must also understand they make money primarily by trading. Commission billing revenue for specialists is not what it used to be, so there is a much greater emphasis on trading. The daytrader’s shot of utilizing knowledge about specialists is primarily on openings and the subsequent trading after the open. That is enough to give you a profitable day anytime we get those “tail-wag-the-dog” openings due to the S&P futures. Another good opportunity is happy program time when the specialists step aside and let the robots do their thing. If you asked me the one thing about specialists that you should be aware of and can capitalize on, it would be: “Spe “S peci cial alis ists ts wi will ll ta take ke th thee st stoc ock k to th thee vo volu lume me an and d wh wher eree it wa want ntss to tr trad ade. e. Th They ey wi will ll ge gett it th ther eree by bu buyi ying ng or se sell llin ing g on only ly the required amount of stock that complies with market-making duties.”
CONCLUDING REMARKS After reading this chapter, you should understand that despite not being included in that vast institution institutional al information network, you can compete at a high level by recognizing the various dynamics that point to high-probability trades. Practice with the market table and get a good feel of how the market dynamics are constantly changing intraday. Pick several stocks that are close to what you think are good inflection points and watch them all day. Relate their action to your market table and notice how they react trading near or through these inflection points. Put th Put thee ti time me in in,, an and d yo your ur ef effo fort rtss wi will ll ta take ke yo you u to a di diff ffer eren entt le leve vell or or,, at wo wors rst, t, ge gett yo you u st star arte ted d on th thee ri righ ghtt le leve vell an and d in th thee right direction. The ne The next xt pa part rt is pa patt tter ern n pa part rt,, an and d th ther eree wi will ll be so some me hi high ghly ly ef effe fect ctiv ivee in intr trad aday ay an and d da dail ily y pa patt tter erns ns th that at ar aree ea easy sy to id iden enti tify fy.. With your better market feel, you should be able to contribute to the profit side of the Trader’s Equation.
PART FOUR: THE BEST DAILY SETUPS TO TRADE This week we want to focus entirely on patterns and some of the key interpretations of bar charts. It is essential that you try to keep it simple, believe what you see, and act on it. Many traders spend thousands of dollars looking for complicated formulas because when they observe something that appears so obvious, they are not capable of believing it. Remember, as a trader you can’t impose your will on the market because then you are attempting to trade what should be in inst stea ead d of wh what at is is.. If yo you u ar aree th that at go good od or th thin ink k th that at yo you u ha have ve so some me op opti tima mall sy syst stem em th that at wi will ll wo work rk at al alll ti time mes, s, th then en th this is chap ch apte terr is isn’ n’tt fo forr yo you. u. On th thee ot othe herr ha hand nd,, if yo you u ca can n ob obse serv rvee th thee ta tape pe ac acti tion on fo forr wh what at it ac actu tual ally ly is is,, ig igno nore re wh what at yo you u re read ad or hear, and then enter a trade based on what that action is telling you, you will be on the path to being a better trader.
PART 3 REVIEW During part 3, we demonstrated some of the key price, volume, range and time relationships that, if followed with only average ability, will place you in trades that have high predictive probability. Volume precedes price —is stock advancing on increased volume or declining on light volume (sells reversed).
—WRB RBss on in incr crea easi sing ng vo volu lume me wi with th cl clos osee in to top p or bo bott ttom om of ra rang ngee te tell llss us ab abou outt th thee su supp pply ly/d /dem eman and d Range Expan Expansion sion—W situation of the stock. Are the buyers reaching for stock, or are the sellers having to give up price to get out? Price and Time —Where is a stock closing relative to previous days? Trading above or below the previous 5 days is
more significant than one day. Closing above or below the same 5 days is most significant. Range Contraction —If after a move up you see a narrowing of range and increased volume, it could mean the sellers
have ar have arri rive ved d an and d th thee bu buyi ying ng/s /sel elli ling ng pr pres essu sure re eq equa uati tion on ha hass sh shif ifte ted. d. It is th thee re reve vers rsee on th thee do down wnsi side de if yo you u se seee na narr rrow owin ing g range and increase in volume. Remember, always look to see if you are at any key inflection points which would help confirm your observation. Are there rising lows prior to key buy inflection points (Sells reversed)? Is stock closing above or below the midpoint of its daily range? More importantly, is the stock closing in the top or bottom of its range?
SPOTTING MOMENTUM CHANGES When you are day When daytra tradin ding, g, you are wor workin king g pri primar marily ily wit with h dai daily ly and int intrad raday ay cha charts rts.. You are sel select ecting ing upt uptren rendin ding g sto stocks cks to buy and downtrending stocks for short sales. There will be times when you enter stocks just as momentum changes, as in the AOL example. Regardless of the time frame, you are looking for the same clues that the Generals are active, and which pressure is greater—the buying or selling? Before we start talking through the charts, I thought it would be beneficial to review some basic bar relationships that you must see clearly and let frame your thought process so you free your inner self to trade what is.
BAR PATTERN REVIEW The strongest sign that a stock wants to get somewhere in a hurry is when you observe the following relationships.
Bar Pattern (BP 1)—SELLS REVERSED
• Higher high than prior day (PD) high • Opens above PD high • Closes up on the day, above PD high and above today’s today’s open • Today’s low higher than PD high
This relationship is the strongest indication that the direction will continue. If you also get expanded range and increased volume it is even stronger. When you see this bar relationship, your logical progression of thought is to relate it to previous bars. Remember that it doesn’t matter which time frame you are tracking in, the relationships have the same significance. How many previous closes and highs did today’s close expand? Did today’s bar and close take stock above a swing point trendline, out of a consolidation, above a significant moving average or did it attract buying/selling at a key geometric retracement level such as .38, .50, .618, or .786. Those are fibonacci levels and institutions are very much awar aw aree of th them em fo forr st stoc ocks ks,, so yo you u sh shou ould ld un unde ders rsta tand nd th thei eirr us usag age. e. Yo You u lo look ok fo forr re reac acti tion onss at th thee va vari riou ouss re retr trac acem emen entt le leve vels ls.. You don’t trade the levels blindly just because they hit a number.
BAR PATTERNS 2,3
BP 2 is th thee sa same me as BP 1 ex exce cept pt th that at to toda day’ y’ss lo low w is th thee sa same me as th thee pr prio iorr da day’ y’ss hi high gh.. BP 3 is onl only y dif differ ferent ent tha than n BP 1 and BP 2 in that today’s range is slightly within prior day’s range.
All three relationships tell a strong story. Simple—yes. Important—you bet, especially when deciding which one of your trade selections to choose from.
Bar Pattern 4
BP 4 is your normal higher-high and higher-low continuation in direction
If you were to see a higher high and higher low except that today’s close was below the prior day’s close, it would be neutral and you would wait for the next bar to confirm direction. If today’s close was below the open, even with the high hi gher er lo low, w, it mi migh ghtt in indi dica cate te a fa fail ilur uree mo move ve or po poss ssib ible le ch chan ange ge in di dire rect ctio ion. n. Wh What at wi will ll th thee ne next xt ba barr sa say? y? We wi will ll di disc scus usss reversal bars and outside days with some of the patterns. Anothe Anot herr im impo port rtan antt as aspe pect ct of lo look okin ing g at th thes esee re rela lati tion onsh ship ipss is to co comp mpar aree yo your ur st stoc ocks ks re rela late ted d to st stoc ocks ks in th thee gr grou oup p an and d to any an y se sect ctor or in inde dex x th that at is pe pert rtin inen ent, t, in ad addi diti tion on to th thee S& S&P P 50 500, 0, if in fa fact ct,, th that at is th thee co corr rrec ectt bo boge gey y th that at yo your ur st stoc ock k tr trac acks ks..
SWING POINTS You he You hear ar me of ofte ten n re refe ferr to sw swin ing g po poin ints ts or co conf nfir irma mati tion on of a sw swin ing g hi high gh or lo low, w, so a qu quic ick k re revi view ew of sw swin ing g po poin ints ts mi migh ghtt be he help lpfu ful, l, as th they ey ar aree ke key y in infl flec ecti tion on po poin ints ts.. St Stoc ocks ks do don’ n’tt go st stra raig ight ht up or do down wn.. Th They ey ge gene nera rall lly y ma make ke hi high gher er hi high ghss an and d lows lo ws in an up uptr tren end d (S (Sel ells ls re reve vers rsed ed). ). Th Thee hi high gh wi will ll ha have ve a lo lowe werr hi high gh on ea each ch si side de of it it,, an and d th thee lo low w sw swin ing g po poin intt wi will ll ha have ve a higher low on each side. If the swing point has only one on each side, it is S1, two S2 and three is S3. EXAMPLE
As you can see an S3 would have more significance than S1.
NEXTLINK NEXTLIN K COMMUN COMMUNICATIO ICATIONS NS (NXLK) Primary trade entries selected from the daily charts consist mostly of the following: 1. Wide-range bar expansion (WRB). 2. Pullback entries in the direction of trend. 3. Consolidation patterns such as dynamite triangles, flags, trading ranges etc. . .
Note: The name of the consolidation patterns and definitions can be found in any textbook on the subj su bjec ect. t. Wh What at yo you u mu must st co conc ncen entr trat atee on is to re reco cogn gniz izee wh when en a st stoc ock k is mo movi ving ng or is ab abou outt to mo move ve to new levels. I will name the patterns as we walk through the examples. The following chart of NEXTLINK Communications (NXLK), “A” illustrates some WRB expansions, which demonstrate BP patterns 1–4. It also shows you some dynamite triangles and flags which often form the consolidating phase after a sharp WRB move. There are also several pullback and go patterns at the 50-DAY EMA.
