Trader’s Narrative

Today the stock market echoed Friday’s late day surge on similar rumors of a bond insurer bailout.

Market breadth was very positive with advancing volume outnumbering declining volume on the NYSE 6:1 and on the Nasdaq 4:1.

I’ve had a few requests for more bread and butter technical analysis so here you go:

The volume today was a bit too muted for my liking. If we are to follow market prerequisites of the past, we’ll need much more enthusiasm to put up a 90-90 day. Today was more like a 65-80 day. Not bad. Not bad at all.

But a very forceful breakout, especially as we’ve been coiling inside a triangle for more than a month now, would be welcome by the bulls.

I didn’t really want to comment on the triangle formation because I had a hunch that since everyone had talked it to death, it would not complete. Usually patterns that are extremely obvious do that.

After all, just because we’ve coiled into a tighter and tighter range, doesn’t mean that prices can’t just peter out of the apex and continue sideways. Right?

I continue to expect higher prices. When we’ve seen so many extreme readings from trusty indicators, it isn’t surprising to see an upside breakout. For example, when the Dow Jones Industrial Index has only 4 stocks above their 200 day moving average we know that things have gotten very stretched to the downside and a “regression to the mean” will be upon us.

But I would caution against reading too much into a peek above a resistance line. The Achilles heel of this market is the financial sector. And until we move beyond rumors we won’t have a solid floor under them.

I find the fractal nature of financial markets fascinating. You can look at a minute chart, a 30 minute chart, a daily chart, a weekly chart and you will see basically the same formations, the same elemental forces of support and resistance and the same setups.

As a trader, you can use this to your advantage. Switching time frames can help you avoid a “noisy” market. It’s also a great trick to avoid looking at the same charts that everyone else is looking at. It can, in fact, be an edge if everyone is looking at the 15 minute chart, for example, and you’re looking at the hourly chart or the 40 minute chart. You will see things that others will simply miss.

To illustrate what I mean, let me show you an example of a trade executed following the basic rules of the dummy trading setup: look for a thrust (expansion in price), then a contraction or pullback and hop on as the contraction is taken out by the continuation of the trend. The dummy trading setup is meant to be executed intraday but knowing the fractal nature of the markets, there is no reason we can’t trade it at a higher time level. This example is a swing trade using daily charts.

Metalico Inc. (MEA) is in the hot metals sub-sector. It put in a stable, long base for over 4 months. Then in early April it broke out with unusually high volume. It consolidated a little around the $5.25 breakout area and continued higher. If you missed this first opportunity, the next one came on April 18th 2007 as price pulled back significantly. It formed a hammer like candlestick with a very long tail. This was a tell that price was being supported as a second wave of buyers saw their chance to get in on price levels they had missed before.

The next day there was a contraction as it printed a narrow range, inside candle. This is what a “dummy trader” looks for! The break-out of this contraction (green line) then took price to the previous swing high and beyond. Notice also that the volume shrank significantly as price pulled back in mid April. This was another tell that people really weren’t interested to part with their shares but rather to accumulate more (blue rounded box).

How you trade this setup is really up to you. You can wait for a tightening of the price range or you can wait for a real pullback. Traders like Tony Oz only get in on a deep pullback, preferably all the way back to the break out price. But as you can see with Metalico’s example, you may not get such a deep pullback when faced with a strong trending stock.

I don’t think anyone can say one entry setup is better than the other. Ultimately it is up to each trader to fine tune the setup to their liking and temperment. But keep in mind that such setups are merely starting places. Take them and build on them with your own ideas.

In any case, getting back to the point about different time frames… take a look at M&F Worldwide Corp. (MFW) on a weekly chart. Yes, weekly. And then count how many “dummy spots” you notice!

By some cosmic confluence, on the same day, we had two great trading blogs describe how they approach the trading day. Make sure you check them out and pick up some great tidbits.

PinoyTRADER has a swing or position trading strategy that relies on scans he runs the previous day (he looks at ~400 charts a day!). He does take intra-day positions also but his forte I think is in getting long on a pullback of breakout patterns.

Wallstreet Warrior (aka Trader Jamie) trades exclusively intraday price action (as far as I can tell). His strategy is a combination of dummy trading, gap plays and some stuff he has added to the mix himself. Not only does he trade like a machine, he explains his reasoning with impressive lucidity.

Don’t forget to check out the archives of each blog as well.

Two days ago I offered a chart and asked whether you would buy it or not. Rather than reveal it in the comments section as promised before, I decided to make a new post to show you the price action that followed:

For those keeping score:

• Eyal went long with a trailing stop above $7
• Michael preferred to stand aside but ‘gun to the head’ he went short (and was stopped out)
• Idempotent tried to short it below $6 but never got the chance since HANS never saw that handle again
• Yunis stood aside
• Chad went long with a stop at the trendline and got stopped out in the $40-$50 range
• Pradeep went long and targeted $20 (which he might have gotten if he held on through the July pullback)
• and finally, Mousefinger went long and is assumed to be still munching on a massive block of cheese he bought with the profits

Thanks to all who participated!

If you haven’t taken a look at Hansen’s long term (monthly) chart, go ahead and do so. You’ll find that from mid-1998 to mid-2003 it was going sideways. Boring if you were trading the stock but if you happened to come in later, you would have appreciated the massive base that it built. Without it, I don’t think it would have been able to launch such a rocket to the moon.

Your mission, should you choose to accept it, is to find the ‘next HANS’. It is out there, biding its time, waiting to be discovered. Fire up the filters!

Simclar, Inc. contract manufactures electronic and electro-mechanical products. The products are manufactured to customer specifications and designed for original equipment manufacturers in the data processing, telecommunications, instrumentation, and food preparation equipment industries.

Simclar broke out of a long and flat base in early May. So far, its rise has been meteoric. Will it continue after this recent pullback?

Who knows? But the odds of that are looking pretty good. Especially after today’s move up out of the June bull flag. Notice how the volume was receding as price was falling in June and then it picked up as price increased:

Simclar bears a striking resemblance to the other chart I posted (where I asked, would you buy this stock?). Obviously they are different charts and stocks. I’ll let you mull over that mystery a bit more. I’ll reveal the name of the stock tomorrow (look for it in the comments of the original post).