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Today, the reaction to the Fed announcement was classic… textbook, even. It’s the spike/ reversal scenario I’ve observed (and occasionally traded) for years, and documented step- by- step in September as referenced in the pre-announcement post earlier today (see “related link” below).

As I said, the reaction isn’t always so perfect. But when it is, it’s simply beautiful.

Here’s the hand-drawn scribble I used last month to explain the trade:

And now here’s a 3-minute chart of today’s action and The Trade:

The Big Dummy is onto something, n’est ce pas?

Today, the FFT gave an entry at 54.20 on the Qs, with an initial stop at the bottom of the spike-noodle (that’s my scientific term for it), or 54.04. That’s a total initial risk, or “R” of 16 cents.

Using a simple 2-bar trailing stop, the trade was exited at 54.88, for a gain of 68 cents, or 4.25R in only 36 minutes.

For you home gamers, that means risking $320 on the Qs would have returned $1360 in the same 36 minutes.

As I’ve also said before, this trade works maybe 60 percent of the time. Perhaps 5 or 6 “Fed days” each year. But when it does (like today, and big-time in June), it’s possible to make a serious gain in only a few minutes if traded correctly.

Related link: Profiting from the Fed Announcement: The Fed Fade Trade (15 Sep 07)

As always, cheers and best of luck.

[Please note this post is from 5/30/07; work and life intervened, and I’m publishing it a day late– ed.]

Today I noticed a pattern forming on the Qs, started drawing lines here and there, and lo and behold, a beautiful example emerged.

I’m talking about the Three Little Indians setup popularized by Linda Bradford Raschke (also known as Three Pushes to a Top, Three Drives, Three Waves to a Peak, Three Monkeys on a Branch, etc), and also the concept of the Wolfe Wave, a subset of Three Little Indians which has more particular rules, but which in return provides clear entry and exit targets.

Three Little Indians

Around midday, I was looking at the smooth swings the chart of the Qs was making as price methodically plodded higher. It’s gotta run out of steam at some point, I was thinking. Suddenly it occurred to me that I was looking at Three Little Indians:

Three higher highs, three higher lows. Time to watch for a double-top and failure.

Then I got to looking closer, saw that the second higher low was below the first peak at “1“, and realized I was looking at the elusive Wolfe Wave.

Wolfe Waves

In Wolfe Waves, the three highs are numbered according to the thrust, or “wave”:

Wolfe Waves have more stringent requirements than Three Little Indians. I’m no expert on them, so do your own homework, but on the chart above the following would be necessary:

• The thrusts must be evenly spaced, time-wise

• High “3” must be higher than high “1“

• Low “4” must retrace to below High “1” but not beyond Low “2“

• And so on… (to quote Vonnegut)

So, realizing we have a Wolfe Wave, we draw lines through 1-3 and 2-4. These lines should form a rising wedge in an uptrend and a falling wedge in a downtrend. We see on this chart they do:

Now the Wolfe Wave strategy says that point “5” typically is an exhaustion spike which exceeds the 1-3 trendline. A short could be entered on the failure back below that line. We see on the above chart that the price went ahead and walked up to the point of the wedge, still a good place to short.

What are we shooting (shorting) for? Wolfe gives us a target: The extension of a line between High “1” and Low “4“:

Enough already. What happened?

At this point one could theoretically flip and go back long (the primary direction of the day, after all), with an appropriate stop loss, of course. That would have worked to perfection today:

Again, I’m not an expert here. Caviar Emperor, as the Romans say.

Remember, none of these indicators predicts the future! They only help you to see when probability is likely to be on your side, and your trading skill and money management do the rest. A stochastics reading of 90 means nothing if a stock has just broken out of a range.

That’s me, from 2005, and repeated in the sticky page up in the navigation bar I called Dummy Wisdom.

See, I know the rules. We all do, except for the neophytes. That’s not the problem. The problem is in the execution. Remembering to follow those rules. And I still fall off the wagon every time I turn around.

The S&P had the big selloff, then bottomed, then rose on decreasing volume. Then it started throwing off topping candles. This chart is the best example I’ve ever seen of why we need to wait for confirmation of what appears to be a bearish topping formation:

The dojis and hanging men have cried “Wolf!” over and over, only to be cancelled by another up-thrust. And the whole time everyone and their brother has oscillators showing overbought.

