or position type of trade. Since I look forfaster profits in my trades, I find a 2-day time frame to be fine.In this chart, we see that some support from the previous day wasnear $38.30 and then again near $37.70. These are labeled by two linesfrom the previous day. When we got near these areas, I looked for simplevolume indications. If we had slow selling into it, I had a greater probability of seeing it continue lower because not all sellers are washed out. Ifwe saw faster selling into it, we had a higher probability for a base to bemade, and quite possibly a reversal.The long vertical price bar (circle A) on the chart suggests that it wastime to exit for scalpers, and for holders to take half. I did the latter. Fromthis point on, instead of keeping the stop at $39.05, we could institute atrailing stop or a confidence level.I normally establish trading stops and confidence levels by using thelast range high before the next low is reached. In this case, we had $38.80as the new confidence level. In essence this says that if the stock goes overthis level, I have less confidence that I will see new lows and so I will usethe next selling activity to exit into. The confidence level on the chart isin the $38.80 area. There was a tick over, which told me to exit.The stock didn’t make new lows from that point, suggesting that cre-
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Drop-base–implosion (DBI) setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
FIGURE EX15
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ating structure among stop, confidence level, and current price allows usto not give back any profits, thereby overcoming the problem that manyof us have of turning a profit into a loss. I don’t mind seeing profit or partof a profit go flat. But I mind very much seeing a profit become a loss. Ifwe break the confidence level, we should exit no worse than flat.Hopefully we will get a little countermove to enable us to exit at a betterprice, just as Veritas Software (VRTS) shows us we can because it soldback down near $38.50, which is much better than $38.80 and much better than taking a stop at $39.05 on the remaining shares.So you can see why entry was taken, how to use the 2-day 5-minutechart to see supports when the intraday support is broken, how to determine an exit strategy using these supports, and finally volume indicationsnear those levels. Confidence levels add more structure to the trade, alleviating the problem of turning a profit into a loss.
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EXAMPLE 16
Jump-Base–Explosion (JBE) SetupThe first thing we see on the chart in Figure EX16 is the move from theopen to $21 on relatively stable volume. The fourth volume bar shows aslight increase in volume as the pace increased off the $21 level (line 1).Traders could have tried an entry when they saw bid strength and interestcoming into the stock, with a stop no worse than selling at $21.I was able to enter at $213/8. To me, taking the trade 3/8 off the bottom was somewhat too far for a reasonable entry price. I considered this
FIGURE EX16Jump-base–explosion (JBE) setup. (RealTick graphics are used with permission of TownsendAnalytics, Ltd.)
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to be chasing, as my risk tolerance was $250. But I felt strongly about thistrade and decided to stretch my risk tolerance a little. The optimal entryfor me would have been $211/4 or better in order not to consider it chasing, but entry at that price was nearly impossible.The next few volume bars show a volume spike while at the sametime the stock move to $22. According to tape-reading principles, acceleration in the price advancing, an almost vertical movement, is usually notsustained and indicates the end of this stage of the move (euphoria stage).A rise in price in conjunction with a volume spike is where the majorityof traders who entered off the $21 level would be exiting. I liquidated myshares into this buying at $217/8.Further, this $22 level, as you can see on the chart, serves as newresistance for the next 10 minutes or so. The pullback from the $22 areacame to a level of $215/8. This pullback from $22 to $215/8 serves as ourminirange (lines R1 and R2). There are two options when this happens:1. Buy the low of the pullback of the minirange, in this case, no higherthan $2111/16 with a stop