Updating Three Trendlines

here is an update of our poster children of a parabolic rise, measured by three progressing trendlines.

As our previous work suggested, when the first trendline breaks, the odds are very high that they all break. Which means GOOG and GLD probably have a bit further to go.

Structured Retracements, continued

Here we have another live example of structured retracements which i felt should be reviewed again.

The theory goes as such; When in an uptrend, and the MACD moving averages go below 0, then rise up to a high, then cross back below 0, we should be able to retrace the price low and high to get relevant retracement levels. So in the chart below, ive erased part of the price action to focus on the areas of concern. the 1029 low up to the 1050 high. that was one completed cycle. This means we would not run a retracement level from 1029 low to 1119 high because MACD MA’s did not go below zero yet. so we will now run our retracements from the low up to the high to get relevant retracement levels (shown on second chart)

Based on our earlier work defining major support levels, we know the 1029-1019 area is a major support area for the SPX. we know that 89% of the time these major areas hold. which means in an uptrend 89% of the time those levels are not breached by a daily close. From this knowledge we know there are other, or minor, support levels. I’m continuing to try to find out if retracements is a good way to define these minor support levels. For now it looks as though we need two daily closes below the 62% retracement to predict if the major support level will be breached.

more work is needed though.

The Over/Under Bought Myth

When i first started trading i believed as i was told. I was told that markets become oversold, and that they were buying opportunities. As anyone would ask, i wondered how you could tell the market was oversold. I was told there were many indicators that could tell me this. I traded them as such–i lost money.

I found that sometimes it worked though. This made me continue the punishment of ignorance. Eventually though, there was a breakthrough. oversold markets should be sold!

Look here, using a Williams %R, an overbought/oversold indicator on the weekly chart, we can see when it turns red (oversold) the market is declining and we can sell it. When it turns green, we need to become buyers. Simple!

uh oh…

Same indicator, different timeframe

So now there we see my original experience. Sometimes buying oversold worked, and it’d feel great. Then–well, then–overbought meant buy instead of short and all that hard earned money is taken away. So what the heck is going on? Is there a solution? Or is the concept of overbought and oversold just one big scam?

There is a solution…and its also one big scam.

Now we have our indicator in both timeframes. So right away we’ve solved part of the equation.

• Indicators can be used as overbought/oversold tools as well as bullish/bearish trend tools. Timeframe and timing is the key!

Then we look back at our daily chart and see that when the market was in a triangle–or a range—the oversold/overbought rules worked. But when it broke out, everything fell apart and was no use. This means we’ve solved the next part;

• When the market is within a range, an oversold market should be bought and an overbought market should be sold.
• When the market breaks out of a range and gets into a trend environment, we must use trend tools (such as trendlines) to properly capture and understand the market.

Finishing up here, we now know how and why the myth of overbought and oversold is a money loser. Why it is perceived as something that works enough to keep using and how we properly use it going forward. 

The context of the market is what we need. Once we have defined if the market is trending or consolidating we can then further understand how to use oscillators to our advantage.

Structured Retracements

Often times i find that many traders can come up with approaches to the market that are–in theory–correct. However, what tends to be lacking is the structure and discipline to carry it out in practice. This leads to inconsistency in trading results, which leads to lack of confidence, which in turn leads to more inconsistency.

One of the methods i find this to be most true is in Fibonacci and Elliot Wave practices. This is my attempt to create some sense of structure within the pratice of fibonacci retracements.

As in earlier posts we’ve found that if we match trend to short term momentum lows, we can better identify real, or game changing, support/resistance levels. We are going to now take that same method and apply it to retracements.

So once again here we are going to find a momentum low, then momentum high and match lowest price point and highest price point respectively. Then run a simple retracement from those levels. Then as that retracement is complete, we wait for the next cycle.

This gives us structured analysis of which swing lows/highs to run our retracements off of. Which levels do we use to try to find confluence areas without letting our subjective desires interfere. This approach takes opinion and human emotions out of the analysis. Instead of you telling the market which lows, or which areas are “retrecement worthy”, the market is showing you.

