Daily Archives: September 1, 2010

Resilience

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Let me start with an important premise: I love trading. Because if I didn't love trading, days like today would have compelled me to quit long, long ago.

My love for trading makes the thousands of hours I put into charting and doing this blog each year seem almost effortless. Most of the time, there's really nothing else I'd rather be doing.

So I've had thoughts racing through my head all day long, particularly after the close. I've been questioning myself, my methods, my approach………everything. By "question", I don't mean "dismissing"; I mean critically analyzing. I still believe my style and approach to the markets work best for me, although, unfortunately, it has been very out-of-synch with the market for far too long.

So what has all this thinking yielded? Two important questions I've been posing to myself:

Why not just resort to day-trading? It's tempting. When I read about nummy having something like 28 profitable days in a row, and Market Sniper having – what was it? – something like 50 – – not to mention day traders not having to worry about overnight gaps, it is horribly tempting to throw all the knowledge I've built over the past quarter-century into the shredder and just take that approach. But, simply stated, that just isn't me, and it's not my style. There's a reason I approach the markets the way I do; sometimes it works brilliantly; sometimes it seems foolhardy. Lately, it seems to be more of the latter. But throwing my arms up and completely changing styles just because I'm frustrated doesn't seem prudent to me, although I'm willing to hear other opinions.

What worries you more than anything? It isn't pre-election shenanigans; it isn't monthly OPEX silliness; it isn't the Fed; it isn't Geithner. What worries me above all is…….what if I'm wrong about the economy? What if all this government intervention, in the end, turns out to be a brilliant stroke, and it really does set the economy on the road to a robust economy complete with healthy, growing earnings, growing employment, and worldwide prosperity? What if my sense of "balance" and "natural" is just misguided, and the modern knowledge of economics has yielded a situation where things simply aren't going to roll over again? I have no answer. That's simply my question.

0901-depressed

A Harrowing Session

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Today was my worst trading day ever, measured in dollar terms.

 

I came into the day not just fully short, but margined to about 135%. Virtually every one of my positions was in the red, and I trimmed the quantity of my positions substantially. I picked up three large long positions – GDX, FXE and IWM – although obviously it would have been nice to have bought them at yesterday's prices instead of today's.

All in all, a day like this is disheartening beyond words and makes me wonder what all the hard work is for.

It seems that 1040 as a buy-everything-you-can point has been a good rule lately. If we pass the area marked in yellow (1098.50), it will weaken the bear case. It we cross the green tint (1129.50), it's time to hang it up.

0901-es

I'm done for the day and will probably just go crawl under a blanket now.

Bullish Action Overnight (by Springheel Jack)

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The overnight action wasn’t encouraging for bears last night and ES retested the upper trendline of the ES declining channel from the August high:

100901_ES_60min_Declining_Channel

Over the last day ES has formed a rising wedge from the low. That is bearish, but only weakly so as these often evolve into rising channels or broadening ascending wedges. They also break upwards about 30% of the time of course:

100901_ES15min_Rising_Wedge

EURUSD broke up from the second declining channel overnight, and while it has found rising trendline resistance at 1.28, the obvious upside target here is 1.292 as I mentioned last Thursday when EURUSD broke up from the first declining channel.

100901_EURUSD_60min_Patterns

Copper, as ever in recent weeks is much stronger than SPX and has broken the August high. There are two patterns building at the moment on copper. For the first the obvious target is 352.5 to put in the top of the right shoulder on a big H&S pattern. If that breaks then the most likely target becomes the 390 area for the top trendline of a possible megaphone and that is well above the current 2010 high for copper of course:

  100901_Copper_Daily_HS_or_Megaphone

I’m expecting a big move today, though the direction is uncertain, and I’m leaning bullish on the overnight action so far. What really matters here though is the SPX levels during market hours. If SPX opens above or breaks above 1057 SPX, then I’m expecting a move to the 1070 area. If that doesn’t hold then the next obvious resistance level is 1080.

If we don’t see a break of 1057 SPX, then we’re just putting in the right shoulder on the possible continuation H&S pattern that I mentioned yesterday morning, and in that case I would expect the 1040 SPX level to be retested and most likely broken today:

100901 SPX 15min Targets

Declining resistance from the April high is now in the 1105 – 1110 SPX area, and that is the key line in the sand for the bear case over the next few weeks. That is most unlikely to be threatened by anything that happens today, but it will be the level to watch if there is a strong rally off the multiple tests of the 1040 SPX level in the last few days.

Trading The Opening Gap (by Market Sniper)

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Trading the opening gap is a contrarian trade. You are looking to trade in the opposite direction of the gap. You will look to "fade" the gap. The stock market open at 9:30 Eastern time is a time, usually, of high emotions. You are looking to take advantage of those emotions.

What creates the opening gap?

