Smart Trading and Dumb Trading

As promised today I will be presenting two real time trades I took.  One simply awesome.  The other simple stupid.  Both show why sticking to the rules is so important and how emotions can and will hurt your trading.  

First let me show you the prep for the trade and take you on a journey through my brilliant mind.  The SPY 60 min PnF mind clearly showed me on the close of February 10 the support and resistance area of 179.97-179.76.  That is step one.  Check.

The next chart is a 15min SPY candlestick chart the a Volume by Price (VP) overlay for the past two trading days.  You will notice that our support and resistance area has the most amount of volume activity.  This is where the accumulation or distribution is clearly happening.  However, we will not know which one until the range is broken.  We get the answer the next day with a breakout above the range on increased volume. This is where going long would make sense. You will also notice how the SPY would breakout of each smaller trading range on increased volume validating the move higher.   So yes that was a text book long trade and makes trading seem like a piece of cake.  

The next trade made very little sense.  It was more along the line of 'If I'm selling my long position I should or short'.  In hindsight I realized how idiotic of a trade this was.  There was nothing on the chart at that point indicating a move lower.  I was lucky enough to get out with a tiny loss after we broke higher once again.  The lesson was learned and cost me little.  I hope this example helps I will be adding more as the trades happen so stay tuned.   Thanks for reading.

I have found the Holy Grail of Trading!

Now that I got your attention and probably lost any credibility I might have had with you I have not found the holy grail of trading.  The past month or so has been filled with several epiphanies and I think I found MY holy grail.  Which in short is just a trading system which I believe is complete enough to consistently make money using.  I will break down my trading system in steps and the tools I use to essentially document the trading system for myself and for all to see and criticize.  Below is the overview of the breakdown.

Wyckoff's Three Laws:  I've studied Richard Wyckoff's work and it is absolutely brilliant but the most important concepts that I believe every trader should have ingrained into their minds each and every time they analyze the markets are his three laws:

• The Law of Supply and Demand 
• The Law of Effort versus Result
• The Law of Cause and Effect

This is the cornerstone of my trading and all the tools I use evolve around these three rules.  I ask myself these questions each time I analyze the markets.

1. Are we trending or are we in a trading range?
2. If we are trending then is the effort (volume) supporting the result (price move)?
3. If we are in a trading range what are the upper and lower price boundaries?
4. What was the amount of volume and time spent in the trading range and does it support a sustained price increase/decrease to make money from?

Support and Resistance:  This is probably the most important aspect to any trading system.  Being able to accurately define support and resistance areas alone could result in at least a 50% chance of being right on any trade.  More importantly, it is at these support and resistance areas that the battle of demand and supply is fought determining if there will be a continuation of the trend or a reversal.  I have not found any other tool better than Point and Figure chart to accurately determine support and resistance and hence it is my tool of choice and has been since the beginning.

Volume:  The second most important aspect to any trading system.  Does volume precedes price?  I think so and I think anyone that relies on price only will have a more difficult time making money consistently in the market then one who uses both price and volume.  I am of the mind that you want to follow the big money and not fade them to really catch those big trends.  How would you determine if the big money is buying or selling without analyzing volume?  Volume analyzes the effort of each price move.  I use two tools to look at volume and that is simple volume bars and volume by price both of which help me determine the volume support at specific price levels and strength/decline of any trend.

Price Bar Analysis:  Candlesticks vs bars? Another of the trading community's  great debates.  Honestly, they both are telling you the same thing however, candlesticks are more visual.  In the end though so long as you can determine the journey of price for that time period represented by the price bar and if it was bearish or bullish then feel free to pick your poison of candlesticks or bars. Just a note that I will follow up with in a separate post, up bars are not always bullish and down bars are not always bearish.

In the posts to follow this one I will provide examples of my recent trading highlighting all the points I've mentioned above into my analysis.  You will notice that I don't use any traditional technical indicators which signal when to buy or when to sell.  The reason is they do not fit into my understanding of how the markets work.  A MACD or Stochastic does not tell me anything about supply and demand.  Below are my steps to trading and the time frame makes no difference. The analysis is exactly the same.  Just don't expect a 50 cent trading range on a 5 min chart to lead to a $10 breakout move.

Entry Analysis:

1.  Define support and resistance areas using point and figure charts
2.  Determine if we are in a current trend or trading range in the timeframe being analyzed.
3.  Determine any price and volume congestion using volume by price.
4. If we are in a trading range determine the next possible price pause area above and below the trading range. This will determine you risk reward on any breakout.
5. Wait for the breakout of the trading range and ideally a test of the breakout range to enter your trade.
6. If we are trending again determine the next possible price pause to determine you risk reward should you enter the trade.

Exit Analysis:

1.  I usually place my stop loss just below the top of the trading range on an breakout higher.  I've found that if the price comes back into the trading range then it usually isn't a good sign.  The same goes for a breakout lower from the trading range I will place the stop slightly higher than the bottom of the range.  The loss is usually very small and I've found myself when trading lower time frames that i will get stopped out 2 or 3 times before the trend kicks in and my profits completely overshadow any small losses I've taken.

2. If the price has moved in favor of my position then having the predefined levels of support and resistance and volume congestion zones handy really help.  Usually when price hits a support or resistance level it will usually go into another temporary trading range (remember this is where the battle of demand and supply happens) so you can either exist your position at whatever profit you have at the time or wait to see how the trading range resolves.

Price can sometimes simply pullback or bounce higher when it hits support or resistance respectively without going into a trading range.  I've found that when that happens its just a temporary pause in the move and the trend will continue in the original direction.  The reason being is that the pullback serves as an opportunity for the big money to pick up some cheaper shares from weak hands and then continue to rally the market.

