web analytics
 

Archive for January, 2012

Waverly Advisors Weekly Market Analysis

by Adam on 31/01/2012 in General Comments, Risk Management with 2 Comments

I have shared some of my daily market review and analysis that I do for Waverly Advisors here in the past, but I thought it was worthwhile to do so again. This is a copy of our large weekend report and our market analysis webinar which we do every Monday at 11:30 AM. I know many of my readers focus on a small set of markets, or perhaps only on intraday trading, but everyone should be at least tangentially aware of macro factors and of movements in major world markets. It’s a global marketplace, and only becoming more so every day.

Download the pdf report here: Macro Playbook – 013012

 

1/31/12 Chart of the Day

by Adam on 31/01/2012 in Chart of the Day, Pullback with No comments

This chart shows the bull flag in JAZZ that tested the previous swing high and failed. As this stock was nearing that previous pivot, I tweeted that it was breaking out, but not to chase it. Why? Because this day was pretty close to a worst-case scenario for a bull flag trader. This pattern failed around the previous high (the arrow), and closed down strongly. In an instrument that trades more cleanly (stock index, some commodities, large cap stocks) it probably makes sense to close out of the position on a day like this. In something a little bit more crazy like a pharma stock, your options are a bit more open. You are accepting gap risk, but it probably makes sense to work with a stop somewhere in the range of the red box. At the very least, acknowledge that this is not the hoped-for resolution of this pattern, and be alert to manage a bit more actively tomorrow.


First Principles in Technical Analysis (4/?)

by Adam on 30/01/2012 in Climax, First Principles Lectures, General Comments with 1 Comment

 Trends end in one of two ways

The last lecture looked at the power of an intact trend. Of course, trends do not go one forever. They do end, and they tend to end in one of two predictable ways. Consider an established uptrend that has shown a clear pattern of impulse move up, retracements against the trend, and then new impulse moves in the direction of the uptrend. At some point, buyers will lose some conviction and the market will start to stall around previous resistance. Perhaps resistance will still break, but the moves through will not be as sharp or as clean as they have been. Perhaps each upswing is smaller. We might characterize this market as being “tired”, or, in the language of technical analysis, momentum divergences are emerging on each upswing. Resistance is starting to hold against the trend, and eventually the trend will end. From a the perspective of simple chart analysis, this pattern often looks like a rounding top (or rounding bottom, in the case of a downtrend) on charts.

This is often a very quiet and polite way for trends to end, but there is another way–trends can also end in dramatic climaxes. In this case, the trend accelerates into a series of more and more dramatic trend moves and goes “parabolic”. Emotions get very strong in a move like this (which is why you, as a successful trader, must learn to control your emotions and stand apart from the crowd), and it looks like the market is going straight to the moon. At some point, the last willing buyer has bought and a vacuum is created on the other side. The market immediately collapses as bulls, who were feeling giddy with excitement, now panic as they realize they are caught on the wrong side of the market. As they scramble to exit, their selling pressure (in the case of an uptrend) further accelerates the selloff. Though traders are often drawn the possibility of outsized profits on these last swings, that potential for profits is accompanied by even greater danger. When the trend pattern breaks, it does so with a ferocity that can stun traders trapped on the wrong side.

Many traders are also drawn to the possibility of picking the top of bottom of a move like this, but imagine you successfully caught the top in that last blowoff trend. Now what? It is certainly possible that the uptrend will turn into an equally dramatic downtrend (anything is possible at any time in the market), but remember our first principle of market behavior: markets alternate between trends and trading ranges. It is more likely that the top you caught will now lead to a sideways trading range rather than an actual trend reversal. Your capital (financial, mental, and emotional) will now be tied up in an unproductive trading range as you agonize over each tick. Once you are in that trading range, now you have to watch and see if it is likely to break out into continuation of the original trend or eventually start a new trend in the other direction. There is money to be made here, but it is hard money. Most traders will have better success positioning with the direction of the intact trend than trying to pick the exact moment for trend reversal.

In the next post, a look at the last fundamental principle of price behavior: action around support and resistance.

Chart of the Day: 1/29/12

by Adam on 29/01/2012 in Chart of the Day, Pullback with No comments

The bull flag is a simple, classic pattern that is a fundamental expression of the ebb and flow of buying pressure in an uptrend. In this case, we entered a position in Jazz Pharmaceuticals pcl (Nasdaq: JAZZ) intraday, but the position could also be initiated on the close or on the next day as close to the previous close as possible. (Note also the “hook up” on the MACD fast line which, in this context, is further support for a new long position here.) Always consider the bigger picture concept when executing any technical trade, but it’s hard to beat this pattern for a defining a precise entry spot.

Bull flag in JAZZ


First Principles of Technical Analysis (3/?)

by Adam on 28/01/2012 in First Principles Lectures, General Comments, Pullback with 1 Comment

2: Trends are more likely to continue than to end

The previous post in this series considered the first principle of price behavior: that markets tend to alternate between periods of trends and trading ranges. This post will dig a little deeper into the power of an intact trend and the second principle–that trends, once set in motion, are more likely to continue than to end.

