or more) range.
 
“ WideRange
h Hid
tI
 
  
24 Chapter 3
Here’s an example of a stock that shows multiple Trend Qualifiersthroughout a 90-day period. The trend was easily determined early on bythe base breakout. The stock then proceeded to show strong trendingcharacteristics.
FIGURE 3.3
 
 
WRB |:
      
NH. OARho Strong Ny -_ Close beat (! taf5g petBase - NH. NE 1! tN asBreakout - : ty suex Hergyet! th /N pret WRB
pettrtre” |
 
7 SuperChaits by Omega Research © 1997
 
 
 
Alexion Pharmaceuticals (ALXN) rises over 700% in 10 weeks. During that period, it broke out froma base, made new two-month highs (NH), had strong closes and gaps and wide-range bars (WRB) inthe direction of the uptrend.
MOVING AVERAGES
Moving averages are also helpful when determining trend. I like to use a10-day simple moving average (GMA), 20-day exponential moving aver-age (EMA) and 30-day EMA. The 10-day SMA gives me a true represen-tation of price over the last two weeks (10 trading days). The 20- and30-period EMAs give a rough representation of performance over the lastmonth and six weeks, respectively. ] like the exponential averages for 
Trend Qualifiers 25
these longer periods as they are front-weighted and catch up to pricesfaster.
The characteristics of moving averages that I use to help me determinetrend include slope, Daylight and proper order.
SLOPE
Slope is quite simply the direction in which the moving averages arepointing. Positive slope suggests an uptrend, negative slope suggests adowntrend and very little slope suggests a consolidation.
DAYLIGHT
In December of 1996, I published the 2/20 EMA Breakout System inStocks And Commodities Magazine. The system essentially looks to go longafter two or more lows are greater than the 20-day EMA. Soon after itwas published, several traders contacted me to discuss how they usedand modified the system to fit their needs. One trader, Joe Sansolo,dubbed the lows being greater than the moving average “Daylight” be-cause you could see “daylight” in between the low of the bar (or highsfor downtrends) and the moving average. This daylight many timesmeans the trend is in place and beginning to accelerate.
Moving
Ave rage /\ f ( ,
— —~Daylight
 
 
PROPER ORDER
In an uptrend, a faster (shorter time frames) moving average will followcloser to price than a slower (longer time frames) moving average. There-fore, when using a 10-day SMA, a 20-day EMA and a 30-day EMA, the 
26 Chapter 3
10-day SMA should be greater than the 20-day EMA and the 20-dayEMA should be greater than the 30-day EMA.
Notice the moving averages in Alexion Pharmaceuticals, mentioned pre-viously. There was Daylight and the moving averages were in proper or-der and had a positive slope throughout its strong uptrend.
FIGURE 3.4
 
Alexion Pharma Inc-Daily 03/01/2000 C=115.500
      
DaylightAy
[ett
  
 
 
 
 
THE TREND SHOULD BE OBVIOUS
Even though we have gone to great length to describe trend, the truth is,it doesn’t have to be rocket science. Therefore, don’t get too caught up inthe specific details. In fact, if you have a young child at home, ask him orher what direction they think a chart is headed. If you don’t have anyyoung kids, think to yourself, “In which direction would a 6-year-old saythis stock is headed?”
And finally, keep in mind that markets only trend about 30% of the time.Trade that 30% and ignore the remaining 70%. This will further ensureyou are trading in the correct markets.Trend Qualifiers
O&A
Do you recommend any additional reading on determining trends?
Yes. Mark Boucher has done intensive studies of early identification ofrunaway markets. He has quantified market constructs such as gaps,laps and thrusts. He published this research in his book The HedgeFund Edge.
Are there any hard fast rules when it comes to determining trend?
No. If the right side of the chart is higher than the left, then that is anuptrend. If the right side of the chart is lower than the left side, then itis in a downtrend. Seriously, it should be obvious.
You used 10-day simple and 20-day and 30-day exponential movingaverages for stocks. Do you also use these in other markets?
Yes. For an index, like the Nasdaq or S&P, I like to also plot a 50-dayand 200-day simple moving average simply because it is well-watchedby institutions.
Is a simple moving average better than an exponential moving aver-age or vise versa?
I think both have their place. I like the simple for shorter time periods,say 10 days or less, because this gives me true representation of theaverage price. Longer term, I like to use exponential moving averagesas they still give me a feel for the longer-term average price, but beingfront-weighted, tend to catch up to current prices faster.
 
