failinglows and SEBL already in a downtrend that started near 3 p.m. on the previous day, I wanted to go with a short setup bias.The range from $18.05 to $18.55 was too wide for me to enter witha DBI setup, meaning to short the low. This setup is used to short intoresistance on a downtrending issue. I had the trend with me in the stockas well as the NDX cooperating, since it broke the lows. This simplyadded to the probabilities that I would get what I needed when I took theentry.The two lines, one at open resistance of $18.55 and the other beinglow support at $18.05, gave me my range (labeled A). The entry wasshorting into that resistance, with a stop just above it at $18.65–$18.70.Circle B illustrates this setup.As the stock pulled into the range of C, we had congestion—a stockmaking a smaller range, then buying equals selling. This happened atabout $18.20. At this point, the NDX began to sit in a narrower range.There simply was no way to know what would happen during the congestion phase. Guessing which side would win wasn’t our goal in this situation. Our goal was to let the buyers or sellers tip their hands and go withthat side of the trade.Since we were already short and downtrend-biased, we positionedourselves for a downtrend movement scenario. Scalpers would take a fulllot off the table at a 1:1 reward/risk ratio. There wasn’t any reason to riska scalp in congestion. Holders needed a better reward for their risk, but, incongestion, on a narrow day, they needed to think of capital preservation,rather than aggressive scaling. Since we couldn’t break the support near$18.20, I took half my shares off the table.
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Trailing stops and confidence levels. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
FIGURE EX22
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Then I moved my stop to a breakeven level and waited for a breakdown of the congestion range. I had already locked in profits on the firsthalf of my shares. As you can see, we got the breakdown and the trendcontinuation signal. We got faster selling into $18 on this phase, and,when you get faster selling into a level, you want to partial out again. Soon this round of selling, marked by circle D, I covered a quarter more ofmy shares.An important tape-reading principle states that faster selling showsexhaustion and that the trend becomes less certain from that point.Starting at 18, another range started building, from $18.15 to $18. Whenit broke again, I still owned a quarter of my shares, and I had a choice:take the remaining quarter of my shares or trail the stop. You can see howthe volume spiked again at 11:45 a.m. on a more vertical price drop to$17.70. This would be the signal to exit your remaining shares if you wishto, and it’s perfectly valid to do so. That was what I did.Another possibility would be to see how much of a downtrend wecould ride with the remaining shares. In this case, I used confidence levels and trailing stops. Confidence levels simply say to me: If the stockbreaks this level, I’m less confident that the trend will continue. The trailing stop says: If the stock hits this, I’ll take the remaining shares off thetable no matter what.As we moved into breaking support of $18, we needed to establishthe confidence level. This is marked by the line E. It is simply the lastrange high before the stock finally fails support. So if SEBL broke $18.15,I would be less confident that we would see new lows.The above situation would warrant our trading in the following manner. The stock breaks $18.15, so we will either let it hit our stop price oruse the next round of selling to cover the remaining shares. Your risk isthat you lose the profit if it hits the stop. Your gain is that you will get better price cover if you use the next selling round to go back under the confidence level. If you aren’t comfortable with the confidence level,meaning you don’t want to let it hit the stop, then trail the stop tighter tothis $18.15 area. It’s simply a matter of where your aggression lies. If youwant to see if you can ride a trend, then your confidence level is fine. Ifyou would rather take the full profits, then trail the stop tighter and lockin the gains.What is your mindset? Are you in a win cluster? Do you ride gainswhile you read the market correctly? Are you in a drawdown or slowbleeding phase? Don’t try as hard to ride gains because it will get youcloser to revenge trading, trying to make it all back in a short period oftime. Maybe you should trail stops tighter in this period so that you get the
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sense that you are seeing things well and profiting from them—creatingthat winning attitude. There are more reasons to trail the stop or to useconfidence levels than just, “It’s going in my direction.” The market is areflection of you, and you are willing to give yourself only what you thinkyou are worth at a particular moment. If you are feeling well, maybe scaling out is better for you because the stock is moving in your direction andyou want to stay with your confidence. If you are feeling confused or in adown period, taking full profits to get used to the feeling of profits is better. Eventually you can go back to scaling out if the market allows you todo so.This trade helps to identify three important things we use every day,even if we don’t naturally or consciously understand why:1. Technical analysis helps to define the structure.2. Tape-reading principles help to define the entry and exit points(price/volume relationships).3. Exit strategies help to pull us through flat or negative periods and movebetter during positive periods.