TRADE A
4/20 - DAY 1
NXLK pu NXLK pull lled ed ba back ck 5 ba bars rs to th thee 50 50-D -DAY AY EM EMA. A. Mo Most st of yo your ur PB tr trad ades es in st stro rong ngly ly tr tren endi ding ng st stoc ocks ks se seem em to be 33-,, 55-,, 77-,, 8-, or 13-day PB’s. After that, momentum is not quite the same until stock bases a bit. You count bars by starting with actual low (High) or by the preceding bar if a low, or the next bar if a high. In this example, we started with the actual low bar on Day 1. It is an either/or count. NXLK closes in bottom of the range at 53 1/4 right on the 50 EMA. The 5-bar PB was from a new high of 70 to low of 52 on Day 1. 4/21 - DAY 2
WRB up to close at 63 confirming Day 1 as a swing point (S3) low. Checking the volume chart you see that R1 is a big WRB WR B ou outs tsid idee re reve vers rsal al da day y on in incr crea ease sed d vo volu lume me.. Th This is se sets ts up a co coun unte terr tr tren end d sh shor ortt tr trad adee fo forr R2 R2,, wh whic ich h is a bi big g do down wn da day y on 1, 1,00 000, 0,20 200 0 sh shar ares es.. No Noti tice ce ho how w Da Dayy-1 1 lo low w (S (S3) 3) wa wass on de decl clin inin ing g vo volu lume me.. No un unus usua uall vo volu lume me on th this is WR WRB B mo move ve up up.. DAY 3
Is a ba barr pa patt tter ern n BP BP1 1 st stro rong ng ga gap p mo move ve up up,, no en entr try y un unle less ss yo you u we were re ab able le to tr trad adee in intr trad aday ay pa patt tter ern n fr from om th thee 55-mi min n ch char art. t.
DAY 4, 5, 6
All gave good entry above the previous day’s high before Day 7, which was a reversal day. Three good daytrades. DAY 7
Is a WRB down, which then consolidates to a dynamite triangle which is usually a minimum of 2 inside days as vola vo lati tili lity ty an and d vo volu lume me di dimi mini nish sh.. Th Thee mo move ve ou outt of th thee tr tria iang ngle le is us usua uall lly y a go good od tr trad ade, e, as yo you u se seee on th thee da dayy-12 12 ba barr wh whic ich h is a WRB to downside. It doesn’t have to be a perfect shape but will have mostly lower highs and higher lows as it narrows. Day 12
WRB is a 7-bar low and then you got two inside Days, 13 and 14, forming another dynamite triangle with an explosive upsi up side de br brea eako kout ut fr from om 69 7/ 7/8 8 to 77 3/ 3/4 4 on Da Day y 15 wi with th go good od vo volu lume me.. Da Days ys 16 an and d 17 ga gave ve yo you u tw two o mo more re gr grea eatt da dayt ytra rade dess with multi-point moves. NXLK ran from a Day-1 low of 52 to a Day-6 high of 81 1/4 with only a 5-bar move. That is traders’ volatility. The Day-6 high of 81 1/4 sold down to 64 on a 7-bar move which retraced 59% of the prior swing before the dynamite triangle breakout took NXLK to another new high at Day 18 of 88 3/4. The power of a high RS value and strong ADX coupled with volatility is the formula.
TRADE B NXLK trended down to the 50-DAY EMA from Day 18, hitting a low of 66 3/4 on 6/15/99, closing at 67. DAY—1 5-bar PB from S3 high of 85 to close below 50-DAY EMA at 67 DAY—2 is a BP4 day, closing right at 50 EMA, confirming Day 1 as a swing point low DAY—3 Good entry 1/8 above Day-2 high DAY—4 Good entry 1/8 above Day-3 high DAY—5 Good entry 1/8 above Day-4 high DAY—6 Good entry, but stopped out, no profit
The trades on days 3, 4 and 5 were multi-point trades. Days 2 through 5 were all BP4 or BP3. Day 6 was a reversal day and also a 5 BAR swing point top at 82 7/16. This Day-6 top then traded 7 bars down to the 50-DAY EMA once again. This is the fourth PB to the 50 EMA.
TRADE C DAY—1 Outside reversal day and a re-crossing and close above the 50 EMA after a 7 bar pullback from previous S3
high of 82 7/16. This was another higher low of 69. This was a strong reversal on 1,098,000 shares setting up the trade for Day 2. DAY—2 Good entry at 75, which is 1/8 above the Day-1 high stock trades up to 78 1/4 high. DAY—3 No entry, narrow range. DAY—4 Good entry 1/8 above Day-3 high. DAY—5 No entry, narrow range. DAY—6 Good entry 1/8 above Day-4 high on a BP3 move. Explosive 6-point move. DAY—7 BP2 bar pattern with explosive continuation move. DAY—8 Good entry, multi-point move on WRB expansion which is biggest thrust of this move up from the 50-DAY
EMA. This WRB move was followed by Days 9 and 10, two inside days, which formed, YES, you are correct, a dynamite triangle. DAY—11 Br Brea eak k ou outt fr from om DT in di dire rect ctio ion n of tr tren end d on a BP BP2 2 mo move ve.. Go Good od en entr try y an and d al almo most st a 44-po poin intt ad adva vanc ncee fr from om en entr try. y.
This is an S2 swing top. Note: Day 6 was an S3 swing point trendline breakout on strong volume of 687,300 shares followed by another WRB of 738,700 shares. The Day 8 WRB was on only 592,000 shares, then came the two inside days.
TRADE D
TRADE D starts with Day 1
5-BA BAR R mo move ve do down wn fr from om Da Day y 11 – S2 to top. p. Th This is is a hu huge ge re reve vers rsal al of th thee 5 ba barr do down wnsi side de mo move ve fr from om th thee Da Day y 11 DAY—1 5high on light volume. It was due to an upside earnings surprise. It closed at 98 3/4 versus Day-11 high of 98 3/16. Thee Ge Gene nera rals ls ca came me fo forr st stoc ock k ag agai ain n on a BP BP1 1 pa patt tter ern. n. Th Thee lo low w wa wass 3/ 3/4 4 of a po poin intt ab abov ovee Da Dayy-1 1 hi high gh.. Th Ther eree wa wass DAY—2 Th no inflection-point entry unless you entered off a 5-min chart pattern. Volume was big at 1,026,400 shares. After this second WRB move up, NXLK consolidated on Days 3, 4 and 5 in another dynamite triangle, or some would call it a FLAG. Who cares what the name is, we are ready to enter above high of second inside Day 5. DAY—6 Good entry above inside Day-5 high as it trades and closes at a new high of 108. DAY—7 Good entry 1/8 above Day-6 high makes another new all-time high of 115 3/8, but on only 477,800 shares.
Give me a break. The stock is up 7 3/8 points from Day-6 close of 108. Great end-of-the-month move, isn’t it? You are aware Day 7 is July 30. These are the moves all traders dream about. DAY—8 August 2, first day of the new month. What a surprise. NXLK opens at 112—trades down to a low of 102 1/8,
before closing in bottom of range at 104 7/16. This is a big move down on only 357,100 shares. No more mark-up buyers, but this WRB expansion move to the downside in price shook the tree. Pani nicc Ci City ty.. St Stoc ock k op open enss at 10 104 4 7/ 7/8 8 an and d tr trad ades es do down wn to 85 3/ 3/8 8 on 1, 1,89 894, 4,60 600 0 sh shar ares es,, th then en cl clos oses es at 87 7/ 7/8. 8. Ho Home me DAY—9 Pa Run. The Generals couldn’t get to the exits fast enough and no market makers in sight. This was a pullback entry and break back below Day 8 low. DAY—10 Opens at 90 7/8, trades below entry point of 85 1/4, the prior day’s low and a key inflection point. It trades
down to low of 80 and closes at 82 on volume of 2,036,000 shares, which means more panic. Closes below 50 EMA. Note: Day 8 had broken an S3 swing point trendline from Day 1 to the S3 point on Day 6. If you were in this stock, short entry on the downside crossing of this trendline was profitable. Goodent odentry ry be belo low w Da Dayy-10 10 lo low w of 80 an and d NX NXLK LK tr trad ades es to a lo low w of 76 3/ 3/8 8 on mo more re bi big g vo volu lume me by th thee Ge Gene nera rals ls DAY—11 Go of 1,658,500 shares. Note: After Day-11, volume dried up as the sellers backed away. The stock consolidated before starting a weak up move relative to volume.
REVIEW REVI EW NXL NXLK K WRB’s, WRB’ s, BP’ BP’ss 1– 1–4, 4, dy dyna nami mite te tr tria iang ngle less or fl flag ags, s, pu pull llba back ckss to th thee 50 50-D -DAY AY EM EMA, A, Ou Outs tsid idee Re Reve vers rsal al Da Days ys on go good od vo volu lume me and momentum crack and panic on Wide range reversal bars. Also, you saw the action at the swing point trendline breaks. Any combination of S2 or S3 points will form your tren tr endl dlin ine. e. Th Thee st stro rong ng po poin intt is th thee S3 to S3 TL as in tr trad ades es B an and d C. Yo You u dr draw aw th thee tr tren endl dlin inee (T (TL) L) fr from om ri righ ghtt to le left ft,, as th that at is the most current data. That is why my S3 TL isn’t straight as it would be if I drew it from Day 18. I hope this example brings some life to your thought process and to what you see on the chart. You can take these examples down to the 5-min chart level.
American Express (AXP)
Trade A
This ch This char artt sh show owss yo you, u, in or orde der, r, a dy dyna nami mite te tr tria iang ngle le (T (Tra rade de A) th that at br brea eaks ks to th thee do down wnsi side de at Da Day y 1 bu butt cl clos oses es in to top p of it itss rang ra nge, e, in indi dica cati ting ng th thee fa fail ilur uree of th thee mo move ve.. Ha Had d yo you u en ente tere red d co comi ming ng ou outt of th thee tr tria iang ngle le,, wh whic ich h is an en entr try y be belo low w th thee lo low w of the closest inside bar, you had a good daytrade. Day 2 gave you good entry above the triangle line extended. Day 3 was good continuation entry and an excellent move. Entry was 121 3/4, and it ran to a high of 125 1/4. Dynamite Triangle Entry Guidelines
Ente terr be belo low w th thee lo low w or ab abov ovee th thee hi high gh of th thee cl clos oses estt in insi side de da day y (i (itt do does esn’ n’tt ha have ve to be a pe perf rfec ectt 1. En inside day). 2. If the triangle trend line extended gives you earlier entry, take it if the dynamics are good. Trade B
After the upside breakout from the dynamite triangle in Trade A, AXP ran to a high of 129 3/8 which was an S3 swing point high and consolidated forming a symmetrical triangle which is shown by points 1, 2, 3, and 4. They happen to be all S3 swing points. Day 1—AXP breaks above the swing point trend line and also out of the symmetrical triangle. If the stock and market
dynamics are ok, then you take the trade.