27 
CHAPTER 4
STOCK SELECTION
As momentum swing traders, we are looking to capture explosiveshort-term market moves. We do not have the luxury of waiting around forsomething to happen. Therefore, it’s vitally important that we are trading instocks that show the most immediate potential. Obviously, as momentumplayers, trend is one of our main criteria. In addition to trend, the stocksmust be volatile, a member of the strongest sector, priced high enough andhave a reasonable spread to make short-term trading worthwhile. These,along with several other criteria for selecting stocks, are discussed below.
Trend—In general, the stocks should have an ADX reading of 30 orhigher and +DMI > -DMI for uptrends and -DMI > +DMI for down-trends. Keep in mind that no indicator guarantees that a stock is in atrend. Therefore, make sure the trend is obvious (regardless of the ADXreading) and shows characteristics described under “Trend Qualifiers.”
Sector—Trade in stocks that are members of the strongest sectors. Theold stock market adage “A rising tide lifts all boats” is as relevant to in-dividual sectors as it is to the major averages. In fact, because sectors canoften outperform and even trade counter to the overall market, the sectoraction is more important than the overall stock market.
Under ideal conditions, the overall sector should be in a strong trend.However, keep in mind that sometimes sub-sectors can trade independ-ently of the overall sector. For instance, in mid-2000, the telecommunica-
 
29eee eeeeeeeeeeeee eee eeee ee eeeeee30 Chapter 4
tion stocks overall were in a strong downtrend but the fiber sub-sectorwas in a strong uptrend.
Spread—The spread is the difference between the bid price and the askprice. For instance, if a stock is bidding 98 and asking 100, it has a2-point spread. So if you bought that stock at the market for $100, youwould immediately have a 2-point loss, as the best you could sell thestock for would be $98. In general, you should avoid stocks with suchlarge spreads and focus on issues that have a spread of % point or less.Keep in mind, however, that in trading, there are trade-offs. Sometimesstocks in fast moves will have larger spreads, as traders are reluctant tosell near the bid. In these cases, you'll have to decide whether or not thepotential for gains outweighs the immediate loss.
Price—As I've learned from Jeff Cooper, professional trader and authorof Hit and Run Trading I & II, if you are going to trade on a short-term ba-sis, you need to be in higher-priced stocks. This is because they have thepotential to make larger point moves than their lower-priced counter-parts. For instance, a $10 stock must gain 30% in value for a 3-pointmove. A $50 stock would only have to gain 6% and $100 stock wouldonly have to gain 3%. Therefore, I suggest only trading in stocks priced$20 and preferable $30 or higher.
Price Persistency—Focus on those stocks that tend to be most price per-sistent. This means that the stock price tends to follow through from oneday to the next. For instance, if the stock is up sharply today, it tends tofollow through to the upside over the next few days. I have yet to findan accurate measurement of persistency other than looking at charts. No-tice how a stock acts when coming out of a pullback. Does it tend tothrust and fail? Or do thrusts tend to carry through over the next fewdays?
Daily Range—The stock must exhibit the potential to make large movesover a short period of time. One of the easiest ways to recognize this po-tential is to look at the average range (high — low). As a general rule, theaverage range should be two points or higher.
Volume/Liquidity—One advantage of being a smaller independenttrader versus an institution is that you can trade in smaller cap issues.Many times, these issues have the potential to make larger gains thantheir bigger cap counterparts. However, the issues need to be liquidenough to allow you to move in and out with ease. In general, the stock’s10-day average volume should be at least 100,000 shares. 
Stock Selection 31
Volatility—Volatility is simply how much prices fluctuate over time. Thelonger-term trader has the luxury of waiting for a stock to move. Theswing trader, on the other hand, is looking for an immediate movewithin a short time frame. Therefore, he must trade in more volatile is-sues. I believe the best, standardized measurement of volatility is histori-cal volatility (HV). Stocks you trade should have a HV reading of at least40% or higher. I will discuss HV in further detail in Section Three,
Volatility. 
 