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EXAMPLE 23
Jump-Base–Explosion (JBE) SetupThe first thing we see on the chart in Figure EX23 is a move from the $73to the $74 area on relatively stable volume. There was a small price spikeright at $74 where traders in from lower levels would be exiting. As thestock began to pull back, we noticed a shallow pullback to $735/8. So, weestablished the range from $735/8 to $74. The broader trend continued toshow strength during this time period, and QUALCOMM (QCOM) is astock that may follow a broader trend a bit better than others.
FIGURE EX23Jump-base–explosion (JBE) setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
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Traders have two options in this case. The first is to buy the lowminirange, in this case, at $735/8. The other is take the offer at $7311/16 ifyou feel that $735/8 isn’t attainable. In either case, with selling at $735/8,you need to get ready for the stop exit. If traders wished to bid QCOM,they could scalp within the range or wait for the break. Here, the stockmade a break of the high, offering the setup for a long trade. Buying for abreakout required a stop at $735/8.We saw the initial break as being weak; the stock price came backdown to $7311/16 and held. At this point, if I saw any selling at $7311/16, Iwould be ready to hit the bid fast for an exit. Many times, a failed breakoutmakes a great short. We wouldn’t want to get caught in stronger selling.With the hold of the low minirange and a move back to new highs,we looked for a reasonable exit strategy. The price spike that put us tonear $743/4 was the area for this. We can see a price spike associated witha volume spike in this area. This is where traders would exit at least halfof their positions and raise a stop to near breakeven if not absolutebreakeven on the rest. I used $737/8 as a stop because I wanted to use $74,the previous resistance, to now serve as support.From this point we saw basing for about 20 minutes. We wanted toraise the stop to the $741/2 level, which was serving as the bottom of theminirange during this period. Any break of that and we would take the restof our shares at $743/8.Fortunately the $751/2 level held, and the stock broke the $75 level.Notice that on the pullback to $741/2 there was an inclining volume riseleading to a volume spike at about 2:05 p.m., or 14:05 on the chart. Thisis the next point at which traders looked to exit their remaining shares.The $741/2 level wasn’t jeopardized, so anyone holding for the break of the$75 level would be looking to exit into this spike.Taking profits within the $741/2 to $75 range was reasonable. Forthose who held, this is the action that they would be looking for to exit.As the stock moved to the $76 area, we noticed that the volumedropped considerably and that the market participants were jumping onand off levels, making the trade hard to read. At the point at which thestock became hard to read, we’d certainly be looking to exit, if we hadn’talready, into the price/volume spike. From this exit, you can see thevolatility on the issue as the day wore on.There were a few other possibilities, but the action was jumpy,erratic, and hard to read, so it was best to back off.This is an example of a breakout trade from an established minirange, using price/volume spikes to define the exit strategy as weapproach it from a tape-reading point of view.