Anecdotally at least, it seems to me that the only times I remember everything getting pegged against the redline for this long (where so many shorts and longs get stopped from the excessive extension) are when we’ve been at the first thrust of a major trend, usually in the opposite direction of the preceeding one. I plan to do some “real” research on this in the near future and see if it holds water, or if it’s just wishful thinking brought on by the nostalgia hidden behind the cobwebs in the attic of my mind.

I’m off to Six Flags with my girlz. Ya’ll have a good weekend.

Red Alert: Today the SPYders formed a Bearish Doji Star:

Tomorrow’s action will tell whether that becomes a full-fledged Bearish Evening Doji Star or not. This formation is one of the strongest “reversal formations” you’ll see. How would I trade it?

• On a gap-down opening tomorrow, I’d look for any intraday setup to get short for a daytrade potentially turning into a swing trade by the close. A gap down, rise to today’s low, and failure would be perfect, which means it’s unlikely.

• On an opening within today’s range, I’d view it as a short-term swing, waiting for the break of today’s bottom of 146.65 for an entry, with a stop at the entry bar’s high.

• On a gap-UP opening, I might get short on an OGRe, but with a reduced position size. A gap up would indicate residual buying pressure, negating the Evening Star’s signal.

GOOG Pullback After Double Top

With all the 100% positive press Google gets, you’d never suspect that it was pulling back into a big ‘ole double top:

Note the volume pattern on that last upswing. Their earnings “news” Thursday had better be gangbusters, else we may see just how deep (and cold) that water is…

Don’t Forget Options Expiry!

Options Expiry is this Friday. That usually means a great excuse to take a 4-day weekend, as everything gets pinned in a range. However, you may want to have a laptop nearby as you grill and drink. Never know when we’ll have another Black Swan options expiry day like January 20, 2006 (if you click it, read on down- it gets more interesting towards the bottom). The current setup is ripe to be clobbered by a “precipitating event”; be prepared in case we get one.

This morning at about 6AM, my head was full of ideas. Articles, essays, witticisms. Now here I am 14 hours later, and all I can think about is a steak, a glass of warm red wine, a little reading, and a good night’s sleep. Unfortunately I’m still in the live to trade camp, vs. the trade to live one, and I get too tired from my profession to pursue my passion. It sucks.

However, we’re at that place, with the S&P above its February Highs and the NDX threatening. So I’ve got to at least throw out some thoughts.

UNO

Clearly scenario one from my 08 April post has not materialized. So that one’s a shift-Delete.

DOS

Now we’re staring scenario two in the eyeballs. Remember, a failure from this breakout will spell a swift and steep decline. Be prepared. This will call for a rapid reversal by longs, or rapid adds or just high-fives all around by shorts.

TRES

‘Course, there still lurks scenario three, where we all end up long. My short stop is at 148.50 on the SPYders. (The second baseman is “WHAT”, BTW). I won’t like getting long, with the dollar only one cent from a historical breakdown against the Euro, but if the chart raises its shirt and flashes an uptrend, well, how can we refuse?

Food For Thought: SPY, VIX, and Fibs

Here’s a chart of the SPYders, with the volume emphasized, including a 10-day moving average of the volume. Note the volume trend, even with today’s “breakout”:

Now here’s a chart of the VIX, with a 10-day SMA also. Chances are you weren’t with me back when I wrote about the VIX Fade Trade. It’s still a valid concept to keep in mind:

And for the veddy intevesting picture? Let’s look at the VIX overlayed on the volume of the SPY:

Like a hand in a glove, and both showing that the current short-term trend shouldn’t be trusted at this point. In other words, if we’re looking to go long, best to wait for scenario three above, where we get a thrust on higher volume and a nice “take me now baby” pullback.

Finally, one you Fibonacci Retracement fans should note, and one you Fibonacci critics should note even more notably:

The old Golden Ratio, with no other technical analysis, provided a perfect support point to go long after the selloff. Fibs aren’t magical- nothing is. But you’d be doing yourself a favor to keep them in your toolbox with your other technical studies.

Cheers. Let’s make some money.

This morning, QQQQ, SPY and a host of individual stocks opened with what at first appeared to be a prime opportunity to go short, but which rapidly turned into a chance to make a high-percentage long trade. The cue to change directions came from one of our favorite old friends: the OGRe, or Opening Gap Reversal.