Day 2—Good entry above Day-1 high, small profit, but stock closed in top of range. Volume not exciting yet. Your
Day-3 trading plan calls for entry 1/8 above Day-2 high. This would also be a good entry for a position trade. Day 2 closed above its 10- and 50-day EMA. Both these averages are above the 200 EMA and are rising. Day 2 also closed above the ST and in top of range and above the last 13 closes and highs. The S&P 500 index was also up in a favorable pattern, and you now have the perfect setup. —Hom omee ru run. n. Yo You u ge gett 12 127 7 5/ 5/8 8 en entr try y an and d st stoc ock k ru runsto nsto a hi high gh of 13 133 3 5/ 5/8. 8. S& S&P P 50 500 0 al also so ma made de st stro rong ng up mo move ve,, sothe Day Da y 3—H dynamics were good. Volume was big at 3,215,900 shares. Day 4—Inside day, no entry, but stock closed on top of range ready for tomorrow.
—Ano noth ther er gi gift ft BP BP2 2 da day. y. St Stoc ocks ks at hi high gh of Da Day y 4, wh whic ich h is 13 133 3 1/ 1/4, 4, an and d yo you u ge gett en entr try y at 13 133 3 3/ 3/8 8 an and d st stoc ock k tr trad ades es to Day Da y 5—A a high of 138 1/2. The low of the day is 133 1/4. BP1 and BP2 are strong indicators. Day 6—Good entry, 1 1/2 point run and end of this thrust out of the symmetrical triangle. Trade C
AXP had rallied to a 144 high (2) which was a narrow range bar on strong volume of 2,727,800. This followed a WRB( WR B(x) x) to ne new w hi high ghss on 3, 3,00 000, 0,00 000 0 sh shar ares es.. Th This is co cont ntra ract ctio ion n of ra rang ngee on st stro rong ng vo volu lume me is a si sign gn th that at th thee su supp pply ly/d /dem eman and d equation might be changing and a possible reversal in trend. The next four days provided continuation entries from the short side after breaking swing point trend line (see point 4 to Q bar). AXP bottoms at 121 7/8 at Day 1, which is a higher low than Trade B. Once again we get our dynamite consolidation, and AXP breaks out for a good trade on Day 5. The rest is straight up to a new high of 150 5/8 on 8/24/99.
S&P 500 Chart
Day 1—Same situation as Trade B, day 2. AXP ready for continuation continuation entry to further highs. Day 2—Good breakout and the market dynamics were strong when AXP made its move. R1—Outside Reversal Day R2—Big reversal day that breaks a swing point S3 trendline and the decline is from the 1420.19 top.
INTRADAY INTRAD AY PATTERN PATTERNS S It is ea easi sier er an and d mo more re ef effe fect ctiv ivee to da dayt ytra rade de if yo you u li limi mitt yo your urse self lf to a fe few w si simp mple le bu butt ea easi sily ly re reco cogn gniz ized ed pa patt tter erns ns.. Al Alll of yo your ur entries will be determined by your interpretation of the market and stock dynamics at the time you are deciding to enter your trade. 1. Opening Reversal (OR)
This is a tr This trad adee yo you u wi will ll us usua uall lly y ge gett in th thee fi firs rstt 30 mi minu nute tess of tr trad adin ing. g. Th Thee tr trad adee se sets ts up af afte terr an emotional opening due to early morning S&P futures activity or some news announcement that creates the usual overreaction.
Trade Setup (Buys, Sells are reversed) 1. Stock opens and sells off no more than 25% of its daily range. (maximum is 33%). 2. The stock makes a quick reversal in price and trades back through the open. 3. Entry is 1/8 above opening price.
ORs will be selected from your list of high-RS value stocks and from your Trading Plan stocks for the day. If you see a stock( sto ck(s) s) tha thatt is dem demons onstra tratin ting g str strong ong rel relati ative ve str streng ength th as the mar market ket ope opens ns low lower, er, and thi thiss sto stock ck is onl only y sli slight ghtly ly bel below ow its opening price, then this will usually be your best selection, especially if it is a high RS value stock. Because of the early trading noise, (9:30–10:00 AM EST) you must keep tight stops. This trade must be accompanied by improving market dynamics (going up) and the stock dynamics which you have been observing must be good. Also, be ready for a second entry if stopped out and if the dynamics are still solid. If the futures are on a search and destroy mission, i.e. taking out both the early low and early high before the first trend of the day, you will often get second entries.
HWP
Day Da y 1—H —HWP WP tr trad ades es do down wn to an and d cl clos oses es ju just st ab abov ovee it itss 50 50-d -day ay EM EMA. A. Th Thee st stoc ock k is do down wn 6 5/ 5/16 16 on th thee da day. y. Th Thee S& S&P P 50 500 0
cash index is only down 3 3/4 points. The company is expected to announce earnings after the close on 8/16/99.
Day 2—HWP rallies and closes up 2 15/16 (2.8%) and the S&P 500 finishes up 2.3% on a good market day. I circled
HWP as a possible trade on Day 3 because the company was supposed to make the whisper earnings number. If you get trade entry 1/8 above the Day-2 high, get on it because the momentum traders will probably front-run the earnings.
I mentioned HWP on the call this morning. Take it if they come for it to front-run the earnings. The st The stoc ock k ga gapp pped ed op open en 1 7/ 7/16 16 po poin ints ts to107 7/ 7/16 16 fr from om th thee pr prio iorr cl clos osee of 10 106 6 (B (BAR AR 1) 1).. It tr trad aded ed do down wn to 10 106 6 11 11/1 /16 6 (B (BAR AR 3), showing strong relative strength, as it didn’t come close to filling the opening gap. The stock quickly reversed on volume and traded back above the opening price. It traded to 108 1/2 on a WRB (BAR 6), consolidated to a FLAG and broke out again at BAR 10, moving straight to 111 1/2 before fading. The di The disc scip ipli line ne of th thee pa patt tter ern n an and d th thee dy dyna nami mics cs pu putt yo you u in th thee tr trad ade. e. We go gott lu luck cky y th that at th thee mo mome ment ntum um fr fron ontt-ru runn nner erss to took ok it so high. They got their lunch handed to them the next day, as HWP closed down 5 3/4 points.
Opening Reversal Recap It is important to note that this HWP example is a stock that gapped up, traded down, remaining above prior close and reversed opening to the upside. Most of your OR’s will be stocks that open below or trade below the prior close then reverse opening to the upside (sells reversed).
SLIM SLI M JI JIMS MS This is a ti This tigh ghtt co cons nsol olid idat atio ion n pa patt tter ern n th that at wi will ll ha have ve yo you u bu buyi ying ng or se sell llin ing g ne new w in intr trad aday ay hi high ghss or lo lows ws.. It wi will ll al also so ha have ve yo you u ente en teri ring ng a re reve vers rsal al tr trad adee of th thee da day’ y’ss ex extr trem emee mo move ve (s (see ee BB BBY Y Ch Char artt be belo low) w) or a co cont ntin inua uati tion on en entr try y fr from om a co cons nsol olid idat atio ion n above or below the day’s high our low (see SPY Chart). The longer and tighter the consolidation, the more powerful the breakout. If you see these consolidations in the first hour of trading, they won’t be as long, but if it’s a narrow range and are rising lows (sells reversed) as it bumps up against a price, be ready for a good first move to new highs or lows. If yo you u ca can n in inte terp rpre rett th thee st stoc ock k dy dyna nami mics cs th that at we ha have ve ou outl tlin ined ed (p (par artt 3) as yo you u wa watc tch h th thee dy dyna nami micc ti time me an and d sa sale less ti tick cker er,, in addition to getting a decent feel for the market dynamics prior to entering your trade, then Slim Jim is your main man. This pattern will take you there.
The first thing you must do is load up your charts with as many of your high RS value stocks with strong ADX and +DMI +D MI > –D –DMI MI (r (rev ever erse se if yo you u ar aree ju just st lo look okin ing g fo forr sh shor orts ts). ). Af Afte terr th thee fi firs rstt 3 or 4 55-mi minu nute te ba bars rs,, st star artt fl flip ippi ping ng th thro roug ugh h yo your ur charts to see what is setting up. This process takes place all day long. There is never a day that you don’t have probable trade candidates.
BBY Cha Chart rt 1
BBY opened at 60, made a high of 61 3/4, and then traded down to 56 5/8. It then entered a long tight consolidation between 56 5/8 and 57 3/8. It was a 37-bar range from 11:30 AM to 2:30 PM. The market started acting really good as the S&P futures futures started started to to run. Buyers Buyers came came immed immediatel iately y to an oversol oversold d BBY. It was a fast fast move (Bars 1 and and 2), but but the entry proved very rewarding, as the stock and S&P 500 took off to the upside. All you did was identify the pattern, mark down in your trading plan that you would enter 1/8 above the trading range high hi gh,, an and d de deci cide de ba base sed d up upon on yo your ur ow own n pa para rame mete ters rs wh what at yo your ur mo mone ney y st stop op wo woul uld d be be.. Th Thee en entr try y wa was, s, of co cour urse se,, pr pred edic icat ated ed on whether the market was rallying and whether there was buying pressure on the stock. This was a strong move, and it didn’t re-enter the, range possibly stopping you out. If that happens, be prepared to enter a second time out of the range. Second entry is almost the norm in OTC stocks. Remember, always look at your daily chart (see chart below) in conjunction with your 5-minute charts. It will tell you whether or not there are any inflection points that might help or hinder the trade.
BBY Cha Chart rt 2
Asyou se Asyou seee on Ch Char artt 2, BB BBY Y mo move ved d fr from om a lowof 401/ 401/2 2 to a hi highof ghof 80 1/2 /2.. The 56 5/ 5/8 8 lowon th thee 5-m -min inut utee ch char artt wa wass a 60% retracement of the entire move. Institutions are well aware of these levels, and maybe a few decided to add to their position, which was the first opportunity after such a powerful advance. When a Slim Jim forms at the high of the day and it coincides with a key inflection on the daily chart, you definitely want to take the trade. This pattern will also take the form of a rising wedge or ascending triangle if you would prefer names, but the bottom line to me is that it is bumping up against a key price level with rising lows and closing above midpoint of the closest bars. The following example of BMY is a Slim Jim with rising lows that breaks out the following day at the same time it moves above a key inflection point on the daily chart.