You will notice that this is all really prep work before you even begin the trading day.  The rest of trading day is really just waiting and watching to enter based on your price and volume analysis.

So there you have it my trading plan.  In the following days I'll be posting with examples of my recent trading to highlight both the success and mistakes I've made.

Thanks for reading.

Things change

I'll admit the market was looking bullish since the past week every intraday decline was met with demand to close the day near the highs.  That came to an abrupt end today when the market crashed through the trading range.  These is decisively bearish in the short term.  I would like to see a rally to test the broken resistance around 1825-29 before initiating a short position.  So lets watch and see what happens.  

Thanks for reading. 

Stuck

Last time we highlighted the trading range between 1836.8-1829.2 which saw a short lived break to support before priced traded back in the range.  This signaled to me the strength (not the weakness I was anticipating) of the market since the bears failed to take advantage of the break of support.  Instead the market is looking more bullish as we are now making higher highs and higher lows in this now expanded trading range.  A break of the 1838.6 would lead me to believe that price will look to challenge the all time highs.

The SPX 15 min candlestick chart below highlights the trading activity over the past two trading sessions.  Prices have been trading in the upper end of the trading range and the declines have been short lived.  There appears to be absorption of the supply coming in at the top of the trading range which looks bullish.  The important part is we can see clearly from the PnF chart above the trading range boundaries which appear to be expanding upward.  So we wait for a breakout and jump on for the ride.

Thanks for reading.

Follow up

Ever look at a chart and say to yourself 'What a great setup!' and wait impatiently for the markets to open so you can start on your journey to making that first million?  Then when the moment comes you freeze like a deer in headlights.  I felt that today when I was looking at the opening bell and it took all my might to fight that feeling and just do it! In our last post we saw a clear trading range which on a break would have giving us the clue to the path of least resistance. I'll admit I did have a bias to the downside and was looking to play that.  Below is the SPX 15min PnF including today's trading action and you can see the trading range even more clearly between 1836.8-1829.2.

The SPX 5 min chart below highlights the quick move this morning to the top of the trading range only to fail and break support (bottom trading range). Interesting enough we had a test of broken support which was a good opportunity to go short.  Also notice the speed of the drop once support is broken.  If you are short then you know you first target is 1810 and you stop should be the top of the trading range risking about 7-8 points with a potential gain of 18-19 points.  Not a bad risk reward. 

Thanks for reading. 

2014 and beyond

“Cheers to a new year and another chance for us to get it right.”
― Oprah Winfrey

Happy New Year all.  It was a great holiday and always seemed too short.  However, like a good blacksmith and continued to sharpen my blade of knowledge reading and understanding the workings of the market.  Okay so I read a couple of days when the weather was bad outside in-between drinks. This year I'll will be posting only when i see potential set ups that I would like to execute on.  The posts will be shorter (thank goodness) but still helpful I believe.

Without further delay below is the SPX 15min PnF chart highlighting in green the current trading range.  We simply wait to see which way it breaks and jump on board.  The red area highlights the potential first target (support and resistance) on a break of the trading range.   Simple right?  Just try trading in real time. Not so simple.  I would like to see a break (either way) and subsequent test of the broken support/resistance area before having the confidence to enter a position but sometime the market is not that kind.

Lets watch and see.

Thanks for reading.

 

Wow

I totally saw today's massive move! Did you? 

Just kidding!  It has been a while since my last post but if you look back at the last couple of entries those price levels were still very relevant.  Of course back then we had just hit all time highs so we had to maneuver the markets by looking at intraday levels and watch as they manifest themselves into higher timeframes.  Below is the SPX 15min PnF chart posted on November 21st entry.   You will notice that even back then the 1773 area was growing in importance as a significant level of support and resistance.


Fast forward to December 13.  The SPX 30min PnF chart paints the same picture of support and resistance.  Once again you can see 1773 area (this time 1772) acting as support as price dropped from all time highs.  I want to point out that the variance in support and resistance is due to volatility.  Just look at the box size and how it changes.   Again we are only taking about 1 or 2 points or fractions of a percent.

Fast forward to today's massive move triggered by the Feds announcing a reduction of the bond buying program.  I remember a time not too long ago that the mention of tapering would have trigger a decent decline but I guess times have changed.  Support and resistance does not change and once again 1773 (1771) reveals itself as a significant area of support and resistance.  Additionally, we can now see that 1810 is current resistance.  So we now have a boarder trading range between 1810-1773 which for a short term trader is a decent size trading range.   Today's volume was massive which at these nose bleed levels is either the start of a new uptrend or the beginning of distribution to those that honestly believe that tapering will lead to a continued move up for the markets (and lower bond yields).    I'm leaning towards the distribution option myself.  The market will reveal its intentions in the next couple of days since we are at a key inflection point.  So lets wait and see.

As for me, this will be the last post for the year for me.  The past couple of months have been tough personally which served to distract me from analyzing the markets and of course posting regularly.  This year has however, been one of the most educational for me in my journey to better understanding the markets which I plan on continuing into 2014 and beyond.  I've posted close to 70 entries and often find myself repeating the same content which is boring me and probably everyone else.  For 2014 I will be changing things up by posting only when I see a trade setup and initiate my own trades based on that analysis.  I think that will be much more interesting to write and read about.

I just want to say to all my readers and followers to have a wonderful holiday and enjoy the time with loved ones.  The markets will always be here tomorrow so spend quality time with those around you.  Acts of benevolence provide far greater rewards then monetary riches.

"Happy Christmas to all, and to all a good-night!"