In my post yesterday, I talked about the plethora of short setups showing. So what went wrong? Nothing! Setups are not magic crystal balls which always tell us where the market (or an individual stock) is going. They simply help us to judge the probability of a move and (hopefully) give us an edge over pure chance. How we use that probability and whether we make or lose money has everything to do with our Trading Plan (entries/exits, stops, position sizing, etc), not with being “right” all the time.

If you are looking for a way to be right all the time, you should not be trading! Trading is about discipline and money management, and it is entirely possible to make money while being “right” only 30% of the time. It’s also possible to lose money while being “right” 70% of the time.

Good Setups Gone Bad

Good setups can be very powerful. But paradoxically, an even stronger signal often comes from a good setup that fails.

What we got today were failed short setups all around. It’s not that the setups weren’t there. Even Oscar and his OMNI (which is correct so much you’d think he must have drinks with Mr. Dow and Mr. Jones every evening) were pointing down.

What I think happened today is that looking to go short was a little too obvious. There is an old rule that The Market likes to make its moves with as few people on board as possible. On a day like today, the very best way for The Market to shake off the most barnacles (traders) is the old Michael Jordan Head Fake, aka the OGRe.

OGRes are powerful because they catch so many people looking the other way. It can seem counterintuitive at first, but if we learn to watch for them, we can take advantage of these high-probability morning patterns.

Here’s a diagram of what an OGRe looks like on a daily chart:

There’s not a special Japanese Candlestick name for an OGRe, although many notable and powerful candles can start out as OGRes, candles such as the bullish piercing, bullish and bearish engulfing, dark cloud cover and the squirrel on a transformer. Ok, I made that last one up.

Today’s OGRe Example, Brought To You By QQQQ

Many, many individual stocks had similar formations today, so let’s just look at Big Daddy:

The chart never showed a short entry. It gapped down and then ran down farther. Be careful not to be taken in by the panic to get short on a gap-down opening like today. Patience, grasshoppa. Wait for an entry, then when it happens take it and set your initial stop.

At 1005, the QQQQ pierced into the Opening Gap, at which point we’d start watching for the first pullback to get long. That pullback happened immediately, and on the 1020 bars’ break of the 1015 bar’s high, we had a spot for an entry into a beautiful daytrade.

Here’s what today’s OGRe looked like on a daily chart:

This bullish piercing candle, which began with the OGRe this morning, may provide an entry for a short-term long entry tomorrow. I say short-term because I don’t believe this rally. Only a confirmed break of the February highs will convince me.

And, lest I be remiss, I must show my dear AAPL:

That, my friends, is a picture-perfect hammer, the break of whose top will provide a great jump-in point for yet another short-term long trade. Alas, not for me. I am sworn, or doomed, to make my money from Apple on the short side.

That’s all for now, ya’ll. I gotta get to bed.

First, a quick look at The Market Today. As you know, the Dow and S&P remain firmly in their uptrends, and both set new highs again today (for the Dow it was another all-time high). I don’t think that’s news to anyone. What may have fallen by the wayside is the fact that the Dow Transports also hit another intraday and closing high today:

That’s what the Dow Theorists would call a bit of confirmation (the stock market version, not the Catholic one). Very rosy news (couldn’t help the pun, with Valentine’s and all), but there’s one more bit of confirmation that would make the picture complete:

Yep, the Nasdaq 100 is still going solidly Sideways, in a formation which, over the last 3 months, looks a bit like a Head and Shoulders (and yes, I’m a bit delirious tonight and started to link to this).

However, we’re also less than one good solid “up” day from breaking out to a new high, so the next few trading sessions will be veddy interrresting. We’re near the top of what would be the right shoulder if it fails from here without breaking the former high of 45.40.

Was lucky enough to work late today, so had an hour or so after the market opened to doodle around with Ameritrade StrategyDesk a bit during market hours (so far I’ve been using it for End-of-Day backtesting). I must say I was certainly still frustrated with the clunky interface, but again pleased with the program’s potential. I set up a test alert screen to kick out stocks which had gapped up, were in the top half of the day’s trading range, and were within “x” cents of the last “y” minutes’ high (I varied this one, for instance, within 10 cents of the last 15 minutes’ high).

StrategyDesk’s charts are simply a pain in the butt, so I just used it for the screener. I had it on my left monitor, Quotetracker (main window) on my middle monitor, Firefox with 3-4 tabbed sites (Yahoo, Prophet.net, Order entry) on the right monitor, and various QuoteTracker charts scattered across all three monitors.