Bristol Brist ol Myers Myers BMY
1. BMY pulls back to its 200-Day EMA EMA which is rising. It is acting much better than the other
drugs such as MRK, PFE, WLA and the sector index DRG, all of which have traded below and closed under their 200-day 200-day EMA’s. BMY has much better relative strength strength versus the group. You draw the swing point point trend line connecting connecting an S3 point to an S2 point. You draw these TL’s TL ’s fr from om po poin intt to po poin int, t, an and d it do does esn’ n’tt ma matt tter er if it in inte ters rsec ects ts an any y ot othe herr ba bar. r. Th This is li line ne pu puts ts me in al aler ertt to wa watc tch h fo forr a ch chan ange ge in di dire rect ctio ion n on in incr crea ease sed d vo volu lume me.. I am lo look okin ing g fo forr cl clos oses es ab abov ovee thee mi th midp dpoi oint nt an and d to top p of ra rang nge. e. Th Thee od odds ds ar aree st stro rong ng th that at th thee in inst stit itut utio ions ns wi will ll re retu turn rn to th thee dr drug ugss because valuations have come back to better levels. 2. BMY makes a significant move above the trend line on BP 1 pattern, which is the strongest
indication, and it does this this on good volume. It closes above the previous 11 11 highs which certainly tells you we are looking at a directional change. Your trading plan should include a planned entry 1/8 above the 2 BARS high for the next day. Goodent odentry ry at 68 7/ 7/8 8 an and d st stoc ock k ru runsto nsto a hi high gh of 69 3/ 3/4. 4. Itis us usua uall lly y th thee ca case se th that at yo you u wi willget llget a 3. Go continuation move after BP 1, market conditions permitting (rally mode). 4. Th Thisis isis a 55-ba barr pu pull llba back ck th that at cl clos oses es in th thee to top p of th thee ra rang nge. e. Th Thee mo move ve fr from om th thee lo low w of 64at 1 to
69 3/4 was 5 3/4 points. points. The retracement retracement to 66 5/8 5/8 at 4 is a 54% retracemen retracement. t. The entire entire world will be entering above S3 at 69 3/4 which is a completion of a 1-2-3 breakout from a significant low (Some call it an A-B-C Chart). To me it just means the Generals are taking it high hi gher er,, an and d yo you u wa want nt to be th ther eree wi with th th them em fo forr th thee ri ride de.. Th Thee ac acti tion on at 4 wi with th a cl clos osee in th thee to top p of ra rang ngee af afte terr a 5 ba barr pu pull llba back ck an and d af afte terr th thee BP 1 br brea eako kout ut of a sw swin ing g po poin intt TL se send ndss me ri righ ghtt to my trading trading plan plan for the next next day. Buy 1/8 above above 4’s high. high. Rememb Remember, er, you are always always looking for the earliest entry that has sound reason. 3/4 on the day. 5. Good entry and excellent move. 68 1/8 entry and stock traded to a high of 70 3/4 Relative to BMY’s range, this is good action. (See BMY chart.)
BMY formed an intraday Slim Jim right at the 68 high (A) of 4 bar (see chart 1). You had a planned entry off the daily char ch artt co conf nfir irme med d by a Sl Slim im Ji Jim m wi with th ri risi sing ng lo lows ws on th thee 5 mi minu nute te ch char art. t. Si Sign gnal al is go go.. Ba Barr 6 wa wass a BP BP,, as al alll th thee ac acti tion on wa wass above Bar 5. Pigs at the trough. trough. When they want them, they come in with the herd mentality. Recognize it and go with it. Bar 6 was a gap day but you got another another Slim Jim at R which broke out as the S&P 500 mounted a 3:00 PM charge. BMY formed an intraday Slim Jim right at the 68 high of 4 Bar.
Slim Jim Reversal These con These consol solida idatio tions ns can tak takee the for form m of hor horizo izonta ntall tra tradin ding g ran ranges ges,, sli slim m tri triang angles les or wed wedges ges wit with h ris rising ing low lows. s. The They y can be very explosive breaking out to new intraday highs and lows. By trading these patterns on high RS value strong ADX stocks, you capitalize on the momentum caused by Institutions, program traders and any of the accelerators that are involved (sells reversed). The higher priced stocks >50 give the best trades, unless it has unusual volatility.
Key Point When you see a Slim Jim in the last two hours of trading, be ready to act. Institutions, when they are buying futures at fair value to put money to work, will have to run in and buy the underlying stock late in the day because they were not able to buy enough futures at fair value. This is why you see some explosive moves late in the day. This always occurs duri du ring ng an up da day, y, as in inst stit itut utio ions ns mu must st gi give ve up pr pric icee to ge gett in th thee mar marke kett th that at da day. y. Sp Spec ecia iali list stss wo won’ n’tt sh shor ortt si size ze to th thee bu buye yerr late in the day unless it is at an expanded price. These explosions will be in the S&P 500 program stocks. The Slim Jim patterns take on added significance used in conjunction with higher time-frame charts. Also, when today’s patterns breaks out and it is also above a Slim Jim from the prior day, it can be explosive. Remember, the longer and tighter the consolidation, the better the move. The dynamics must be clear for you to enter the trade.
TRAP DOORS These are momentum trades that take advantage of emotional openings due to pre-9:30 AM S&P 500 futures trading. They Th ey ca can n be pl play ayed ed lo long ng or sh shor ort, t, bu butt be beca caus usee of ho how w fa fast st th they ey se sett up up,, it is to toug ugh h to ge gett th thee ti tick ck on th thee sh shor ortt si side de.. We ar aree talking about NYSE stocks only because we can follow the volume and see bid and ask size shown with much more cons co nsis iste tenc ncy. y. Th This is is th thee be best st st stra rate tegy gy to ta take ke ad adva vant ntag agee of a po pote tent ntia iall lly y pr prof ofit itab able le tr trad adee as yo you u ge gett in ge gear ar wi with th th thee NY NYSE SE specialists.
Trade Criteria 1. Best trades are in high RS value S&P 500 stocks. 2. Average daily trading range should be a minimum of 1 1/2 to 2 points. 3. Stock should also be trading above its 50- and 200-day EMAs. this is usually the situation
with a high RS value stock.
Entry Rules (For Buys, sells reversed) Thee st stoc ock k mu must st op open en be belo low w th thee pr prev evio ious us cl clos osee an and d tr trad adee do down wn at le leas astt 1 po poin intt fr from om th that at cl clos ose. e. 1. Th 2. After the opening bar, the second bar must make a lower high and a lower low.
above the high of the second bar. This indicates the market 3. Enter long if the third bar trades above isn’t going to follow-through on the bad news that caused the down opening and a reversal may be in order. This is the earliest you you can enter the the trade. Under normal conditions conditions you you will enter on the fourth or fifth bar. The specialist takes out the emotional sellers on the opening and leaves the trapdoor wide open to take the additional selling out at lower prices. If he he/s /she he ha hass to ge gett lo long ng,, it mi migh ghtt as we well ll be at lo lowe werr pr pric ices es.. Ta Take ke it to wh wher eree th thee vo volu lume me is is.. At so some me po poin int, t, th this is st stoc ock k wi will ll ha have ve a go good od re refl flex ex ra rall lly y as bu buye yers rs re retu turn rn,, pr prog ogra rams ms ki kick ck in an and d th thee sp spec ecia iali list st le lets ts th thee st stoc ock k up fast as he/she unwinds unwinds inventory. You, as the trader, must recognize the the market and stock dynamics (Part 3) that that make you enter the trade.
Merck Chart MRK
1. The trapdoor is set when MRK opens at 157 5/8, down 7/8 from previous close of 158 1/2.
(The volume on the open is 80,700 shares.) It quickly trades down to 156 13/16 on only 19,000 shares. This low volume helps create the vacuum that will make a reversal that much more forceful. 2. MRK trades at 156 13/16 and buyers start to enter the market. 3. The third bar closes at 157 1/16 (at its high) and above the high of bar two, giving the early
buy signal (bar three trading above bar two). MRK is now trading at the midpoint of bid/ask spread and then quickly moves to the ask size, another indication of buying pressure (the bid has been raised three times at this point). 4. MRK is now offered at 157 1/8. When bar four trades above bar three (at 157 1/8), you go
long, 1/16 over the bar-three high. When the trigger was pulled on the trade, the following conditions existed: • • • • •
NYSE ticks had increased by +200. The S&P futures had started to rally. Other key market leading stocks had also started to rally. Buy programs were starting to kick in. The stock had reached a level down 1 1/16 points from the previous close that began to attract some buyers.
The stage was then set to climb past the trapdoor. Probabilities now favored the trade because the specialist wanted the stock to rally so he could move some inventory, buy programs were kicking in, and major S&P stocks were rallying. Institutions buying buying MRK had to move up with the rally and maintain their share of the volume because the low-volume drop after the opening meant they had not bought enough stock at the lower levels. Note: On your 5-minute charts, you are going going to have a 3- to 5-bar reversal on 90% of the trapdoors. trapdoors. You are looking for that move back above the high of the low bar if the close of that low bar was above the midpoint or on top of range. This is a trade that can quickly change direction if the dynamics don’t remain positive.
CONCLUDING REMARKS At th thee co conc nclu lusi sion on of th this is ch chap apte ter, r, yo you u sh shou ould ld be co comf mfor orta tabl blee id iden enti tify fyin ing g st stoc ocks ks th that at ar aree in st stro rong ng mo mome ment ntum um pa patt tter erns ns or are cha changi nging ng dir direct ection ion and abo about ut to tra trade de at new lev levels els.. It mat matter terss lit little tle whe whethe therr it is a pul pullba lback ck tra trade, de, con consol solida idatio tion n tra trade de or WRB moves. Your are always working versus inflection points such as previous highs, lows, range, closes, swingpoint trendlines, volume, volatility, price and time. Plan yo Plan your ur tr trad ade, e, an and d us usee th thee in infl flec ecti tion on po poin ints ts in co conj njun unct ctio ion n wi with th th thee ma mark rket et an and d st stoc ock k dy dyna nami mics cs.. Yo You u ca can’ n’tt fo forc rcee an up trade on a down tape. In Part Five, I will conclude with putting it all all together with several more patterns, including including the implied volatility measurement for an extended stock.
PART FIVE: TRADING IN THE REAL WORLD In the fifth and final part of an all-too-short course on daytrading, we want to leave you with a good outline of the key points that we have discussed so that you have a good guide to refer to going forward in what I trust will be a successful trading experience.
