SPY Daily Recap (by Leaf West)

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St Louis 06 Wow what a day … the market that was looking for a reason to correct and got it in the form of Egypt's public protests.  I guess we know why the US gov't keeps extending unemployment benefits, food stamps etc.  It doesn't seem possible but without these programs, the scenes from Egypt could very well be coming from Chicago or Detroit or …..

After that pleasant thought, let's review the day's action in the SPY …


In my pre-market comments on the SPY I tried to hit home again for people the fact that the SPY was still in a consolidation/contraction pattern and it was my guess that it would be resolved today.  I was thinking the last couple of hours but of course the market had its own plan.

Here was chart from this morning …

SPY_Jan 28, 2011_PreMkt01

Again, note what studies say about rectangular consolidation topping patterns … about 2/3rds of them resolve to the upside (don't forget that means 1/3rd to the south).  As with all patterns, those who try and guess are playing with fire.  Readers of my blogs/chats know that I always say that you need to wait for the pattern to break and to not try and anticipate which way the market will break.  In fact in most cases, I will wait for the pullback after the original break as a way of confirming the move.  That is not always the most profitable strategy but it can make your winning percentage much higher.

The pre-market action was effected today by the 4th Q GDP report, which was actually light from expectations on the headline number, but the underlying final sales figure impressed everyone so the SPY hit a new high pre-market.  At the open the market opened just short of the regular hour highs from yesterday – opening at $130.14.  This was just below the expected $130.25 resistance line.

Clearly, odds favored at the minimum a test of prices higher than the $130.25 level … likely, if prices could stay above this level for two to three 5-min candles, shorts would have to start covering and longs would pile on.  Thoughts of sugar plums and 12k Dow/1300 S&P were dancing in traders minds.

All of man's best laid plans ….

Here is what actually happened …

SPY_Jan 28, 2011_Recap01

So why do successful traders prepare before hand?  They do it so they are prepared for any "what ifs?" the market can throw its way.  I hope people are learning why I spend so much time discussing resistance/support levels.

To be as good of a trader as you can be, you have to have a game plan in your mind or on paper in front of you each day.  Your game plan for today should have been as follows:

  1. + I am expecting a break out of the rectangular topping pattern that has existed the past two days.  Odds favor a break to the upside (2/3rds according to research), but I will remain unbiased until there is a break.
  2. + For conservative traders … I will not act on the first break of the support/resistance lines.  I want to see if the break is real and I will wait to see two-three 5-min candles above the $130.25 level or below the $129.65 level.
  3. + If the break beyond the resistance lines is quickly rejected, I will make a "starter" fade trade with a tight stop.  This is intended to take advantage of your pre-market work where you identified areas where the market could reverse.
  4. + My trades will be triggered on the break of signal candles only … I will not try and anticipate a break of a level.
  5. + When in a trade, I will look ahead and plan for possible areas of resistance/support and utilize that to better manage my trades.
  6. + I will monitor different time frames and various internal indicators to better manage my trades.

I'm telling you all if you were to put this in writing each day in front of you in large type it will make you way more profitable and much less stressed in your trading day.  I don't write it down but it would probably even benefit me, especially in that first hour.

Boy this is going to be a long post … LOL

 

Trade #1:

SPY_Jan 28, 2011_Recap02

As you can see in the above chart the fourth candle (9:45am) of the regular trading day broke above the black horizontal pre-market high and as well the red solid horizontal resistance line at $130.25 and hit a high of $130.35.

So we got what we thought would happen … a quick test of the upper resistance area.  Now what?  Well, you should be prepared for a break higher and a failure/rejection of this area.  In terms of a break higher … you need to wait for a couple of closes above that $130.25 level so there was nothing to do yet about that.

In terms of a failure, you need to take note of that first test candle that failed to close above the resistance line … the 9:45 am candle's low was $130.13 and the high was $130.35.  Three minutes after that 9:45 am candle closed, its low was broken, triggering in all conservative traders that were focused and prepared for a possible failure.  Aggressive traders would have tried to get short right after the 9:45am candle closed and first showed  signs of a possible failure.

Now with so much anticipation of a break higher, I would not suggest people go balls to the wall short here.  Odds still favored a break to the upside.  Not all traders are going to want to try a short in the face of such investor consensus that the "market must go higher"!!

I would suggest that the more readers of this blog trade these set-ups, the more money they will end up making.  It's all about taking the set-ups that you plan for.  Become an unemotional trading machine and you will be surprised how much money you make on these scary set-ups.

The best way to deal with your emotions on these types of set-ups is to reduce your size.  With trending, high-odds trades, increase your size and pile on.  With higher risk, reversal-type trades, use smaller size to reduce your emotional fears.

