climb,and as stocks and markets fall, buying pressure will increase. Daytradersfeed on the movements that are sufficient to create potential between thehighs and lows as stocks trade each day. No movement means no trading for pros.
THE WAS MARKETMarkets are estimated by watching news event stocks and their tradingprior to the open, after the open, at late morning, in the afternoon, andat end. Your high-momentum gainers (stocks that have positive newsevents on very good volume) will be watched for 2 days and each dayis estimated by watching how the gainers swing during the day. On anormal day I would expect a typical gainer to receive pre-market volumeover 50K and gap up.The higher the volume pre-market, the more traders are interested,and the more apt they are to continue the buying after the open. The gapwill produce a very short period of profit-taking, depending on the percentage it is gapping in relationship to yesterday’s closing price. WhenI see an overly optimistic gap on a mediocre story, I will consider a shortprior to the open. Normally, profit-taking will occur at the open and thegainers will drop to some value and then climb to some high, depending on the momentum. They will then settle into a range of oscillationsbetween the high and low most of the day. The amount of drop will giveme a peek into the day’s profit-taking demeanor and the potential forshorting off the tops. This is because I feel that if traders are willing to
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take profits early, they will usually take profits off the tops during theday’s trading.The amount of selling and buying will be generally consideredstrong, neutral, or weak. If stocks swing up, and get little selling, I willconsider the market very strong. If stocks swing up, but sell down offthe tops fairly well, I will consider the market becoming weak. If stocksswing up and sell down to end near the lows, I will consider the marketweak going into the next day of trading. You can also look at the Nasdaqnumbers and consider generalities about the preceding days of trading,but sometimes the general numbers can be misleading. It is better tounderstand the market by looking at the strongest members.Remember a general rule of movement: most of the time stocks thatare strong will begin to weaken during subsequent days of trading andwill produce drops in volume and price. Strong stocks are always in astate of dwindling momentum with a few exceptions. Most of the timeexceptions are within sector momentum where traders are rotating intoa hot sector, and as our three groups of traders turn their attention to anarea of trading, the gains can last much longer than my typical 2 days. Iwill keep playing momentum stocks until the swings become too narrow to extract sufficient profits or the volume drops dramatically.If the market has been ending near the highs with little selling offthe tops of our gainers, the market is strong and climbing. As the market continues to climb, you should begin to be aware of gainers retreating off the highs to indicate a weakening market. The longer a marketclimbs, the more selling pressure I would expect as we trade each subsequent day. Daytraders make the most money when the swings are bigand the market is consistent. We trade on percentages and when the market consistently behaves the same day after day, it enables our aggression to grow as we see the same patterns. We only need movement andwe do not care if it is down or up.When a market goes into patterns of up one day and down the next,it puts traders in a defensive posture. You really need to understand thecomponents of momentum to change adequately to take advantage ofthe changes. So, the real point of the WAS market is to play consistency,but understand that as a market climbs or drops, the likelihood of achange is growing greater and greater. A trader should be on his or hertoes to look for the signs of change and go with the flow.The daytrader’s job each day is to buy the bottoms and shortthe tops while understanding the potential of each. When the marketis changing and volatile, the bottoms become more difficult to ascertain,and so will the tops. A daytrader attempts to ride the tide of the trading,
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entering, and exiting just before the tide changes. Going against the tidalflow of the market is a losing proposition over time, so a daytrader needssome leverage before he or she commits his or her dollars to the prospective trades.