Another One Bites the Dust

The parabolic rise strikes again? Well im streatching the definition a bit, but this certainly was a stock going too far too fast in one direction. It does not yet look structurally damaged, id need to see it take out the 400 area. However, given where the RSI has been, i wouldnt be shocked to find this the initial stages of a topping out formation.

Great candle bar confirmation as the trendline breaks on a trend day. Then a following red candle. Thats either a good exit signal or–depending on your style–a good short entry signal.

Volatility Cycle–Revised

In previous posts i outlined what i thought was the optimal way to swing trade the trend of markets consolidating and then trending. This is an updated–simplified–version.

Selection: we first want to select a market that has lost trend and volatility. To do this we are only going to use a standard ADX, then we are going to look for when the standard bollinger band is within the standard keltner channel. Like so:

Notice how this weekly chart of Gold sets up the big moves based on the volatility cycle. Now lets find some price patterns and some indicators.

Now we must pay attention to price patterns first and foremost. without it, we have no structure. Sure the market is set up for a move. If youre playing Texas Hold’em and you draw pocket Aces, youre set up to do very well. But if you dont know how to set up your bets properly, youre not gonna get the most out of that hand. This is no different.

In the chart above youll see for breakouts you are looking for an overbought signal which–some would say ironically–sets up the buy. Without it, you should not take the trade. You also want the longer term oscillator (MACD) to be pointing in your direction. The focus for this should be the histogram, not if the MA’s are positive or negative.

Drawing trendlines can be tricky. sometimes you force a situation, sometimes you use too thin of a line. Trading trendlines can be even worse. its not that they cant work, its that no one sets their stoplosses according to a line drawn in the sky. Ultimately, stops are determined by price. So we use channels for getting a psychologically pleasing entry. You will be getting in as others are being stopped out, this should produce and explosive move right as you are entering your trade. If you feel capable and confident about your abilities to trade trendlines, and to deal with the potential whiplashes–then by all means do it. For those less sure, use channels. I still use channels.

Stop, Drop, and Exit.

For your initial stoploss, i use bollinger bands on smaller timeframes. If using a daily chart ill go to a 10 min bar chart, take a 39 (one day) moving average and set a two standard deviation band around it. For a breakout, use the lowest point on the bollinger band. Flip for breakdown. On weekly chart set ups, i use the standard daily bollinger band.

Exits such as trendlines, channels, options plays etc. can be explained in more detail in previous posts. There you will find that this gold chart is not just curve fitted to my liking, but that this phenomena of volatility cycles exists on all markets, and all timeframes.

Note: here is another piece on setting proper expectations in range bound markets

ADVANCING Logic/DECLINING Technical Analysis

 

Why is it that some days a market just cant break out? Why is it that some days a 30 min bar close above the first half hour is a sign of a rip roaring trend day, then on other days it is reversed and the market heads for the low of the day? Why is it that some days a momentum divergence is ignored, while others it produces the most powerful intraday move of the week?

These were important questions I had. Questions that–to be quite frank–technical analysis was unable to answer. If anything, the traditional folklore would have you running off a cliff like a lemming (if you think im going to start talking book value, dont get too excited).

The answer does come back to that eternal truth in which markets trend, then they consolidate. We must first identify these environments before we can understand the tools that we are using. We must use indicators that are not directly related to price to identify the proper environment. Once that is diagnosed, we can start to expand our understanding of our other indicators. Finally, we can apply this knowledge into real time trading signals using real time data (as opposed to past price).

Think of advance/decline like the seesaw in the opening picture. Clearly, what is shown would be an analogy of a trend day. the bulk of the weight is on one side, and so therefore that side will dominate. However, if new information is provided to the market, this can change. And A/D will be slow to catch it. Think of our illustration of the fat guy and the little kid on the seesaw. Assuming that there is no new information in the scene, the fat guy will never be lifted off the ground. But imagine that a giant wrecking ball was dropped onto the other side at 20 m.p.h…The fat guy would go flying. Think of how fast this new information would change the current situation.