So traders should have had at least a small short on here with a stop of say $0.05 above the HOD ($130.35) … say $130.40.  Your target should have been the lower support line at $129.65.  Risk/reward ratio was $0.48/$0.27 or 1.8:1.  Not great so it is better to keep these types of trades small.  You need a winning percentage of at least 56% on these types of set-ups to make a profit in the long run (1/1.78).

So what happened after we got short … price moved down quickly with three large-range bars and bounced off our support price.  It was understandable why traders would take profit here after coming quickly into the expected target.  However, it also hits home my comment about making a trade before a trigger actually happens.  Sometimes this will be ok and sometimes it won't.  This was one of those "it won't" cases.

 

Trade #2/Exit of Trade #1:

SPY_Jan 28, 2011_Recap03

Traders should have been taken note that price failed at the test of making a break of a new high and didn't even hang around to try again …  market made a high tail move lower.  Think back to most successful breaks higher … is that normal?  In a word … NO!

So when the market sells hard/quick down to the next area of support what should you do?  Well if you were short you should try very hard to hang on … don't anticipate a reversal … wait for a signal to trigger.   If you were, for what ever  reason, not short coming into this test of the lower support, you should have been prepared to go long a confirmed bounce or short a confirmed failure.

 

The chart here shows the test of the bottom support area … the 10:05am candle was the first candle to test the $129.65 price.  It was a doji candle which are typically reversal candles at areas of confluence.  So we get long on the break of this candle's high right?  In theory yes.

This is where traders have to take into account various factors … to me I have a "4-Candle Rule" which I have mentioned before when it comes to trying a reversal trade.  The 4-Candle Rule states that if the four candles prior to your signal candle are in the opposite direction, you should respect the strength of the trend and wait for a second signal candle to confirm your trade and increase the odds of a successful reversal trade.

In this case, we had only three candles so we are ok right?  To me no … it is not so much 3 vs. 4 candles.  It is what you are trying to stop yourself from doing … you are trying to stop yourself from going against a strong trend.  That's the bottom line … nothing else.  Look at the momentum indicator … is that telling you a reversal is at hand …. NO!

So here, after seeing such a quick failure of the upside trade and then a quick hard sale to the south, traders should have waited for a second signal before trying a scalp north.

The 10:10am candle was also a large range doji … should you go long on the break of that candle.  Again, this candle was not really any stronger looking than the first doji to me.  Aggressive traders may have covered their Trade #1 short and then tried to go long on the break of this candle's high here I guess.  The high was $129.80.

To me any sideways chop/doji candles after a hard push higher or lower is correctional, and I expect the trend to continue when the chop finishes.  At the worst, I would have covered my short here, all the while being suspect of any move slightly higher than the $129.80 trigger.

The 10:15am candle broke the $129.80 high by $0.01 and if you were watching your 1-min charts you would have seen that the candle breaking the high was actually a shooting star, which was quickly rejected.

The low of this candle was actually $129.61, $0.01 below the low of the last two dojis … not only that, look at the top tail of this candle.  Again, this looks more like a weak consolidation candle than it does a candle at the start of a  strong reversal move.

I know it is getting confusing here as I describe the end of Trade #1 and the start of Trade #2, but bear with me.

Just below the lows of these candles and therefore just below the $129.65 support price, was a pivot price at $129.57 and the 200SMA at $129.60.  You should always be planning "what if …".  If this area of support fails, what would be your trigger short?

The 200SMA is a huge line in all time frames … my experience is that when you get a real break of the 200SMA on the 5-min chart, you want to play along with that break.

So that was actually your next trade … add to your short if you were still hanging on from Trade #1, start a short if you didn't short Trade #1, or if you covered it too soon here at the confluence.  And if you actually got triggered long here, you should have covered and flipped short if at all possible.

Your stop should have been $0.05 above the $129.65 support/resistance line and your target should have been likely the $129 round number.  A risk/reward ratio of (assuming the trigger on the pivot price of $129.57) $0.57/$0.13 or 4.4:1.  That's more like it.

Educational Break:

Today I posted a blog at 10:30am eastern (see post) … it was a blog about the importance of possible market swing highs or lows that are put in around the 10:30am time frame.  Go back and look at your intra-day charts … it is uncanny how often you will find reversals at around the 10:30am time.

I was not expecting that today per-say, the point I raised in the blog post was that if the 1030am low area was broken to the downside then today was likely to be a Trend Day to the south!!

Here is the 10:30am chart …

SPY_Jan 28, 2011_Recap04

So having all of this in our minds what happened when we came into our targeted support area at the pivotal 10:30am time period.

SPY_Jan 28, 2011_Recap05

So we are now pretty confident that this is a Trend Day and as ninja traders we put on our Trend Day trading hats … look to short any bounces into resistance areas (20EMA) and to not try a reversal trade until price crosses the 50EMA.

This is very hard to do … I often find myself trying bounces higher on what appears like good set-ups.  These generally fail, but my saving grace is that I am very quick to take profits.