Some traders love to pick tops and bottoms. It is a huge ego rush to have sold the high in Gold or to have picked the exact bottom in a pharmaceutical stock that melts down because it was denied an FDA approval. However exciting they are, trades like this are probably not how most traders are going to build a trading career. It is far simpler to trade on the side of the trend, and the easiest money in the market is to be made in alignment with the trend. In fact, a simple, but effective, trading plan could be to identify trending markets and use the more or less predictable elements of trend structure to position yourself on the same side as the trend. Trading with the trend is more forgiving because the power of trend continuation allows you to be a little early or late on your entries and still make profits; if you are aligned with the trend, many mistakes may be forgiven.

Given any chart, your first thought should be do identify the trend and to find ways to position yourself in that trend. Carefully examine your instincts. If you find yourself always wanting to fade the trend, you probably need to make some changes to your thought process or you are likely in for a short and painful career as a trader.

Rather than spending your time examining moving averages or looking for chart patterns, most trader’s mental energy would be best spent trying to understand what the characteristics of price patterns are in both trends and trading ranges. Here are a few generalizations to get you started:

  • In trends, the basic price pattern is an impulse move, a retracement against that impulse move, and then another trend leg in the original direction.
  • One of the best technical trades there is comes from identifying impulse moves, entering on the counter-trend retracement against that move, and holding the trade as the market turns back in the direction of the impulse move. There are many ways to trade this concept, ranging from positioning in the retracement to entering the with-trend momentum when the market turns.
  • Understanding length of swing analysis can give early warnings as to when the balance of buyers and sellers has shifted in any market.
  • Note that the standard definitions of trends should probably be treated as guidelines, rather than hard and fast rules.

In the next post, a look at some of the standard patterns of trend terminations.

 

First Principles of Technical Analysis (2/?)

by Adam on 27/01/2012 in First Principles Lectures, Individual Self-Directed Traders, Institutional Mangers/Traders with 1 Comment

1: Alternation of Trend and Range

Continued from this post.

Markets alternate between periods trends and trading ranges. This first principle of market behavior is responsible for many trading losses because what is right in one market “phase” is precisely wrong in the other—if you incorrectly identify the market context, you will place one losing trade after another.  Understanding the difference between how markets behave in trends and trading ranges and how it moves between the two phases is perhaps the first, and most important, skill in technical analysis.

There are two points to consider here. First, what do trends and trading ranges look like? In trading ranges, support and resistance tend to hold. Ranges (in this context, meaning the distance from the high and low of each individual price bar) tend to contract as the market seeks out areas where selling pressure is sufficient to stop price advances or where buying will arrest declines. Volume tends to be lighter and liquidity generally lower; smaller orders can have a large impact on prices as there may not be enough traders on the other side of the book to absorb the order.

Mean reversion strategies (fade trades) tend to work in trading ranges as the market trades back and forth through the same price multiple times. It would seem to be easy to trade in ranges—just sell at resistance and buy at support and watch the pile of money grow. In reality, it is not that easy. Resistance may fail as the market breaks into an uptrend, putting the trader on the wrong side of a new and vigorous trend. If the trader adds to shorts fading this new trend, losses can become truly… dramatic. On the other hand, there are many times where resistance fails, and the market trades a little bit higher to establish a new resistance area just above the old one. In this case,  the trading range has simply been expanded; the right play would have been to hold, or even to add to, shorts on the break.

A simple definition of a trend is that it is an area where a market moves from one price to another. While technically true, this definition misses many subtleties and may be too broad to be useful. However you choose to define trends, your job is clear: get on the ride side of them. There are many specific trading plans and ways to accomplish this, but all with-trend trading plans seek to position the trader on the side of the trend.

The study of trends and trading ranges, and the correct techniques to apply in those areas, is fairly common in the literature of technical analysis. However, there is another area of study that is often neglected–the critical transitions between the two areas. This is a deep and complex subject because these areas, perhaps more than any other in the market structure, are subject to a high degree of randomness. Yes, there are patterns here, but they are obscured by volatility, fakeouts, and generally noisy price action. Unfortunately, much of the opportunity and also the danger in technical trading lies in these areas between trends and trading ranges, so traders must be able to navigate them successfully. This is a subject that will repay deep thought and study.

Next post: the second principle of market behavior, that trends are more likely to continue than to end…

 

 

1/26/12 Chart of the Day

by Adam on 27/01/2012 in Anti, Chart of the Day, Technical Patterns with 4 Comments

This chart shows an Anti pattern in the chart of Apollo Group, Inc (Nasdaq: APOL). This is an important trend termination that often leads to some very clean trades. This is a repeatable pattern in all timeframes:

  • A: Overextension. (In this case 3 pushes and climax beyond the upper Keltner channel.)
  • B: Sharp countertrend momentum indicating that sentiment and control has shifted in the market.
  • B1: Note that this also takes the MACD to a significant new low, relative to its recent history.
  • C: Small consolidation. In essence, this is the first bear flag in a possible new trend. The actual entry is on a break out of that consolidation.