at $211/2. Then you have the choice of eitherscalping within the range of $215/8 to $22 or holding for a breakout ofthe high.2. Watch for the test of the high and the look of the break, and buy thebreakout at $22.By the “look of the break” I am referring to the strength in the bid;the ask gets smaller as the pace increases. You can see on the volumechart that the pace was increasing into the break.Since the stock showed all the signs of breakout, I reentered at $22.We see that the next volume bar at 9:47 a.m. is another volume spike. Onbreakout plays for scalpers, those who take faster profits on larger shares,volume spikes should be considered a good reason to exit. The solid blackcircle on this chart at $223/8 represents the price strength combined withthe volume spike. I sold my position on this spike.For those who wished to hold for a continued uptrend, this would bea good area for selling half their shares at the scalpers’ target and trailingthe stop to breakeven.As stock pulled back from the scalpers’ exit area, it held the $22 support. This situation is a tough spot for traders. For example, traders whobought the breakout of $22 now had a few things running through theirheads. “The trade was 3/8 to 1/2 point positive and is now testing my buyprice. Do I hold it with a stop at $215/8 or exit, selling at $22? If I exit at$22 and it holds, I’ll be frustrated for not holding. If I exit at $215/8 by not
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trailing my stop, I’ll be frustrated for turning a 3/8- to 1/2-point gain into a3/8-point loss.”Traders must rid themselves of such thoughts. Instead, as the stockis climbing they should be planning their exit strategy, “Okay, the stockis positive. I’m either going to keep the stop at $215/8 or trail it tobreakeven. I don’t want to take a 3/8 loss on a failed breakout. I’d rathertake the flat trade. Maybe I’ll use $2115/16 so that, if $22 fails, I take a smallloss but my break of the $22 stop is confirmed.”The idea is that traders have to have the exit strategy. This lets themfocus on the stock activity as the stock moves. Cluttering their minds withthoughts of profit and loss does not allow for clear thinking and the application of tape-reading principles. The less they are focused on the actionitself, the more their emotions control the trade. Successful traders mustmaintain self-control at all times. They must define their strategy and execute it when the time comes.Fortunately, in this case, the $22 held. At this point, the former resistance of $22 now has changed to support. For me, if there were any signsof selling at $22, and I would have exited the trade. With $22 as our stop,we wanted a move to over $221/2 to occur.In the chart, we again see a volume increase as well as the break of$221/2. At that moment, holders of the stock began to consider exiting atleast half their shares above the $221/2 level into strength. $223/4 is a goodlevel to sell into strength on the price and volume increases (line 2).Holders would trail the stop to $221/2 as we broke over $23. The nextfew volume bars from the point at which we took half our shares began tofade. The slowing pace of buying with decreasing volume indicated thatthe top of this stage of movement was near. We now wanted to look for aprice to exit our remaining shares. As the stock moved over the $231/2level, buying dried up considerably (line 3). We saw a drop in the bid to$231/2 and then $233/8 within minutes. If you waited and didn’t exit intostrength, you would have to go as low as $233/8 (circle 4).The lesson here is that exiting after confirmation of the top is moredifficult. Those who wished to hold the trade longer were stopped out laterat $221/2 on the trailed stop represented by the circle.
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EXAMPLE 17
Jump-Base–Explosion (JBE) SetupIn Figure EX17, let’s first look at the time period just before 10:30 wherethe stock moved from $291/2 to $30 on a relatively good volume spike.Unfortunately, I missed the pickup in pace at the $291/2 level. What wesaw next was a tight range. The shallow pullback and the absorption ofselling suggested a possible continuation of the uptrend. I allowed thestock to define its range from $30 to $293/4.
FIGURE EX17Jump-base–explosion (JBE) setup. (RealTick graphics are used with permission of TownsendAnalytics, Ltd.)
