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Are we in the middle of a classic “2b top” on the S&P 500?

Like most passionate traders, I have a veritable library of market-related books. In what is, pound-for-pound, one of the best ones ever written, Trader Vic: Methods of a Wall Street Master, Vic Sperandeo illustrates the most useful and (not coincidentally) simple chart patterns, as well as giving invaluable advice on psychology and money management– the two main reasons most of us fail at acheiving long-term success in trading.

In his section on the basic double top (he calls it a 1-2-3 double top if I remember correctly), Vic describes a variation on the 1-2-3 where the second top momentarily pops above the first one before failing. This head-fake he dubbed the 2b top, and can be an even stronger signal than a regular double-top.

Enough chatter– here’s “what I’m lookin’ at.” In the chart below, notice the S&P had a near-term high on 11/23/05 at 1270.64. It then descended to two almost perfectly even lows on 11/30/05 and 12/1/05 at 1249 and change. Finally, it spiked to 1272.89 (the 2b top) on 12/6/05, and failed back below 1270 the same day.

An agressive trader could have gone short on the break of the 2b (12/6) bar:

(Note: A less aggressive play would be to wait for a break below the 11/30-12/1 level of 1249.)

I’ve included here a 5-day, 60-minute chart to show exactly where the aggresive short would take place. The bottom of the 2b bar was right at 1263, which was broken just after the open on 12/7. The stop would have been set at the top of the 2b bar, or 1273, for a maximum loss, or “R,” of 10 points.

NOW, if we’re practicing prudent money management (and we all do, don’t we?), we might follow the practice most commonly employed by Dave Landry and others, and close half our position at “1R” while at the same time moving our stop to breakeven. We’d now be in the cushy position of having locked in at least a 5-point gain on our entire position, with half the position still in for a free ride.

If you’re unfamiliar with some of these concepts, fear not. Read the blogs of some of the folks who do this full-time (see my sidebar for a couple), read all the books you can get your hands on, and practice, practice, practice. I’ll fill in as many of the blanks as possible as the site evolves. I’ve still gotta get my old website stuff up, and then there is that living thing I’ve gotta try and fit in somewhere.