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EXAMPLE 24
Cup-and-Handle BreakoutThe day the trade took place (See Figure EX24) there was a nice uptrend,with the majority of the potential taken from breakout trades and pullbacks. Stocks such as TUTS, CRDS, ATHM, and NEON were makingnew highs, and those issues that had been beaten up over the previous yearwere showing signs of reversals from their lows.Adtran Inc. (ADTN), however, was a stock that was down on thatday after guiding estimates lower for the quarter. So we had a negative
FIGURE EX24Cup-and-handle breakout. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
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gap on negative news in a market that was showing pretty good strengthoverall. Whether or not the broader trend mood gave some excitement tothe ADTN uptrend from its lows is uncertain, but the idea of playingbreakout trades was reasonable.Tape-reading principles are usually the same in any market, for anykind of stocks, with or without news surrounding them. The stock tells uswhat to do at any given moment. In this sense, the setup occurs, and thetape tells us whether to enter or not. We move from there to the exitstrategy.We can see on the ADTN chart a move from the $21 area. One ofthe principles of tape reading is illustrated on this move. We had steadyvolume with an increase in price. This is so-called good buying. The endof the move is shown as a top near $23 with the volume spike. This isnormally when “everyone wants in on the stock,” and the smart moneybegins to sell shares it accumulated at lower levels. If you go over chartafter chart after chart on any given stock during the day, you can pick outvolume spikes and price spikes that normally lead to the end of a move. Itis a simple accumulation/distribution principle based on the public beingthe last to figure out what is happening. When it does figure it out andwants in, it’s time to look for your exit. Volume spikes are indications offast buying or of the public’s fear of holding a losing position, which leadsto capitulation selling.So we next saw a pullback on declining volume. Again the principleof tape reading is that you can see that pullback on declining volume, sowe look for an uptrend to continue. What we saw next was a situation inwhich the stock tried to break out again and failed.The circle (Test but No Break) on the horizontal resistance linedemonstrates this failure. At this point, the range defined from the touchedand the failed break was $23–$223/4. If traders entered below $23 beforethe confirmation, they would have had to use the low of the minirange asa stop level.As always, there is a choice when trading breakouts: Buy before thebreakout occurs and trade your convictions or wait for the breakout confirmation and have your order ready to send in. By using money and riskmanagement principles, you will decide how far you are willing to chasethe breakout. This depends on your stop price and your entry price. Thesetup in this case was a 1/4-point stop. But if you couldn’t enter until$231/8, the stop would now be $233/8.On the third attempt, the break finally occurs. The chart illustratesthe cup and handle. You can see this drawn on the chart with the first horizontal line, the cup, and the two diagonal lines, which show the area
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where the handle will formed. Notice how the volume repeated this formation, confirming the validity of the cup-and-handle setup. Normally thebreakout occurs on the third attempt of the high. In this case, the cup hadan unusually short time to form, but the setup still worked well.Now, our stop was set at $223/4. Therefore, our risk was assumed(gamblers create risk; traders assume risk) and it was no worse than the$2211/16 to $223/4 level. We now needed to follow the principles of tapereading for our exit. When the stock broke $23, scalpers exited into a pricespike, which you can see in the first upside price bar, and you can see themovement leveling off after the price spike. Volume increased, offering areasonable chance to exit into strength. For those who were willing tohold the trade, we needed a break of the resistance area near $231/2 to$235/8. So the first square used (exit point 1) offered a chance to sell atleast half of our shares and for scalpers to exit this full lot.Next we had a familiar principle again: shallow pullback on decreasing volume. This suggests that it is still reasonable to expect a continuation of the uptrend. In this situation, traders raised their stop to breakevenafter selling a portion of their shares.Resistance broke, and we looked for a price spike/volume spike toexit into. We were able to hold the trade near the $241/2 level, where thesecond square on the chart (exit point 2) shows the area of exit.Notice what happened at the $241/2 level again. It had a shallow pullback, and volume decreased a bit. Then the stock price formed a littleshelf and then broke higher once again. By exiting, I missed out onanother 11/2 points, but the trade was traded based on principles that tellme when to exit. Those who are better holders of a stock than I am couldfollow the same principles and exit on the next spike between $251/2 to$26. Eventually the trade got too long for my time. My intuition does notlast long for each trade, and it’s tough for me personally to hold a stockall day when the stock action and the principles of tape reading are tellingme to exit.