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I wanted to play it for breakout, so I made a choice to buy the bottom of the minirange at $2913/16 with a stop at $2911/16. The range was toonarrow to scalp in, so I planned to hold the stock for the breakout of thehigh.Bidding the low of a minirange assumes bid strengthening. If the bidappears to be weak and a break of the low is imminent, then we need tounderstand the strong possibility that the stock will not hold the low of theminirange, and we need to pull our bid. In this case support was prettystrong as the stock neared the low of the range. As you can see on thechart, the price spiked to the $301/4 to $305/16 area and then got stuck there.At this point in the trade, when it looked as if the breakout was going tofail, I started to feel nervous about continuing. At the same time I had afairly good cushion thanks to my entry at the low limit of the range, so Iheld it with my original stop in place. The pullback after topping in the$301/4 area came to $297/8, and I put my finger on the mouse and got readyto exit. Support held and the stock upticked off this level. As the stockwent over $301/4, I decided to raise my stop to $30, not allowing my profitto disappear.The ascending line in the bar chart shows a moderate price spike.The circle shows the area $301/2 to $305/8 where I exited half my shares.The stock had another shallow pullback after my exit. Selling wasagain being absorbed. I tested the $305/8 level again and broke it. Noticethe ascending line in the volume chart indicating a large spike. I wantedto look to exit the remaining shares on this larger volume. I chose the areaof $303/4 to $31 as a reasonable exit area. On the break of $303/4, the stockhit a high of $31 but there were plenty of sellers on the ask at $31. I exitedat $307/8, taking fairly good profit on the second half of my shares.We can see on the chart that during the next 15 minutes or so thestock climbed to $311/2. So by exiting into the volume spike, I left abouta 1/2 point on the table. However, on breakout trades, we never know howfar they will go. By trading within these ranges, trailing stops, and following tape-reading principles, we can bring order into our trading and letthe rest of the profits go to those who see things differently.
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EXAMPLE 18
Drop-Base–Implosion (DBI) SetupADC Telecommunications (ADCT) (see Figure EX18) closed right below$19 on the previous day. It opened with a slight gap up. Approximately20 minutes after the open it hit $19 again. That was a short signal forADCT.At that moment someone asked me if it was a good time to buyADCT. Apparently, “buy low, sell high” was deeply ingrained in his trading. I told him that I had just sold it short, and I explained that the “buylow, sell high” principle was in direct contradiction with another: “Trendis your friend.”If you go with the trend, why would you want to buy low or shortthe high? If a stock is trending down, wouldn’t buying the low be fightingthe trend? Every new low confirms the continuation of the trend andshould be shorted, not bought. The same goes for shorting of strongstocks. I am sure that you have seen plenty of examples of traders gettingkilled trying to pick the bottoms or tops. Trading is not about picking topsand bottoms; trading is about determining the trend. Actual buying andselling points within the trend need careful consideration as you try toeither pick up the shares at the bottom of a pullback or at breakout levelor go with some kind of hybrid, buying half of your position on the bottom and adding to it on breakout.Is there a situation in which you buy low and sell high? Yes, thereis. You can do this when you have determined that the stock is tradingwithin the range, not trending. But, as soon as the range is broken, youhave to switch to another kind of trading: Buy high and sell higher or sellshort low and buy back lower.This is why traders who go with “buy low, sell high” do poorly in atrending market. I have seen (and I am sure you have, too) plenty of themgetting killed during the huge market run-up of 1999 through early 2000as they tried to short the tops. The same happened to those who tried tobuy bottoms during the market decline in 2000–2001.Let’s return to the ADCT chart. I shorted ADCT when it broke $19to the downside (trade 1 on the chart). I placed a stop at $191/4 because thestock unsuccessfully tried to penetrate this level during a weak attempt tobounce, so $191/4 became the natural resistance.ADCT broke down pretty quickly. At around $18 it showed somesupport, and I had covered the short in full. I watched it going down more,and, later on, ADCT found more support at $171/2. It made several weak
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FIGURE EX18Drop-base–implosion (DBI) setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
attempts to bounce from this level, and then the volume dried up.Unsuccessful attempts to bounce led me to the conclusion that the downtrend was still intact, and another short signal was generated (trade 2). Ittook traders of ADCT about 20 minutes to realize that the stock was destined to go down. I covered it just below $161/2.Note the volume spike as ADCT went down to $16. That was capitulation: fast selling on sharply increased volume which usually indicatesthe end of selling and offers a reasonable expectation of a reverse. This is
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what makes me reverse from “sell low, buy back lower to buy low, sellhigh.”It was at that point that I started to look for a bottom buy because itreally looked like the trend was about to reverse. I made two attempts: Thefirst led me to a flat trade at $161/2 (trade 3). The stock sold down onceagain on exhausted selling, which I believed was the last gasp of selling.I took my next buy attempt at $161/8 with a stop at $157/8 (trade 4entry). Placing a stop in this case was easy—any new low, and we had toadmit that the downtrend was still there. The closing of the trade was easyas well. As a scalper I got my 3/8 point (Trade 4 exit).I didn’t touch ADCT again that day, despite its nice climb after adouble bottom was formed. It was certainly worth another long play, butI lost my feel for its movement and could not read it as clearly as I couldbefore. The pace became pretty flat; volume stopped giving any usefulindications, which made the stock tough to read.
