Stop Loss Selection

How many times were you taken out of a trade just before the stock turns around and takes off in your presumed direction with you as the spring board?  Not pleasant.  So when a friend of mine asked me to help with placing stops I wanted to be clear on the topic since stops are a key risk management skill that traders must have to survive this game.  This article talks specifically about stop losses, not for break even or stop with profits type exits.

The short answer is the same to many trading questions: it depends.  It depends on the style of trading, time frame, risk tolerance, etc.  That’s why system trading is very popular as the trading parameters; entries, exists, stop losses, stops, targets etc, are mostly pre-defined.

So let’s pick a specific scenario/system and take it from there: Swing trading days/weeks hold-time with buying support on signs of strength on the intra-day/daily/weekly/monthly charts review, using close prices.
You are at a point where you have identified your support levels and have your entry area with a good risk/reward ratio selected.  For picking a stop, you have to get familiar with the stock's personality first to see how it behaves around key levels: Look at the history of the stock, does it trade cleanly around key levels or does it violate it before it recovers?   This will help you decide your initial risk, whether to give your stop more room, use a soft or hard stop, or use that stock at all for that matter.  The cleaner the levels the better.

Keep in mind that key levels can also change from day to day when they are an active moving average.  Or when that moving average enters into the trading range of a stock that previously had clearly defined/drawn lines representing key levels, such as channels, breakout levels, etc.

Now that you have your support levels and are more familiar with the stock behavior, you can have a stop that’s lower than the support levels by roughly 0.5-1.5% depending on the price of the stock and how volatile it is.  On shorter term momentum holds, you can enter as close to the low of the day (LOD) as possible with a stop under the LOD.  Breaking the LOD+ and holding there is your signal that there’s more selling to come and the stock is not ready yet to bounce.  In this case either step aside and let the sellers finish their business or if there’s a good short setups play then take the short side of the trade with as many checks in your favor as possible.  Everything that applies for the long side the reverse applies on the short side, just make sure you are going with the trend in the time frame you are trading (many different topics here beyond the scope of this article.)

In addition, keep in mind that you do not have to stop out your entire position at a single level.  You can get out of your position in stages depending on your risk and the strength of the supports.  It does not have to be an all or none type trading depending on your style.

If you have any questions let me know. 

Peace and profits to all,

@stockaddict

Support and Resistance Zones. A New Concept in Technical Analysis.

Swing trading is my favorite trading style; the planning ahead and the follow through. Win or lose you know you did a good job following your plan. When you win you are confident in knowing that you can do it again with a similar plan. When you lose with a disciplined stop your solace is in knowing that you followed your plan, then you learn from your loss and move on.

One of my most common swing trading styles is buying support on signs of strength.  I apply the concept of Support and Resistance Zones to stocks that do not have a clear support or resistance line to contain 100% of the move. You will find in most cases that a double line can be drawn to contain an area that encompasses the unruly moves and creates a narrow range instead of a simple line.  These zones contain candles, or wicks and tails of candles of such unruly stock, especially when charting on different time frames.

Typically the inside line of the zone contains the majority of the stock move and has the most tags, while the outer line contains the straggling candle(s) action.

The TA support/buy zone is a tight price range where it is acceptable for me, from a Risk/Reward point of view, to buy/accumulate a stock when near or in that zone.  Similar to line support, when zone support is violated on a close it indicates that the current pattern is no longer valid and we need to step aside until the
new pattern emerges.  If a stock breaks out above the top of the resistance zone then the stock has broken out depending on volume and other factors, and vice versa for a breakdown from the support zone.

An example of this idea as well as trading a range bound stock can be seen in the chart of DAKT which can look too messy to swing trade. Take a look yourself before you see the marked up chart below and see if you can identify these zones or you decide it's just too messy for you to trade. Such a chart is a swing traders dream, at least this swing trader.

You buy/scale in anywhere under ~7.5 while in the support zone and sell/scale out while in the 9-9.5 resistance zone. rinse and repeat. just set your buys, stops and sells and forget-aboud-it.


Here are some posted examples of my charts with the zones that are usually drawn with single lines by chartists.

SPX

CRUS

XRT

SA

GS

BBEP

WFT

If you find such patterns, keep them on your pattern trade list.  You can set alerts or you can leave a limit buy order in place while you go on with your busy days.

