fully digested and your lunch isn’t for another hour. To say the least, this stock has broken its supportline. If it isn’t headed down in an atypically violent reversal, itcertainly isn’t going up. Contrary Conglomerations, Inc., looksto have been (and still looks like) a good stock to sell shortafter all. Let us do something now that you should have doneright away—check the daily charts.What a surprise. Figure 4.2a fits neatly between Points 2and 8 of Figure 4.2b. This big picture shows us that our apparent uptrend was merely part of—and likely the end of—ourold friend the distribution phase.If this analysis seems a little too pat, let’s get closer tothe real world and assume that the daily chart showed usnothing, or at least nothing we could figure out. So what happened to our stock? Who knows—legal problems, bad news,
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plain bad management? Does that mean we give up day trading? Not likely. Does that mean we lose interest in ContraryConglomerations, Inc.? No chance. You want to go short. Butdo you want to go short now or hold off a bit. Typically, it tookyou so long to decide that you in fact did hold off a bit. It is justas well, because our stock has now rallied to Point 10 on Figure 4.2a. A moment later it starts down again. Is this the timeto sell short?Well, this is not necessarily the time to sell short, but it iscertainly the time to look for confirmation. You could try comparing our graph to the S&P Wave, as in Figure 4.3a. This lookslike confirmation to me. I would advise taking a look at someother indicators, but I would do it fast. This could be a ride youdon’t want to miss.Let’s take a look at the opposite occurrence, a violent reversal of a downtrend as in Figure 4.3b. That break in resistance
figure 4.3 confirmation of trends
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at Point 6 looks like a clear buy signal. It is time for a quicksearch of other indicators for some confirmation. One thingyou should look for is high volume between Points 6 and 8.Conversely, low volume between Points 8 and 10 tends to further confirm a temporary reaction to a reversal of trend. Whenthis stock starts back up again, you just may want to be on it.There are a number of signals that indicate a probable reversal of trend. Before we go on, allow me to point out thatthere exists a shade difference in meaning between the phrase“indicate a probable” and the phrase “guarantee a definite.”Enough said? I hope so.The most famous reversal signal is the Head and Shoulders(Figure 4.4a). If you think the high is too pointed to resemble ahead, then you are one of those lucky people who hasn’t hadmuch contact with bureaucrats. The horizontal support line issometimes referred to as the “neck.” The lines below the pricegraph represent volume. Now Point 9 is an important test of resistance, one that failed by a large margin. This means an even
figure 4.4 reversal of trend signals
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more important test is the next one, that of support at Point 10.If share price breaks the neck here, and if concurrently volumeis high, then selling short looks like a very good bet. Furtherconfirmation of a downtrend would be low volume during theshort rallies that precede subsequent downward movement.This is exactly what we see in Figure 4.4a. The places to sellshort are as close as possible to the break low (Point 10) andjust after the peaks of the rallies that follow (Points 12 and 14,and so on).Of course in the real world, a place many expert theoristshave never had the displeasure of visiting, the neck line mayslant up as in Figure 4.4b or down as in Figure 4.4c. The HeadAnd Shoulders can also stand on its head, as in Figure 4.4d. Upside down, this graph represents the reversal of a downtrend.We would then contemplate buying long instead of selling short.All we established about buying signals and volume still holdstrue, only in reverse.Another reversal signal is the Double Top ( Figure 4.5a).The most interesting thing about this event is the psychologybehind it. The Double Top is not merely an example of, it isproof positive of the memory of traders. On the ride up fromPoint 2 to Point 5, your average trader is wondering all the way,
figure 4.5 the Double Top and the Double Bottom
