Broken Record

Repetition of the same thought or physical action develops into a habit which, repeated frequently enough, becomes an automatic reflex.Norman Vincent Peale

I know this blog, now only a month old, sounds like a broken record.  Supply and demand, support and resistance,  volume, <insert offensive comments>, blah blah blah.  However, the quote above is exactly what I'm shooting for.  Just like a good athlete that practices the same moves and set ups over and over again until it is second nature to them when the opportunity presents itself they don't have to think about it they simply react.  This is analogous to a good trader.  The best part is you don't have to be perfect you just have to be good.  Good traders just like good athletes can perform under pressure.  More importantly they believe in their abilities and react automatically to the setups they have studied and seen a thousand times before.   Imagine if Michael Jordan paused and wondered if he should shoot or dunk each time he was passed the ball with only seconds left on the clock.

The three day rally that ensued was no surprise and where it hit resistance is even less of a surprise.  I had been expecting some type of rally based on the large volume seen on the recent down move.  I saw that as a transfer of ownership from the weak to the strong handed market players.  We saw the importance of the 1594 area acting as both support and resistance this week and watched as it broke and tested this area before rallying to a high of 1620 this week.  But why did it stop there you ask?  If you look at the daily chart of the SPX below you will see that on Thursday both the 50 day and 20 day simple moving average converged right at 1620.  I spoken extensively about the importance of the 50 day moving average (dma) on this blog as well as the 20dma.  You can read these bits of brilliance here.

To have both moving averages converge at the same point would have been a great opportunity to assess the potential of either reducing longs or adding shorts. Also note that we had a bearish cross over of these moving average not seen since November 5th 2012.  Just saying.  However, remember the larger plan here or at least one of the many set ups I believe may transpire.  We have had a relatively large volume  downmove with a resulting low volume up move.  I view the large volume as bullish especially considering it happened in and around major support levels.  However, before I can believe the market will continue to move higher I would like to see a test of the high volume area between 1576 and 1594 on lower volume and of course with these support levels holding.  Why?  Because the low volume test would signal to me that there is a lack of supply and that the previous high volume area was indeed a transfer of stock from weak to strong hands.   So lets see what happens next week as it should provide us some good opportunity.  The market is ready to pass you the ball are you going to be Michael Jordan or Sun Yue?  Who is Sun Yue?  Exactly.

Thanks for reading.

Principles

Important principles may, and must, be inflexible. Abraham Lincoln
Obey the principles without being bound by them. Bruce Lee

I am not sure which one the above quotes resonance with me more.  Abe Lincoln, a champion for human liberty remained steadfast to his principles even in the face of adversity. Or Bruce Lee who kicked Kareem Abdul Jabbar in the head.  Regardless of which one you shape your life by the fact is each were successful by following or obeying (as Bruce put it) their principles.  This is what this blog is all about.  Big love and principles.  The principles of supply and demand that I keep yammering on about remain the same regardless of the time frame we are looking at.  However, the principles that may not be readily apparent on the a higher time frame may appear crystal clear on lower time frame.

To demonstrate the point, yesterday we spoke again about the importance of the 1594 support and resistance level.  Yesterday it acted as resistance.  Today is was support.  If we look at the daily chart we know that the low for the day was 1594.94 but doesn't really demonstrate the principles.  The lower time frames reveals much more about and better demonstrates the battle of supply and demand.  The SPX 30 min chart below shows that price gapped up above the 1594 area at the opening bell today followed by a decline back to the 1594 area (1594.94) before the lunch time rally began.  Resistance was clearly broken at the open but it was the test of that broken resistance which was subsequently confirm as support which would have given me the confidence to go long.  What do i mean by 'confirm as support'?  We define support as an area where demand overcomes supply,  If price moved back to to the area of broken resistance and continue lower accompanied by higher volume then we know that supply was present and overcame demand.  That level would once again be considered resistance.  Instead what we saw today was price falling back to broke resistance on lower volume with the 30 min candlesticks closing off their lows as price approached the 1594 area.  This indicated that either demand was present or simply supply was lacking.  Either way demand was winning the battle at the 1594 level and a rally ensued.  Simple right?  Now try to do it in real time.  Big love for all!