THE NOW MARKETUnderstanding the NOW market begins by reading the news and watching the pre-market gapping and volume. This is a reflection of the impactof the news event. Your first peek into the future is to have a workingknowledge of how news events will affect a stock in a positive, neutral,and negative market. You must have a springboard for trading by watching for the same things over and over until the movements of stocksbecome second-nature supports to your foundation of trading.The NOW market is defined by the pre-market action; the first dropswhen stocks move down at the open, if they do, and the first climbs astraders buy the hot trades and the oscillations during the day. It finisheswith the end of the day’s trading that moves you into the aftermarket.Preparing properly for the open will enable you to take advantageearly, and is usually the best opportunity after the market opens. Manytraders cannot trade early because they are not prepared properly andwill take the small profits during the narrowing part of the trading day.I like to trade the big gainers as they climb off those first bottoms andmove up dramatically, providing the daytrader the best returns; however,if you are ill prepared, it can be most volatile and costly as the trades aremoving very fast and quotes can be delayed. What looks like buying canactually be selling and vice versa. Once a stock begins to move againstyou, it takes experience to anticipate the trade and move ahead of thestock and execute properly. I will usually preset exit targets if the bid andask move against me and I will accept a larger loss, but sometimes therisk/reward justifies the early trade.If you tend to be a greedy person, you will have a tendency to setunrealistic exits and miss your executions when the trade is under yourcontrol and you are able to take reasonable losses. Some traders arepenny-wise but dollar-foolish and try for that perfect execution to keepfrom losing another few dollars when the prudent action is to take awider loss and get out of the trade safely. Living on the trading edge willguarantee a big fall one day, and big falls cause mental and monetarydamage that many traders never recover from.Normally, when I enter a long position, I will immediately set anexit price; my hand will be on the mouse ready to execute if I see the stock
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is moving against me. If the stock is very volatile, I will set a wider stoploss and accept a bigger loss to make sure I can get out adequately andin a timely manner. Many traders will adjust the price as the stock climbsto have a moving stop to protect profits in the event of a direction reversal, but I usually have a predetermined idea of the amount of profits Ican expect given all the factors of the trade. I simply focus on the stoploss and the sell price as I usually take smaller profits than the full potential of the trade. This ensures I put the profits where they belong, in mypocket.If I feel I have a trade that can exceed the normal profit potential, Iwill take 1⁄2 shares off the table at the normal sell price and let the othersride. I like to focus solely on the bid, ask at the open, and watch theirmovements to give me a hint of the stock’s general direction. Focusingon the individual trades at the open is a waste of time. I will also watchthe positive gaps very closely in the last half-hour prior to the open tosee if they are climbing (which would indicate a buying and strengthening market) or if they begin to dwindle down (which would indicate a weakening or profit-taking market). I have found that the last5 minutes prior to the open is the most important, and many times theopen direction will be an exact copy of the last 5 minutes of buying orselling.I remember a dramatic example of watching the gaps disappear oneday in late 1999 when I was watching YHOO (see Figure 8-1). It had beenon a screaming upward trend for days. I was expecting some seriousprofit-taking any day and about 10 minutes before the open, the gap reallybegan to disappear fast. I told my traders that I would be shorting YHOOat the open due to the indication of change and the growing selling pressure as the stock had been climbing straight up for days. I told them toshort at or just prior to the open and if YHOO only dropped $5 or lessand began to climb, it would signal that the stock could go up again. Butif it dropped more than $5 at the open, the stock would be very weak andthey should hold the short. To our enjoyment, YHOO dropped $100 afterthe open, paused, and began to get some buying where I suggested wego long. We sat back in more amazement as it climbed 50 bucks!Trading profitably and consistently means you must put all thepieces of the trading puzzle together each day and you will find that eachmorning the market will present you with a new disassembled puzzlethat you must contend with. I find it challenging and exciting. A real professional knows when to trade aggressively, when to back off tradingaltogether, and when to allow the money market percentages to work forhim or her as he or she sits in cash.