DAYTRADING DAYTRAD ING DEFINE DEFINED D The pro profes fessio sional nal day daytra trader der is a per person son who tak takes es no pos positi itions ons hom homee ove overni rnight ght.. The ris risk k pro profil filee doe doesn’ sn’tt inc includ ludee a NEO NEON N type of trade that closes at 44 and due to company news opens at 18 3/8 the next day (Part 1). To be successful, assuming you have acquired the necessary market and execution skills, you must be utilizing the proper technologies. Most traders that attempt to trade for a living do so out of an office of a registered broker dealer. Brok Br oker er de deal aler ers’ s’ co commu mmuni nica cati tion onss ar aree th thee fa fast stes estt an and d mo most st de depe pend ndab able le,, an and d th they ey ar aree av avai aila labl blee wi with th ac acce cess ss to TT-1 1 li line ness fo forr all direct-execution hookups hookups to Super Dot, NASDAQ, NASDAQ, ECNs, etc. Daytraders that trade in a remote remote office or their homes should attempt to get direct access communications. T-1 lines are expensive but try for ISDN or 56K-frame relay. If yo you u ca can’ n’tt go fi fixe xed d di dire rect ct-a -acc cces esss co comm mmun unic icat atio ions ns th then en yo you u sh shou ould ld ha have ve AD ADSL SL or ca cabl blee bo box x ac acce cess ss th thro roug ugh h IS ISP. P. Th Thes esee are both fast but your ISP is the potential problem. You must adjust your trading to the communication speed. I highly suggest you trade through a direct access NASD broker dealer that will also provide you with some excellent analytical and execution software.
PROBLEMS WITH ONLINE BROKERS If you are going to trade through an online broker and expect to daytrade you will face the following problems: 1. Most online brokerage firms will send your order to another market making firm (payment
for or for orde derr fl flow ow). ). Th This is sl slow owss th thee pr proc oces ess; s; it is no nott di dire rect ct ac acce cess ss to ex exec ecut utio ion. n. On Onli line ne br brok oker erss ar aree middlemen in the execution process. Fail ilur ures es or de dela lays ys in ex exec ecut utin ing g or orde ders rs ar aree a ma majo jorr ri risk sk in da dayt ytra radi ding ng.. Th Thee st stoc ock k co coul uld d be do down wn 2. Fa a point and you can’t sell it because you haven’t even received an execution report. 3. Unable to reach the order desk by phone in a timely fashion during fast markets and peak
volume periods. Prices on screen might not be reality in fast markets causing you to miss the market or pay too much for stock. Note: Always use limit or stop limit orders with an online brokers. A position trader that holds stock, let’s say, 2–5 days for each trade can operate with an online broker utilizing limit orders without much problem and it might be slightly cheaper than a direct-access firm.
MARGIN Review the examples in part 1. You must understand the rules and risks of margin before you begin trading. Don’t buy it on margin if you don’t have the allocated cash reserve to pay for it in cash. Daytrading has less risk using margin then taking home a position overnight but a stock can and will again stop trading during the trading day due to news. You can find yourself in the same situation as the NEON trader that took it home at 44 and saw it open at 18 3/8 the next day.
Short selling is extremely dangerous. If you have enough capital to pay for it in cash, when you use margin, the stock can only go to zero, but what about a short sale? Let’s say the stock stops trading during market hours with news pend pe ndin ing g be beca caus usee of a ta take keov over er.. Th Thee pr pric icee ca can n be wa way y be beyo yond nd yo your ur ma marg rgin in re rese serv rvee an and d no now w wh what at wi will ll yo you u do do?? A lo long ng ca can n only go to zero but a short is unlimited to the upside. It does happen, so be aware of the kind of stocks you short and don’t ever take a naked short home overnight. Buy a put if you think stock is a short.
THE BUSINESS You have done the initial due diligence (it’s never complete) and fully understand the risks of trading. The difference between direct-access firms and online brokers is clear, as is your knowledge of direct access communications such as T1, ISDN, 56-frame relay (part 1) and ADSL or a cable box through an ISP. If you have anything less than what I’ve mentioned, please don’t daytrade unless you are prepared financially and mentally to buy and hold the stock because of the current fundamentals. Excellent Excell ent.. You hav havee mad madee the cor correc rectt dec decisi ision on goi going ng thr throug ough h a dir direct ect-ac -acces cesss bro broker ker dea dealer ler bec becaus ausee you hav havee dec decide ided d to daytrade. Just like any other business, you must make a financial commitment to starting the business and realize that you run the risk of losing 100% of your initial investment.
FINANCIAL COMMITMENT Your capital must be enough to sustain your positions. Most traders start in the $25,000—$50,000 range if they expect to make a living in a reasonable period of time. Anything less and you are just probing the business to see how you do, which is an excellent way to do it provided there is no pressing need financially to have the business return enough of a profit margin for you to live off the business. The financial commitment is not the amount of capital; it is the amount you can afford to lose. You are willing to continue trading after a stretch of losses because you believe in your trading plan and have allocated X amount to make the business profitable. Let’ss lo Let’ look ok at a si simp mple le ex exam ampl plee th that at yo you u mi migh ghtt us usee as a ne new w tr trad ader er.. Yo You u ha have ve de deci cide ded d to st star artt wi with th $5 $50, 0,00 000 0 in capital and will wi ll ma make ke a fi fina nanc ncia iall co comm mmit itme ment nt of $1 $15, 5,00 000 0 or 30 30% % of th thee in init itia iall ca capi pita tall to tu turn rn th this is bu busi sine ness ss pr prof ofit itab able le.. If yo you u lo lose se th thee $15,000, you walk, or if you decide at anytime that you are not suited psychologically to daytrade, close down the business and find something else to do.
MAXIMUM LOSS PER TRADE The next step is to determine your initial initial maximum loss per trade. A good way to do this is to paper trade your stock stock selections for a period of time to approximate the percent of profitable trades you get assuming entry. If you select a stock in your trading plan but don’t get good entry, it doesn’t matter—no entry, no loss. Keep track of the range from entry to high because this is so important in the traders’ equation regarding maximum profit per trade. It will be rare if you manage the trade to its full range, but it will tell you that the volatility and trade selection was good. Allow room when judging shorts because it’s not easy to get the tick. Paper trade from entries off the daily charts utilizing inflection points such as a previous high or low, and swing points (see part 4). Only use the 5-minute charts if you have a clearly defined pattern, such as a slim jim with a definite entry price. Don’tt ge Don’ gett to too o ex exci cite ted d if yo you u ha have ve gr grea eatt su succ cces esss be beca caus usee it it’s ’s no nott ne near arly ly th thee sa same me un unti till yo you u fi find nd ou outt wh whet ethe herr or no nott yo you u ca can n pull the trigger (enter) or push the buttons (exit) with real money. That is the psychology they talk about but never defi de fine ne.. It is no nott th that at di diff ffic icul ultt if yo your ur se sele lect ctio ion n pr proc oces esss is go good od an and d yo you u ha have ve en enou ough gh se self lf-c -con onfi fide denc ncee to re real aliz izee th thee ma mark rket et controls us (not vice versa) and that a good trading plan will succeed over time. Paper trading was successful, you’re ready to go live, but still nervous. Here is a very conservative plan to use.
CONSERVATIVE PLAN Your financial commitment is for $15,000 or 30% of your $50,000 in capital. We are going to use 50 trades as the maximum number of consecutive losses before you lose the entire $15,000: with these two numbers you can determine your maximum loss per trade. 30% / 50 trades = 0.006 % maximum % of capital $50,000 x 0.006 % = $300 MAX loss per trade Note: You can increase the 50-trade number and lower your max loss per trade if you need more cushion getting started. This is a very conservative plan for a trader, but why not? You are starting a new business. Most traders tend to use 1% to 2% as guidelines. We have dropped to less than 1%, giving you lots of room for your trading plan with a 50-trade consecutive-loss allowance. Your trading plan is better than that, so in reality you are probably only going to blow up if you don’t control the loss side of the traders’ equation. Remember, if the market doesn’t prove your trade correct in a reasonable time frame, you get out immediately. You don’t just sit and wait for the $300 loss number to come up. You can’t control what the market does, but you can control your risk. Unless they stop trading on you, that $300 loss can’t be violated. Yes, you should be encouraged. This business has an excellent chance at being successful, provided you have the discipline of keeping to the $300 max loss per trade and your trading plan is decent. The combination will keep you in the game as you get better in your trade selection and market feel. You can allocate the $300 max per trade loss in different ways. Starting out, I suggest you trade a smaller amount of shares. The more volatile the stock, the less shares per trade. It is always easier emotionally to give yourself more room on the stop with less shares than trading say 1000 shares of IBM and trying to keep your loss to $300. It puts too much pressure on your entry timing. It might be better to have two trades of 300 shares per trade allowing 1/2 point ($150) stop room for each trade than 1,000 shares risking a 1/4 ($250). This assumes the stocks have reasonable volatility. If GE ha hass an im impl plie ied d vo vola lati tili lity ty of 40 40% % an and d yo your ur no norm rmal al tr trad adee is 30 300 0 sh shar ares es an and d yo you u de deci cide de to ta take ke a tr trad adee in MU wi with th IV of 80%, I might cut my trade size in half so I wouldn’t have to keep my stop too close in such a volatile stock. The average daily range of the stock, in addition to its travel range will determine your share allocation. GE and AOL are two different stocks. Regardless of how you allocate maximum loss per trade, the “Daytraders’ Equation” must be balanced.
DAYTRADERS’ DAYTRAD ERS’ EQUATI EQUATION ON Maximum percentage of profitable trades + maximum profit per trade – small losses X multiple trades = SUCCESSFUL DAYTRADER.
If you have some very large winning trades and your losses remain small, then your percentage of profitable trades can be less (Part 1, NEON, trader C). A high percentage of profitable trades and losses still small takes pressure off of how big your profit per trade must be. If you tend to take profits too soon then your stock selection must be extra good to compensate for narrow a margin of profit on winning-versus-losing trades. The constant that you have the most control over is your loss number. This must remain small. If your percentage of winn wi nnin ing g tr trad ades es is po posi siti tive ve an and d yo your ur pr prof ofit it pe perr tr trad adee is gr grea eate terr th than an lo loss ss pe perr tr trad ade, e, do don’ n’tt fo forg rget et to ma maxi ximi mize ze th thee am amou ount nt of trades for a higher absolute profit. There are many different ways to manage a winning trade, and I believe you have to be more aggressive with moving your stops up once your trade is profitable when you daytrade stocks. This is because of range and time limitations.