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EXAMPLE 25
CapitulationFigure EX25 is a 2-day, 5-minute chart. Capitulatory selling is represented by the first two vertical price bars at the open on February 14. Whydidn’t I try to go long near $32.75? After all, there was fast selling, somesupport in that area, and so on. In fact, this was just one of those intuitiveresponses. I didn’t believe that this was the area that would give a solidreversal for quick profits. And I was proved correct. I looked for something closer to $32. You can see some congestion and support from theprevious day in this area. If we got faster selling into this level, then Iwould be far more confident of the stock’s probability to reverse. As youcan see, the reversal occurred right at $32 and gave an entry signal on buying into contraction.As the stock broke $32.20 (the small range high from $31.95), I feltit had a better chance to get some profit potential. So the entry was either:1. Wait for contraction of fast selling into support (normally only aggressive traders do this).2. Wait for $32.20 to break and go long (get confirmation, but fight forshares).I chose the second option. Now that I had entry, I needed an exitstrategy. You can see again from the previous day that there was resistance at just above $33, and this should provide resistance on the day ofthe trade. Also, on that first round of faster selling into $32.75, we gotsome support and then failure. On the principle that what was supportshould become resistance, we wanted to exit from this area with at leastpartial profits.You can see that when the stock broke above $32.50, some verticalprice movement began into $32.75, where it was smart to exit at least aportion. I did just that. Scalpers might be out in full.As we pulled back from that resistance just under $33, we held$32.45 pretty well. We then wanted to trail our stop to at least breakevenand use a confidence level on the remaining shares. As we moved backinto $33 and failed one more time, this was where I wanted to exit anotherquarter of my shares.Exiting in full is reasonable as well because your profit is locked inand you have no worries from there. In this case resistance at $33 provedto be too strong, and my trailed stop at $32.35 was hit and taken.
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Capitulation. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
FIGURE EX25
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Lessons from this example include the following:1. Faster selling into support from the previous day and intraday is a goodarea to look for a reversal.2. Look at resistance levels from the previous day and intraday to determine some upside targets.3. Look for price/volume action into these areas to begin to exit in full orscale out.4. If you scale out, bring a trailing stop to establish a confidence level.5. Scale out more at the next resistance level, if you have enough remaining shares.6. Let the rest ride and see where it can go with a stop no worse thanbreakeven, and hopefully somewhere higher.7. Eventually you will hit a resistance level, at which point the NDXdoesn’t help your position confidence, so you can exit in full there.
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EXAMPLE 26
Open-Low–Break SetupFor the situation illustrated in Figure EX26, we had a range of $43.15 orso to $43, and liquidity was good. The break of $43 gave confirmation ofa downtrend signal. The stop was placed above the open high at $43.25.If there was to be a higher-probability downtrend trade, then the stockshouldn’t go over.There were two possibilities for entry:Before the breakdown, ensuring an easy fill, but with no confirmation.After the breakdown, with confirmation, but with a more difficult fill.I chose the first simply on aggression in the downtrending market.The NDX 1500 area was holding as support, but there was no major selling. Our tape-reading principles suggest that slower selling into supportgive us less chance of a rebound; rather we would hit congestion and seenew lows. The quick premarket gap higher faded into the open, meaningthat sellers put pressure on the buying and moved the market lower. So Iwas on a more short focus for open-break trades.Broadcom Corporation (BRCM) had a good open range shown bytwo lines on the chart. I went in aggressively with a short at above $43before the trigger, which was based on all the above. Had it hit $43.25, I’dhave taken my stop with no regret because my aggression would havebeen justified and my reasoning was sound.Let’s now move to the exit strategy.You can see the three circles on the chart of where I partialled out. Iused tape-reading principles of faster selling to cover, which made it easier to get a favorable fill. This action doesn’t necessarily get you the bestprices, but you can be assured of an easier fill. In this case, as we movedinto $42.60 on the longer black bar, I took half my shares off to lock inprofits.I’m not usually looking for more than a 2:1 reward/risk ratio on opentrades, so this trade offered a bit more than my normal profit targets. Also,with half my shares locked in on profit, I wanted something nearer the $42area. This was not based on “guessing,” but rather from the previous day’ssupport. I saw faster selling into this area, so I partialled out another quarter of my position, keeping a fair cushion from my entry to see if I couldride the other quarter a bit longer.This was a purely aggressive judgment call. Taking all the remain-