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I remember a student of mine who was once a young aggressivetrader who would pounce on any trade like a new puppy pounces on aball, all four feet at maximum energy. During the market climbs, hewould do extremely well and the word “back off” was not in his vocabulary. He was continually asking for the next trade. I warned him thatonce the market changed, and it always does, he would need to exercisesome patience and wait for the next cycle of opportunity with long positions. The market did indeed change and I began to short the opens,which in his book was a retreat in the face of the enemy, and he keptgoing long come hell or high water. I wound up shorting almost exclusively for about 2 months; the poor guy saw his great profits disappearand he eventually headed back into the work force.During one buying frenzy market, I saw a news event that was awonder to behold. Anything with a .com at the end of the story was fodder for the fire. KTEL hit the wires regarding its intention to sell ’70smusic on the Internet; it was a cheap stock so I knew daytraders wouldbe interested. I did not think much of most of the ’70s music scene, so Iwas not too excited about the story, but my opinion did not matter as day-
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traders and others jumped on the bandwagon. KTEL was one of thoseNASA rockets launching into the stratosphere. The amazing thing aboutKTEL is it climbed and held its price for much longer than normal (seeFigure 8-2).That is really what gave me my first clue to the fact that a newdynamic was entering the market: the online investor. KTEL endedcareers as shorters blew stop losses, expecting KTEL to fall big. I too wason the shorters bandwagon, but thankfully I stopped out and protectedmy money. Remember to always control the trade and never let it control you.To understand what the market is telling me, I will watch the market in different phases of the day’s trading. I watch the pre-market, theopen, the mid-morning, and the afternoon trading, as well as the end andthe post-market. I try to break up the trading demeanor in relationshipto time because quite often you will see waves of buying and sellingoccurring during specific times of the day. I have seen early buying, latebuying, early selling, and late selling because the market tends to run in
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cycles. I will look for repeating patterns of time-related activity. When Isee a change during one of the phases of the market, I will take carefulnote because it can be the first whisper of the winds of change.
TRADING THE MARKETAs we consider market dynamics, we quickly understand that many variables are in the stock market, and successful trading depends on how oneassesses all the factors that are moving the trade. It takes experience togain a working knowledge of how one dynamic reflects upon another.Basically, I would like to begin our discussion of trading by making somegeneralizations before we attempt to get more in-depth.I like to think of the market in terms of negative, neutral, and positive, even though there are shades of gray between a negative and neutral, and a neutral and positive market.I have taught using a numbering system that we can use to clarifythe market behavior. A value of ⫺10 will represent a very negative market and be seen at an open by most stocks gapping down very big. A negative market where gaps are generally down with the first-day gainersgapping up moderately will be represented by ⫺5. A neutral marketwhere gainers will be slightly gapping up and down will be representedby 0. A market where the gainers are gapping fairly well will be represented by ⫹5, and ⫹10 will be a market that is gapping up very big.Generally speaking, the first-day gainers will be gapping up morethan the second-day gainers, so gapping and momentum would beexpected to be dropping with the second-day gainer group. It is usuallyfrom this group that I will pick my open shorts. I try to find a nonparticipating stock in a market where gapping is good. I will look forstocks that are gapping slightly down or even. Remember, any big gapsdown will bring in value-traders, and buying can occur early, especiallyin a ⫺10 market. I find it helpful to look at a 20-day chart to find out howmuch selling pressure or buying pressure will be built into the stock. Forexample, if a stock has been climbing for 3 days straight beginning at $10,has climbed to $25, and is gapping up on good news to $35, I will consider the selling pressure to be much greater than with a stock that hasdwindled down from $50 to $25 and is gapping up to $35.Remember the rule of momentum: time and movement. The fastera stock moves in one direction, the more pressure it will have to reverseand go in the opposite direction. The rule applies to days, hours, and minutes. The slower a stock moves, the less pressure it will have to reverse.