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“Why should I sell now and forego additional profits?” On theride down from Point 5 to Point 7, he is wondering, “Why thehell didn’t I sell at $86? Why? Why!?” On the ride back up between Points 7 and 9, he crosses his fingers and says to himselfall the way up, “If only it hits $86 again, I’ll sell in an instant.”Rest assured he has plenty of company. When they all try tounload at Point 9, share price drops back down to $80.Now you are probably asking yourself, “If stock tradershave such good memories, how come so many are so busymaking the same old mistakes, they have barely enough timeto make new mistakes?” I have a hunch much of the blame lieswith the two little traits—egotism and stubbornness—with ahealthy pinch of stupidity mixed in. However, you shouldprobably be asking this question of a psychologist.Our next reversal signal, Figure 4.5b, is the Double Bottom.Congratulations if you spot some similarities to the Double Top.Suffice to say, the Double Bottom works just like the DoubleTop, except, if you”ll pardon the technical jargon, upside downand opposite.The Triple Top ( Figure 4.6a) is merely a Double Top, onlymore so, 50 percent more so to be exact. It could also be called
figure 4.6 the Triple Bottom
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a trading range, and of course everything we have learnedabout these ranges can be applied to it. So as not to insultyour intelligence, I will leave you to figure out the implicationsof a Triple Bottom ( Figure 4.6b). You might start with trying tofind the only difference between Figures 4.6a and 4.6b. Take allthe time you need.If by now you have not found the difference between Figures 4.6a and 4.6b, I doubt you are going to. Figure 4.6c is actually a quadruple bottom, which for our purposes is the samething as both a Triple Bottom and a plain old trading range.Let’s assume you came upon this graph while checking the fiveminute charts around 2:30 P.M. The stock started out by dropping five points at the beginning of the day. Around 11:00 A.M. itsettled down into a two point trading range. Then a few minutesago, it broke the resistance line at Point 10. This is an obviousbuy signal, and we should start checking, and checking fast,some other indicators for confirmation. Experience, if you possess it, will tell you something else. When a move like this happens around 2:30 P.M., there is a good chance a lot of traders aresecond guessing the five-point drop from yesterday’s close. Before the final bell, this stock is likely to make up at least some ofthose five points it lost. A strategically placed buy stop, as anentry strategy, will grab a few of them for you. If it does, and ifsubsequently you have similar success on other days, thesepleasant experiences will become ingrained in your memory.You will start paying attention, not only to what is happeningand how it is happening, but also when in the trading day it ishappening. Such awareness cannot help but make you a better,and therefore more profitable, trader.Another often encountered denizen of the five-minutecharts is a reversal signal called the Descending Triangle ( Figure 4.7a). Here we have a stock that has been in an uptrend. Itmakes a peak at Point 5, then a lower peak at Point 7, and an79
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figure 4.7 Descending and Ascending Triangles
even lower one at Point 9. All the while, support has been firm.If you connect Points 6 and 8, and then extrapolate, you get ahorizontal line. Now if you draw a trend line between Points 5and 7 and extrapolate, what you come up with is a DescendingTriangle. Let us try to figure out what is happening. As wesaid, support has remained steady. Yet every attempt to exceed the previous high has fallen shorter than the last. Thereseems to be a lack of confidence in this stock. Traders who regretted not selling at the previous peak are getting a littleantsy and settling for less the next time. Traders settling forless is not a good sign. The likely outcome is a break low and areversal of trend at Point 10. With the break low, you definitelywant to see some high volume to confirm it.Figure 4.7b is the other side of the coin, the reversal of adowntrend called an Ascending Triangle. Remember ourmodel with its accumulation and distribution trading ranges.A serious difficulty with it was telling one range from theother. Let’s say you are watching a trading range and have
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pegged it as a distribution phase. This range turns into anAscending Triangle, which tends to contradict your prediction. Turning into a Descending Triangle would tend to confirm it. Of course the reverse is true when you think you aredealing with an accumulation phase. Furthermore, all theseindications are opposite and backward when you are dealingwith a Descending Triangle.The most important thing to remember about reversalsignals is that they never come with a guarantee. Only a foolgoes straight from a reversal signal to her checkbook. Thereare a few mandatory stops along the way. They are called indicators. Check them out. That’s what they are for.