Hope that helps.  I enjoy teaching the "trade", so go ahead and ask questions.

Peace and profits to all.
@stockaddict

Intrinsic Movers

This market reminds me of the time the engine of our boat broke down on the way back from Murion islands.  We had a great day filled with fun and frolicking, but now we are stuck in the middle of the ocean off Ningaloo reef in Western Australia, waiting for help to arrive.  Similarly, 2009 was a fun filled year, you couldn’t pick a stock that didn’t move up.  But now we are stuck possibly a range or a down channel waiting for the big orders to come in and move us in the “right” direction again.  Have the opportunities dried up?  Are there no trades out there to be had for swing and longer holds?    Not really, the market always presents opportunities, you just need to go fishing while you wait to have a little sashimi.

In this type of environment, where there’s no clear wind direction to fill your sails, my style changes a bit.  I go to my “intrinsic movers”.  A favorite in any market really, but proves most useful, with a high probability of success, when many other stocks and indexes are bobbing in the waves.   The pattern that best serves these movers is the long-term down channel (and to a lesser degree the long-term triangle) breakout.  Not the little flags and pennants that everyone looks at after a big move already happened, those will likely fail in this environment, but the ones that took months in the making.  Whether you’re talking about a penny stock or a  hundred dollar stock or ETF this is one of your fishing tools regardless of the circumstances.

Once the down channel breaks its resistance and confirms by closing two days in a row outside of the channel you will see some big moves coming in any tape.  This is due to the nature of the pattern; you have the short-term channel players who shorted at the top of the channel, and the longer-term trend riders who shorted at much higher levels.  They will see the channel dissolving and will want to get out before anyone else does.  Therefore you get a violent initial move that you can ride blissfully with either a trailing stop of a manual/mental stop to get you out before the move is done.

There are many examples I’ve posted over time.  Take sugar ETF SSG for example.  I posted the chart of the breakout back in December when the channel broke to the upside.  A violent move from 65 to 85 in about a month ensued.

Another obvious one is the US Dollar UUP, after a long downtrend that started in March 2009, also broke the channel with such violence that you couldn’t miss the opportunity.  Crowded or not, those labels don’t negate the opportunity these down-channel-breaks present.   I posted this chart many times on chart.ly.
RMD, I posted the chart of this stock back in August with its long down trend, AZO December 9 CQP as well as many others .  All had a strong down trend that caused the price to catapult after the channel break.

This does not mean that we will have an uptrend after the break of the down trend, just a change of the current pattern.  If you are a fundy player who thinks the stock is undervalued, this is your signal to get in as well instead of “averaging down”.   There are other details that entail, but this is the crux of this trading style.
Many of the retail stocks are going through this right now including M and JCP as well as a few others I’ve tweeted about recently.  This is purely a technical play, more of a knee jerk reaction type of move really with a high probability of success.

Add this to your bag of tricks and have fun with it.  There’s always an opportunity in the markets no matter what direction we’re moving, the more patterns and tools you have the better prepared you will be for any market.

Peace and profits to all,
@stockaddict

The Power of Technical Analysis; A Case in Point Study of the S&P500 Chart.

Technical analysis is a graph of the psychology of the market and should be part of every trader and investor’s arsenal if they don’t want to become road kill on Wall Street. It is a guide to the future empowered by the past and based on human psychology.

Case in point is the SPY500 starting back in 2004 in mid-bubble times. Note that there are other Technical factors contributing to the success of the patterns, such as the 50MA crossing above the 200MA in mid 2004, then below it towards the second half of 2008 and a few others.

(double click on the image to enlarge)

Pattern 1 (orange): This is the key pattern here, The Bump-and-Run-Reversal pattern, BARR (formerly and aptly known as the Bump-and-Run-Formation - BARF) started forming with a speculation phase in the mid 2006 when the market psychology was euphoric and gave a new meaning to irrational exuberance. This pattern was at disbelief at the key breaking levels, but finally succumbed to it. The psychology behind it is valid. Pattern 2 below is also part of the BARR pattern indicating the end of the speculation phase.

Pattern 2 (orange/white/blue): The double top (white) or a Head and Shoulders (blue) topping patterns depending on where you draw the line. Both are bearish topping patterns and both break at around the same level and measure to the same target. This is a sub–pattern that is part of the BARR pattern above, which takes a long time to develop in this time-frame.