Thanks for reading.

Time is money

You may delay, but time will not.

Benjamin Franklin

These are but two of many of Benjamin Franklin's famous quotes.  Actually, he has over 400 recorded quotes.  Benny sounded like a chatty patty.

Yesterday I spoke about the need to be patient.  Patient is usually equated with waiting.  Waiting means the passage of time.  Waiting causes anxiety in some.  I wonder if its our innate fear of time passing that causes us to be impatient.  Then we have quotes like 'Time is money' that place a monetary value on our limited time.  Or those of us that place deadlines for our success.  How many of you have already planned to retire rich from trading in the next 5 years?  Maybe this is what leads to so many bad trading decisions.  It is the need to profit quickly to meet our lofty goals essentially placing a great value on our time.  But enough of my Aristotle type babble and to the point which is you cannot 'time the market' in the sense of predicting when price will reach a certain level or target.  You must simply react when it does.

Yesterday I posted that should a rally ensue that the likely target would be the support turned resistance area of 1594.  Today's high was 1593.79.  Stop the applause please! Did I know that this was going to happen today.  No.  Actually I didn't know if was going to happen at all.  Support and resistance is not only where the battle of supply and demand has happened in the past it is also the 'time' to make a trading decision.  We react to these levels using the theory of demand and supply using volume - the main predictor of such behavior.

So why did price stop at 1594?  Price stalled at this level simply because supply overcame demand.  Plain and simple.  In order to break this resistance area demand needs to overcome supply which is the definition of support.  This is the reason why support becomes resistance and resistance becomes support.

So are we going to tank now?  Maybe.  Or maybe we simply move back to support (1578) and look at volume for clues for our next trading decision. Or maybe we break our predefined resistance area (1594).  Lets wait be patience and during this passage of time come up with some life changing quotes.

Thanks for reading.

Old and Experienced

Anyone who stops learning is old, whether at twenty or eighty. Anyone who keeps learning stays young. The greatest thing in life is to keep your mind young.Henry Ford

Henry checked out at the ripe age of 83 so I guess he was an expert on the subject but that hasn't changed my opinion that growing old sucks! Body aches are more frequent, healing takes forever, your facial cartilage continues to grow making you look more elephant than human and throwing your hip out during fervid intercourse is a distinct possibility.   Many believe that with age comes wisdom.  I believe with age comes experiences and wisdom comes from learning from those experiences and acting accordingly in similar situations.  When it comes to the trading world I have known traders and investors that gloat about the number for years that they have been in the 'game'. They all had great insight into the inner workings of the market and most of them had called 10 of the last 3 major market tops.  They could talk the talk and carry a decent conversation about the markets but seem incapable of walking the walk.  Is the human race so self-defeating that we can commit the most heinous of trading mistakes over and over again and not learn from them? Why aren't we getting any wiser?  This isn't a rhetorical question I honestly don't know.  I can only conclude that the emotions of fear and greed are too overwhelming for even the most experienced of traders to tame.

I believe there are 2 parts to a trading plan:  1) Market analysis and the execution of your analysis using proper risk and money management.

Market Analysis

Have a way of analyzing the markets in a consistent way. By consistent I mean don't flip flop between indicators or methodologies.  The new SuperDuperBigMoney indicator that Marky Markets is selling for only $199.99 isn't going to become a money making machine unless it fits into your existing analysis.  Understand that markets are a function of supply and demand.  Build on this premise and study the concepts  (like price and volume :)) over and over again.  You will come to many self-realizations that will allow you to put meaning behind the words of supply and demand and the relationship with price.   Believe in the concepts that you are studying to the point that you can explain them to others easily with clarity and confidence. Study the markets with a psychological lens.  Understand when the big boys are unusually active or disinterested and what is their intent.  Understand the tactics used to lead the retailer traders to slaughter and join the attack.  Look at your trading account as if it was the account of someone else.  If you are up congrats keep up the good work if you are down then swallow that pride without choking and admit there is an issue with your trading and fix it.  You are only fooling yourself in the end.  Validate your analysis by backtesting your rules but be honest and don't curve fit the analysis.  Again, you are only fooling yourself in the end.  Be consistent each and every time to the point that your trading seems mundane but profitable.  This will help keep your emotions in check.