continuation signalsOur first continuation signal is the Isosceles Triangle. In Figure4.8a we have an uptrend that leads to a shrinking tradingrange. Notice that the triangle formed is neither ascending nordescending. Notice also that the two lateral sides are equal inlength. A triangle with two equal sides is symmetrical and
figure 4.8 the Isosceles Triangle signal
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called an isosceles triangle. Thus, our continuation signal iscalled the Isosceles Triangle. Now you can believe that eitherall this is just a big coincidence, or that the world is starting tomake sense. The choice is yours.When you have a trend that ends in an Isosceles Triangletrading range, the likely outcome is a continuation of trend, asin Figure 4.8b If the original trend had been down, then afterthe Isosceles Triangle, the likely outcome would be a continuation of the downtrend. With this signal, you will usually see adecrease in volume accompany the decrease in range. Thenwhen the trend resumes there should be a jump in volume.However, if the trading range continues beyond the triangle, asin Figure 4.8c, this is an indication that our signal is no signalat all. Anything can happen, and all bets are off.Another continuation signal is illustrated in Figure 4.9a,the Flag. We start with an uptrend that ends in what looks like aflag. Not exactly a coincidence. This pattern is accompanied by
figure 4.9 the Flag and Pennant signals
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low volume. The Pennant, illustrated in Figure 4.9b is basicallythe same phenomenon, except it looks more like a pennant thana flag. In case you are wondering how to differentiate these signals from the triangle signals we discussed previously, youneedn’t worry. The Flag and Pennant have fewer up and downcycles, and they play themselves out over a much shorter period of time. They also have an even more severe shrinkage involume.Remember, in using our model that the crucial trick wasbeing able to differentiate the accumulation phase from thedistribution phase, and it was no easy trick at that. In themselves, they looked exactly alike, and if all their highs and lowsdid not precisely hit the support and resistance lines, theycame very close. We mentioned then that these patterns wereideals, rarely seen in the real world. This seemed a disadvantage at the time. It isn’t. The idiosyncrasies that accompanythese trading ranges in the real world can sometimes be valuable clues in determining whether they are accumulation ordistribution phases. In fact, these idiosyncrasies may coincidewith those of the reversal and continuation signals we havejust covered. When they do, you have yourself some weightyindicators.
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buy and sell signalsit’s true!!! buy low, sell high
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It would now be worthwhile to review our buy and sell signals.First of all, remember a signal is just that and no more. Not oneof the following buy or sell signals came down from Mount Sinaicarved in stone. Never has anyone been struck by lightning fordisregarding a buy or sell signal, even on a golf course, during athunderstorm, taking cover under a tree. They are not signals toreach for your checkbook. They are signals to reach for yourchecklist of other possible signals, to quickly see if the relevantones provide confirmation.
major buy signals1. Buy on upturn off support as in Figure 5.1a.2. Buy on break high as in Figure 5.1b.3. Buy on pullback after break high as in Figure 5.1c.4. Buy on last point of support in an uptrend, as in Figure5.2a.5. Buy on a break in resistance that indicates the reversal of a downtrend into an uptrend, as in Figure 5.2b.
figure 5.1 major buy signals I
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figure 5.2 major buy signals II
6. Buy when the Stochastic Oscillator is oversold andpercentage K crosses percentage D, such as occurred at Point 5, Figure 5.3.7. Buy when price is at a new low yet the RSI refuses toconfirm any further drop by not going lower itself, asin Figure 5.4.
figure 5.3 major buy signals III
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figure 5.4 major buy signals IV
8. Using Quick Quote, buy on a negative to positivecrossover, or when a stock rises above its openingprice.9. Buy a stock that is acting stronger than a decliningS&P 500 when the S&P 500 Futures enters an upturn,such as Stock Q in Figure 5.5.
major short signals1. Short on downturn off resistance, as in Figure 5.6a.2. Short on break low, as in Figure 5.6b.3. Short after rally following break low, as in Figure 5.6c.4. Short just after last point of supply during a downtrend, as in Figure 5.7a.89
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figure 5.5 major buy signals V
5. Short on break in support indicating reversal of uptrend into downtrend, as in Figure 5.7b.6. Short when Stochastic Oscillator is overbought andpercentage K crosses percentage D, as occurs atPoint 3, Figure 5.3.
