Technical Analysis (2)

Trading the Financial Markets

Major Market Analysis

Breaking Down the Markets

Broad Markets

• Four Major Markets
  • S&P 500 Index ($SPX)
    • Consists of 500 large-cap stocks
  • Dow Jones Industrial Average ($INDU)
    • Consists of 30 large-cap stocks
  • NASDAQ (or Nasdaq) Composite ($COMPQ)
    • Consists of all the stocks (>3,000) listed on the NASDAQ Stock Market
  • Russell 2000 Index ($RUT)
    • A basket of 2,000 small cap-stocks

The Four Major Markets

• The S&P 500 is widely considered the best benchmark for analysing the entire market and is often referred to as “the market”
• The Dow Jones Industrial Average (DJIA) is 1 of 3 Dow Averages, along with
  • Dow Jones Transportation Average
    • Airlines, railroads, etc.
  • Dow Jones Utility Average
    • Gas, electric, water companies, etc.
• The NASDAQ was once almost entirely technology companies and is still heavily weighted in that sector
• The Russel 2000 consists of small-cap companies
  • Gives traders an idea of how the lesser-known companies are performing

Exchange-Traded Funds (ETFs)

• An investment vehicle traded on stock exchanges, much like stocks or bonds
  • Holds assets such as stocks or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day
• Most ETFs track an index, such as the Dow Jones Industrial Average or the S&P 500
• A great tool to analyse and trade the broad markets and individual sectors

Broad Market ETFs

• DIA Dow Jones Industrial Average
• SPY S&P 500 Index
• QQQ NASDAQ Composite
• IWM Russell 2000 Index

Broad Market Analysis Checklist

1. What are the primary and short-term trends?
2. Where the next support & resistance levels are (check SRI intervals)?
3. Is there a trend line?
4. What stage is the trend?
5. Where are you in comparison to 20-, 50-, 200-day moving averages?
6. What is the slop of the moving averages (any crossovers)?
7. Does volume confirm trend?
8. MACD indicator (direction of momentum)?
9. Relative Strength Index (RSI) indicator overbought/oversold?
10. Any major economic or financial news?

Sector Analysis

• The Standard & Poor’s (S&P) has divided stocks into nine (9) sectors
  • XLB Basic Materials chemical
  • XLY Consumer Discretionary lv
  • XLP Consumer Staples bread
  • XLE Energy oil
  • XLF Financials
  • XLV Healthcare
  • XLI Industrials
  • XLK Technology
  • XLU Utilities

Sector Analysis Checklist

1. What are the primary and short-term trends?
2. Where the next support & resistance levels are (check SRI intervals)?
3. Is there a trend line?
4. What stage is the trend?
5. Where are you in comparison to 20-, 50-, 200-day moving averages?
6. What is the slop of the moving averages (any crossovers)?
7. Does volume confirm trend?
8. MACD indicator (direction of momentum)?
9. Relative Strength Index (RSI) indicator overbought/oversold?
10. Any major economic or financial news?

Proper Management

Money Management

• How many shares should I purchase?
  • Perhaps the better question is, “How much money am I willing to risk in each trade that I take?”
• Normalized risk means creating all of your trades equally by setting your risk at a predetermined dollar amount
• Most professional trades limit loss exposure to no more than 2% of total capital
  • If possible, they keep their position sizes under 10-20% of total capital
    • Easier to do with bigger accounts!

Proper Diversification

• Diversification is emphasized more for “buy and hold” investors than traders
  • Professional traders prefer to have their beat trading ideas at work and use stop losses to help control risks
• Too little diversification can be higher risk
  • “All your eggs in one basket”
• Too much diversification will have a tendency to water down returns and mirror the broader markets
  • Similar to a large mutual fund

Position Size

• What should my position size be when I take the various types of stock and option trades?
  • What is the size of your portfolio?
  • How much of a loss would be too big?
  • What are your normalized numbers?
  • What would your anticipated profit be?

Stock Position Size Example

• Normalized risk determines position size
• Position sizing example:
  • Trading Capital = $20,000
  • 2% loss of $20,000 = $400
  • This trader would risk $400 or less on all of his trades (normalized risk dollar amount)
  • Divide your max risk dollar amount, $400, by the anticipated risk in the trade and it gives you the number of shares right for you
• T.E.S.T = Time Frame, Entry, Stop Loss & Target
  • Entry = $20.00
  • Stop Loss = $19.00
  • Target = $23.00
• How many shares can this trader purchase? Answer = 400
  • Entry of $20.00 – Stop loss of $19.00 = anticipated risk of $1.00/share
  • He already knows that $400.00 is his normalized risk dollar amount

Pay Attention to Risk

• Remember, a stock trader typically does not want to risk more than 1-2% of capital if the trade doesn’t work
• An option trader will also want to keep losses at 1-2% (or less) of total capital!
• Remember that 2% is the max
  • If you can keep losses at 1% of capital, then that might be even better
    • Easier done when you have larger accounts
      • More trading capital to trade with

Trade Management (T.E.S.T.)