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EXAMPLE 19
Trend ContinuationIn Figure EX19 the circle marked 1 is a long entry after capitulation selling. This is illustrated by the declining line in the price section and the circle in the volume section. A steep price decline on sharply increasedvolume indicated capitulation and led to a long entry called at $753/8. Thestock spiked at over $76, where I made my exit.Let’s take a look at what has happened. The price stalled at around$76, and the volume dried up. You can see the two lines marked as bearflags, one in the price section and the other in the volume section. A relatively big volume increase on the price advance with shallow volume onthe reaction indicates a continuing uptrend. Here we have reversal of thisprinciple for a downtrend: volume drying up on a short-lived rally indicates a continuing downtrend.I interpreted this as an indication of potential further decline and prepared to short JDS Uniphase Corporation (JDSU) at a new low, as itwould penetrate $75 to the downside. We didn’t want to short it at around$76. Although this is a valid play, in this particular case we refrained fromdoing it because the stock was moving extremely fast, which can be dangerous, and we needed more confirmation of direction. It was easy to shortit at around $76 only to see it making a double bottom 1/2 point lower andthen jumping higher. That’s why I made the short entry at under $75 asthe stock made a new low. My actual entry was $743/4, which was all thatwas possible considering the speed of JDSU.The next stage of the movement was accelerated selling, which ismarked as capitulation on the chart. When selling became furious at under$74, it was the time to cover and/or go long. As you can see, the cover andreverse would have happened at around $731/2 to $735/8.The next event is quite remarkable. It’s an exact repetition of whathappened on the first rally. The stock spiked to $75, and again, as in thefirst case, the price stalled and the volume has dried up. The same principle was applied, and this is indicated by the bear flag, which suggests thatthe downtrend is likely to continue. The price broke down fast once againand reached the previous low. The line marked “previous low broken”shows the level of that low. And, once again, the entire cycle repeateditself. The new short entry was $73, just below the previous low, and thenew capitulation took the stock to new lows on increasing volume. Youcan see a sharp volume spike drop to under $71. This spike alerted me tothe bottom being close, and the stock rocketed from here. The next stage
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FIGURE EX19Trend continuation. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
was again the bear flag, and the stock met resistance at the level where itbounced the previous time—at around $73.Former support became new resistance. After the stock had droppedfrom this level, it became much less readable mainly because the pricemovement and pace became plainer, which usually makes readability low.
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EXAMPLE 20
Open-Low Break and ReversalNetwork Appliance (NTAP) (see Figure EX20) was lower right from theopening, and it had a nice open-break trade possibility. Its early range was$25.20 to $25.40. When it broke $25.20, I took this to be a signal to takeit on the short side, with a stop just over the high of the narrow range. Iwasn’t aggressive on my open plays that morning, so I missed it becauseof my lack of aggression.The downside movement is shown in the area with two lines and thecircle A. This movement was resistance from the previous day. I lookedhere for some possible support in order to form a range that would leadme to trend continuation or reversal. During this period of movement, Istayed with the trend and went with a short bias, looking for a breakdownof support.