figure 5.6 major short signals I
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figure 5.7 major short signals II
7. Short when stock price is rising to new high, but RSIis over 70 and refuses confirmation by rising anyhigher, as in Figure 5.8.8. Using Quick Quote, short on a positive to negativecrossover, or a drop in price below opening.9. Short a stock that is acting weaker than an advancingS&P 500 when the S&P 500 Futures enters a downturn, as in Figure 5.9.Not that I’m the least bit nervous about it, but before Iturn you loose on the world with these buy and sell signals,perhaps it would be advisable to bring together what we havecovered in this chapter within a controlled environment, thatis, Fantasyland. Let’s say you have been closely following thestock Rerecycle.com, Inc., ever since it changed its name fromEast Jersey Garbage Haulers. Well today, glued to the fiveminute charts, you are less than excited, in fact you are mesmerized. Rerecycle.com, Inc. is locked inside a reinforcedconcrete, seemingly escape-proof trading range. You sit therewondering how many more damn times Rerecycle.com, Inc. isgoing to test its low. This stock has obviously got a support91
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figure 5.8 major short signals III
line made of enough concrete to shoe every stool pigeonand welsher alive. Which reminds you, if you do not wantyour own Gucci’s encased in cement overshoes, then youhad better pay off your bookie, fast. This payment could befacilitated by a nice little stock to sell short, because the S&P500 has been in a steady downtrend from the opening bell,as in Figure 5.10a. Yet, in trying to find that one little stockto short, you have already been burned a half dozen timesthat day.Rerecycle.com, Inc., is certainly no candidate to sellshort. It has shown a lot of strength by not following the S&P500 down. Wait a minute! You suddenly snap out of the daylong trance you had not even realized you were in. Maybe youhave been playing the wrong game. This market may just92
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figure 5.9 major short signals IV
figure 5.10 rerecycle.com
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turn around. It could happen any minute. It is time to dosome research.You check the Stochastic on Rerecycle.com., and withvery interesting results. The stock is oversold and percentageK has just crossed percentage D, as illustrated in Figure 5.10b.You cannot check the RSI fast enough. It is under 30 in “oversold territory,” and it is turning upwards (see Figure 5.10).Your pulse has quickened, your eyes are wide open, andyou are ready to move. It is time to forget, at least for the moment, about looking for a stock to sell short. An upturn in theS&P Futures should mean a quick break high for Rerecycle, Inc.You are willing to bet on it, and bet heavy. Your fingers cannotwork fast enough as you load up your order screen and wait forthe S&P Futures to turn. Because if and when it does, what youwill have, in technical terms, is a SCREAMING BUY!!!
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breeds of stock traderswho’s your daddy?
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Four pure-blooded breeds account for a gigantic 2.479percent of the stock trading population. Mongrelizations ofinfinite variety make up the remaining 97.521 percent. Fortunately, as it pertains to traders, breeding is a Pavlovian concept. Even a pit bull can be a poodle, merely by acting likeone, and despite the trend in the opposite direction. The hardtrick is to admit to yourself that the type of trader you reallyare may be quite different from the type of trader you thinkyou are or want to be. Remember, this book is not written fortraders who want to have a lot of fun, or meet interesting people, or make a lot of friends, that is, except as an adjunct towhat I hope is your main objective in trading—makingmoney. To make money, you have to keep from going broke.To keep from going broke, you better figure out fast whatbreed of trader you are. This means keeping records and determining the type or types of trading you find the most financially rewarding.As we have said before, there are four basic modus operandifor the buying and selling of stock—day trading, overnight trading, swing trading, and position trading. As we have also saidbefore, the basic distinction between these approaches is thetimeframe involved. Though countless would-be traders haveproven themselves equally inept at all four methods, very, veryfew traders have proven themselves equally adept at all four.The most successful traders know with certainty which methods, for them, mean more profits, and they more or less stick tothese methods. They realize that gaining experience and knowledge about a troublesome method can only help up to a point.This is because each separate method requires its own mindset,97
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focus, and approach. These factors are substantially dependantupon personality. Whenever you are faced with the choice ofchanging your methods or changing your personality, take myadvice and junk your methods.
day tradersThe day trader couldn’t care less about the long haul. He orshe buys a stock with the intention of selling it in a few minutes or a few hours, and absolutely no intention of keeping itovernight. The day trader expends a lot of energy while themarket is open. He can easily make fifty trades in a day, manyof course overlapping. He has to be something of a juggler, andthe stocks he juggles are closer to eggs than rubber balls. If hemakes a mistake, they do not bounce back up into his hand.And rest assured, he will make mistakes. They are inevitable.When the market closes, the day trader wants to slow downand recharge his batteries, at the very most do some low pressure research. No way does he want any stocks in his portfolioto worry about overnight.The day trader’s primary tools are the intraday fiveminute and one-minute charts. He keeps a close eye on theS&P Futures Index, hoping that where it leads, the market willfollow, with him one step ahead. He is far more interested inthe price momentum of a stock than he is in its “true” value.The successful day trader has to be able to focus his concentration on his monitors. A moment’s distraction can mean disaster. If you try day trading, and frequently find yourselfstaring at the screen wondering, “When did that happen?”, thisform of trading is not for you. Day trading does not require superhuman powers, but it does require the self-awareness toknow when your concentration is flagging. At these times, it
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also requires the discipline to abandon your positions andyour monitors, and of course it also requires the stamina tofocus until you can do so.The day trader searches for volatility like a vampiresearching for blood. Predicting directions of volatility is hisforte, or so he believes. He avoids thinly traded stocks. Theyare too easily manipulated and subject to unpredictable aberrations. The higher a stock’s normal volume, the harder it is tomanipulate. Keep in mind that volatility is a relative term. Mostday traders are “scalpers,” willing and satisfied to take their 1⁄4or 1⁄ 2 point profits. Of course many of them multiply these profits by taking on the added risk of buying on margin. Every oncein a while, they also clean up or get cleaned out by some unexpectedly wide volatility. Of course, they could have protectedthemselves on the down side with buy stops and sell orders.Then again, there are those day traders that actually search outvery high volatility stocks and the five- and ten-point profitsthat can be made on them.