T.E.S.T. - Your New Mantra

• “Plan your trade, then trade your plan”
• T = Timeframe ---- How long could this trade take?
• E = Entry Point ---- Where will you enter the trade?
• S = Stop Loss ---- Where will you exit if wrong?
• T = Target ---- Where will you exit if right?

Calculate Reward-to-Risk Ratio

• Using T.E.S.T, we calculate a reward vs. risk ratio
  • Entry Point – Stop Loss = Anticipated Risk
  • Target – Entry Point = Anticipated Reward
  • Divide Anticipated Reward by Anticipated Reward by Anticipated Risk = Reward-to-Risk Ratio
• A reward-to-risk ratio should be analysed before entering any trade
  • Remember that this is the plan going into the trade
  • We can adjust stop losses up to create less risk
  • We also can stay in the trade even after it has reached our profit target to create even more profit

Success Rates

• “Plan your trade, then trade your plan”
• Trader try to quantify how likely the trade is to succeed, called “success rate”
  • 1-to-1 reward-to-risk ratios
    • Best used for trades expected to succeed greater than 60% of the time
  • 2-to-1 reward-to-risk ratio
    • Best used for trades expected to succeed greater than 40% of the time
  • 3-to-1 reward-to-risk ratios
    • Best used for trades expected to succeed greater than 30% of the time

Bullish Trading Strategies

Bullish Breakouts

• Psychology: A resistance is halting the stock
• There are different types of resistance zones
  • Multiple retest resistance (sellers continue selling the stock when it reaches a certain level)
  • Trend stalling or changing resistance (intermediate or major pivot from the past)
  • Psychological resistance (e.g., a price point such as $100)
  • Moving averages: 20-, 50- & 200-day. Moving Averages(MA’s) are the most widely followed on Wall Street
• The bullish breakout occurs when the stock bursts above any of those resistance zones
  • Should give the buyers confidence to aggressively buy the stock
    • “Clear skies above”
  • Should cause short sellers to scramble to buy back their short positions, driving the stock up further
    • “Short squeeze”

Bullish Continuation Patterns

• There are many different types of bullish breakout patterns that create trading opportunities
  • Base Pattern
    • Equal swing highs & lows
  • Cup and Handle
    • Deep cup and shallow handle
  • Ascending Triangle
    • Equal swing highs & rising swing lows
  • Symmetrical Triangle
    • Lower swing highs & higher swing lows

Bullish Continuation Pattern Checklist

1. Is the stock in a primary and short-term up trend?
2. Does the stock have a pattern or solid resistance zone to break above?
3. Is your profit target set just below the next significant level of resistance?
4. Is the volume low or normal as the stock is preparing for a breakout?
5. What is the stage of the trend (avoid Stage 4 exhaustion)?
6. Is the momentum quiet, with moving averages moving sideways or rising slightly?
7. Is the RSI indicator between 50-70?
8. Are the broad market & stock’s sector agreeing with a bullish trade?
9. Did you check the earnings date for this stock?
10. Are you using proper money management and is the trade planned: T.E.S.T. (Timeframe, Entry, Stop & Target)?

Bullish Continuation Pattern Summary

• Bullish pattern formations
  • Ascending triangle
  • Cup and handle
  • Bullish base
• Typically called “bullish continuation” patterns
  • Form as consolidation patterns within the up trend
  • Stage 1 resting period for the stock
• Can form as a bottoming pattern after a long down trend (same formation and principles apply)
• Traded just like a bullish breakout (same checklist)
  • Enter above the resistance zone
  • Stop loss below a support
  • Target an old resistance or other logical area

Bullish Pullback Trading

• You will hear many different name for this trading strategy
  • “Bullish Retracement”
  • “Buy the Dip”
  • “Fade the Selloff”
• Up Trend: Higher highs and higher lows
  • We are attempting to buy at the swing low
• Psychology: Normal profit taking has driven the stock downward for a few days within the up trend
• Buyers are anxiously awaiting the opportunity to buy at a better price, selling pressure is without much conviction (low volume sell off)
• Price should find some level of support (moving average, trend line, old support zone etc.)
• Candlestick should turn bullish on the support level possibly a bullish reversal formation
  • Most powerful are expanded range bullish candles (Hammer, Dragonfly Doji, Bullish Engulfing)

Bullish Pullback Trade

• When a stock is on a strong upward move, we may want to wait for a pullback to buy
  • We don’t want to buy when it is over-extended to the upside
  • We wish to buy “wholesale” and sell at “retail” prices
• Quality filter for buying a dip is to buy when it pulls back from a higher swing high and is making a higher swing low!

Bullish Pullback Checklist

1. Is the stock in a primary and short-term up trend?
2. Has the stock pulled back mildly to an up trend line, moving average or other form of support?
3. Is the volume decreasing or low on the pullback?
4. Are the moving averages upward sloping, showing bullish momentum?
5. Is the stock firmly within a Stage 2 breakout on Stage 3 continuation (avoid Stage 4 exhaustion)?
6. Do you have a bullish candle on support, signalling a pivot reversal?
7. Is your profit target set just below the next significant level of resistance?
8. Have you checked the earnings date for this stock?
9. Are the broad market & stock’s sector agreeing with a bullish trade?
10. Are you using proper money management and is the trade planned: T.E.S.T. (Timeframe, Entry, Stop & Target)?

