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How’s that for a teaser title?

In trading, our job is to read the chart to the best of our abilities, then to position so that we stand to gain significantly relative to the loss we will sustain if our initial stop (and we’ve always got to have one) is hit.

The S&P has rebounded back to the top of the Big Drop Day of 2/27/07. This puts us just into a major area of support/ resistance, and we should be prepared to see some action.

From here, of all the possible scenarios, there are three which I think stand out, and I’ve been considering how I’ll trade each of them. Let’s take a look at them.

Scenario One is where we head down from where we are now, at the bottom of the S/R band:

The diminishing volume leading up to the last close makes this setup very plausible, and it’s where I came up with the plan to add to my short position on a failure from here, moving my stop down to the top of the resistance band or even slightly into it.

Scenario Two would provide an extremely strong signal and trade opportunity. This is the setup where price climbs through the resistance, pops up above the February highs, then fails back below those highs:

Such a failure would be swift and strong, likely falling rapidly to the March lows and probably below. I’m talking, of course, about the start of a Bear Market.

Scenario Three is the optimistic Dorothy setup where we get to go long:

On a strong thrust up and away from the Support/ Resistance area, I’ll wait patiently for the first pullback on decreasing volume, and I’ll get long with great vigor. Of course, I’ll get stopped out of my shorts first.

Why am I keeping the shorts on? Well, first, it’s been cold lately with that Canadian air making it all the way down here. Pa-dum-pump. No really, it’s that I’ve got a position I’m comfortable with and I’m waiting for a signal to add to it, or else my stop will be triggered. All I have to do is follow my plan. Second, I think that the last (long optimistic Dorothy) scenario is the least likely of the three.

I could be wrong. I often am. However, this game is not about being right all the time. It’s about how you position, and then how you manage those positions so that you lose small when you’re wrong (and you’re gonna be), and so that you gain as much as possible when you do happen to get up on your board and ride that big wave towards the shore. Shoot the tube, baby, shoot the tube!