Risk and Money Management

So you studied the markets for months, back tested your trading analysis and found a decent number of trade opportunities that you would execute and profit.  So what is the next step?  Of course plowing 100% of your capital into the next set up and retire.  Duh!  To be serious for a moment (only a moment) being able to analyze the markets is part of the trading plan the other part, which I believe is the most important part, is the execution. When do you get in? When do you get out? When do you know when to hold'em, know when to fold'em? Again this is the pitfall for many.  If emotion is the arch enemy of traders then maybe laying out some hard and fast rules and not deviating from them may help with the emotional aspect of trading.  I do relatively well with my directional options trading when my trading plan is executed with very strict rules.  I realized that if I was consistent with trade execution and didn't deviate regardless of what I was feeling that the merits (profit) of my trading system would reveal itself.  If I was constantly changing the rules then how would I know that my trading plan was profitable.  When I identified a trade setup I allocate the same amount of capital and set the same stop loss amount which is 2.5% of my account. Changing the allocated amount would mean that one trade set up is 'better' than another.  To me that negates the principle of consistence.  It also means that somehow I have discover some additional insight into the outcome of the trade.  The percentage I allocate is an amount I am comfortable with keeping the emotion of fear at bay.  I view each trade as a potential loser and ask if I'm okay with this loss.  I also started to look at risk and reward in terms of percentage changes vs absolute amounts, again to tame the emotions of fear and greed.  Which sounds more exciting making $2500 or 2.5%?  Use the one that doesn't get you excited.    Lastly, I always enter a stop loss and limit sell order immediately after my trade is executed.  The reason is that I cannot rely on myself to enter the order should my pre-defined profit target be reached.  I'm just too greedy! This is not to say that I won't adjust or move my stop loss up (only up) to breakeven but the idea is to automate as much of your trading as possible to remove the emotion  that leads to bad decision making.  

Thanks for reading

50/50

I'll be honest with you, I did not think the 50 day moving average (dma) was going to hold again after yesterdays close but then again the market doesn't really give a rats ass what I think or feel.  Good lesson on why you should not follow your gut feeling especially when it may turnout to be a gastral anomaly.  Once again the 50 dma which is a widely used average by many market participants acted as a spring board for a bounce higher.  So regardless of my gastral issues I would have not shorted even after yesterdays poor close and increase in volume because of its proximity to this average.  If however, it broke the 50 dma and subsequently tested it be resistance then a short position might have been viewed as the higher probability trade. So patience would have been in order here.  But of course I saw this massive rally today...didn't everyone?  Just kidding.  What I did see was a similar set up that I posted about last week.  The 5 min chart of the SPY below reveals the same activity as we spoke about previously around the 50dma.  The only real difference was that there was no dip back into the area of support but then again this happened only 10 minutes after the opening bell and the volume, like it always is after the bell, was very high.  The transfer from weak to strong hands happened fairly quickly and the market never looked back.

On the daily chart below we went from a bearish scenario yesterday where price closed near the low of the day on increased volume to now a bullish engulfing pattern today with price closing on the highs, on slightly lower volume. So where do we go from here.  Probably back to resistance and if you read any of my poorly written posts would know that sits at $165.  When is it going to happen?  Beats me and it might not even make it there!  If it does you should be prepared to make a decision and maybe take a peak at what volume is doing if price does get there for additional clues, Most important of all is remember to take your GasX if it does and listen to the charts and not your bloated stomach.

Thanks for reading.

