Daniel S writes from Brazil: “Take a look at these charts of SPY
Bollinger Bands, aka Volatility Bands, and Alex’s 2-day Force Index, are two of my favorite trading tools. Bollinger Bands measure volatility, or price range up or down from a baseline (20-day SMA). I use them for a variety of things–squeezes, short-term overbought/oversold, profit targets, and an indicator of potential trend change.The market’s recent decline is a good example of how the measurement of volatility can help us traders. When the market plunged in late January, the BBs expanded in opposite directions indicating a violent move. The lower band led price down, while the upper band expanded in the opposite direction as volatility increased. The upper band traced above the 115 for several days, eventually turning back toward the lower band as volatility dried up. At the same time, price bounced, then made another plunge ending with a penetration of the lower band, but a close above it, accompanied by a selling climax measured by FI. The end of the move was foreshadowed when the bands stopped expanding away from each other and started contracting.The more I use the 2-day FI, the more intriguing I find it. Notice that when the SPY was in a bull move, each time there was a retracement, it ended in a FI spike, or short-term selling climax. Interestingly, the deepest spike was at the start of the correction, which indicated we were headed for something much bigger than our previous retracements. Notice that another smaller spike (also indicating bullish divergence) marked the end of the decline. I also marked the mid-February bounce forming a higher low. This bounce was the perfect set up for another move down. The tip-off that we were going to continue down was the inside day bar (on the right in the rectangle), a handy tool in itself.
When Anna C, a long-term SpikeTrade Member wrote to us that she was going to have a baby, we encouraged to stay in the group and to contribute picks whenever she felt like it.
A Spike member asked me how I find the 1,2,3 Bottom patterns and Alex suggested I post my reply.I find it nearly impossible to come up with an accurate screen for this pattern, so I do it the old fashion way. Because I’m a Mac guy, I use an old charting software system built for Mac computers, and a database of about 500 large cap and ETFs. I’m a short-term swing trader and use 2-day RSI and 2-day FI to measure short-term oversold and short-term overbought. I buy weakness and sell strength, so I look for longs if the S&P is oversold and shorts if the S&P is overbought, and rank all my stocks by their 2-day RSI and look for longs if the 2-day RSI is under 20 and shorts if it is over 95.Then I cycle through each daily chart looking for reversals or other set-ups. It usually takes me about 20 minutes to go through them all and I do it once a week or so. I often trade these 123 Bottom patterns (if the weekly charts are favorable) and usually hold them for a bounce to the downtrending 20 day EMA. In the case of NSC, I took profits very quickly because I don’t trust this market and I’m going out later today and don’t want the profits to slip away. I did the same with DIS, EWZ and KO, but still hold GS with a tight stop. The set ups for EWZ, DIS and GS were variations of the 123 B, but KO was a failed break down with major bullish divergence (a set up that Alex has described several times). I picked them all up by cycling through my 2-day RSI stocks that were below 20. I’m particularly careful these days because of the chop caused by ultra high correlation between the dollar and stocks, so I take profits quickly.If the market holds together, I will revisit these stocks in a few days to see how they handled the resistance from the downtrending 20 EMA. If they consolidated, or the 8 EMA crossed up through the 20 EMA, I’ll look for a continuation trade. If they fail at the 20 EMA, but hold support at the bottom of Spike #2, I’ll probably take another shot long if the MACD strengthens. If they crash through support at Spike #2, then the game reverses and I’ll short them.
As a group, I don’t think we’ve given the correlation between the dollar and stocks the attention it deserves. However, since Daniel from Brazil has posted a chart of the dollar with comments, I thought I would jump in with a couple observations. The rally off the market bottom was fueled by central banks pouring liquidity into economies with the hope of averting a fiscal meltdown. The US took the lead, pouring billions of dollars into the markets. As the Treasury poured, each dollar got cheaper.Consequently, as the dollar dropped in value, investments with a higher level of risk–commodities, stocks, gold, etc, went up. Astute traders, like Goldman Sachs, figured out that shorting the dollar and going long risk was blissful, and they and others piled in, creating the “carry” trade–short the dollar, go long commodities, stocks, etc. There are now so many folks, and so much paper profits in this trade that the correlation between the dollar and the S&P has reached an extreme, seeming to move inversely tick by tick. The Forex guys goose the dollar, stocks sell off; they take profits, the dollar falls and stocks rally. You can see this correlation in the comparison chart. It shows two ETFs–UUP (long dollar) and the SPY (long S&P) and the inverse comparison is remarkable.While at the moment it looks like the dollar and the S&P are drawing together (perhaps seeking value as Alex often points out), I find myself wondering how and when this enormous bubble of a carry trade gets resolved. Like all bubbles, once it blows a lot of people are going to lose, and a tiny few will profit. I prefer to be in the latter group instead of the former. If this carry trade does unwind with a jolt, the dollar will soar as the shorts cover, and the S&P will plunge. If this happens, I’ll be short the indexes via the inverse ETFs.Until this intense inverse correlation between the dollar and the S&P resolves itself, I’ve pretty much given up on individual stocks. I find it simpler and safer to trade the index ETFs, mostly SPY, SSO and SDS, and some of the foreign country funds like EWZ. Though they are very thin, I’m also trying small bets in the currency ETFs, like ULE and EUO. I plan to trade for many more years, and even though this volatility is exciting and compelling, I’ve cut my trade size back and watch drawdowns like a hawk. Remember, the Forex markets are traded around the clock and morning gaps in either direction can be brutal. To compensate, I’m buying weakness on the close, selling quickly into strength and using tight stops.