overnight tradersThe overnight trader is the rarest breed. Like the day trader,he or she takes and abandons positions within an extremelyshort timeframe and feels at home in front of one- and fiveminute intraday charts. His most distinguishing personalcharacteristic is probably his ability to sleep like a log. Insomnia has never been this guy’s problem. Generally, thisbreed of trader waits until between 3:00 and 4:00 P.M. to puton positions. If he thinks a stock is going to continue in an uptrend the next morning, or perhaps even gap open, he buyslong. If he thinks it is going to continue in a downtrend, hesells short, hopefully with a buy stop. I should mention one
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other distinguishing characteristic of the overnight trader.He or she is not prone to oversleeping.Ideally, overnight traders have closed out all their positions by 11:00 A.M. the next morning. This leaves them free toabandon their monitors until 2:30 P.M., possibly later. Allow menow to insert a serious word of warning. I realize that many ofyou readers that hibernate like bears at night, prefer longlunches, or are into illicit afternoon sexual affairs are nowthinking that you have found not only your ideal method oftrading stocks, but also the key to a happy future. Well, forgiveme for pointing out that your suitability for this type of trading is not a matter of lifestyle preferences. The deciding factorshould and ultimately will be: Can you make money as anovernight trader?
swing tradersThe swing trader operates in a much longer timeframe thaneither the day or overnight trader, whole days at a time. He canactually have a life away from his monitors, even when the market is open. This breed is not interested in every little squiggleon the intraday charts. Sure, sometimes he sits glued to hismonitors waiting for the next trade. Yet usually, the thing thatbrings him there, is some expectation drawn from the dailycharts. The trends and trading ranges that interest him play outover a longer timeframe than those that are the bread and butter of the day trader or overnight trader. He also makes lesstrades than they do, and expects higher profits per trade.A swing trader will play the trend of a stock, and if foolhardy or sophisticated enough to ignore the advice of thisbook, then contra trend the reactions. Of course, if he knowswhat is good for him, the swing trader will then waste no time
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getting back with the trend. He will also play those tradingranges that are wide enough to provide a worthwhile profit.This can mean buying and covering shorts on support, sellingand selling short on resistance. If he is a sharp trader, he willhave a good idea what type of trading range he is playing beforehe actually plays it. Remember, the likely resolution of an accumulation trading range is an uptrend, which is no place to beholding shorts. Conversely, the likely resolution of a distribution trading range is a downtrend—no place to be long. Therefore, your more prudent swing trader will stick to buying andselling in an accumulation phase, shorting and covering in a distribution phase.
position tradersThe position trader, like the swing trader, is interested in thecumulative results of a day’s trading, not the minute-by-minutevolatility within that day. He chooses stocks for the long haul,uphill or down. Though his timeframe may stretch for years, afew weeks is also a possibility. A swing trader, ostensively trading with the trend, may very well try to grab a few points off areaction. The position trader just guts out the reactions, waitingfor the graphs to start moving in the right direction again.Merely because of the timeframe involved, do not assume thatposition traders are investors as opposed to speculators. Thatsubjective judgment depends on numerous factors, the foremost being their choice of stocks.Now that we are familiar with the modus operandi of our fourpure breeds of stock traders, let’s hunt us up a few. A goodplace to stalk them is their natural habitat, where they dotheir own stalking—the wild world of stock charts. The chart
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in Figure 6.1 is where you will find the position trader. In January he hears a rumor that Organic Bananas and Radishes isplanning a hostile takeover of American Steel. Still, he hasheard too many similar rumors that died stillborn to leap intoa position before he looks. Looking doesn’t tell him much. AtPoint 5, Organic Ban