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So the gaps can have added selling pressure due to the historical movement of the stock. It is much like a moving pendulum.Let’s look at the market as a swinging pendulum where the farthestleft side is the ⫺10 very negative market and the farthest right side is the⫹10 very positive market. I would also like to apply the same calibration measure to stocks. The farthest left position is a very negative stockmove, and the farthest right is a very positive stock move. The newsevent begins the movement of our pendulum and we have momentumthat should be predictable about 90-percent of the time. The more consistent the market has been behaving, the more consistent the news eventreactions. So our best trading occurs when the WAS market is doing thesame thing day after day.We have bad news reactions and good news reactions, and we makeour living on the overreactions to the upside and downside. During earnings season, we get a lot of overreactions as stocks can move dramatically up or down, and pre-earnings season brings earnings warnings,which is great for downside action. Anything unexpected will cause aknee-jerk reaction by the market, and daytraders should be ready to playthe overactive pendulum. CNBC has always been a huge force ofmomentum since the days of Dan Dorfman and now Joe Kernen, and itpays to listen with both ears whenever stocks are talked about in detail.I normally listen for the spin of the story, and go with the spin before Isee any buying or selling action because once the CNBC train leaves thestation, it is really tough to execute.I have found that the amount of force a story has on a trade can begauged by the first move before profit-taking begins. On cheaper stockstrading under $5, a basic rule of thumb is about .50 point. In other words,I will look for selling to begin when cheap stocks go up .50 point.However, sometimes we get daytrader buying frenzies where cheapstocks will double or triple. It pays to track the reactions of news to differently priced stocks because it also runs in cycles. Normally, if I see acheap stock make an unusually dramatic move to the upside, I will thenbe on daytrader-buying-frenzy alert as daytraders will be looking for thenext candidate to make them unusual profits.Generally, I have an average expected rise, based on the news eventstored in my trading memory, and I can quickly note any significant surprises. So, if I get a story on a $30 stock that I expect to rise about $2,and the first selling doesn’t occur until it has risen $5, I know that I havemore traders interested in the story than normal. When the first riseis much more than my mental average, I will classify the trade as apotential runner. If I have executed a long position right after the news
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event, I will take my profits on 1⁄2 shares at the $5 rise when I see the stockis topping, but I am ready to exit at the normal $2 expected rise.If I have not entered the trade, I will expect the runner to fall about.50 point after the initial $5 climb and at that price I will make my decision to give it a chance or not. Generally, runners will only go down offthe first climb by about .50 to .75 of a point, and then begin to climb again.No real exit price is set when a runner makes unusual moves because bydefinition they are the exception and not the rule. One rule that shouldbe fixed in your brain is, “Don’t go short unless you are very good atstops.” This is because exceptional runners can advance for days and goup hundreds of points, wiping the stop blower out of a career. The eventual tops take a lot of experience to accurately judge and I have becomequite adept at doing it, but it takes an accurate read on the playersinvolved, the market, and the news event to even come close.The pace of trading can also judge the beginning of a momentummove. The pace is defined by the amount of small trades per secondshowing up on your Level 1 quote screen. Generally speaking, a newsevent will trigger a few buys in the beginning, and it is at that juncturein the trade that a daytrader must commit to buying after a quick readof the headline because the trading can get faster and faster and you caneasily miss the train pulling out of the station. You will generally have amaximum of 10 seconds to enter the trade in the beginning of a very bigstory as the news gets published from one daytrading chat to anotheruntil it gets to CNBC potentially. Many times, early bio-tech stories canget repeated on CNBC and the momentum can increase dramatically.Buying early is essential to riding the big wave, and many traders regularly buy bio-tech news and they hold, hoping for a repeat of the storyby CNBC.
MID-RANGE RULENormally, I will expect the trading range to be established by the leaders in the first 2 hours of trading, and I go into watching mode for anyquick moves up or down or fresh news. I will also keep an eye on mygainers to see how their prices relate to the lows and highs made early.If the prices are drifting under the middle of the price range, I will lookfor an opportunity to go long because in normally climbing markets, thegainers will end the day above the mid-range, and any dips under willbring in buyers. If my gainers move down to form a new low, I will buythe bottoms, but I will place a weaker value to the market and expect mygainers to end nearer to the lower end of the day’s trading range.