The key to this is that in U.S. trading, most vital information comes out before noon and even further most comes out before 10:30 eastern. When there is critical information expected to be announced after noon (think fed days) then this understanding of the market loses much of its luster.

Many use the NYSE Advance/Decline indicator to determine price action. Typically though, they use the A/D line which squiggles around all day long and lends itself to excessive interpretation. We need it to be easier, faster, simpler. Lets instead look at it in terms of percentages. The bulk of this analysis will focus on 70%. knowing if advancers or decliners have that much weight on their side of the seesaw is critical to knowing what the rest of the day will typically look like. There will be two major types of days and certain variations of each. There will be;

1. Trend days

2. Range days

• Standard Range day
• Range day with late day break
• Large Range day

Now, Let us define these;

Trend day:They occur 20-25% of the time.

• If 70% or greater of stocks are advancing at the end of the first half hour of trading, this is predicting a trend day. So at 10:00 eastern if the A/D is 75% decliners, 20% advancers, 5% unchanged then we are looking at a trend day to the downside.
• There will be a 30 minute bar close higher (or lower) than the first 30 minute range.
• When looking at a standard 5 min ADX (23 on 3min bars) the +DI and -DI will very rarely cross and certainly shouldnt in the first half of trading. There will be times when it does though. this usually happens after 12 est. and typically will last for about an hour. Any longer, and we must start to look to roll our stops up and be on the look out.
• A trend day higher will close in the top 23% of its range from the previous close to the current days high. Reverse for downside. To test this just simply take the previous days close, and the highest price point of the day (or lowest if trending down) and run a simple fibonacci retracement.

 Range Days:

• Simply days in the market place where neither advancers nor decliners exceed 70% or greater of the total market. 
• The + and – DI’s will cross, and often cross frequently.
• Once trading gets to 12 est. the highs and lows of the day are “set”. What i mean by this is a range day has been established, and any price break of this range should–eventually–be faded. A move beyond them should be seen as a failed move provided there has not been a major news event.
• Do not think the above means that price will never exceed the first halfs range. In fact, we want it to–thats our trade.

Standard Range Day:They occur 40-50% of the time

• A/D will be very balanced. A true prototype of this would be something like 45% advancers, 40% decliners. It doesnt NEED to be that, but thats the ideal.
• The market may or may not break the first 30 min range (often depends how wide that range is) but when it does–thats often a failed move and should be faded.
• There will be range behavior. what i mean by this is we will see price formations. a Triangle, wedge, double bottom etc etc.
• Divergences work here, as they almost always do in range environments.

Large Range Day: These occur 15-20% of the time

• This one can be tricky. this will develop with an A/D where one side has a 40% advantage vs the other side, and that side has greater than 60% but less than 70% of stocks in its favor. Example; large range day up would have 65% advancers vs 24% decliners (41% difference between the two).
• This will very often finish like a Trend day, and even the daily candle will often be mistaken as a trend day if the intraday charts arent looked at.
• There will be a strong open that will look trend day esque. However, the simple math of the A/D and the weight put in that direction will make its intraday countertrend move more agressive. This makes it tougher to trade than any other type of day.

Range with Late Day Break: Occur 10-15% of the time.

• These will start off like a Standard Range day. they look the same, feel the same–but develop differently.
• Their ranges are so tight that stoplosses among daytraders are in such close quarters for too long throughout the day and inevitably too many stops are hit, which produces a late day break.

More on what to expect from these:

Trend days:

• They will be scary. the stops required on these days will be very wide, and disturb a lot of traders.
• I guarantee you intraday indicators will be showing divergences galore, and you will have every technical reason to fade the move.
• your “price targets” and support/resistance levels will be blow out of the water. Or, worse yet, theyll be hit at about 2:30 and youll convince yourself the market cant go further. At 2:50 youll feel like the smartest person in the world. At  3:50 youll bang your head against the wall because you missed 3 handles.