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Open-low–break setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
FIGURE EX26
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ing shares into that round of selling was perfectly valid, too. I felt that Ihad the overall trend with me, that I had BRCM action with me, and thatit was worth holding on another quarter of my shares for movement under$42.I then had a quarter of my shares left. It was now time to make a confidence level. This is different from a trailing stop, which means that ifyou hit the stop-loss level that the trade is exited at, take the stop. A confidence level means that if you hit the confidence level, you’re less confident in seeing better prices in the prevailing trend.I judged the confidence level based on retracements. You can seehow BRCM held at above $42 and went to $42.60 before backing offagain. If we were to go over $42.60, we would show a higher high, andI’d be less convinced that we would see a lower low. So instead of takinga stop here, I used the next round of selling under $42.60, and my stop wasat breakeven. Then I tried to get a better fill somewhere under $42.40 forthe remaining shares.The risk is that you get a breakeven stop. The reward is that you geta better price under the confidence level for more profit. This is yourdecision.You can see how this level held well enough to give us a move atunder $42, which is what I wanted for the remaining quarter of myposition.The tape-reading principle of faster selling is shown on the chart atthe circle—the one with the vertical price bar that is labeled 3. On the volume chart, you can see the volume spike to the sell side. These two thingscombine to say to “cover it all.”My target profits were met. I had confirmation according to tapereading principles, so I took my profits and moved on. And, by doing so,I missed out on nearly 1 point more in potential.Do I care? I don’t. I played the trade as well as I could within mysystem. So I’m happy with my assessment, my aggressiveness, my scaling out to lock in profits, and my final exit on my remaining shares.Everything was in sync for this trade, so I have no reason to regret missedprofits.
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EXAMPLE 27
Fading BreakoutThis example on Adobe Sytems (ADBE) describes how to fade the breakout setup. Again, to fade a setup is to initiate a position contrary to whatthe setup should bring in profitability. You will see how volume indications on this setup offer a higher probability for a short setup than a longsetup on the break of resistance from the open. Thus fading the long setupmeans initiating a short position after the failed breakout of the resistance.(See Figure EX27.)In the chart, the resistance is clearly marked from the open high atthe $37.50 level, which leads to a move into support near $36.70. Fromthis support, a reversal forms and moves the stock back up to the $37.50level. Quite often, 30-minute highs will form a significant level thattraders key in on for watching for some kind of reaction from the market.
FIGURE EX27Fading breakout. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
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In this case, the stock trapped the buy-side players and rewarded the shortside players.As the stock moved higher into the $37.50 level, you can see volumeindications that showed a steady buy-side slant. Near the 10:30 a.m.period, however, volume began to increase, and eventually the volumespike corresponded with a price spike. Tape-reading principles suggestthat minority action is slow and stable and that majority action is erraticand unstable. Given the increase on the buy side in relation to the volumeas well as the price increase being more vertical into resistance, there ishigher probability for the breakout to fail on that retest. Traders want slowand steady buy-side volume into resistance because it shows good support. A volume increase and a price spike into resistance show that theprobability is higher for the buying to have been exhausted and that therewon’t be enough buying on the break of resistance to keep the stock moving higher for profitability.This leads traders to fade the breakout in the hope of seeing thebreak of resistance trap more buyers with unsustainable upside movementresulting from exhaustion buying. Traders initiate a short position on thebreak of the resistance and look for the trade to move back below theresistance point for better confidence. Traders then look for a break of themost recent support to confirm that the downtrend is intact from that fadedbreak. This support level in the ADBE example would be around $37.30.This is regarded as support from the level that paused briefly beforereaching back over the 30-minute highs. Scalpers who wish to initiate a1:1 reward/risk ratio for this trade would look for a cover into this supportwith a stop at the high of the level from which the trade would be fadedor shorted into. Those traders who wish to scale out of the position wouldthen exit a portion of their position into this support level and trail the stopto breakeven levels. If the position were to break this $37.30 level, traderscould then begin to pick out their next support target based on the previous price action and to look for an exit on the remaining position. In thiscase, we would see support at the $37 level. Unfortunately, the stocknever got that low and moved back into resistance, where the remainingportion of the trade would be exited at breakeven levels.