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In normal inclining markets, I will always expect the gainers to moveoff the highs and dip toward the middle of the day’s trading range andend just above that target. The moves below mid-range mean we areincreasing profit-taking, and anytime the gainers hold near the highs, Iincrease the day’s momentum going into the close and expect tomorrowto be an up open. On many strong days, you will see the gainers gap up$5 and then retreat $3 and end there. The market will still be strongbecause of the gaps, but the ending numbers can be misleading. Whenthe gainers are ending at the day’s lows, it can signal a weak market goinginto the next day, and I will be on alert for more selling at the open.Once in a while, you will encounter stocks that have $50 swings inthe early hours. If a market has been exhibiting normal profit-taking, Iwill play the mid-range rule by shorting near the high and waiting forthe ending above the mid-range price. The only problem is that somestocks can run unusually high, and you must set reasonable stop losses.I have found that it is best to simply stop out and try another short atthe next high. I will accept three stops of about .50 point each because ifa stock has run up by $50, it should potentially fall at least $20. So therisk-reward is 1.50 in stops and $20 in gains.The nice thing about the mid-range rule is when high flyers beginto lose momentum and you are short the stock, you can ride the downward momentum for a few days. If my high flyer has ended the dayunder the middle of the price range, I consider that stock to be weakening and I will hold subsequent days until I see it gap up, at which timeI will cover the short at the first up-tick. Many times high flyers will comedown over $100. If I have shorted the high flyer and it does not retreatas expected but ends near my short price well above the mid-range price,I will cover and look for another short on the next day. I will keep doingthis mid-range trading until the swings are too narrow to give me adequate profits or I get acceptable profits. High flyers can run anytime andcontrolling the trade is of the utmost importance; you control a trade bytaking small losses.Over the years, the worst conversations I had in my chat room wentsomething like this:Trader: Hey, Ken.KenWolff: Hey, Bob. What’s up?Trader: I did something dumb.KenWolff: Uh-oh, what did you do??Trader: Remember that short the other day, XYZZ?KenWolff: Yeah, I remember. We took two stop losses on it beforewe found the top and only made 1.50 because it never
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weakened as much as we normally see. Barely worth theeffort.Trader: Well, Ken, I never stopped out and I am down big thinkingit would go down sooner or later. What do you think it will dotoday?Sometimes this scenario will indeed take a trader out of the gameas he or she can get a margin call that terminates the trader’s career. Thisis very sad for me because it can happen to the best of traders and itserves as a way of stressing a big point that is probably the biggest reason for eliminating a trader’s career: stop losses. This topic will be covered completely in Chapter 12, “Rules of a Trader.”
MID-MORNING AND AFTERNOONThe normal action during an average day of trading in the early goingwill be faster action. As you progress into the mid-morning and afternoon trading, you will see the trading slow down. I call the trading actionpace of trading. I usually watch the stocks buy and sell on a Level 1 screen.I like to use RealTick 3 because it has a shadowing feature that enablesme to see each trade on each stock by highlighting the symbol, trade size,Bid, and Ask. This shadowing feature is great to get a visual presentation on a number of stocks on my quote screen. When I watch the slowerpart of the day, I can easily see when one stock may be getting some extramomentum by the shadow quickening as trades begin to appear fasterthan what I had been seeing.This pace of trading is good to watch for individual stocks as wellas the whole market. Many times you can spot unusual momentum bypaying attention to quickened pace as it can signal waves of fresh buying or selling. Unless I see abnormal quick action in the slower parts ofthe day, I will not consider trades to have much potential. Again, the market tends to run in cycles and I have seen markets provide adequatepotential all day long. Most of the time I am simply watching the newsand my gainers to see how they relate to the lows and highs.
THE ENDI will focus on the market intently for the last half-hour of trading. I watchthe news closely and look for the buying or selling pace to quicken. I am
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narrowing down the end of the market to the last 10 minutes where I willbegin to consider gappers. I want my potential gapper candidates tobegin to get quickened buying 10 minutes before the end. The last 5 minutes will be more crucial as I watch for gapper candidates to have mostlybuying. I have found over the years that the more selling you see withgainers in the last 5 minutes, the more apt they are to not gap very well.I will also consider the gaps of the previous days and go according tothe historical flow of the WAS market.Sometimes the market will gap up for days on end, defying the lawof gravity, and the biggest profits can be in the gaps. I have found thatmy percentages for picking winners lie within the confines of the last5 minutes when I spot stocks making new highs on very fast-paced buying. Gapper candidates should also be nearer the high to indicate traderbuying interest.If any important government numbers are due out the next tradingday, the risk for playing gappers will increase. The overnight risk willalso increase if the market has been very volatile and changing. I normally encourage traders who have good profits after the market close totake profits and thereby decrease the increased risk of holding longer. Iwill normally only play gappers when I feel the market is stable and verylikely to open up the next day.