Range days:

• They will be scary. The entry on these are ‘insane’. your optimal entry time will be right about the time when it looks the worst. As if it MUST be a trend day, and odds are you wont be able to stomach it–at first.
• Divergences will now work. If you can get a divergence in MACD, ADX or from other indicies ($DJI, $NASDAQ) youll want to take that signal and exit on the close or if one of these three indicies makes a High/Low of the day after 12 est.
• Your levels will be more likely to hold as you previously expected them too (though theyre of little consequence on the days actions) and things will make more “sense” in this way.

 

The trade:

For trend days it is really simple; watch the first 30 min range. then look for between 10:30-12:30 for there to be a 30 minute close above/below that first 30 minute range. If A/D is showing a 70% greater advantage in the direction of price, you buy at the close of the 30 min bar. Your stop should be a point or two beyond the previous days close. Your exit is on the current days close.

For range days we will check that the environment (A/D) is in favor of a range day. we’ll then check to see if any vital news is being posted past noon eastern. If this is the case we will then start trading after 12 and trade failed breakouts, divergences, price formations (i.e. triangles) and the exits will be on the close. There will be more on how to trade these with greater timing in upcoming posts.

Moreover, we can use a non-price indicator to determine what type of environment the day is trading in. Once we have that, we can use price–as well as momentum indicators–to tell us how to trade this specific environment. The fundamental foundation for why this works is that critical information–by and large–is issued before noon eastern. We can use these fundamentals of the market place to technically trade at highly successful rates.

More Bonding

I think i may have jumped the gun on bonds going truly parabolic, perhaps just in an attempt to ‘prove’ something. That being said, i think its clearly identifiable that there is a second trendline established

We can see bond yields breaking out of a triangle like formation highlighted @ the circled area. it was a trend day (or full candle) which is a nice confirmation. but that third trendline is suspect, i think the actual bonds show a better picture

we could be getting close, and i wouldnt mind adding or initation for a short term trade. but one should be checking in on these trendlines at this point IMO. after that id expect a rally in the way 2009 saw a rally mid year. but i expect it to be a bear market rally, and then bonds could get pretty wild. Just imagine, bonds have lost 25% without the fed raising rates. Imagine when they do…

Bonds, Parabolic decline

Here we go again. this is a chart of bond yields (price goes in inverse) and as we can see here, bonds have gone parabolic. now just waiting for the trendline to break  before exiting the trade. been a nice one at that.

Three Trendlines

I have read and written a lot about three trendlines before. Its often misunderstood as to why this works and this is an attempt to explain.

When you are able to establish a shallow trendline you’ve show that the market is expressing a shallow rise–or decline. These types of advances can go on for a long time as they allow large traders to build positions over time. when you find steep trendlines you’ve found a market that is explosive but will only be that way for a short period of time.

Think of it this way; if youre running around a track you can choose to go fast or slow. if you jog–or heck, even walk–you can do so for a long period of time. however, if you sprint your energy will run out faster.

Three trendlines that continue to get steeper one after the other is more significant though. This is the straight edged expression of a parabolic rise. Lets take a moment and really think about what this means. People talk about how a market is rising and they’ll “sell it when it goes parabolic”, but they have no way to quantify this. Its like when people say, “i dont know how to describe it, but i know it when i see it”.

Yet traders miss these moves time and again.

These parabolic rises are missed because people are literally looking for something to go up 15% a week for 3 weeks in a row. but a parabolic rise–or a move that isnt sustainable–can be expressed through trendlines which will make it easier to find. If a parabola is something that increases steadily as time goes on, then all we need is consecutive trendlines that continue to rise as time progresses.

Notice how the shallow or initial trendline took a long time to develop. The second was much shorter, and the third again was shorter. We how have a visual of a straight edged parabolic rise.

The trade: The right question to ask to back up a theory is, what is the trade?

My answer is that for me, the best trade is when you see the third trendline break to play it through options. You can either buy puts attempting to capitalize on the increased volatility. Or you can sell a call spread and simply express a view that once that steepest trendline breaks, it will not make new highs for some time. I personally would look to exit the position after the second trendline breaks. You can of course express this through common stock, but i find it to be an optimal time to trade options.