Art & Science of Active Trend Trading 3-23-2014

March 23, 2014

Good Day Traders,

I’ve been back from Vegas a week after the great two day training session there covering Market School & Chart School.  Both were great trainings, but my favorite was the Chart School.  The Mid-Week Market Sanity Checks have been going well as we move into our 3rd month of providing these brief overviews of current market conditions, a short training session on traditional technical analysis techniques, and individual stock review. 

Starting in April we will begin running the Mid-Week Webinars through the Active Trend Trading website, and we will offer a healthy discount for members of Bay Area Money Makers.  More details will be coming out by the end of March.  For everyone who has already enrolled in these mid-week sessions, notifications will be made as usual and there is nothing else you have to do to get them.

For YouTube fans we just started a free weekly market and stock review called Market Stock Talk.  Joe Gruender, David Grandey and I talk about the market and potential set ups for the following week.  If you’re interested, here’s the link to take a peek at what’s going on. Market Stock Talk

Please keep those great personal stories flowing, it is awesome to share in each other’s successes!

 General Market Observation:   One peek at the daily and weekly charts for the Indexes show that the current uptrend is at least under pressure and that distribution days on both the Nasdaq and S&P continue to build—currently setting at 8 & 5 respectively.  Several noted commentators are trying to find the “why” for Friday’s downside reversal, covering everything from uneasiness with Russia’s action to take over Ukraine, to Yellen’s less than dovish comments about the Fed’s continued tightening and increasing interest rates in 2015.  Or maybe it was sector rotation in the biotech and drug stocks.  The charts tell us that something is happening and that it actually started happening during the first week of March.  Based on the 50-day and 10-week moving averages the longer-term trend remains up, however weakness has shown up over the past few weeks.  Could it be that this is a 5-year-old Bull Market needing to do some significant correcting, or just the start of a short and shallow pullback? 

The candlestick patterns over the last few weeks look to be bearish in nature, and as I’ve said several times, topping is a process that takes time.  The Russell may be showing the greatest potential for more downside because it is clear from its chart that momentum has been coming out of this small cap index since August of last year.  As of right, now the uptrend is under pressure and not under water, so we traders must take a path of caution while trading the patterns provided by price action. Short and shallow pullbacks have characterized this bull market, and that may be what plays out.

 Outs & Ins:   This weekend is unique, with no stocks joining the Running List.  A quick look through the IBD 50 showed a lot of weakness in the stocks.  Many stocks on the list are providing sloppy price action that is wide and loose, in other words volatile.  Price action like this makes stock picking challenging because of the large daily price moves.  When leading stocks start playing fast and loose, one must switch to a shorter trade window. It’s best to be content with smaller gains and protect profits like a mama bear protecting her cubs. 

 Here are a few stocks that look interesting with orderly pullbacks:  FB, LVS, WYNN & even FLT, which may be forming a base-on-base pattern.  It was much easier to find weak stocks that may provide downside opportunities if they continue to break support or provide a low volume relief rally.  These include ACT, ALXN, VRX, JAZZZ, PCLN, GMCR & BIIB.

Off-list stocks of interest to the downside include  BITA & SFUN (on a weak move back towards the 50 day SMA, NFLX, and LNKD).  Surprisingly, AAPL was up on Friday and looks to be trying to move back into an uptrend.  For option traders AAPL provides numerous opportunities for various strategies. 

Tech Tip:   Learning how to draw a simple trend line can improve a trader’s awareness to trend continuation and trend change.  There are many ways to draw trend lines—this is one of the “art” areas of technical analysis.  Some believe that trend lines are only valid if they continue for a certain length of time, and touch price action a specific number of times.  While it is true that trend length, and frequency of touches on a trend line indicate the power of a specific trend, one must be aware that breaking shorter term trend lines may also lead to very profitable trades. 

 The shorter term trend lines that often define pullbacks to support after an initial run up may provide buying opportunities if the first breakout was missed.  These Bull Flags are great, especially if they converge with bounces off a significant moving average.  The opposite is true in downtrends, when low volume rebounds create short trends called Bear Flags. 

 Most technical analysts use either bar charts or candle charts to draw trend lines. Either of these works well, with a bit of variance depending on who draws the line.  But have you ever thought about drawing trend lines using a line chart?  Some analysts use this technique because it makes finding the highs and lows clear.  Line charts are based on the closing price for a trading period and eliminate the noise of the high and low prices on the bars or candles. 

 Here is a line chart and a candle chart of NFLX from last year.  The first trend line labeled 1 connects the highs on the line chart and the trend labeled 2 connects the highs from the candle chart.  What do you notice?  If you say the break of line 1 triggered earlier than line 2, you would be correct.  It triggered a little over $2 earlier.  Now, on a $230 stock this might not seem like a lot.  But that is a $2 reduction of risk if the trade fails (because you’re closer to the stop), and an extra $2 in profit if it runs. If you have not studied line charts, they offer some additional insight into price action and help reduce noise.  I encourage you to check them out on all time frames—you may find some hidden clues that do not show up on bar or candle charts.

Line Chart  Candle Chart

 

Comments and opinions written below this line of text may be provocative and only obliquely related to trading.  Some may find these “Off the Wall” comments challenging to their outlook on life.  I will not post any comments made on subject matter below this line to the group, so if you disagree blast away. 

 Surf Wall

Off the Wall:   Do you have an Edge as a trader?  When we share with our friends and family that we are learning how to trade stocks and options, many of us have experienced the “oh, that’s too much like gambling” reaction.  While this may be their belief, does that mean it’s true? 

 For those who trade without hard and fast rules I would probably say yes, that is like gambling.  But what about the wise and disciplined trader? 

 If we understand that any chance we take in life is a gamble, then even those who sit on the sideline are exposed to risk, even if they think they’re playing it safe.  They are gambling by actually not taking a chance.

 For the wise and disciplined trader to avoid gambling and become a profitable trader, they must have an edge over the market.  I believe that the most reliable edge is the technical patterns that reflect human emotions about a certain stock or ETF.  This edge provides us an understanding of the likelihood that any particular trade will be successful.  So, if we are trading a system with a 60% probability of having a successful trade, then out of 100 trades one would expect to have 60 profitable trades and 40 non-profitable trades. 

 The challenge for traders is that sometimes, due to market behavior, those 40 non-profitable trades can come in bunches.  This results in drawdowns, frustrations and often impatience while we wait for the winners to start showing up.  Some traders will scrap their rules and go totally impulsive with their trading entries and exits (i.e. gambling).  What usually happens next is they get small winners and big losers.  These events then start to become cyclic and a trader may jump on a downward spiral and totally abandon any rules, and really start gambling with their capital.  They open positions that are too large, thus placing a lot of their hard earned money on the line with the HOPE that one big jump will get them back to even!

 I spent the last week in Las Vegas visiting friends and attending the Market & Chart School.  The casinos there have an edge of between 5%-15%, depending on the game of chance on which a patron chooses to risk their money.  This edge is always in place, so the probabilities always favor the house.  With a constant edge of 5-15%, would you consider the Vegas house to be gambling?

 The edge for us traders is often no more than the house in Vegas. For instance, trading systems that have a 6:4 win-loss ratio have an edge of 20%.  Is this amount of edge enough for a trader to be successful and avoid gambling?  For many the answer is definitely yes.

 

 

 

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