Bullish Pullback Summary

• A stock that has run up in price to make a strong higher swing high, then begins to pullback
  • There are buyers on the sidelines waiting for this dip to buy the stock after missing the prior move
  • There are “trapped bears” traders that are short the stock and are losing money; they are waiting for a better price point to exit their losing trade (they will buy back the stock)
• Stock should find a strong support zone
  • Trade line, moving average, previous intermediate or major pivot, price level support or any other form
• Pullback should be weak and on low volume as this shows a lack of aggressice selling
  • We want to avoid trend reversals which normally occur on big volume with expanded range candles

Bearish Trading Strategies

Bearish Breakdown Trade

• Psychology: A support is holding up the stock
• There are different types of support zones
  • Multiple retest support
    • Buyers continue buying the stock when it reaches a certain level
  • Trend stalling or changing support
    • Intermediate or major pivot from the past
  • Psychological support
    • E.g., a price point such as $100
• The bearish breakdown occurs when the stock busts below any of those support zones
  • Should give sellers confidence to aggressively short the stock
    • “There is clear room to fall future!”
  • Should cause buyers to scramble to sell their shares, thus driving the stock down further
    • “Support didn’t hold, so I’m out!”

Bearish Continuation Patterns

• Many different types of bearish breakdown patterns create trading opportunities
  • Base Pattern
    • Equal swing highs & lows
  • Inverted Cup and Handle
    • Deep cup and shallow handle
  • Descending Triangle
    • Equal swing lows and falling swing highs

Bearish Continuation Pattern Checklist

1. Is the stock in a primary and short-term down trend?
2. Does the stock have a pattern or solid support zone to break below?
3. Is your profit target set just above the next significant level of support?
4. Is the volume low or normal as the stock is preparing for a breakdown?
5. What is the stage of the trend (avoid Stage 4 exhaustion)?
6. Is the momentum quiet, with moving averages moving sideways of falling slightly?
7. Is the RSI indicator between 30-50?
8. Are the broad market & stock’s sector agreeing with a bearish trade?
9. Did you check the earnings date for this stock?
10. Are you using proper money management and is the trade planned: T.E.S.T. (Timeframe, Entry, Stop & Target)?

Bearish Continuation Pattern Summary

• Bearish Pattern formations
  • Descending triangle
  • Inverted cup and handle
  • Bearish base
• Typically called bearish continuation patterns
  • Form as consolidation patterns within the down trend
  • Stage 1 resting period for the stock
• Can form as a topping pattern after a long up trend
  • Same formation and principles apply
• Traded just like a bearish breakdown (same checklist)
  • Enter below the support zone
  • Stop low above a resistance
  • Target an old support or other logical area

Bearish Pullback Trading

• You will hear many different names for this trading strategy
  • “Bearish Retracement”
  • “Fade the Rally”
  • “Sell the Rip”
• Down trend: Lower highs and lower lows
  • We are attempting to short at the swing high
• When a stock is on a strong downward move, we may want to wait for a pullback to short
• We don’t want to short when it is over-extended to the downside
• Quality filter for shorting a rally is to short when it rallies up from a lower swing low and is making a lower swing high!

Bearish Pullback Trade

• Psychology
  • Normal buying pressure has rallied the stock upward for a few days within the down trend
• Sellers are anxiously awaiting the opportunity to sell off their stock at a better price and buying pressure is without much conviction (a low volume rally)
• Price should find a level of resistance
  • Trade line, moving average, old resistance zone, etc.
• Candlestick should turn bearish at the resistance level (possibly a bearish reversal formation)
  • Most powerful are expanded range bearish candles
  • Bearish Engulfing
  • Shooting Star
  • Gravestone Doji

Bearish Pullback Checklist

1. Is the stock in a primary and short-term down trend?
2. Has the stock pulled back mildly to a down trend line, moving average or other form of resistance?
3. Is the volume decreasing or low on the pullback?
4. Are the moving averages downward sloping, showing bearish momentum?
5. Is the stock firmly within a Stage 2 breakout or Stage 3 continuation (avoid Stage 4 exhaustion)?
6. Do you have a bearish candle at resistance, signalling a pivot reversal?
7. Is your profit target set just above the next significant level of support?
8. Have you checked the earning date for this stock?
9. Are the broad market & stock’s sector agreeing with a bearish trade?
10. Are you using proper money management and s the trade planned: T.E.S.T. (Timeframe, Entry, Stop & Target)?

