Sometimes in trading, it’s more important how little you lose than how much you make–which is a benefit I’ve learned from Alex & Kerry and Spike Trade over the years. Many times Alex & Kerry have pointed out key turning points in the market; points that if you heeded their warnings would have saved you a ton of money. We may be reaching such a point now, and both Alex and Kerry have mentioned the market’s heaviness and lack of upward mojo.This struggle to form a top after a multi-month run is also playing out on the chart patterns. As you can see the SPY may be forming a 1,2,3 Top on the weekly charts–a rare and powerful trend reversal. The #3 point has not been formed yet, and it won’t be confirmed until we close below the previous week’s low; however, we’re probably forming that # 3 point now. On the daily, the 1,2,3 Top pattern is a little more subtle since it is trying to reverse the up move from early February. The pattern on the daily is a 1,2,3 UT, with the #3 overshooting the initial, or #1 spike. Confirmation for the daily pattern would be a close below the #1 high or below 110.80. In any case, now is probably the time to tighten stops, trim long positions, or learn to hedge a long portfolio with inverse ETFs or index puts. Trading is all about finding edges to exploit, and knowing that a major trend reversal may be imminent is a definite edge.
[ this was sent by Rick K – a long-time SpikeTrade member.
I couldn’t help but notice that CVA, one of our Spikers picks is a variation of the 1,2,3 Bottom pattern that I like. I call this pattern the 1,2,3 Lower Bottom, or LB. Since pt #3, or the second spike down closes below spike #1, my rules won’t let me buy until it reverses back and closes above the low of the spike #1 bar. That condition was met with the last bar’s close, so various entry strategies can now be implemented. The pattern would be voided if CVA closed back below the spike #1 close, or around 16.60.
I like to trade the bond ETFs–TLT for long 20-year and TBT for short 20-year. They form trading set ups right out of the text books, move slowly enough so you can anticipate the set ups, follow supply and demand principles, and aren’t subject to stock risks. In fact, they usually go up in times of stock stress and down when stocks are in a bull run. The only real draw back is that they are expensive and you need a lot of shares to make any money; nonetheless, I trade them a few times each quarter just to stay in shape.While the 1,2,3 Bottom set up is found on all time-frames from monthly to 5-minutes, the longer term ones are rare and generally indicate a more substantive move. After a 14-week decline, TLT is forming a classic 1,2,3 Double Bottom on the weekly chart. The first spike happened in early Jan, then there was a bounce to the declining 15 week EMA, and the second spike down on bullish divergence found support just under 90. This week it looks like we will close strong in an engulfing pattern so the set up will complete with the pivot above the second spike. The early buy point was a daily close above the second spike, or around 90.45. TLT has now rallied for 3-4 days, so new positions should wait until it retraces to the daily rising 20 EMA.
This email came in from a friend – a very sharp professional trader who trades strictly his own account from the Isle of Man – a British dependency located between England and Ireland.
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.