THE SPECIFICSSo far we have talked about market dynamics in general terms. Now itis time to narrow it down into more practical terms: how the trader canidentify, classify, and use this information.A daytrader who plays the same game over and over again, overtime, will get slaughtered when the market changes. What worked yesterday and the day before may not necessarily work today. A good tradercan change with the changing market. This has been one of the main reasons for my success as a daytrader. When the market changes, I recognize that it has changed, hold back on my trading until I understand howit has changed, and then change my tactics to adapt to the new marketdynamics.In the Mtrader.com chat room, I hear comments all the time such as“how did Ken know XYZ would run from the open?” or “how did heknow the stock would drop after a short climb?” I have even heard someof my students claim that I must have my own special crystal ball to beable to determine a large percentage of the time what a stock is expected
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to do. It is nothing of the sort. It is a simple understanding of these forcesand how they affect a stock’s movement. If you can master these concepts, you too can have your own crystal ball. There is nothing magicalabout it.This concept has many separate components, so I have brokenthem down into five basic sections: sector strength, historical marketstrength, market strength (macro-momentum), daytrader strength, andmicro-momentum strength. Again, remember this only applies to ourgainers and not our dumper patterns.
SECTOR STRENGTHTo determine sector strength, I monitor 5 to 10 stocks in the sector I amwatching with the highest volume (from the previous day). You can findthis on the leaders board, Investor’s Business Daily, CNBC, or any scanning program. Once they are on my Level 1 screen, I simply watch themto determine general trends. Are they all running or dumping? Are theyall up? Did they all gap up or down? I then give the sector a strengthscore, from ⫺10 to ⫹10, with zero being neutral. If a sector has gappedup, and the stocks are all running like wildfire, I score it as a ⫹10. If theyare all aggressively dumping and have gapped down, I give it a score of⫺10. Generally, they will be somewhere in between these two extremesand are scored accordingly. Once a sector is hot for a period of 2 to 3 daysin a row, the momentum catches on and any positive news will greatlyaffect a stock.If a sector is hot, I will not short at the high as the dips will be small,if any occur at all, and I may consider holding a bit longer as the upsidepotential is larger. I normally consider a stock that has price swings of20-percent or greater to be appropriate potential, but if a sector is hot, Iwill consider swings of 10-percent or so as long as the sector has goodmomentum.If the sector leaders end near the high end of the price range for theday, they are excellent candidates for position plays that I will hold forlonger periods. Once a stock or stocks in a sector end below the midrange on the day, I exit the long-term trade. Many times you can have afairly neutral market in which nothing much is happening, but one sector will be hot and moving, such as the Internets. They can be at ⫹10when all other indicators are neutral and your only window of opportunity is with that sector. When this occurs, I will take smaller, short-termprofits because of the uncertainty with the other indicators. I write downthe sector strength number and then move onto figuring out the marketstrength score.
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MARKET STRENGTHMarket strength is the strength of the general market that day. We determine market strength in two ways:1. Watching first-day gainers gapping and volume prior to theopen2. Watching second-day gainers for follow-through buying volume and gappingNote that the gapping and volume will normally be a bit weaker onsecond-day gainers than first-day gainers. A market strength of ⫹10would be first-day gainers gapping up a large percentage with huge volume just prior to the open and second-day gainers following through,gapping up on large volume. A market strength of ⫺10 would be the exactopposite. Note that market strength as we use it is not a normal indicator. In other words, you cannot listen to CNBC for comments such as “astrong market is expected today”; this is not the same type of indicator.If I see big gapping on first-day gainers but second-day gainers arenot participating with gapping and volume (or even gapping minimally), I will consider open shorts to be very good. If everything is gapping up from the open a large amount, I will consider the possibility ofa strong run-up from the open and will not short anything. I may alsoconsider buying the first up-tick instead of waiting for the first bottom.If I see gapping fade near the open, this will be a tip-off to early profittaking and I will short. This fading trend is very important to understanding how the open selling will go. If first-day gainers are trendingdown before the open, it will indicate selling pressure. The same is truefor first-day gainers; if the gapping is trending up or climbing near theopen, I will expect buying and a possible run-up. Once I determine andgive the market strength a score, I write it down and move onto the historical market.
THE HISTORICAL MARKETAlthough the historical market has the least effect of all the indicators, ithas an effect nonetheless and needs to be factored in. It is determined bythe combination of two indicators. The first is simply watching whatscore you gave the first- and second-day gainers over the last 3 days. Thesecond is watching the Nasdaq numbers and how they are affecting thepsychology of a trader’s mentality. For example, if the Nasdaq is up90 points one day, we will see more selling as it continues to climb thefollowing days on profit-taking.
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So selling pressure climbs as the market climbs and