CHAPTER 5
PULLBACKS
The simplest theory that fits the facts of a problemis the one that should be selected.
— Occam’s Razor
Although I emphasize trading with the trend, this does not mean blindlybuying a stock simply because it is in a strong uptrend. Strongly trendingmarkets are prone to correct. And, you never know when what appears tobe a correction, may in fact be the end of the trend. Therefore, it’s muchwiser to wait for the correction to occur and then look to enter if (and only i)the original trend begins to re-assert itself—this is the theory and essence ofthe pullback. In my opinion, this is the single strongest way to trade.
Referring to Figure 5.1, a hypothetical pullback example, the market is ina strong uptrend (a) and begins to correct (b). Upon trend resumption (arally), an entry is triggered (c). A protective stop (d) is placed right belowthe low of the pullback (d), just in case the correction is not complete.
33ee reer reer rere reer34 Chapter 5
FIGURE 5.1
 
 
Correction |
(b)
Trend
| | | | Resumption
| | Entry (C)
(d)
| | — Protective Stop
| a,| ( strongTrend
 
 
Entering if, and only if, the trend resumes helps to avoid markets thathave topped. Notice in Figure 5.2, another hypothetical example, what atfirst looked like a pullback, turned out to be the exact top of the marketand the beginning of a new downtrend.|Pullbacks 35
FIGURE 5.2
 
1 | Dy Failure
i
StrongTrend
 
 
 
 
Trends often last much longer and go much further than most are willingto accept. Markets often thrust, pull back and thrust over and over again.This is why top and bottom picking is often a loser’s game.
This is not to say that trends last forever. Eventually, all trends end.Therefore, when trading pullbacks, there’s always a chance that what ap-pears to be yet another pullback, in fact, turns out to be a major reversal.However, by waiting for an entry and using protective stops, you may befortunate enough to either avoid the trade (no entry) or get stopped outwith no more than a modest loss. 
36 Chapter 5
Infospace (INSP) provides a good real-world example. Referring to Fig-ure 5.3, notice that the stock “stair stepped” higher, over and over again,but eventually fails. One note of observation: The more times a stockpulls back and resumes its trend, the less likely the next pullback will fol-low through. Said another way, early pullbacks are superior to later pull-backs.
FIGURE 5.3
 
 
 
 
 
 
DEFINING A PULLBACK
A pullback can be.defined in terms of the trend, the new high, the widthand the depth. These are illustrated in Figure 5.4.|Pullbacks 37
FIGURE 5.4
 
 
 
 
TREND AND NEW HIGH
Obviously, a market must be in a trend and make a significant new highbefore a pullback can take place. Trend can be defined in terms of anADX reading of 30 or higher and +DMI > -DMI or by other Trend Quali-fiers (Chapter 3). The new high should be at least a two-month calendarhigh (approximately 43 trading days).
WIDTH
The width is the number of bars since the last new high was made. Forinstance, a four-bar pullback has gone four days since its last new high.This is illustrated in Figure 5.5. 
38 Chapter 5
FIGURE 5.5
 
 
 
 
The width should be wide enough so the market has enough time to cor-rect but not too long as to negate the market’s initial momentum.Three-to-seven bars is a good rule of thumb here. Referring to Figure 5.6,Emulex (EMLX), notice that after pulling back for eight days (a), thestock begins to drift sideways (b). 
Pullbacks
FIGURE 5.6
39
 
 
 
 
 