Pattern 3 (blue): The typical Head and Shoulders pattern at an angle.

Pattern 4 (yellow): unveiling as we speak, the reverse head and shoulders topping pattern on the weekly time frame. Will it clear the key gap resistance and move to reach its target of ~1200? bounce down from the ~1080 resistance, Or will it stall and create another pattern that will reveal itself with time? (All of the above are possible on different time frames) Plan for all scenarios, and remember that being out of the market at times is also a plan to follow.

You can read more about the actual psychology that forms these patterns in any good technical analysis book. And you can be sure you will see this chart in the next book about The Crash of 2008, in the technical analysis section, maybe my own.

Of course hindsight is 20/20 and it’s easy to talk about these patterns of the past when they have already been drawn, but hindsight is what gives us the confidence in these patterns, especially in the longer time frames, enough confidence for that above than 50% probability we all seek in our trading. So when I see a pattern emerging I create my thesis around it, and trade it, while being cautious around the key levels where I typically look at other indicators to gauge the pulse of the market.

Swing and day traders are in the business of predicting the next move to make money, and technical analysis is the key tool for that.

@Stockaddict

It's a Matter of Time..

Time is a key piece of the puzzle in technical analysis. A lot of the chart analysis you see on the stocktwits stream are for a specific time frame, usually that of the chartist, and not necessarily yours. So before you jump into that trade, check the time-frame of the chart and see if it agrees with yours.

If you are a day trader then you’re looking at the price action down to the minute and don’t care what will happen tomorrow. If you are a swing trader, then you’re looking at the 15/60 minute charts to confirm your thesis and time your entry, but mainly focused on the last few days up to a few weeks of that stock’s action, and perhaps pan out to see where they fit in the big picture. If you are a longer term trader then many weeks, months and years is your target, and you are really focused on the fundamentals and the economic environment at that level, and technical analysis becomes an auxiliary tool and not your main focus.

Due to the time frame differences a lot of people will have conflicting views of the same financial instument, and be both correct. So always clarify your time frame before you make up your mind.

Finally, thanks to all those who chart and take charting requests, I know that the time and effort put into that is significant and the education by example provided to others is much appreciated.

Peace and profits to all.
Stockaddict

Mistakes even the best of us make: Not keeping the trading vehicle in mind..

Reading Wall Street Cheat Sheets excellent article on beginners’ trading mistakes today inspired me to write this little thought dump for all of us to benefit from, beginner and expert traders alike.

1) When I first joined Stocktwits in the beginning of April 09 many traders were using technical analysis on the Direxion Triple ETFs, which reflect triple the daily price movements of indices of specific sectors or markets. FAS and FAZ of the triple financials were favorites. The issue arises from the fact that the math behind the movement of these vehicles creates false chart patterns and misleading technical indicators. These ETFs will not return to the same values when the underlying index does due to the asymmetrical up and down movement of the ETF prices. This is one of many issues that make these ETFs not amenable to technical analysis. For further details refer to the prospectus of these ETFs. Hopefully this will save people some money and agony.  There is an art to trading these leveraged ETFs in addition to day trading vehicles, and I may do another post on how to trade these.  Meanwhile, if your money manager is someone who held these for a long time for whatever reason, consider getting another money manager is not responsible enough to manage your money. 

Solution:

Only use the underlining index of these triple ETFs for charting and technical analysis.

2) The second and most recent issue that is popping up on stocktwits is related to commodity ETFs. The issue comes when traders look for the ETF volume as a valid TA signal especially during a chart breakout as we do for stocks. This is not correct as the volume of the ETF trading vehicle simply means that more traders are interested in buying the ETF itself and does not in any manner reflect the economics of supply and demand of the underlying commodity (volume of the ETF may inadvertently cause pricing issues for the commodity, but this issue is not the scope of this article). Simply said: Volume breakouts of an ETF chart bears no information other than interest in the ETF itself.  The only information that is relevant in TA is the actual commodity price and chart when evaluating your ETF purchase based on TA.

Solution:

Study the underlying commodity for TA to trade the corresponding ETF and not the ETF charts themselves.

I hope this was educational and helps clear up some of the common misunderstandings of trading ETFs. I usually tweet my stock research around midnight Pacific time, but you can always find my setups on stocktwits and sometimes charts posted on chart.ly when time allows.

Peace & profits to all,
@stockaddict