This Weekly chart of the US Dollar shows that it hit its long term support at 74.50 nine weeks ago, which should enable the Dollar to gain traction for the upside … it did.Note the weekly support level at 77.86 with the Dollar now above that level. The Dollar continues to gain strength, which should take it up to the 80 – 82 level where it will meet its first important resistance. Let us continue to monitor …Daniel SBrazil
I thought I would post another of my 1,2,3 Bottom trades. It shows the 1,2,3 Bottom forming over a longer period than usual, and above the 200 SMA. The ones that form above the 200 SMA seem particularly successful. On the weekly, the decline retraced 60% of the original up move, and then settled at 50% on the second downturn. Finding support at the 50% retracement and forming a higher low, while the MACD-H and FI tick up provides further confidence. UGL is a 2X ETF that tracks the price of gold, similar to GLD. The first target is 50, and then the old high at 57. I may add to the position if we consolidate around the 20 EMA for a couple of days without losing much ground. I actually tried to enter this trade 5 days earlier and got stopped out, but when price slipped and 2-day FI didn’t, I decided to watch for another entrance. This one is profitable.–Grant CookeSustainable Energy Associatesgcooke@sustainableenergyassc.com925-989-7117
Recently, a Spike Member asked me a few questions about my approach. Alex thought it might be of general interest, so I’ll post it. It started with a question about AAPL, which is referenced in the accompanying chart.While I think the market (1/13/2010) is short-term oversold, I don’t see a lot of potential profit left. So, I’m basically flat, having sold my inverse ETFs (QID, SSG, SKF, and a few others this morning). I also covered my shorts (except for MO) this morning as the market sold off early. I did this because I’m going to the airport and don’t want to let any profits (though some are small) slip away over the next few days. I dislike worrying about positions while I’m traveling or concentrating on my business. Over the years, I’ve accepted a style of trading that fits my personality–short-term swing trading, buy weakness and sell strength with multiple low-risk, small profit trades, and lots of action.So, I’ve come to accept the fact I can’t really trade with trailing stops supporting cumulative profits over long holding periods. I prefer to trade ETFs, but will trade large cap stocks that have high-volume and clearly defined patterns–1,2,3 Tops & Bottoms, or similar formations. I trade in the direction of the weekly charts, and use a 2-day RSI to pinpoint oversold conditions. I typically will buy when the 2-day RSI is around 10-15 and sell when it goes above 70. After many years of experimenting, I’ve settled on a short-term MACD that is 3,10,16.I use the MACD mostly to find short-term bullish or bearish divergences on the daily charts. I also look for higher lows on the MACD. I don’t day-trade–it makes me too nervous, but will look to enter longs during mid-morning slumps or usually at the close. I try to cut losses as fast as possible and never risk more than 1 percent of my account on one trade, usually not more than half a percent. Over the years, trading has been a fascinating hobby with enormous challenges, horrible disappointments and enough profits to keep me coming back. For 2010, I’ve managed to change my day job, and now run my business out of my house. I’m trying to concentrate more on trading these days, because I anticipate a volatile market in 2010 and look forward to the challenges. The upshot of all this is that Alex and Kerry are extraordinarily capable teachers and their ideas are practical and profitable. I’ve taken what they do and adapted it to my personality and it seems to work.
The market has had a mighty run, but many of the stocks in my database are forming my favorite reversal pattern–the 1,2,3 Top. A couple of folks have asked me about it, so I thought I would post some charts as a refresher. Most of the ones I’m currently trading all have huge bearish divergences on the weekly charts, greatly contributing to the pattern’s reliability.For those not familiar with the 1,2,3 Top (or 1,2,3 Bottoms) the pattern is based on the classic market dynamic that almost all significant tops, or bottoms, consist of 3 moves–# 1 is an initial thrust that ends a trend, followed by #2 a pullback as the smart money takes profits, then #3 is a retest of highs as late comers want another shot at glory. The pattern completes as price trades below #3 and forms a pivot. Short on the close of the move below #3, and the stop is above the high of #3, or #1, whichever makes the most sense. The lowest risk is to short on the close below the #3 low, so you need to adjust the number of shares traded based on money management. I particularly like 1,2,3 Tops because they tend to trap late buyers who quickly sell their shares when they realize the up move is failing. Look for lower volume on move #3 and increasing volume on the move down.As I cycle through my database I’m seeing many stocks in various stages of the pattern. Traders say that when the averages are forming a top, 1/3 of the stocks will peak before the top (probably now), 1/3 will peak along with the averages, and 1/3 after the averages peak. So, I’m looking for a host of 1,2,3 Top opportunities over the next few weeks, or short trades after half-hearted bounces as the stocks correct.–Grant CookeSustainable Energy Associatesgcooke@sustainableenergyassc.com925-989-7117
[This comes from a Member in Sao Paulo, Brazil – Alex]Beyond