FIGURE EX20Open-low break and reversal. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
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Entry was taken just before confirmation, but liquidity at this pointwas thin, giving me only half my shares of the original order, before moving lower. When I get less than my original order, around 500 to 600shares, I look to scale out half and half, rather than half, quarter, quarter. Inthis case, as entry was taken on the breakdown of this range near $24.50, Ilooked for an exit strategy that would yield a near 2:1 reward/risk ratio.Selling was faster into the $24 area, and I looked to scale out into that fasterselling. In this case, the faster selling took the stock lower to about $23.60,leaving me with around 35 cents in missed potential because I scaled outnearer $24, but what could I do? I saw what I needed, I had no idea howfar the stock would drop, and I could scale only as I saw fit.I then had half my shares left, so I used the next rebound as a confidence level, in this case just under $24, near $23.80. If I were to go backover $23.80 from here, I’d be less convinced that I’d see new lows on themovement. Fortunately, it didn’t happen, and the stock moved lower fortrend continuation.At this point, there was another fast selling phase with vertical pricedrop movement into about $23.20. I took my exit just under $23.50 as thefaster selling hit again on the remaining shares. This is shown by circle C.This gave me about 2:1 in my reward/risk ratio for the first lot. I scaledout of the second lot and achieved a 4:1 reward/risk ratio.We saw capitulation movement a few times on this stock. Butinstead of trying to trade the reversal at $24 and $23.50, I looked at something nearer $23 because the 2-day chart showed the previous day’s support there. When I got a few signals working together, my confidence inthe trade became a bit stronger.We now had:1. Faster selling (capitulation showing exhaustion and leading to a highprobability of reversal)2. Support from the previous day that I thought would hold on the day ofthe tradeFaster selling into a support is a good reason to bid the issue,because you have selling exhaustion and clear support. If they hold, itshould be a nice reversal. If they fail, you have a clear stop exit strategy.I took entry at $23.27, and looked for a movement back into resistance levels to scale out or exit in full depending on the action. I took mystop as the stock broke back below the low, which did not get me to a reasonable reward/risk ratio (circle D). This stop loss was defined by the lackof buying into a resistance level, and then the failure of the former low tohold. I didn’t reenter the stock because I lost confidence in its ability torecover. Further action proved me to be wrong.
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Let’s see how a trader should have acted if this entry was taken.Circle E represents the real low. Let’s assume that we caught it. Manytraders often have a tough time distinguishing where to exit reversals. Inthese cases, I try to establish two things:1. Areas where the downside movement begins to become more vertical.This is along the lines of “what was support, should now be resistance.”The level where support breaks, and the point at which the pricebecomes vertical, should now be an area of resistance.2. In areas where there are ranges, use the high of a range to establish aresistance level that the stock needs to eat through if the upside reversal is to continue.This situation is represented by the three lines tied into the black circle labeled F.Let’s assume we took entry near $23. We kept an eye on that $23.40area. You can see the resistance it made between circles D and C. If we brokethat, we could have used $23.80 as a next one. But if we broke $23.40, wewould have some cushion to work with so that I wouldn’t care as much aboutcloser resistance. I could have scaled into this area if I had wanted to.The next movement resistance was back again at the $23.80 area—the former confidence level. The price moved to this level at 9:50 a.m. andthen dropped sharply to $23.30—an area of resistance again. If the buying had been any faster, I’d have looked to exit another portion of myshares. By doing so, I would have given up a little more movement to justover $24.10. Remember, we are defining areas in which things are likelyto happen, not creating certainties where things will happen. So let’sassume that I still held a half or a quarter of my position. The most likelyresistance would be where my original entry was made. You can see onthe chart how the price moved right back to $24.50 and failed to continue,as this former support, once broken, then served as the ultimate resistance.If we broke $24.50 with stability, I have trailed the stop, moved theconfidence level up to just under $24 (you can see support there on theshallow pullback), looked for final resistance at $25.20 or so, and exited infull to close the daily trade. Rarely do we get that lucky. But the lesson is:1. Don’t guess on where to exit (or enter for that matter).2. Find the areas of support and resistance.3. Use the correlations of price and volume to find areas for entry and exit.4. Use areas in items 2 and 3 as guides for stock movement on retracements.5. Scale out as the stock moves in your direction.6. Keep your stop if items 1 through 5 fail to be profitable.