MANAGING A WINNING TRADE For example, you are long 400 SHS of XYZ with a 1/2 point stop loss ($200) and it is now trading up with a 1/2-point profit. What will you do? 1. Sell 200 SHS, lock in 1/2 point ($100) and leave the stop as is, so the worst you will do is
break even if your stop is hit, which is now 1 full point away from current price? 2. Sell 200 SHS, lock in 1/2 point ($100) and move the stop up to entry price, which essentially
guarantees you the $100 profit if you subsequently get stopped out? 3. Do nothing because the dynamics of your stock still look good and market direction is still
up? I wo woul uld d el elim imin inat atee #1 be beca caus usee it is a da dayt ytra rade de,, an and d yo you u do don’ n’tt wa want nt to gi give ve ba back ck 1/ 1/22-po poin intt pr prof ofit itss wh when en yo your ur av aver erag agee pr prof ofit it perr tr pe trad adee mi migh ghtt ra rang ngee fr from om 5/ 5/8 8 to 7/ 7/8. 8. Al Also so,, yo you u on only ly wa want nt to re rema main in in th thee tr trad adee if th thee ma mark rket et pr prov oves es yo your ur tr trad adee co corr rrec ect, t, so how can you sit and do nothing while your stock trades down a point? #2 is my choice because I have locked in a $200 profit and am giving the remaining 200 shares a chance to run until the market dictates that I exit the trade. Yes, you might get stopped out by the first normal pullback, but you can always re-enter the trade. #3 is a choice you might make if the stock dynamics are very strong, as the buyers are very aggressive with no visible sell se llin ing g pr pres essu sure re.. Yo You u wi will ll ha have ve th this is de deci cisi sion on ve very ry of ofte ten n on a st stro rong ng up up-t -tre rend ndin ing g da day. y. By ke keep epin ing g th thee en enti tire re 40 400 0 sh shar ares es in play, you have a good multi-point opportunity. You can move up a tight stop under the 1/2 point profit and if it runs great. If not, you have accomplished what you did in #2. If it’s early in your day, you will probably take the 1/2-point sale on 200 shares to get the ledger profitable. In an effort to keep your losses small, you will get stopped out often in daytrading. There is lots of daily noise due to S&P 500 futures and program trading, so you must maximize your profit per trade. That is why your stock selection shou sh ould ld co cons nsis istt of th thee hi high gh RS va valu lue, e, hi high gh al alph pha, a, an and d st stro rong ng EP EPS S st stoc ocks ks.. We wa want nt to tr trad adee th thes esee st stoc ocks ks in th thei eirr ad adva vanc ncin ing g stages when momentum is strongest.
STOCK SELECTION Stocks all go through four four major phases which include include the following: accumulation (basing), advancing, advancing, distribution distribution (topping), and and declining. declining. Short-term traders want to be involved in the dynamic advancing advancing stage (Wave 3 for you Elliot Elli ot Wave fans) and in the declining declining phase for shorts. shorts. Durin During g the advan advancing cing phase, phase, stocks will run and then consolidate for a short period or pullback 3, 5, 7, 8, or 13 days then explode again to the upside (sells reversed). I point out these pullback days because they are most common but not a rule. All moving averages will be rising during this explosive phase, and the stock will be above its 20-, 50- and 200-day EMAs. If you did nothing else in stock selection selection except pick stocks in momentum phases (advancing/declining), (advancing/declining), how bad can you do? However, to make your selection selection process more powerful, we want you you to do a little more work.
KEY POINT If a ce cert rtai ain n st stoc ock k is ou outp tper erfo form rmin ing g th thee S& S&P P 50 500 0 an and d is pa part rt of th thee in inde dex x or is so some me ot othe herr li liqu quid id bi big g ca cap p na name me,, yo you u ca can n be bett that the institutions will overweight this stock and build a large position as new money comes in. They have to beat the S&P 500 reg regard arding ing per perfor forman mance, ce, so the they y mus mustt cha chase se win winner nerss in thi thiss pur pursui suit. t. Thi Thiss agg aggres ressiv sivee per perfor forman mance ce gam gamee to sta stay y ahead of the S&P 500 is responsible for the explosive moves out of short-term consolidations and pullbacks during the advancing (declining) (declining) phases. As daytraders, we want to ride ride these waves.
The big-cap S&P 500 hysteria helps us as traders because we will often get a major assist from program trading, momentum players that are front-running the institutions, option-related trading and the specialist/market makers propensity to commit capital to the big-cap stocks. There will be times that you will spot the stocks just as they break out of the accumulation or distribution phases, and you can get involved early, but I believe as a daytrader, you are better served going right to the high-relativeperfor per forman mance ce sto stocks cks alr alread eady y int into o the exp explos losive ive adv advanc ance. e. Rem Rememb ember, er, whe when n the Gen Genera erals ls are run runnin ning, g, the then n we wan wantt to be on board.
FILTERS The primary filters I use to find these high RS stocks (sells reversed) are on the TRADINGMARKETS.COM Stock Scan Sc anne ner. r. Ma Make ke su sure re yo you u fi filt lter er fo forr a mi mini nimu mum m of 50 500, 0,00 000 0 sh shar ares es,, an and d yo you u wi will ll do be bett tter er wi with th hi high gher er pr pric iced ed st stoc ocks ks.. I lo look ok for stocks with RS Value of 80-99 for longs and 40 and below for shorts. The se The seco cond nd fi filt lter er I us usee is th thee AD ADX X fi filt lter er in th thee St Stoc ock k Sc Scan anne ner. r. As I sa said id in Pa Part rt 2, if I ha had d on only ly on onee fi filt lter er,, th this is wo woul uld d be it it.. For longs, don’t forget to search all ADX Values with +DMI > –DMI (shorts –DMI > +DMI). These two filters give me a good master list. The next step is to look at a daily chart of each stock on the list looking for setu se tups ps.. Af Afte terr yo you u ha have ve do done ne th this is se seve vera rall ti time mes, s, yo you u wi will ll de deve velo lop p a se sens nsee of wh what at is cl clos osee to be bein ing g tr trad adab able le an and d wh what at is isn’ n’t. t. There is some lag on the search results as fast-changing momentum won’t necessarily show up in reduced or increased RS right away.
KEY POINT 2 ADX tells us how strong the stock is trending, and the DMI tells you which direction. When you combine this with High RS value stocks, you will end up with a solid trading trading list of stocks in the momentum phase. After I have scanned the charts I will check some of the other specific searches on TRADINGMARKETS.COM such as Pullbacks, Expl Ex plos osio ions ns an and d “W “Whe here re th thee Ac Acti tion on Is Is”” li list st.. I wi will ll th then en wo work rk my wa way y th thro roug ugh h th thee si site te fo forr st stoc ocks ks I mi migh ghtt ha have ve mi miss ssed ed fr from om checking my master lists. Mandatory reading for you everyday is Mark Boucher’s Top Relative Strength and Earnings New Highs Highs List. These stocks have made new highs, and also are ranked in the top 15%–20% of both relative strength and earnings. Normally thes th esee st stoc ocks ks ha have ve th thee be best st te tech chni nica call an and d fu fund ndam amen enta tall pr pros ospe pect ctss to mo move ve hi high gher er.. Yo You u ca can n ch chec eck k an any y of yo your ur ot othe herr st stoc ocks ks for EPS in IBD ( Investor's business daily ). As you have learned during the course, WRB breakouts to new highs from consolidations or pullbacks are usually followed by strong continuation moves which is what the daytrader can easily enter as it trades through an inflection point. One ot One othe herr si site te I us usee ev ever eryd yday ay is ww www. w.fn fntn tn.c .com om.. Th This is is a fr free ee si site te th that at gi give vess yo you u ma mark rket et su summ mmar arie iess of th thee S& S&P P 50 500, 0, Do Dow w 30, NDX 100 and some of of the other major sectors. These summaries give you key data such as volume volume relative to 50-day average volume and where the stock finished in its daily range, which is key to your trade selection. There is a quick guide to the summary charts on the site.
STOCK DYNAMICS The trading list you are now working from has the top RS stocks versus the entire database of all stocks that satisfy a minimu min imum-v m-volu olume me req requir uireme ement. nt. You sho should uld als also o fav favor or the top RS and EPS com combin binati ation on for bet better ter res result ults. s. The These se are the stocks that the institutions will be pushing provided provided they are outperforming the S&P 500. They screen for earnings, so why can’t you?
Once you have selected your entry point from the daily chart (assume it is not intraday pattern), you must be keyed on the stock and market dynamics to decide if you will take the trade.
Quick Checklist (Buys, Sells Reversed) 1. Did stock open up on the day? 2. Is it trading above the open? 3. Where is the volume trading, on the bid, or at the midpoint and offered sides, which is what
you want to see as a buyer? ask? 4. Where is size reflected? Bid or ask? 5. Are the bid and ask moving higher without unusual volume trading? 6. If there are blocks (5000 shares or more) trading, are they at midpoint and offered side?
stocks trading? Is rest of group group ok? 7. How are related stocks
KEY POINT 3 Your best trades will always come from trending stocks above the open for buys (sells reversed), and with the market averag ave rages es mov moving ing in the sam samee dir direct ection ion as you yourr tra trade. de. The There re are con contra tra-tr -trade ades—s s—such uch as Tra Trapdo pdoors ors—Sl —Slim im Jim Jimss in sto stocks cks that are oversold intraday and snap back for a good trade, but many of these are reflex trades, and you must be nimble because they can reverse in direction of trend quickly. When the Generals are in and buying pressure is strong, you will get expansion of range (higher prices), help from programs kicking in and momentum players players buying strength. Throw in the hedge funds front running, running, and it makes for multi-poin multi -pointt moves. As a dayt daytrader rader you are not in the information information flow between Instituti Institutions, ons, brokerage brokerage firms and spec sp ecia iali list sts/ s/ma mark rket et ma make kers rs,, bu butt yo you u ca can n se seee wh when en th thee st stoc ock k dy dyna nami mics cs fa favo vorr bu buyi ying ng pr pres essu sure re an and d if th thee ma mark rket et lo look okss go good od (sells reversed). (Part 3) The Generals get very aggressive when they have competition on the same side, and when the Accelerators get going it can lead to multi-point moves.
MARKET DYNAMICS The following table is a simple but effective tool that will help your decision on both entry and exit more than you can imagine. It will take you some time to see different situations develop, but your intraday intraday market feel will improve dramatically.