Bearish Pullback Summary

• A stock that has sold off sharply in price to make a lower swing low, then begins to pull back
  • There are sellers on the sidelines waiting for this rally to short the stock after missing the prior move
  • There are “trapped bulls” traders that are long the stock and are losing money; they are waiting for a better price point to exit their losing trade (they want to sell their shares)
• Stock should find a strong resistance zone
  • Trend line, moving average, previous intermediate or major pivot, price level resistance or any other form
• Pullback should be weak and on low volume as this shows a lack of aggressive buying
• We want to avoid trend reversals which normally occur on big volume with expanded range candles

Filters: Trading Triggers

• Filter are used for confirmation
• Trigger on:
  • Bullish Swing Trade Strategy = Buy above previous day’s high
  • Bullish Breakout Strategy = Buy above the resistance zone or following a close above resistance
  • Bearish Swing Trade Strategy = Short below previous day’s low
  • Bearish Breakdown Strategy = Short below the support zone or following a close below support

Stop Loss Technique

• You want to find the best location for your stop loss
  • Too far away and you have given the stock room to wiggle, but may be risking too much in the trade
  • Too close to the stock and you may be stopped out of the trade on normal choppiness (market noise)
• Professional traders commonly use the following stop loss placement methods
  • Below the previous day’s low
  • Below the swing low
  • Below a support zone (trend line, moving average, previous support, etc.)
• Alternatively, a volatility stop loss utilizing a calculation of ATR
  • Commonly used calculations are 1 ATR, 1.5 ATR’s or 2 ATR’s away from your entry price

Price Target Techniques

• Basic Target
  • Traders will expect a move of 1 ATR or a move to a very nearby resistance zone
  • Typically, reward-to-risk ratio = 1-to-1
• Intermediate Target
  • Traders will expect a move of 2 ATR’s or to the previous swing high
  • Typically, reward-to-risk ratio = 2-to-1 or more
• Extended Target
  • Traders will expect a move of a 3 ATR’s or a move to an intermediate or major resistance level from the past
  • Typically, reward-to-risk ratio = 3-to-1 or more

Using the T.E.S.T

• T = Timeframe
• E = Entry
• S = Stop
• T = Target

Entry Order Summary

• Bullish Pullback Entry Tigger
  • Buy order is placed above previous day’s high
• Bullish Breakout Entry Tigger
  • Buy order is placed above the resistance zone
  • Buy order is placed to get in after the stock has closed for a day above resistance
• Bearish Pullback Entry Trigger
  • Short order is placed below previous day’s low
• Bearish Breakdown Entry Tigger
  • Short order is placed below the support zone
  • Short is placed to get in after the stock has closed for a day below support

Stop (Loss) Order Summary

· For bullish trades, place stop loss either:

o Below a level of support

§ Use moving average, trend line, previous support, old resistance, whole round number price support ($50，$100, etc.)

§ Or outside normal price volatility

· Use a volatility stop by using 1 ATR, 1.5 ATRs or 2 ATRs below your price

· If two or more supports are very close to each other, it often makes for the best stop loss

o E.g., if the trend line & 50 day SMA both at $50, then the stop loss is well protected of placed below $50

Target Order Summary

· Bullish trading targets

o Resistance zone from the past (intermediate or major)

o Previous swing high (very useful in a pullback trade)

o Stock price levels ($40, $50, $60, etc.)

o Use the stock’s personality

§ ATR (Average Ture Range) of 1 ATR, 2 ATRs or 3ATRs above entry

§ Normal trading range

· Average number of days and average number of points

· It is not necessary to exit entire position if more upside is expected (‘Let your winners run!”)

The Volatility Index (VIX)

· The Volatility Index shows the market’s expectation of 30-day volatility

o Constructed using the implied volatilities of a wide range of S&P 500 index options

o Meant to be forward looking and is calculated from both call and put options

· A measure of market risk

· Often referred to as “The Investor Fear Gauge”

The Volatility Index (VIX)

· There is an old trader’s adage: “When the VIX is high, it’s time to buy. When the VIX is low, look out below.”

· High volatility is a timing device for traders as it typically signals sharp, immediate reversals

· Low volatility is a gauge, but not great for timing

o Low volatility can last for long periods of time and does not typically have immediate reversals

· The VIX typically moves opposite the broad markets

o When the stock market sells off, fear (volatility) goes up

o When the market goes up, complacency sets in and fear (volatility) goes away

Volatility Index Summary

· The VIX moves opposite the stock market

o When the VIX is high = the stock market is down

o When the VIX is low = the stock market is up

· Warren Buffett made famous the saying, “I buy when other people are fearful and I sell when other people are greedy.”

· Emotions of the stock market: Fear & Greed

o Traders adage: “When the VIX is high, it’s time to buy. When VIX is low, look out below”

o When the VIX is high = Fear in the market (buy?)

o When the VIX is low = Greed in the market (sell?)

o High volatility is much better for timing and will often be when significant market bottoms occur

§ High volatility, or lots of fear creates special buying opportunities!