Also note that we still haven't even broke the down trend line … first step to a reversal trade is the break of the trend line!!

The first real sign of the start of a counter trend bounce is evident on this next chart …

SPY_Jan 28, 2011_Recap06

The 11:00am candle was a hammer, the next a doji and the next a spinning top nearer the top of the previous two's tops.  In addition to this was the turning up of the momentum indicator … it actually broke the signal line.

To me, I think your exit was here at any level.  We know that we are going to short any bounce here so, we shouldn't be scared to let go of our short here.  For retracements that we intend to short we look for one of three things:

 

  1. Aggressive traders can re-short when price comes into a confluence area … i.e, they set up a limit order right at say the 20ema.  In this case would be the pivot price at $129.15; or,
  2. Conservative traders would wait for price to get to this confluence area and then short on a reversal candle; or,
  3. The break of the 1-min trend line support price for the retracement.

 

Trade #3:

SPY_Jan 28, 2011_Recap07

The 11:25am candle broke that trend line support and triggered you long.  Note that we didn't even get close to the 20EMA … another sign of how strong the down trend was today.

The trigger price was at about $128.80, and we placed our stop above the high of the bear flag candle high ($129.02) … say $129.07.  Our target was the next support line we had on our chart … $128.25.  You don't have to do the formal math on this one  … this is a sweet risk/reward trade.  Beep, beep, beep … that should be your truck backing up on this trade.

This next chart shows our exit …

SPY_Jan 28, 2011_Recap08

Traders have to keep in their mind, significant time periods … one of those is the typical 12-noon end to morning trends.  Today the 12-noon candle was a huge "spinning top" style candle.  The next candle was a positive inside candle and that should have been enough for us to cover the short on the break of its high.  Again, we are in Trend Day mode and we plan to short 1 of the 3 set-ups of the next weak push higher.

So we should have covered on the break of the top at $128.08, and then waited for our next short.

 

Trade #4:

SPY_Jan 28, 2011_Recap09

The 1:00pm eastern candle broke the trend line support at around $128.20 … note that again the market couldn't even get all the way to the 20 EMA once again.

The next target was $127.25ish based on looking all the way over to the support seen on January 20th.  Our stop should have been just above the bear flag candle high ($128.34) … say $128.39.  Again a juicy risk/reward.

SPY_Jan 28, 2011_Recap10

So as nija traders, we are looking for changes/warnings of when to cover our shorts.  Look at the above chart … what do you notice?  I see the move down after the break of the trend line being a lot different than the last short set-up (trade #3).  After the break of the trend line in trade #3 price moved quickly lower … here the candles are flattening out and actually overlapping to a large degree.

Overlapping candles are correctional, not trend-like.  Our Spidey senses are tingling.  The doji candle at 1:40pm was followed by a pretty bullish looking candle … add to that the positive divergence with momentum (3-Push Pattern), and we are happy to cover our short on the break of the high of that 1:45pm bullish candle at $127.86.

Now, we have had a very successful down Trend Day and we are getting some very strong signs that the absolute power of the trend maybe waning.  Experienced traders know that they can only press the directional trade so long.  Traders who played this down trend well could be excused to call it a day at this point.

However, there is another educational point here … don't catch yourself saying that the market can't keep going down.  We see that the strength of this trend was so strong that there was another short set up at the break of the trend line support at 2:50pm at around $128.10.

 

Trade #5:

SPY_Jan 28, 2011_Recap11

So if you dare to dance with the devil going into the ending hour of the day, you could have taken the break of this trend line support.  Items in favor of taking it were the SPY's inability to get above the $128.25 resistance line, or the last swing high at $128.34.

One thing that you should have seen that would cause you some caution or even tell you to pack it in for the day is the possible start to a "Rounded Reversal" pattern.

Anyways … you should have been quick to take profits on any hint of a reversal and having a target of the LOD was probably the best you could expect.

SPY_Jan 28, 2011_Recap12

You should have exited in that last 1/2 hour "danger zone".

 

Final Note:

No one can be expected to nail all these trades unless you have blinders on and zeroed in only on the SPY all day.  That is not always the best strategy so don't think you are a terrible trader because you only caught 1 or 2 of these set-ups.

The goal of these posting is to educate you so that you will be able to recognize set ups no matter where you come into a chart during the day.

I guarantee you that these set-ups will repeat … Trend Days happen 3-4 times a month on average for the SPY.  They happen every day on different stocks.

This was a long post (over 3000 words) … I hope you learn something from it.  It is a lot of work for me … what I get from it is hopefully some good market karma from helping people, but more realistically, I actually hone my trading skills by writing these.  When I dissect the day's trades I burn those rules/set-ups etc. further into my mind.  I am now a Nija level 9 trader …LOL

Have a great weekend ….

Make sure you read the newsletter.

Cheers … Leaf_West

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