This chart was taken midday at the time I entered a short trade with an initial target in the mid 52′s. The term “Anti” was coined by my friend and mentor Linda Raschke in Street Smarts: High Probability Short-Term Trading Strategies, and it is also one of the seven trading patterns I cover in considerable detail in my book.


First Principles of Technical Analysis (1/?)

by Adam on 26/01/2012 in First Principles Lectures, Individual Self-Directed Traders, Institutional Mangers/Traders with 3 Comments

The building blocks of market structure and price action.

Technical analysis is the art and science of predicting the future direction, timing, and/or magnitude of a market’s movements, mainly by using information contained in the price changes of that market. The term technical analysis is used to differentiate this approach from fundamental analysis, which focuses on analysis of items such as financial statements, competitive advantage, a company’s management, supply and demand factors, and an understanding of the overall economic environment. There are die-hard adherents of each school who claim that their approach is the only one that makes sense, and that the other school is completely worthless. In reality, most traders use a combination of the two, and the goal of both of these approaches is the same—to try to understand the forces of supply and demand at work in the market.

For very short-term traders, fundamentals usually do not matter because the day-to-day price path of stocks does not depend on elements of their balance sheet, superiority of management, or even the company’s competitive position within its industry. Longer term investors will tell you that the short-term fluctuations of stocks are illogical and are completely random noise, but we know from careful observation of prices that buyers and sellers leave many clues to their intentions. There are verifiable statistical edges to certain kinds of technical analysis, but they must be applied in a precise and disciplined fashion, because the edges are very small indeed.

It is very easy to find books (Amazon lists over 17,500), websites, seminars, and classes on technical analysis. You probably hear traders talking about great trades they have made when the moving averages are set up a certain way and the stochastic fast line crosses some other line… this is what most people think of when they think of technical analysis. Be very careful. There is a huge difference between finding trading “setups” that look good on historical charts and actually placing these trades in real-time. As traders, we do not have the luxury of going back through charts to find the best examples—we must live and work at the “hard right edge” of the chart where the future, the very next tick, is unknowable.

Unless you have made substantial, consistent money with a technical tool (consistent being the key word), it is always good to be open to the possibility that your tools do not work. 99.99% of what you read or have been told about technical analysis is worthless. There is no statistically verifiable edge in moving average patterns and only slight edges in some of the common oscillators. There is no statistical edge to the common candlestick patterns. There are no magic chart patterns that can make sense of the randomness. This is the bad news is—that almost everything everyone thinks works in the market, simply does not work. However, the good news is that it is possible to find an edge in the market that can lead to a consistent trading advantage. The key to this is to understand how the patterns of the market’s movement reveal the true buying and selling pressure behind the market, and this can sometimes give clues to future market direction. That is the true foundation of technical analysis, and this is the principle upon which my upcoming book is based. It is not possible to reduce trading decisions to a simple set of rules or patterns to be applied blindly.

Rather than focusing on specific trading patterns or setups in these blog posts, I want to lay out some basic principles that drive price action in all markets and all timeframes. These are not foolproof rules, but they do apply universally to stocks, futures, forex, cash commodities, bonds, or, indeed, to any liquid market. We see these same principles driving price action on one minute bars or monthly bars. In addition, these appear to be fairly universal and unchanging. We see the same principles at work in grain prices from the Middle Ages, or in stocks from the 1700’s that we see in today’s markets. Traders will of course need to adapt to new markets and new timeframes, but our goal here is to lay out a more or less universal framework that can provide a basis for trades in any market. These principles are:

  • Markets alternate between trends and trading ranges.
  • Trends are more likely to continue than to end.
  • Trends, when they do end, usually end in one of two specific ways.
  • Last, I will lay out some characteristic price patterns around support and resistance holding or failing.

More to come…


1/26/12 Chart of the Day

by Adam on 25/01/2012 in Chart of the Day with No comments

This chart of Natural Gas futures shows a classic pattern: parabolic acceleration outside the Keltner Channel and the parallel trendline. It is difficult to play a move like this as a fade (i.e., buying for a long) due to potentially unmanageable volatility, but it is always a clear signal to traders positioned on the right side of the trend to tighten stops, perhaps take profits, and avoid shorting into the countertrend pop. In the words of the old Samurai maxim: “after victory, tighten your helmet straps.”

 


1/25/12 Chart of the Day

by Adam on 25/01/2012 in Chart of the Day with No comments

This pullback in Gold futures could offer an opportunity for a short. Positions could be established on a weak close, looking for a first leg to retest previous lows (1,525 – 1,540 basis February contract).

 

← Older Entries