The obvious answer is the price differential between the previous day's close and the next day's open. If your trading the broad market futures indexes, due to GLOBEX, there really is no opening gap. Trade resumes 15 minutes after the close (the close of pit trading and electronic trading for those is 4:15 pm eastern time and trading resumes in GLOBEX 15 minutes after that close at 4:30 pm eastern time) and continues until the open outcry (pit session) with the market open at 9:30 am eastern time. The gap would then be the price differential between 4:15 pm and 9:30 am next day. In the ETF's and individual stock issues, at the present time, there is no trading after the close at 4 pm with the exception of a often VERY thinly traded after hours session for a four hour period. If you are trading in the after hours, word of caution. Your broker may shut down your platform for trading one hour prior to close of the after hours session. You will then be required to call your broker and have him close out your position. That will possibly cost you extra on execution of such an order.

For stocks, the opening gap is created by an imbalance of of buy and sell market orders at the open (also known as MOO which is Market On Open orders). If there is an imbalance of buyers, the NYSE floor specialist and the electronic market makers will open the price higher in an attempt to balance buyers with sellers, Since they are charged with maintaining an orderly market, they will most often sell  stock into the imbalance so as to maintain that orderly market. This would make them net short on the open. The reverse would, of course, hold true if there was an imbalance of sellers, they would then supply stock at a lower price and they would be net long at the open. This is important to the understanding of why gaps tend to fill.

Why do opening gaps TEND to close?

The easiest explanationis because NYSE floor specialists and electronic market makers are in business to make money! If the specialist and or the electronic market makers have a net position either long or short, they will seek to move price in the direction of their net position. If short, they will seek to move price down and if long they will seek to move the price up. They accomplish this because they have vital information that you do not. Since they make a market, they have the resting orders! The NYSE specialist has, in his "black book" ALL the orders by price and size away from the market. He has the stop orders! So if he is short, he can move the price lower to trigger sell stops and thus move price lower so as to cover (buy back his stock short position) at a profitable price. If he is long the stock in his book, he will seek to trigger buy stops by moving price higher so as to, again, exit at a profitable price. There are many market maker games also that are employed to move price. This can be a special study all its own. To obtain more in depth understanding of this I recommend Richard Ney's two classics: The Wall Street Gang and The Wall Street Jungle. Also, a fine book by Joshua Lukeman, The Market Maker's Edge.

When do you fade the gap?

This is complex. All gaps are not created equal! I will briefly outline how I view each gap and give you some additional resources. My basic methodology is derived from the pioneering work of Scott Andrews, also known as The Gap Guy. I was a student of his and even was in his trading room for a few months. Since I now have all the data he does and have added my own refinements, I no longer subscribe but it is a very good place to start. Here is the link to his site. http://www.masterthegap.com/ Scott breaks the gap down into 10 zones. Five for up gaps and 5 for down gaps. Here is his zone "map" http://www.masterthegap.com/public/Gap_Zone_Map.cfm Now to utilize this, you will need to know the historical probabilities for each zone for that day based on the combination of 1) day of the week; 2) day of the month as well as identifying pattern risk. If your planning on using Scott's services, you should be aware of the stops he employs in his trades. It is 5 ES points or 30% of the weekly ATR whichever is greater. Be sure this fits within your risk management parameters. Not a futures trader? No problem. You can trade ETF's, stocks and if you are knowledgeable and very nimble, you can even trade options off the gaps! To give you an example of some historical probabilities by day of week for successful gap fills derived from the work of John Carter:

Monday             65%

Tuesday            77%

Wednesday       79%

Thursday           82%

Friday               78%

In John Carter's exceptional book, Mastering The Trade, he has an entire chapter devoted to trading gaps. Here are two of my basic rules as applied to ES gap fade trades: 1) I do not consider trading a gap that is smaller than 1.75 ES points and 2) if for any reason I do not trade the gap, I do keep it in mind during the trading session if, according to my trading methodology, a trade is triggered in the direction of the gap. Many gap fill trades can come out of other trade triggers during the session. In pen gap trading individual equities you must be aware if that gap was caused by some announcement directly related to the company you are trading. Was it caused by an earnings announcement or something else directly related to the company? If so, perhaps you should pass on the trade. Could be a gap and go situation! Even if you do not choose to include fading opening gaps within your trading plan, awareness of it can yield other dividends. It can set up price action for the rest of the day. The price reaction to the gap if not filled (gap and go) can give you an excellent heads up for a trend day, etc. I have a little pdf that I found about trading around the opening range (of which, a gap can be a large part of). I would be glad to forward it to anyone who wishes it. It is titled Trading The 10 O'clock Bulls. Email me at Dutch at WeJustTrade dot com if you have not gotten it.

The purpose of this post is not to encourage you to fade the opening gap willy-nilly or without discrimination. You must trade it or choose not to trade it based on your own plan. Do your homework on the subject, see if it fits within your trading psychology, methodology, etc. It is one of my top setups, if not the top setup as, with my own refinements, when do I fade the opening gap, I have better than an 80% positive expectancy for the trade. Awareness and understanding of the opening gap should be a part of every trader's tool box even if you choose not to include fading the opening gap within your trading plan.