When I cross-referenced the stocks the StrategyDesk screen burped out with my usual Prophet.net screen, I got some very promising results. For instance, early-on the combo was sitting on CIEN and AMAT like Dickey Betts sitting on that last riff in Ramblin’ Man.

After firmly establishing the major tonality with a singing bend of the 9th or 2nd (A) from the Aeolian mode to the major 3rd (B), he basically treats measures 1–6 (I and IV) as a G tonality and emphasizes the root (G), 3rd (B), and 5th (D) notes from the G major triad. Measures 11 (vi) and 15 (I) are the only time that Betts uses the b6th (C) from the Aeolian mode as a quick pull-off to the B (major 7th of C and 3rd of G) for melodic variety. (from the “Fender Players’ Club”)

Yeah… whatever. But AMAT was a good early-day play, and CIEN just ran and ran thru midday, so I’ll be doing more research in this general direction.

A couple days back an astute regular commenter pointed out the huge down day on Mastercard (MA). I had mentioned that we might get a setup out of it. Well, Fan, here’s our pullback:

The pullback broke through the 61.8% Fibonacci level, but that’s not a deal-breaker, just something of note which takes the probability of our setup down a few percent.

The volume has been diminishing beautifully on the pullback. Classic.

What do we do? I’ll be looking to enter short on a resumption of the downtrend tomorrow, if it happens. A continuation of this “up” thrust much past the 50% point (108 and change), and we’ll go into wait-and-see mode, as there may be too much buying interest to go short. If I do Get Shorty, I’ll set a tight stop just above the pullback high, calculate the difference between that and my entry point (tah-dah! “R“), and size my position accordingly.

Cheers… let’s watch…

• Supper Tonight: The fabulous chicken and egg (how synergistic) sandwich with caffeine-free Sam's Choice diet cola. Yum.
• Watching: "The Departed" if I can stay awake

First, let’s take a quick look at the Qs overlaid with one of the best indicators on earth- Dave Landry’s Big Blue Arrows (and if you want to laugh your butt off, here’s Dave and his Blue Arrows featuring his Top Analyst):

There’s no long-term trade here without a break out of this range, say above 45 or below 43, plus or minus.

Now let’s look at a couple of our most favoritest regular visitors, Boss Google and Boss Cisco. They’re important not only as potential trades, but also because of the effect they have on the NDX and consequently the overall market. They’re both at very crucial points where they need to get off their bee-hinds and show us some strength, or throw in the towel and slide on down the slippery slope. First, GOOG:

Nice, precise “to the penny” double-top action there. We failed out of that second top on big volume, and now the volume’s tapered off. Here’s a closer zoom:

A resumption of the downtrend tomorrow would be a perfect opportunity to move our stops down to today’s high 474.35, (since today’s high will then qualify as a minor pullback top). For someone not short, a resumption would be an opportunity to enter, set a nice tight stop, and join the rest of us shorties.

Google also has the option of breaking out to the upside, which will see many a pretty little 3-day swinger stopped out.

And Cisco. Oh, Cisco. How about that good news?

Stocks inched higher Wednesday after Wall Street welcomed a robust sales forecast from Cisco Systems Inc. and a stronger-than-expected productivity reading.

***

In corporate news, Cisco rose $1.07, or 3.9 percent, to $28.35 after the networking equipment maker predicted its third-quarter revenue would rise 19 to 20 percent.

from an AP article entitled Stocks Rise on Cisco, Productivity News and reprinted by virtually every news organization

So, Cisco rose 3.9 percent, eh? Close- to- close, yeah. But what does the chart say?

It opened way up, then pulled an OGRe (Opening Gap Reversal) and went down, down, down all day. The OGRe would have been a perfect point to get short (anytime a stock gaps way up and pulls an OGRe on you, it’s begging to be shorted). However, I must note that the failure of the OGRe happened at about 0934 at approx. 28.60, and most of us mere mortals like to let things shake out for 30 minutes or more, so it wasn’t that much of an opportunity.

Today could be the failed second top to that 1/11 “highest high.” Since we have a gap below it and it was such a high-volume bar, it’s a pretty straightforward trade: short a break of today’s low with a stop just above the big resistance at 29.00. We either make money or lose a buck. If we lose a buck, that means it’s broken to a new high, and that’s an opportunity to look for trades in the other direction. Sweet.

• Accomplished Today: Worked at the Cancer Center; tore up my in-dash CD changer; pulled the battery on my VFR800, it's old and drained and I plan to go through 2 sets of tires this year