DEPTH
Depth is how much the market gives up during the correction. For in-stance, if a stock rallies up to 100 (a new high) and then sells off to 90,then it has pulled back 10% off its highs.
Shallow pullbacks tend to lead to longer-term, smoother continuationmoves. Deeper pullbacks tend to lead to much shorter-term and muchsharper “knee-jerk” reactions. In general, I consider pullbacks of 15% orless shallow and those greater than 15% deep. Keep in mind that “shal-low” and “deep” become somewhat arbitrary and depend on the volatilityof the stock.
RETRACEMENTS
Depth can also be measured in terms of how much of the underlyingtrend has been retraced. For instance, if a stock rallies 20 points since itslast significant low and then gives up 2 points, that stock has retraced10% of its prior trend. Referring to Figure 5.7, notice that if a stock rallies 
40 Chapter 5
from (a) to (b) and then drops all the way back to (c), then 100% of thattrend has been retraced. Other commonly used retracement levels: 38.2%,50% and 61.8% are shown in Figure 5.7.
FIGURE 5.7
50%61.80%(a) = 100%
Let’s look at some examples of pullbacks.
 
 
 
Here we have an example of a three-bar pullback. 
Pullbacks 41
FIGURE 5.8
 
Alexion Pharma Inc-Daily 02/16/2000 C=88.250 2) EO
Soft - t
oe sod 8
craget tts en
co
   
7H
 
1. Alexion Pharmaceuticals (ALXN) qualifies as a strongly trending stockby having an ADX reading of 60 and +DMI > -DMI (a). Other TrendQualifiers include its having tripled in value over the two months andwide-range bars (b) and strong closes (c) in the direction of theuptrend.
2. The stock makes a new two-month high.
3. It pulls back three bars (width).
4. This is 13% off the prior new high (depth) creating a fairly shallowpullback. This suggests that the stock has the potential to make a lon-
ger-term continuation move. Go long tomorrow at 53 1/16, 1/16above today’s high.
5. The trend resumes as the stock trades at 53 1/16, 1/16 above the priorday’s high and we go long.
6. A protective stop is placed at 50 15/16, 1/16 below the lowest bar inthe pullback.
7. After a slow start, the stock skyrockets over 40 points over the nextfive days. 
42 Chapter 5
Here’s an example on the short side.
FIGURE 5.9
 
 
Motorola Inc. Daily, 05/19/2000, c=27. 593 - 3: 628
 
 
 
Motorola (MOT) qualifies as being in a downtrend by having an ADXreading of 32 and -DMI > +DMI (a). Other Trend Qualifiers includeits having lost over 40% of its value in less than two months and itshaving wide-range bars lower (b) and a gap in the direction of thedowntrend (c).
. The stock makes a two-month low.
The stock pulls back 17.9% (depth) in five bars (width). Go short to-morrow at 38 1/16, 1/16 below today’s low.
The stock trades at 38 1/16 and we go short. A protective stop isplaced at 39 5/8, 1/16 above the highest bar in the pullback (3).
The downward trend resumes as the stock drops over ten points overthe next seven days. 
Pullbacks 43
An easy way to recognize or scan for pullbacks is to look for three toseven consecutive lower highs after a stock hits a new high. I havedubbed these “Simple Pullbacks.” These often set up as pullbacks de-scribed by Gann over 65 years ago and extensions of his work such as
Connors’/Cooper’s 1-2-3-4s.
After at least three, but no more than seven lower highs, look to go longtomorrow if the stock can trade 1/16 above today’s high.
FIGURE 5.10
 
 
 
/ | T= a Faty
3|
i
StrongTrend
  
44 Chapter 5Here’s an example of a four-bar “Simple” pullback.
FIGURE 5.11
 
 
 
 
 
1. Transwitch (TXCC) qualifies as a strongly trending stock by having anADX of 46 and +DMI > -DMI (not shown). In addition, other trendQualifiers include its rising over 200% in less than a month and itshaving gaps (a), (b) and (f), and its having wide-range bars, (d) and(e), and strong closes (e) in the direction of the uptrend.
2. The stock makes a new two-month high.
3. The stock makes four consecutive lower highs. Go long tomorrow at39 3/4, 1/16 above today’s high.
4. The stock gaps open to 40 11/16 (above our entry) and we go long.
5. Because the low of the formation (35 3/16) is more than 13% awayfrom our entry, we will only risk 5% of the stock’s value and place aprotective stop at 38 5/8. 
Pullbacks 45
6. The stock resumes its uptrend and trades around 18 points higherover the four days. 
46 Chapter 5
I have observed that deeper pullbacks, say 15% or greater, of stocks instrong trends tend to create a “knee-jerk” reaction. This is based on thefact that when a stock pulls back sharply, it creates an out-of-balance sit-uation, as eager shorts jump into the market and nervous longs bail out.
Like a rubber band being stretched to extremes, the market often vio-lently “snaps back” in the direction of the longer-term trend as shortsscramble to cover and longs jump back in. Therefore, I have dubbeddeep pullbacks “Snapbacks.”
FIGURE 5.12
 