Trading Exhaustion

Four Keys to Exhaustion Tops

· Overextended up trend

o Stage 4

· Definitive new high

o Often on good news (“sell the news”)

· Bearish reversal candle

o Expanded range, which is ideally a reversal formation

· Massive volume spike

o Institutions are exiting as the public is entering

Four Keys to Exhaustion Bottoms

· Overextended down trend

o Stage 4

· Definitive new low

o Often on bad news (“buy the fear”)

· Bullish reversal candle

o Expanded range, which is ideally a reversal formation

· Massive volume spike

o Institutions are entering as the public is exiting

Volume

· Compare volume spikes to price action

o When you see a massive volume spike begin a move, it is considered a healthy sign and continuation signal

o When you see a massive spike that happens on an overextended move, it is considered a reversal signal

· Analyse volume against most recent volume #’s

o When you see abnormally high volume, it is a sign of increased attention (action)

o When there is a massive spike, there may be a trend that is just beginning, continuing or finishing

Identifying Exhaustion Volume

· When you see a massive surge in volume, compare it to the following questions:

o Did it occur with an expanded range candle?

o Was the candle bullish or bearish?

o Did it occur as the stock was breaking out“

o Did it appear after a long extended move?

o Is it 1.5-2x the 30-day average volume or more?

o Is it the biggest volume spike visible on your chart?

§ Using either a 6-month daily or 1-year weekly for swing/position trading

Trading Exhaustion

· When trading what you believe is a capitulation day, you will be trading against the trend and momentum

o You may be buying on a lower swing low

o You may be shorting on a higher swing high

· This types of trading is effective only is there is good reasoning behind the analysis (very aggressive)

o 4 Keys to Exhaustion

o Over-extended trend or current range

o Reversal candlesticks

o Exhaustion volume

o Indicator divergence

o Over or under valued company (fundamentals)

o Sentiment shift (news)

o Catalyst that causes a change in perception

Exhaustion Trading Summary

· Exhaustion Trading is the most aggressive “against the grain” trade setup

· We are trading against both the trend and momentum

o It is critical that the criterial looks great

· This is a capitulation trade

o Bottoms will often form on the worst news

o Tops will form on the best news

Counter-Trend Trade Pullbacks

· Trading against the trend and not against the momentum

o Buy when stock makes a higher low (down trend)

o Short when the stock makes a lower high (up trend)

· We must have some compelling reasons

o Exhaustion volume

o Indicator divergence

o Slowing pivot momentum

o Over-extended trend or current range

o Reversal candlesticks

Early Trend Trade Setups

· 20-day crossing above the 50-day moving average is a short-term bullish signal

o Two protential great buying opportunities

1) Wait for the first pullback following that crossover

2) Wait for the first breakout pattern following that crossover

· 20-day crossing below the 50-day moving average is a short-term bearish signal

o Two potentially great shorting opportunities

1) Wait for the first pullback following that crossover

2) Wait for the first breakdown pattern following that crossover

Moving Average Retest

· Many market participants consider the 50-day moving average as the dividing line between what constitute and up or down trend

o Stock above 50-day SMA = up trend (bullish)

o Stock below 50-day SMA = down trend (bearish)

· It is one of the most watched MA’s on Wall Street

· A break above or below the 50-day SMA will often be accompanies with large volume

o After a break of that key moving average, look for the first successful retest

§ Pullback strategy

Elliott Wave Analysis

Elliott Wave Theory: Cycles

· Grand Supercycle: Multi-decade to multi-century

· Supercycle: A few years to a few decades

· Cycle: One year to a few years

· Primary: A few months to a couple of years

· Intermediate: Weeks to months

· Minor: Weeks

· Minute: Days

· Minuette: Hours

· Subminuette: Minutes

Elliott Wave Theory: Principles

· 5-Wave pattern is the primary trend

· 3-Wave pattern (or ABC) is the short-term trend (corrective trend)

· When the primary trend changes, then the 5-Wave or 3-Wave pattern goes in the other direction

· Ideally, look to trade with the trend in the 5-Wave pattern

o Then look to reverse trades against the primary trend when the 3-Wave (or ABC) begins

Waves 1, 2,3,4,5

Wave 1

· Rarely obvious at its inception

· When the first wave of a new bull market begins, the fundamental news is almost universally negative

· The previous trend is considered still strongly in force

o Fundamental analysts continue to revise their earnings estimates lower & the economy probably does not look strong

· Sentiment surveys are decidedly bearish, put options are in vogue, and implied volatility in the options market is high

· Volume might increase a bit as price rise, but not by enough to alert many technical analysts

Wave 2

· Corrects Wave 1, but can never extend beyond the starting point of Wave 1

· Typically, the news is still bad

o A prices retest the prior low bearish sentiment quickly builds, and “the crowd” reminds all that bear market is still deeply entrenched

· Some positive signs appear for those who are looking:

o Volume should be lower during Wave 2 than during Wave 1

o Prices usually do not retrace more than 61.8% of the Wave 1 gains.

o Prices should fall in a three wave pattern

Wave 3

· Usually the largest and most powerful wave in a trend

o Although some research suggests that in commodity markets, Wave 5 is the largest