50 Shades of Grey

Haven't read it.  It's referred to as 'mommy porn'.  I'll wait for the 'daddy porn' version. Although the 'The Fifty Shades of Gay' parody sounds amusing.   As I mentioned in my last post we were expecting a move to the 50 day moving average (dma) to act as support.  Now the logical question would be why is the 50dma important? Why would it act as a support and resistance area?  Who knows and really who cares.  What is important to understand is that it is widely used by many investors and analysts.  My goal is to find significant levels of support and resistance and analyze the activity around these levels using volume to better understand what price has and may potentially do.  I view the 50dma as a freebie.  It's readily available and we know its an important psychological level for many traders (except for those clever folks that think using a 51dma somehow provides a trading edge).  We also know that many traders will place stops (both buy spots and stop losses) in and around the 50 dma.  So do the professionals who will use that to their advantage to shake you out of your positions by running your stops and buying when you are selling and selling when you are buying.  Yes, its a conspiracy theory!  Where is Jesse Ventura when you need him!

With this in mind lets take a look at what happened today with the SPY.  In our previous post we identified $162.80 as a level of broken support which lead to us anticipating a move to the 50dma which was at $160.48 as of yesterdays close and rising.  As you can see from the 5 minute SPY chart below the amount of volume increased considerable when price reached $160.48 (blue line).  What is especially interesting to note is the bar at 12:25am when price broke below the 50dma on significantly higher volume but price closed near the highs.  If I had to guess I would say that the stops where taken out and the small guy was selling (getting stopped out) to the big guy that was buying.  Remember the definition of support is where demand overcomes supply.  Volume represents the level of activity of demand and supply  The price closing above support with the hammer candlestick and high volume all indicated bullish behavior.  

Again, I would have waited for confirmation of the $160.48 support area by waiting for a successful test before initiating a long position.  Why?  Because I've found that at areas of significant support and resistance area there will always be test of that level on one of the lower time frames.  I believe the test is a way of confirming that the remaining supply (demand) has been removed represented by lower volume on the way down (up) to test the support (resistance) area.  This is exactly what happened 30 minutes later at 12:55am when price came back down on significantly lower volume to test the $160.48 area of support before rallying.  Pretty interesting I would say.  What is even more interesting is how price closed just 7 cents shy of the $162.80 resistance area!  Someone call Mr. Ventura ASAP!!!

Thanks for reading.

Don't try to catch a falling knife

Don't try to catch a falling knife!

The person that came up with that saying was obviously not a ninja.  Speaking of things falling the market was taken to the woodshed today (don't you love these English idioms),  I'm sure there are a lot of bears out there pounding their chests tell you they saw it coming and I'm sure some did but I'm sure  the rest 'saw it coming' since going short in late November 2012.  So how could someone, if they were so inclined, have seen this drop coming.  The reality is most retail traders believe they know exactly where the market is heading and lose money and I believe its that conviction (a synonym for stubborn) that is their trading downfall.  They anticipate when they should react.  Let me explain what I mean for the less gifted (intelligent).  The definition for anticipating and react is as follows:

Anticipating:  Guess or be aware of (what will happen) and take action in order to be prepared.

React:  Respond or behave in a particular way in response to something:

Trying to anticipate tops and bottoms is synonymous with guessing and usually traders find themselves jumping the gun on a trade. There must be some type of innate need or maybe something programmed by the society we live in that we have to be first in everything in order to prove ourselves better than the next person.  It is the only rationale I can think of that would make one so anxious to get into a trade in hopes of an imminent reversal of a prevailing trend.  Unfortunately, far too often the rationale for the trades come only after the trade is executed and is backed up with sound analysis such as '...the price fell  so much it has to bounce!'  or '.....I bought at double the price let me average down!'.  All solid reasons in there own right and I'm sure their trade account balances reflect the merits of that analysis.  

Reacting in the context of trading, means to respond in a particular way to a market move. Anticipating a move is a precursor to reacting to the expected move.  Reacting requires patience, a control of emotions and to be devoid of pride and ego understanding that its okay to not pick the exact top or bottom and that waiting for the move to transpire and get on early enough results in a trade with a higher probability of success. 