Market Table This is actual market data for 8/19/99 9:45AM to 11:00AM EST. This is the table that monitors overall market dynamics (Part 3). A glossary of symbol definitions definitions is on the following following page. 9:45
10:00
10:20
10:30
10:45
11:00
SPU
–10
–10 –1
–10
–8
–14
–14
SPX
–11
–12 –1
–12
–10
–16
–16
TICK
–482
–474 –4
–528
–172
–181
–470
PREM
3.85
3.80
3.85
3.70
3.75
3.60
–1032
–1014
–958
–908
–1035
–1098
UVOL
13
26
44
48
51
58
DVOL
41
61
93
99
126
149
ctlparDOW
–91
–84
–79
–71
–105
–97
NDX
–21
– 27 –2
–33
–28
–45
–44
BD
–9
–5
–9
–8
–5
–6
SOX
–
–
–
–
–
–
MSH
–
–
–
–
–
–
DRG
–
–
–
–
–
–
RLX
–
–
–
–
–
–
BKX
–
–
–
–
–
–
XOI
–
–
–
–
–
–
OSX
+
+
+
+
+
+
RUT
–
–
–
–
–
–
A-D
This table takes less than 45 seconds to complete. You round off numbers for the S&P Futures, all the averages and the volume figures. You use exact numbers for TICK, PREM, A-D and BD. For the sectors, they are either plus or minus (green or red on your screen). At the bottom of the sheet I make notes on which stocks are showing strong or weak intraday relative strength and look for setups on the 5-minute charts. You sh You shou ould ld al also so ma make ke no note te of an any y ke key y ma mark rket et ne news ws th that at sh shou ould ld ge gene nera rate te a re reac acti tion on an and d ob obse serv rvee ho how w th thee ma mark rket et re reac acts ts to the news. Startt to us Star usee th this is ta tabl blee on a da dail ily y ba basi sis, s, an and d yo you u wi will ll st star artt to se seee th thee re rela lati tion onsh ship ipss de deve velo lop. p. Is it ju just st pr prog ogra ram m se sell llin ing g se seei eing ng that th at th thee se sect ctor orss ar aree al alll pr pret etty ty st stro rong ng an and d th thee br brea eadt dth h is st stil illl go good od,, or ar aree th thee Ge Gene nera rals ls in th ther eree se sell llin ing g be beca caus usee up up-v -vol olum umee / down-volume ratio keeps getting worse with all sectors turning minus? There are many market clues that you will only start to understand if you keep the table. After a period of time your market mar ket fee feell wil willl imp improv rovee ten ten-fo -fold, ld, and thi thiss wil willl imp improv rovee you yourr ent entry ry int into o goo good d tra trades des.. You wil willl obs observ ervee tha thatt tre trendi nding ng day dayss willl all hav wil havee sim simila ilarr tra traits its,, as do the ove overre rreact action ion day dayss tha thatt als also o pro provid videe goo good d opp opport ortuni unity. ty. The neu neutra trall day dayss tel telll you lit little tle by flat averages, but maybe breadth, volume or certain sectors will provide pertinent information. Note: I use 26 boxes for tables so you can record the market every 15 minutes if needed.
SYMBOL GLOSSARY SPU: Near-term S&P 500 future which is now the September contract. SPX: S&P cash index.
TICK: Ne Nett di diff ffer eren ence ce of al alll NY NYSE SE st stoc ocks ks tr trad adin ing g on pl plus us or mi minu nuss ti tick cks. s. I al alwa ways ys ke keep ep an S& S&P P 50 500 0 fu futu ture ress in intr trad aday ay ti tick ck
by tech chart with the NYSE tick chart right below it. If you see the futures making lower lows and the NYSE ticks showin sho wing g pos positi itive ve div diverg ergenc encee and mak making ing hig higher her low lowss (se (sells lls rev revers ersed) ed),, loo look k for ent entry ry in sto stocks cks sho showin wing g pos positi itive ve rel relati ative ve intraday strength. PREM: This is the difference between the S&P Future that you are monitoring and the S&P Cash Index. I use Track
Data Fast Trac and can set the spread on my screen. If you don’t have that on your system, you can just eyeball the two and subtract. A-D: This is the net difference between the advancing and declining stocks on the NYSE. UVOL: Up volume of stocks on NYSE. DVOL: Down volume on the NYSE. DOW: Dow Jones 30 stocks. Net change. NDX: NASDAQ 100 stocks. Net change. BD: 30-year treasury bond. Net change. SOX: Semiconductor stock Index. MSH: Morgan Stanley High-Tech Index. DRG: Drug Index. RLX: Retail Index. BKX: Banking Index. XOI: Energy Index. USX: Oil Service Index. RUT: Russell 2000 Small-Cap Index.
These are the major sector indexes and you can add indexes, at the bottom if they are active such as FPP, XBD, etc.
TRADE SELECTION During the advancing and declining phases of a stock, you will be using some simple trend-continuation trend-continuation strategies to enter these momentum stocks. stocks. These strategies will have have the highest probability probability of a profitable trade. You will be entering trades after WRB (wide range bar expansion) moves out of consolidation and breakouts from consolidating volatility patterns such as dynamite triangles, flags and pullbacks from swing point highs. These minor pullbacks in a trending stock usually only last 3, 5, 7, 8 and 13 days and take place above rising 20-, 50and 200-day EMAs. EMAs. Your entries will will be in the direction of the the trend. If the momentum phase phase is still strong, there should only be minor corrections to the trend. Thirteen-day corrections are the exception with the strongest trending trending stocks. When you are going through the the charts from your master RS and ADX lists, you will be looking looking at the current OHLC bar in relation to the previous highs, lows, closes and range. You must also be observing volume, volatility and swing point trendlines.
KEY POINT REVIEW A review of these comparisons and observations is best done by looking at some charts, but first, let’s review some key points. 1. Volume precedes price.
2. Increased volume with narrow spread on downside is strength and usually precedes a
reversal. 3. Decreased volume and narrow spread on upside is weak and reversal can follow. 4. Breaking of swing point trend lines on good volume is significant while breaking TL on low
volume is not as important. 5. WRB breaking out of congestion or closing over at least two previous closes with increase in
volume is usually a strong indicator of change in direction. 6. Stock rallying on heavy volume from a higher low is bullish, especially if preceding low was
on light volume. This happens often at 1-2-3 bottoms which occur at significant swing point lows. 7. Closing above midpoint and in top of range are both bullish. Below midpoint and the bottom
of the range is bearish. Note: Buys (Sells reversed) for all key points. 8. Stock closing above last five closes is more significant because of time than above prior day.
The same applies to highs or lows if looking for shorts. High gher er lo lows ws on la last st fe few w ba bars rs in co cong nges esti tion on pu puts ts yo you u on al aler ertt fo forr br brea eako kout ut of pa patt tter ern n to up upsi side de.. 9. Hi Lower highs alert you to possible downside break. 10.
Draw the swing point TL’s and draw more than one rising or declining TL from a common point which will give you a stronger buy or sell signal.
Applied Materials (AMAT)
AMAT AMA T Cha Chart rt 1 1. 5-day PB (pullback) from swing point high (S3).
Closes in top of range and above previous two closes. Entry for Day 2 is 66 7/8, which is 1/16 above Day-1 high.
2. Enter at 66 7/8. Stock traded to high of 69 5/8 and closed in top of range at 69 1/8 on increase
in volume from Day 1. This was good thrust. 3. Enter at 69 1/4, 1/8 above Day-2 close of 69 1/8. Stock traded to a high of 75 and closed at 73
7/8. This was a big WRB day that led to an 8-bar consolidation before final high. This wa This wass a hi high gh RS st stoc ock k th that at ha had d a mi mino norr pu pull llba back ck to a ri risi sing ng 50 50-d -day ay EM EMA A wh whic ich h en enab able led d us to en ente terr on a si simp mple le tr tren enddcontinuation strategy for two days in succession.
AMAT—Chart 2
1. Stock closes above its 50 Day EMA in the top of its range, above the last seven closes, in
additi addi tion on to be bein ing g th thee si sixt xth h hi high gher er lo low w in su succ cces essi sion on.. AM AMAT AT cl clos osed ed up 1 9/ 9/16 16 on a da day y th that at th thee S&P 500 cash index was down a big 29 points. AMAT also closed above a swing point TL. The volume wasn’t unusual, but the buyers held their ground. 2. Good entry at 70 5/8. Stock trades to a 71 1/4 high and closes in top of range at 71 1/16 on
Outside Reversal Day and WRB, setting up trade for the next day. 3. Good entry at 71 3/8. AMAT trades to a high of 74 7/8.
TriQuint TriQu int (TQNT (TQNT))
TQNT (Sequence of 8 trades in 15 days)
This se This sequ quen ence ce of tr trad ades es ga gave ve co cont ntin inua uati tion on en entr try y ab abov ovee th thee pr prio iorr da day’ y’ss hi high gh.. It st star arte ted d wi with th a WR WRB B ou outt of a co cons nsol olid idat atio ion n at the 50-day EMA. TQNT NT cl clos oses es in to top p of ra rang ngee at 40 5/ 5/8. 8. Yo You u ar aree on al aler ertt if TQ TQNT NT tr trad ades es ab abov ovee 41 1/ 1/2, 2, wh whic ich h is 1. TQ high close of the eight-bar consolidation. 2. St Stoc ock k op open enss at41 3/4 /4,, bac ack k to 413/ 413/8, 8, th then en ma make kess a mo move ve to a hi highof ghof 461/ 461/4 4 ongo ongoodvol odvolum ume. e.
This opening was a BP1(Part 4) pattern where all of its range was above Day 1. The WRB closed above the swing point trend line and above the last 9 highs and closes. 3, 4, 5.
Momentum carries forward with entry from daily chart each day.
8. TQNT pulls back 3 days and closes in top of range after prior day’s closing in bottom of
range. It also closes above the 10-day EMA. This pullback is from a new high at Day 5 of 54 9/16/99. 9, 10, 11. All good entry and trades as TQNT makes new high of 56 1/2. 15.
TQNT pulls back 5 days (counted from 15 back to 11, double top at 56 1/2) and closes at 51 just above the 10 day EMA (again).
16.
8/31/99 Good entry. Good trade. If they come for it again, get on board. 9/1/99 9/1/ 99 Go Goodent odentry ry at 53 53,, an and d TQ TQNTtra NTtrade dess to a hi high gh of 557/1 557/16 6 by 11 11:3 :30 0 AM be befo fore re an any y st stop op out.