· The news is now positive and fundamental analysts start to raise earnings estimates

o Prices rise quickly, corrections are short-lived and shallow

o Anyone looking to “get in on pullback” will likely miss the boat

· As Wave 3 starts, the news is probably still bearish, and most market players remain negative

o However, by Wave 3’s midpoint, “the crowd” will often join the new bullish trend

· Wave 3 often extends Wave 1 by a ratio of 1.618

Wave 4

· Typically clearly corrective

o Prices may meander sideways for an extended period, and Wave 4 typically retraces less than 38.2% of Wave 3

· Volume is well below that of Wave 3

· This is a good place to buy a pullback if you understand the potential ahead for Wave 5

o Still, forth waves are often frustrating due to their lack of progress in the larger trend

Wave 5

· Wave 5 (Elliott Wave Principle) is the final leg in the direction of the dominant trend

· The news is almost universally positive and everyone is bullish

o Unfortunately, this is when many average investors finally buy in … right before the top

· Volume is often lower in Wave 5 than in Wave 3 and many momentum indicator start to show divergences

o E.g., prices reach a new high, but the indicators do not reach a new peak

· At the end of a major bull market, bear may very well be ridiculed

o Recall how forecasts for a top in the stock market during 2000 were received

Wave A, B, & C

Wave A: Corrective Trend

· Corrections are typically harder to identify than impulse moves

· In Wave A of a bear market, the fundamental news is usually still positive

o Most analysts see the drop as a correction in a still-active bull market

· Some technical indicators that accompany Wave A include:

o Increased volume

o Rising implied volatility in the options markets

o Possibly a turn higher in open interest in related futures markets

Wave B: Corrective Trend

· Prices reverse higher, which many see as a resumption of the now long-gone bull market

· Those familiar with classical technical analysis may see the peak as the right shoulder of a head and shoulders reversal pattern

· The volume during Wave B should be lower than in Wave A

· By this point, fundamentals are probably no longer improving ,but they most likely have not yet turned negative

Wave C: Corrective Trend

· Prices move impulsively lower in five waves

· Volume picks up, and by the third leg of Wave C, almost everyone realizes that a bear market is firmly entrenched

· Wave C is typically at least as large as Wave A and often extends to 1.618 times Wave A or beyond

Using Elliot Waves

Realignment Trade Setups

· Primary trend is moving one direction while the short-term trend is moving in the opposite

· Trade setup is when the short-term trend snaps back in the direction of the long-term trend

· Realignment trades have two scenarios:

o Long-term trend is bullish the short-term bearish trend dails and turns back into an up trend

o Long-term trend bearish the short-term bullish trend fails and turns back into a down trend

Fibonacci’s

History of Fibonacci’s

· Developed by Leonardo of Pisa (1170-1250)

o One of the greatest mathematicians of the Middle Ages

o His father, William, had the nickname of “Bonacci,” which means good natured

o Leonardo received the nickname, “Fibonacci”

§ Short for “filius Bonacci,” or “son of Bonacci”

· Leonardo helped his father at the trading post that William worked at in North Africa

o Here, Leonardo became enamoured with the Arabic method of numbers

o Leonardo popularized the use of 1, 2, 3… instesd of the Roman numberals (I, II, III…) used for centuries in Italy

The Fibonacci Numbers

· One of Leonardo’s great contributions to mathematics

· A sequence of numbers starting with 0 and 1, where each number is the sum of the two preceding numbers

o 0,1,1,2,3,5,8,13,21,34,55,89,144…

· As the sequence progresses, each number divided by its preceding number approaches phi (φ), approximately 1.6180339887…

o Known as the “Golden Ratio”

The Golden Ratio

· Shows up frequently in nature

· For over 2,400 years, biologist, artists and architects have proportioned their works to approximate the golden ratio

o E.g., the Golden Rectangle is when the ratio of the longer side to the shorter is the Golden Ratio

§ Many believe that this proportion is aesthetically pleasing

· Mathematicians have studied the Golden Ratio because of its unique properties

Common Ratios in Fibonacci’s

· Recall the Fibonacci sequence

o 0,1,1,2,3,5,8,13,21,34,55,89,144…

· The 100% ratio

o Found by dividing one number in the series by itself

E.g. 34/34=1.000

· The 61.8% ratio

o The key Fibonacci ratio

o Found by dividing one number in the series by the number that follows

E.g. 34/55=0.678

· The 38.2% ratio

o Found by dividing one number in the series by the number that is found two places to the right

E.g. 34/89=0.382

The 50% Retracement

· Time to be smarter than most other traders

· In addition to the 61.8%, 38.2% and 23.6% ratios, many traders also like using the 50% level

o Not really a Fibonacci ratio

o Used because of the overwhelming tendency for an asset to retrace 50% after a significant move

Measuring Momentum

· In an up trend, stock, stocks should make higher swing highs

o If a stock makes an equal or lower swing high, then clearly the trend is stalled

o If the stock makes a higher swing high, but not by much, then we would consider this slowing momentum

