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!