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EXAMPLE 21
Drop-Base–Implosion (DBI) SetupIn Figure EX21 we see a fairly sharp sell-off at the open—an almost vertical downside price movement associated with a volume spike. As thestock bounced from $16.25 to $16.60, we got stuck in the range. Thisrange trade didn’t allow much for conviction on direction bias until wesaw some clues. Examples of such clues are:1. Are highs and lows higher or lower than those made on a previous movewithin this range?2. Is the volume increasing or decreasing on advances and retreats?In this case, the high of $16.60 gave us a retest of the $16.25 low andthen a lower high at $16.50. This is where I went with a short-side biasrather than looking for reversal. As we finally broke $16.25 support, Ientered short. Short setups are inherently more difficult than others. Theuptick rule negates ease of entry if the stock drops too fast. Fortunately,Comverse Technology (CMVT) fell and then came back to $16.25 for theentry.In this kind of situation a common question is: If stock falls beforeentry, how far do you let it go before you refuse to chase? Usually, if thetrade doesn’t serve at least a 1:1 reward/risk ratio on the first break andthen come back to that best short price, I’ll go with it. If I see it serving1:1 right away, I’m less confident in it and am less likely to enter if itcomes back to that price.The support line on the chart shows the support. When the supportbroke, we went with the trend and found the short entry. The initial stop(shown on the chart) was placed at the previous high made within risk tolerance after the setup formed, in this case, just above $16.50.With risk of about 25 cents, scalpers would exit near $16 for 1:1reward/risk ratio. I wanted to hold for a better exit because the bouncelooked weak.From the $15.95 support level, we had a move back to about $16.15.This was now our new confidence level after we retested the lows. Thismeant that if CMVT were to go higher, back over $16.15, I would be lessconfident that we would see new lows. If CMVT were to go over $16.15,my option would be to set the breakeven stop on the remaining shares oruse the next round of selling back into support to cover.As you can see, the stock did not get near this level again. Rather itmoved into “congestion.” Two horizontal lines denote the congestion in
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FIGURE EX21Drop-base–implosion (DBI) setup. (RealTick graphics are used with permission of TownsendAnalytics, Ltd.)
this area, one just above $16 and one just below.Congestion occurs when the number of buyers is equal to the number of sellers in a narrow range. In this case, it was very difficult to discern direction. I had two choices:1. I could hold a full position until the low of the range broke, keeping mystop-loss level intact.2. I could hold a partial position. I could cover half the position into support, and thereby lock my profits.If the stock broke the high of the congestion, I could use the samestrategy I used with the confidence level, letting it hit a stop at no worsethan breakeven, or I could use the next round of selling into support to exitmy remainder. If the stock broke the low after I had covered the first half,I could then add the half back again, because the continuation signal wasgiven. Or I could not add that half back and just let the remaining half thatI had ride as the continuation signal was given.
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There is no single right way to trade it; these are just options. Choosewhat best fits your style. I went with the first option, held my full positionand waited for $15.95 to break down. It did, and I covered my short into$15.75. This level served a 2:1 reward/risk ratio, and there was faster selling with increasing volume.If traders had covered half their shares at this level, they wouldlower their stop to $16.15, our former confidence level. Their new confidence level would be $15.95, on the principle that what was supportshould now be resistance. If it broke over $15.95, I would have been lessconfident that I would see it under $15.60, so either it would hit the trailing stop at $16.15, or the next round of selling would take it back into the$15.60 to $15.75 area, which is where the exit should be taken.
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EXAMPLE 22
Trailing Stops and Confidence LevelsTwo days previous to the trade shown in Figure EX22, we had very goodaction and were aggressive. On October 28, however things became dull,and it seemed that the resistance levels were getting sold into, rather thanbeing broken out of. Trading became rather narrow and lifeless, leadingus to October 29. The open-break plays were not worth much on the longside, and we had backed off, looking for short setups as the NDX movedlower throughout the opening. Siebel Systems (SEBL) was my focus fromthe short side as the NDX was failing to overcome resistance. Resistanceat $18.55 looked like the top, as NDX lost its low.The two diagonal lines are descending and show lower highs andlower lows, which creates the look of a downtrend. With the NDX