Open TV-Daily..03/13/2000.C=212.000. 427.750... (6), L220
 
 
 
1. Open TV (OPTV) qualifies as a strongly trending stock by having anADX reading of 49 and +DMI > -DMI (not shown). In addition, otherTrend Qualifiers include its more than doubling in less than a month,its having wide-range bars with strong closes, (a) and (d), and a lap(b) and a gap (c) in the direction of the uptrend.
2. Open TV makes a new two-month high. 
Pullbacks 47
. The stock has a sharp 25% sell-off (depth) over four days (width). Buytomorrow at 156 1/16, 1/16 above today’s high.
. The stock trades through at 156 1/16 and we go long.
. Because the low of the setup (3) is more than 8% away from out entry,we will risk 5% of the stocks value and place an initial protective stopat 148 1/4.
. The stock explodes out of the deep pullback and trades over 60 pointshigher over the next four days. 
48 Chapter 5
Here’s another example of a deep pullback or a “Snapback.”
FIGURE 5.13
   
 
Giobespan-Daily | 02/03/2000 C=58.781 +2.750
 
 
 
GlobeSpan (GSPN) qualifies as a strongly trending stock by having anADX reading of 50 and +DMI > -DMI (not shown). In addition, otherTrend Qualifiers include its more than doubling in less than a month,and its having a gap (a), wide-range bars (b), (0), (d) and (e), andstrong closes (b), (c) and (d) in the direction of the uptrend.
GlobeSpan makes a new two-month high.
The stock has a sharp 30% sell-off (depth) over four days (width). Golong tomorrow at 41 3/4, 1/16 above today’s high.
The stock trades at 41 3/4 and we go long.
Because the bottom of the formation (3) is more than 14% away fromour entry, we set an initial protective stop 5% below our entry at 39
5/8. 
Pullbacks 49
6. The strong uptrend resumes and the stock trades over 50% higher thenext two days. 
50 Chapter 5
Here’s an example of a deep pullback (Snapback) of a stock with a lowADxX but still in a downtrend.
FIGURE 5.14
 
 
Ibis. Technology inc-Daily 04/17/2000 .C=37.498....-. | 4140
 
 
 
 
1. Ibis Technology (IBIS) has a fairly low ADX reading of 27 (not shown)but obviously is in a downtrend after losing 60% of its value (high tolow) in less than two weeks. Other Trend Qualifiers include its havinga gap lower (a), Daylight (highs less than the moving averages) (b),negative slope in the 10-day simple, 20-day exponential and 30-dayexponential moving averages (c), a poor close on a wide-range barlower (d) and another wide-range bar lower (e).
2. The stock makes a new two-month low.
3. The stock has a sharp 35% rally (depth) over three days (width). Goshort tomorrow at 79 7/16, 1/16 below today’s low.
4. The stock trades at 79 7/16 and we go short.
5. An initial protective stop is placed at 82 7/8, 1/16 above the highesthigh of the pullback.aPullbacks 51
6. The stock drops over 40 points over the next four days.
Due to their limited trading history, Initial Public Offerings (IPOs) lendthemselves well to the standard 38.2%, 50% and 61.8% retracement levelsas the significant “low” and “high” is more obvious than stocks with lon-ger history.
FIGURE 5.15
 
 
Standford Microelectronics-Daily 06/08/2000,bocc cee eerecaee 40
         
L3s
fee
 
 
 