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EXAMPLE 28
Short of the Range ResistanceThis example of Brocade Communications (BRCD) illustrates tradingwithin a range. Tape-reading principles within the range show why takinga short position into the resistance level at the early range was a higherprobability setup rather than initiating a long position looking for abreakout.On the day of the trade (See Figure EX28) the stock was in an afternoon downtrend on good volume consistency, showing that the near-termprice action was suggesting more downside ahead. Given that the stockgapped up the next morning into the previous day’s resistance level combined with the previous day’s afternoon price action, we would be looking for a short setup from the open. Having missed the early entry on theopen-break play at $26, we were forced to wait for a range to form in
FIGURE EX28Short of the range resistance. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
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order to assess the action within the base to determine if shorting the tradewas still a good possibility.As we watched the range forming from $25.75 to $26, we saw thatany move back into resistance would be associated with higher volume.The tape-reading principle of large buy-side volume associated with noincrease in price suggests distribution and a resistance level. In this case,traders want to initiate a short position within the range at or near theresistance level with a stop right over that range or at the most recent high,depending on their risk tolerance. Regardless of the risk tolerance, anybreak over resistance from this point would make it less likely for us toexpect a break of the low. Therefore, our exit strategy for a stop loss mustbe more focused.Once entry was taken on the short side at the nearest point to $26,our exit strategy for profitability became important. We had our stop-lossstrategy in place, so our profit exit strategy was our focus. In order to gainan idea of where we could exit in full or scale out, we needed to look atthe most recent support levels. The first idea that we had for exit wasderived from the principle that gaps tend to be filled. If this was the case,then being able to scale out along the way down to the previous day’sclosing price at $25.30 would be our target. If we were looking to be moreconservative in our profit objectives, then the previous day’s most recentsupport area near the $25.45 level would be our target. This was againbased on the principle that what was resistance would now serve as support. The previous day showed a move into the $25.45 level at about 2:45p.m., or 14:45 on the chart. This level should get support on the openretracement.Now that we had our targets selected, it was important to use ourtape-reading principles to aid us in determining just exactly when it wastime to exit. Again, as the stock moved, as long as it was stable and steadyin volume indications associated with a gradual descent in price movement, we were confident that we could hold for better profits. As soon asthe trade became more erratic, where the price dropped fast or the volumerose precipitously, then it was time to exit in full or scale out of the position. In this case, our profit objective wasn’t met because the faster selling phase of the breakdown occurred almost immediately into $25.60.However, by utilizing an entry into resistance near $26, we provided ourselves with a profit cushion that we wouldn’t have had if we had waitedand entered on the setup trigger. This goes back to an entry strategy thatis based on your own aggressiveness and risk tolerance. By entering intoresistance, we assured ourselves of a good entry with a full position, butwe gave up the downtrend confirmation, thereby making us less confident
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about the trade. If we had waited for actual confirmation, we would havegiven up our profit cushion, but we would have been sure that the downtrend signal was valid.As it turned out, the trade never got to the desired level, and thosewho were looking for a 1:1 reward/risk ratio type of profit were happyenough to exit into the $25.60 level. Those who were looking to scale outhad to take at least a breakeven exit on any remaining shares. However,the example does a good job of illustrating volume indications during therange-formation process to dictate an entry and then to show us the exitpoint based on the faster selling associated with the price drop the $25.60level.
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EXAMPLE 29
Open-Low–Break SetupThis example (See Figure EX29) illustrates an open-low–breaksetup in which we initiated a short-side entry on the break of both the openlows and the previous day’s support area. The reasoning behind the shortsided entry was based on the previous day’s action into the close as wellas the NDX indicator moving into a larger resistance area overall. We sawa series of lower lows into the close after a nice uptrend throughout theday. A possible pullback was in the cards, which, while profitable, wasn’ta huge reward/risk type of trade and would be one for traders who makelarger-sized trades and look for smaller profits. Those looking to scale outof this type of trade would most likely be stopped out at breakeven on theremaining profit.
FIGURE EX29Open-low–break setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
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The entry was taken on this trade after an open range consisted ofthe support from the previous day at $19.90 and the day of the trade’s highof $