· In a down trend, stocks should make lower swing lows

o If a stock makes an equal or higher swing low, then clearly the trend is stalled

o If the stock makes a lower swing low, but not by much, then we would consider this slowing momentum

Higher Swing Highs

· Bullish Fibonacci Retracements

o Trading Range is from the swing low up to the swing high

o Stock should have made a higher high and now be pulling back

o We are looking for two extreme points (drag the Fib lines)

o If the stock was unable to make a higher high then that is not an extreme point on the chart

o The idea is to find an ideal price to enter a bullish stock that is going to remain within the bullish overall trend

Drawing a Fibonacci Retracement

· Created by taking two extreme points, typically a major peak and trough, on a stock chart and segmenting the vertical distance by the key Fibonacci ratios

o 23.6%, 38.2%, 50%, 61.8% and 100%

· Horizontal lines are drawn at these key ratios

o Used to identify possible support and resistance levels

Fibonacci Retracements (“The Fibs”)

· Fibonacci levels work best following a strong trading range move in the price action

· When higher highs are made (up trend), drag from the swing low up to the swing high

o Used to find where in the retracement the stock should find buyers

· When lower lows are made (down trend), drag from the swing high to the swing low

o Used to find where in the retracement the stock should find sellers

Bottoming Patterns

· Bottoms are formed when strong down trends become exhausted and reverse

· Other key signals will be massive volume at the lows with expanded range bullish candles

· Stocks will be unable to reach new pivot lows and wither make an equal low (double bottom) or higher low (head and shoulders bottom)

o There should be a visible neckline, the trend has changed when the stock breaks above the neckline as it is now making a higher high

Bottoming Pattern Checklist

1. Have you identified a bottoming pattern?

2. Have you identified the resistance neckline (makes for a stronger breakout)?

3. Is your profit target set just below the next significant level of resistance?

4. Do you feel it is in a Stage 4 exhaustion?

5. Do you have expanded range bullish candles and massive volume near the lows on the chart?

6. Is the 20-day moving average now sloping upward?

7. Is the RSI indicator between 50-70?

8. Are the broad market & stock’s sector agreeing with a bullish trade?

9. Did you check the earnings date for this stock?

10. Are you using proper money management and is the trade planned: T.E.S.T. (Timeframe, Entry, Stop & Target)?

Topping Patterns

· Tops are formed when strong up trends become exhausted and break down

· Other key factors will be massive volume at the highs with expanded range bearish candles

· Stocks will be unable to reach new pivot highs and either make an equal high (Double Top) or lower high (Head & shoulders top)

o There should be a visible neckline and the trend has changed when the stock breaks below the neckline, as it is now making a lower low

Topping Pattern Checklist

1. Have you identified a topping pattern?

2. Have you identified the support neckline (makes for a stronger breakout)?

3. Is your profit target set just above the next significant level of support?

4. Do you feel it is in a Stage 4 exhaustion?

5. Do you have expanded range bearish candles and massive volume near the highs on the chart?

6. Is the 20-day moving average now sloping downward?

7. Is the RSI indicator between 30-50?

8. Are the broad market & stock’s sector agreeing with a bearish trade?

9. Did you check the earnings date for this stock?

10. Are you using proper money management and is the trade planned: T.E.S.T. (Timeframe, Entry, Stop & Target)?

Topping Pattern Summary

· Topping patterns are identified through the pivots as an up trend that runs out of gas

o Equal swing highs = Double Top (M Trade)

o Higher highs to lower high reversal = Head & Shoulders

· Key points when identifying a topping pattern

o Should have a long extended up trend

o Expanded range bearish candles should appear

o Massive volume should appear at the highs

· Identify the neckline support

o Strong support necklines create more powerful breakdowns (trend reversal as stock is making a lower low)

Trade Management: Entry Triggers

· Enter above previous day’s high

o Useful when stock has been pulling back in price and trader wants to make sure to enter only as an upward pivot is taking place

· Enter above previous swing high

o Pivot takeout or breakout trades

o Breaking to a new high is an up trend in the purest form

· Enter above resistance zone

o Bullish breakout

o Entry is above a resistance zone that was holding the stock back

· Enter on a trend line break

o Channel trading or trend reversal trend line breakthroughs

Intra-Day Trading Triggers

· Wait for 30 minutes of price action before entry

o Bullish Trades: Wait for the first 30 minutes’ high to be broken before entry

o Bearish Trades: Wait for the first 30 minutes’ low to be broken before entry

o This allows for the early morning order to get taken care of (known as “amateur hour”)

· Once the stock has decided on a daily direction, the position is taken

· Can be used for trading gaps

o Fade the gap or when expecting a breakaway/runway gap

Stop Loss Techniques

· Place it below the previous day’s low

o A very tight stop

o Creates low risk but does not give much wiggle room

· Place below previous swing low

o A loose stop

o Creates more risk, but allows for much more wiggle room

· Place it beyond the Fibonacci box

o Will protect you if the stock retraces back as long as it does not retrace more than 62%