Gateway Chart (GTW)
GTW—Swing Point TL From Common Point
After making a record high, GTW corrects from 84.50 to 56.75. You draw your S3 TL from common point at 84.50 to last S3 (If none, use an S2) before low. In this case, its a four-month trend line. GTW br GTW brea eaks ks TL an and d ru runs ns to 75 75.7 .75, 5, wh whic ich h is a 68 68% % RT of co corr rrec ecti tion on fr from om 84 84.5 .50 0 to 56 56.7 .75. 5. It al also so su surp rpas asse sed d th thee se seco cond nd S3 swin sw ing g po poin int, t, an and d th that at wa wass a st stro rong ng si sign gnal al fo forr a ch chan ange ge of di dire rect ctio ion. n. Th Thee st stoc ock k al also so re re-c -cro ross ssed ed an and d cl clos osed ed ab abov ovee it itss 50 an and d 200 EMA’s. Momentum had been regained. It always seems to happen at and around the 200-day MA’s. GTW hit the wall at the 68% RT level and corrected back to 62 7/8 right at the 200 EMA. This was 68% of the 56.75 to 75.7 75 .75 5 mo move ve.. Fu Funn nny y ho how w th thee Fi Fibo bona nacc ccii nu numb mber erss of .3 .38, 8, .5 .50, 0, .6 .618 18,, .7 .70 0 an and d .7 .786 86 ke keep ep sh show owin ing g up up.. I us usee th them em to al aler ertt me to possible reactions at those levels. The rally from 62.875 starts with a big gap and WRB on news and the stock breaks through TL2 on WRB with good thru th rust st an and d fo forms rms a FLAG at th thee 80 80% % RT le leve vel. l. On Once ce th thee TL TL2 2 wa wass sc scal aled ed,, th ther eree wa wass pl plen enty ty of mo mome ment ntum um,, an and d a ru run n at th thee old high was in the cards.
GTW—Chart 2
GTW Momentum—Chart 2
Seve venn-Ba Barr PB (p (pul ullb lbac ack) k) to a ri risi sing ng 10 10-d -day ay MA wh whic ich h is al also so ab abov ovee a ri risi sing ng 50 an and d 20 200 0 EM EMA A 1. Se in the top of its range and above the TL2. 2. Good entry. Stopped out. Plan to enter on day 3, 1/8 above the day 2 high. 3. Good entry with multi-point move. 4. Entry stopped at loss.
WRB B B/ B/O O (b (bre reak akou out) t) of TL TL3 3 an and d ab abov ovee 79 79.1 .125 25 sw swin ing g po poin intt hi high gh.. GT GTW W to took ok of off, f, an and d th they ey ra ran n 5. WR it directly to 100.375 high on 8/25/99. The low of 56.75 got tested, it broke the TL2 line, and then the momentum phase was in swing to the upside. This was on your master lists.
NARROW-RANGE CONSOLIDATIONS After str After strong ong thr thrust ust mov moves es in eit either her dir direct ection ion,, sto stocks cks wil willl con consol solida idate te as dyn dynami amite te tri triang angles les,, fla flags, gs, sym symmet metric rical al tri triang angles les,, horizo hor izonta ntall tra tradin ding g ran ranges ges,, etc etc., ., but it is all wit with h shr shrink inking ing vol volati atilit lity. y. Thi Thiss red reduct uction ion in vol volati atilit lity y usu usuall ally y pre preced cedes es a str strong ong move in the direction of the trend (see AXP Chart). The dynamite triangle or flag usually gives you the strongest moves in the highest RS stocks because they usually only pullback or consolidate for 3, 5, 7, 8 and 13 days (Review Part 4).
AXP Cha Chart rt
INTRADAY INTRAD AY PATTERN PATTERNS S When you are working off of your intraday charts looking for trades, keep it simple and utilize several patterns that are easy to spot. You will do much better that way instead of using the gunslinger approach where you buy or sell a stock reacting to every increased bid or offer. When you react and trade emotionally, you will lose because of all the short-term noise. The Opening Reversals (OR’s) and Trapdoors are two very good strategies to play overreaction on the openings, due to excessive S&P futures action which always has a fast countertrend reaction. OR’s are, of course, easier to see for a new trader, while Trapdoors require you to read a 3- to 5-bar reversal pattern and be able to recognize when the stock dynamics are changing (Review Trap Doors Part 4).
HWP Chart (OR)
The st The stoc ock k ga gapp pped ed op open en 1 7/ 7/16 16 po poin ints ts to107 7/ 7/16 16 fr from om th thee pr prio iorr cl clos osee of 10 106 6 (B (BAR AR 1) 1).. It tr trad aded ed do down wn to 10 106 6 11 11/1 /16 6 (B (BAR AR 3) showing strong relative strength, as it didn’t come close to filling the opening gap. The stock quickly reversed on volume and traded back above the opening price. It traded to 108 1/2 on a WRB (BAR 6), consolidated to a FLAG and broke out again at BAR 10, consolidated two bars, then two big WRB thrusts to 111 1/2 before fading. The di The disc scip ipli line ne of th thee pa patt tter ern n an and d th thee dy dyna nami mics cs pu putt yo you u in th thee tr trad ade. e. We go gott lu luck cky y th that at th thee mo mome ment ntum um fr fron ontt-ru runn nner erss to took ok it so high. They got their lunch handed to them the next day as HWP closed down 5 3/4 points. It is important to note that this HWP example is a stock that gapped up, traded down, remaining above prior close and reversed opening to the upside. Most of your OR’s will be stocks that open below or trade below the prior close then reverse opening to the upside (sells reversed).
SLIM SLI M JI JIMS MS These are simple easily recognized but explosive patterns that you find every day on your intraday charts (5 minute). They are tight narrow range consolidation patterns where you play the breakout to new intraday highs or lows and also the cou counte ntertr rtrend end mov moves es fro from m ove overso rsold ld or ove overbo rbough ughtt con condit dition ions. s. The They y are sim simple ple tre trend nd con contin tinuat uation ion pat patter terns ns jus justt as you utilize on your daily charts. Slim Jims are most often long tight horizontal trading ranges. The longer and tighter the consolidation, the more powe po werf rful ul th thee br brea eako kout ut.. Th Thee fo foll llow owin ing g ch char artt of BB BBY Y is an ex exam ampl plee of an ov over er so sold ld Sl Slim im Ji Jim m th that at ex expl plod oded ed to th thee up upsi side de..
BBY Cha Chart rt
AGN AG N (5 MI MINU NUTE TE))
AGN is a breakout to new intraday highs from the first consolidation after a 2 WRB thrust up. The related stocks in the same group were also strong.
AMAT (5 MINUTE)
AMAT is an ex AMAT exam ampl plee of a st stoc ock k wh wher eree we en ente tere red d th thee tr trad adee at 71 3/ 3/8 8 ri righ ghtt af afte terr th thee op open enin ing g (8 (8/3 /31/ 1/99 99 Ou Outs tsid idee Ba Barr En Entr try) y).. Entr En try y po poin intt wa wass 1/ 1/8 8 ab abov ovee pr prev evio ious us cl clos ose. e. Th Thee st stoc ock k co cons nsol olid idat ated ed in a sl slim im tr tria iang ngle le af afte terr it ha had d tr trad aded ed up to 72 1/ 1/4. 4. I ca call ll them Dynamite Triangles. You could also draw the larger triangle you see, but it’s not art school, so start from right to left because that gives you the earliest entry. If you were fast enough, you got in between 72–72 1/4. After it made new intraday high above 72 1/4, it ran fast. If you had enough courage, you bought the breakout of the next Slim Jim.
KEY POINTS 1. When you enter a trade from a Slim Jim, it can give you a head fake as it trades back into the
consolidation, and you might get stopped out. Don’t be afraid to take the second entry as it trades through your original entry point. As a ne new w tr trad ader er,, yo you u pr prob obab ably ly sh shou ould ld ma make ke se seco cond nd en entr try y a ru rule le.. It wi will ll mi miss ss so some me tr trad ades es,, bu butt it will give you a higher percentage of of profitable trades, especially in OTC stocks where large market makers can influence the stock. seem emss th that at ma many ny tr trad ader erss ar aree re relu luct ctan antt to ta take ke th thee tr trad adee as it go goes es to ne new w le leve vels ls.. Be Beli liev evee it an and d 2. It se take it. When that high RS stock gets rolling, it is usually because the Generals have to reach for it. 3. Regardless of what pattern(s) you utilize to trade, it all comes down to what the stock and
market dynamics are at the time of entry. As a daytrader, you must manage a trade in a much different manner than a longer term player or even a 2- to 5-day position trader. The pr The prof ofit it op oppo port rtun unit ity y du duri ring ng th thee da day y ca can n be ex expl plos osiv ive, e, bu butt yo you u mu must st be ni nimb mble le as th thee dy dyna nami mics cs ar aree al alwa ways ys ch chan angi ging ng.. It is now the exc except eption ion whe when n you get the pur puree tre trendi nding ng day days. s. Thi Thiss is bec becaus ausee of the exc excess essive ive S&P fut future ures-r s-rela elated ted tra tradin ding. g.
CLOSING REMARKS For the past five weeks, I have attempted to provide you with the necessary information to get started in the daytrading business. It is too short a time to cover every facet of trading, so I tried to highlight the key ingredients. • Financial commitment to start the business. • Knowledge of Stock and Market Dynamics • Good stock selection process • Understanding the trading and margin risks. • Adequate capital to support positions. • Utilization of simple but effective trend-continuati trend-continuation on strategies to enter trades. • Proper communications necessary to trade on a direct access basis. • “Trader’s Equation” must be managed. • Daytrading can in no way be successful if you don’t keep your losses small, small, small!
Review the 5 Parts, paper trade, see how you do, then please feel free to e-mail me with any questions. Keep It Simple , start small, and enter your stop or stop limit orders to exit trades so that your emotions or bad
judge ju dgemen mentt are eli elimin minate ated. d. You wil willl tak takee unun-nee needed ded pre pressu ssure re off you yourse rself lf as a new tra trader der if you adh adhere ere to thi thiss dis discip ciplin line. e. I wish you all the very best in your trading endeavors, but don’t expect it to happen right away. It takes hard work and focus to succeed . It will be very rewarding for me if you take just one thing from this course that helps you become successful. You will if you want to.
Kevin Haggerty