 
1. Standford Microelectronics (SMDD, an IPO, makes a low on its firstday of trading. This is obvious after (2).
2. The stock more than doubles over the next week.
3. The stock pulls back 50% of its prior move. Buy tomorrow at 2911/16, 1/16 above today’s high.
4. The stock trades at 29 11/16 and we are long.
5. Because the low of the setup (3) is nearly 18% away, we place an ini-tial protective stop 1 ¥ points, approximately 5%, below our entry.
6. The stock rallies more than 15 points over two days.I52 Chapter 5
Here’s another example of using retracement levels on IPOs.
FIGURE 5.16
r
 
SINA.com- Daily 05/22/2000 C=55. 813 +7.938 (6);
   
Created with SuperCharts by Omega Research © 7357,
 
 
 
1. SINA.com (SINA) makes a low the second week of trading. This is ob-vious after (2).
2. The stock runs up over 200% over the next 11 days.
3. The stock retraces 38.2%. Go long tomorrow at 29 9/16, 1/16 abovetoday’s high.
4. The stock gaps open to 30 7/16 and we go long.
5. Because the low of the setup is more than 8% away from our entry,we place a protective stop at 28 15/16 for a risk of 1 ¥2 points or 5%
6. The stock resumes its uptrend and explodes more than 20 pointshigher over the next five days.aPullbacks 53
An outside day occurs when a stock trades both below the prior day’slow and above the prior day’s high. When the price drops below theprior day’s low, it attracts sellers. However, if the price reverses and ral-lies above the prior day’s high, buyers are then drawn into the market.This intraday reversal can lead to longer-term reversals. This is especiallytrue when the stock closes strongly—suggesting that the buyers won thebattle. When an outside day occurs in a pullback, it suggests that the cor-rection (pullback) is over.
 54 Chapter 5Here’s an example of an outside day in a pullback.
FIGURE 5.17-
 
Cisco Systems-Daily 02/10/2000 C=67.968 +3.593° 6}
 
 
 
 
1. Cisco Systems (CSCO) qualifies as a strongly trending stock by havingan ADX reading of 30 and +DMI > -DMI (not shown). Other TrendQualifiers include a steady uptrend where the stock nearly doubles inless than three months.
2. A two-month high.
3. The stock makes four consecutive lower highs then sells off intradaybut reverses to close well. This action forms an outside day. Go longtomorrow at 54 7/8, 1/16 above today’s high.
4. The stock trades at 54 7/8 and we go long.
5. Because the low of the setup is more than 9% away from our entry,we risk 5% of the stock’s value and place an initial protective stop at52 1/8.
6. The intraday reversal of trend continues and the stock trades over 13
points higher in eight days.aPullbacks 55
Here’s an example an outside day on the short side:
FIGURE 5.18
 
Digimarce Corp. Daily 04/17/2000 c=21 625 -4.000
 
 
 
1. Digimarc Corp. (DMRC) qualifies as being a strongly trending stockby having an ADX of 38 and -DMI > +DMI (not shown) and by los-ing over 70% of its value in less than a month. Other Trend Qualifiersinclude its having wide-range bars lower (a), (b), (c) and (d), and itshaving poor closes (a) and (c).
2. A two-month low.
3. An outside day down forms after the stock pulls back three bars. Goshort tomorrow at 35 1/16, 1/16 below today’s low.
4. The stock trades at 35 15/16 and we go short.
5. Because the high of the formation is more than 18% away from ourentry, we will place a protective stop at 37 3/4 for a risk of approxi-mately 5%.
6. The trend continues from the outside day and the stock drops 15points in five days. 
56 Chapter 5
O&AQ. Why do pullbacks work?
A. First and foremost, you are trading with the trend. Second, you are al-lowing for the market to have a normal and often healthy correctionbefore attempting an entry. Third, you enter only if the market showssigns of the major trend resuming. Conceptually, this makes a lot ofsense.
Q. Referring to the components of a pullback. How deep is too deep?
A. A pullback is akin to the “two steps forward one step back” analogy.With that in mind, you have to question a pullback once it retracesmore than 50% of the original trend. It also depends upon the stock.The more volatile stocks, by nature, tend to have deeper corrections.
Q. Isa shallow pullback better than a deeper pullback?