So with that in mind lets look at today's SP500 action and see what so many already knew what was coming! 

First you will notice that I had predefined levels of support and resistance taking from a 30 minute PnF chart from June 4th.  On an intraday basis 165.00 and 162.80 are support and resistance areas.  This is key because knowing these levels ahead of time will help eliminate the need to anticipate a move.  I always tell people that I don't have to make a decision until price reaches a predefined level of support and resistance.  

So as you can see on the 5 min SPY chart below we plotted those predefined levels of support and resistance.  Here is where the concept of reacting vs anticipating is important.  In the morning, at approximately 10:10AM the market quickly fell to $162.80.   If I had anticipated a bounce from that support level I would have simply bought at this level.   Instead I opted to wait to see how the next bar closed to confirm my expectations of a bounce.  The next 5 min bar broke and closed below support ending on the low with the highest volume bar at that point.  To me that signaled supply entering the market. Again, I could have anticipated now a move lower and entered a short and as you can see that would have been profitable trade.  Instead, I always tend to wait for broken support (especially on high volume) to be tested and confirmed as resistance.  (Remember my definitions of Support and Resistance).    That is exactly what happened at 10:30AM.  After a weak bounce back into what was now resistance on lower volume it was at that point that a short trade had a high probability of success.   See how easy that was in hindsight! :)  'Brilliant!' you are thinking.  So where do we go from here?  I anticipate a move lower to either the 50 daily moving average at $160.48 and if that doesn't hold then $159.50 (hint: check the PnF above).   Thanks for your reading!

In the beginning - The Strategy

"For the love of money is a root of all kinds of evils. It is through this craving that some have wandered away from the faith and pierced themselves with many pangs."

1 Timothy 6:10

That Tim fellow sure had some powerful insight on human behavior and it looks like things haven't changed all that much two thousand or so years later.  Yeah! Greedy people rock!  We humans are creatures of habit and the old adage that the market is based on fear and greed has never been more true.

So what is my point?  Good question.  My ADHD aside my point is that the market just like people has a mannerism to it that is understood and exploited by professionals.  Simply put the tendency is to get greedy at the top and fearful at the bottom and lose money.  But don't feel bad because this is exactly what is expected of you by those that understand the human psyche (and can control their own) to make them profitable.  See you do serve a purpose in this world.  Now this is nothing original by any stretch but it does make up the basis of my trading strategy, which is to try to identify potentially profitable trading opportunities during times of fear and greed.  I said 'potentially profitable' because there is no holy grail here kids.  We are searching for high probability set ups.

My tools are not very impressive but the way I use these tools is what I think is important.   Price and volume are my weapons of choice.  You will NOT see a MACD (I remember the first time I heard someone can it the MAC-D I thought of McDonalds), no RSI, no Stochastics, no <Insert the Last Name of some mathematician> Indicator on any of my charts.

I use Point and Figure (PnF) charts to analyze price action.  This simple but powerful chart of just Xs and Os is all I need to identify major support and resistance levels with pinpoint accuracy that I can use to trade.  Very few people I know actually use PnF charts which I think is why I like them so much.  I have to feel special.  However, my analysis of price is two fold:  1: To determine significant levels of support and resistance  2:  Analyze the price range for a specific period of time to assess the strength of the price move for that period.

Volume is always analyzed with respects to what price has done.  I believe that volume is the primary indicator of supply and demand. When analyzing price (i.e. support and resistance levels) with volume analysis (i.e supply and demand) a very simple and powerful tool set to assess market movements arises like a phoenix from the ashes of your trading account.  The plan of this blog besides to amuse myself is to show this in action and provide a perspective on how I analysis the markets. 

So here is my trading secret ladies and gents! 

Support = Demand overcomes Supply
Resistance = Supply overcomes Demand
Support is broken when Supply overcomes Demand (definition of Resistance)
Resistance is broken when Demand overcomes Supply (definition of Support)

Don't worry this will make more sense over time as you follow me on this fruitless and thankless  journey of charting the markets using the simple tools I've described.

Thanks for reading!