· Place it below a level of support

o Search for a strong support zone and place below that area

· Place outside normal volatility

o An ATR of 1.0 to 1.5 is very common

Swing Trade Stop Losses

· Swing trades are on average 2-8 days

· 1 ATR to 1.5 ATR is typical for normal trading

o If you want to move in and out of stocks at a quicker pace and profits and losses need to be taken quickly, then one would error on the side of giving very little space (i.e., 1ATR or less)

o If you find that you are being stopped out early, then you would error on giving more room (e.g., 1.5 ATR+)

Position Trade Stop Losses

· Position traders are on average 2-8 weeks

· Weekly ATR numbers are normally 2.5x the daily ATR number

· If the daily ATR = 0.6… then 0.6 *2.5=1.5 is probably pretty close

· The weekly ATR = 1.5

o Multi-week trades will usually have a stop loss of 1 to 1.5 weekly ATR’s away from entry

History of Bollinger Bands

· Developed by John Bollinger

o Mr. Bollinger was the chief market analyst on the Financial News Network (FNN) form 1983 to 1990

o BB’s created in early 1980’s on a computer with 32K of memory

§ In comparison, many computers today come with over 2-4 million K of memory

· An indicator that allows users to compare volatility and trlative price levels over a set period of time

· Consists of three bands designed to encompass the majority of a security’s price action

Settings for the Bollinger Bands

· A simple moving average (SMA) in the middle

o 20-Day SMA for swing/position traders

· An upper band

o SMA plus 2 standard deviations

· A lower band

o SMA minus 2 standard deviations

Two Primary Functions

· BB’s were designed to augment other analysis techniques and indicators

· By themselves, BB’s serve two primary functions

o To identify periods of high and low volatility

o To identify periods when prices are at extreme, and possibly unsustainable, levels

Using BB’s as a Volatility Gauge

· Many securities go through periods of high volatility followed by periods of low volatility

· Using BB’s, these periods can be easily identified with a visual assessment

o Tight bands indicate low volatility

o Wide bands indicate high volatility

· Volatility can be important for options traders

o Options prices will be cheaper when volatility is low

Overbought/Oversold Trading

· The terms “overbought” and “oversold” are equal to saying “too high” or “too low” in price, respectively

· However, who is to say what is too high or what makes something too high?

o Most people think it would be a stock that has gone a long way up and they are probably somewhat correct

o However, it is very dangerous to assume that something strong will suddenly turn weak

o Rather, something is overbought or oversold if it is unsustainable

§ We must then research other technical factors to determine the current move is, in fact, unsustainable

BB’s Setup Criteria

· For many traders, the 50-day simple moving average (SMA) is the difference between being in an up trend or a down trend

o It gives a quarterly average of the stock’s price

o Stocks above the 50-day SMA tend to climb higher and stocks below it tend to fall lower

· It is pretty safe to say that if we are making higher highs in a stock, then…

o The 50-day SMA is upward sloping

o The stock is above the moving average

o We are upward trending

· So would a stock that has these characteristics tend to be better off bought long or sold short?

Bollinger Bands with Moving Averages

· Bollinger Bands give buy signals on strength

o Short-term

§ Stock touches the lower band, but is still above the 50-Day SMA

· Bollinger Bands give short signals on weakness

o Short-term

§ Stock touches the upper band, but is still below the 50-Day SMA

Bollinger Bands Buy Checklist

1. Is the stock above the 50-Day simple moving average (SMA)?

2. Has it touched the lower Bollinger Band?

3. Has the stock found a level of support?

4. Is the volume decreasing or low on the pullback?

5. Are the SMAs upward sloping, i.e. showing bullish momentum?

6. Is the stock currently in a Stage 3 continuation?

7. Avoid Stage 4 exhaustion

8. Do you have a bullish candle on support, signalling a pivot reversal?

9. Is your profit target set with no other resistance prior to it?

10. Have you checked the earnings date for this stock?

11. Are the broad market & stock’s sector agreeing with a bullish trade?

12. Are you using proper money management and is the trade planned?

13. Use the InvestView T.E.S.T. Method (Timeframe, Entry, Stop & Target)

Advanced Orders (Bracket)

· 3 types of advanced orders

o Bracket orders (OCO order)

§ Allows you to place two sell order against one stock position

§ If one of the orders executes, then the other is automatically cancelled

o Going LONG

§ Both a limit order above to sell (profit target) and a stop order below to sell (protective stop loss)

o Going SHORT

§ Both a limit order below to buy (profit target) and a stop order above to buy (protective stop loss)

Advanced Orders (Bracket)

· We want to enter the stock on the breakout with a stop-limit order around $94.50

o So, buy with Stop = 94.28 and Limit = 94.48

o If triggered into the trade, then…

§ Add a tight stop loss of $91.62 (stop loss)

§ Set a price target of $100/share (limit sell)

Advanced Orders (Bracket)

· Step 1: Fill out entry order and accept

· Step 2: Right click on that order, choose “Attach” and select “Bracket orders”\

· Step 3: Adjust stop and limit prices

·