ly safe entry. In Figure EX1, circle 1 represents the buy area on thechart. Line A is the open high-resistance level showing the confirmationof the open-high break. With the risk moderate and the stock still strong,we now needed to define our exit strategies.Exit strategies are different for everyone. You can be a scalper, aholder, or a swing type of trader. Define who you are and follow our com-
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ments as we discuss each setup or trade. Remember, sometimes who youare differs from day to day because the day is trending or the range isbound or maybe something within you feels great or not so great.If PRSF was to set up on the long side, it would have to break$135/8 as a confirmation trigger. The stop would be $135/16 support. For areasonable reward/risk ratio, the stock would have to clear $14. Thosewho like to scalp the stock would look for a move into $137/8 to scale out.Our first exit strategy is for scalpers and those who wish to takequick profits in the early going. Usually, this is where we see areas of volume/price increases with the first resistance for longs/support for shorts.This occurred right under $14. An ISLD offer at $1313/16 to $137/8 wouldhave been for scalpers. Holders continued with the same plan—stop at thelow of the day, $135/16 in this case.For holders, our plan was now to look for the over $14 area in orderfor our reward/risk ratio to always be at least 1:1. This means that if youhave a 1/4-point stop, you need at least a 1/4-point gain to serve it. As thestock began to climb to $14 and over to nearly $141/8, we saw another volume increase telling us this was where we wanted at least half our sharesto be exited. Remember, volume and/or price spikes are areas wherestocks need to be exited with current positions held. It’s a function of ourtape-reading principles. As we climbed to serve 1:1 reward/risk ratio, wethen began to trail stops on the remaining shares to breakeven levels. Aswe began to show some resistance and volume decrease near the $141/2 to$143/4 level, we wanted to lock in profits on another portion at least(assuming we had enough shares to make it worthwhile). At this point wetrailed our stop again. This is where we begin to use Fibonacci retracement levels to aid us. The lines F1, F2, and F3 in Figure EX1 going acrossthe chart illustrate this. The first being 38 percent; the second, 50 percent;and the last, 62 percent.In cases such as this, traders have two options. They can trail thestop tighter to the $141/4 area where the first retracement level is or trail itto the last retracement level, which would be $137/8. On the fast-paceincrease from $14 to $133/4, the scenario is set for the scalp reversal players. Just as fast spikes/volume spikes are areas for covering shorts or exiting longs, we can also use them as reversal pivots for entry, sometimesjust for scalping. It depends on the trade. In this case, at $133/4, supportwas strong, and $1313/16 was slowly melting. This made for a reasonablescalp entry for traders with the worst-case stop being $135/8, which shouldhave been easy to keep, certainly no worse than $139/16 if we really had toget out. On the move back to $14, scalpers exit, and holders of the stockfrom $135/8 can take profits on the support bounce from $133/4. From this
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point, we have no more clear setups, so we let the stock decide what itwants to do.Our morning impressions were to look for distribution, but not togamble on it. The breakout of the open-high and pullback scalp tradeswere valid. Tape-reading principles for entry and exit and chart analysisfor trailing stops defined our exit strategy. Now, we had one more play onit. The bounce from $133/4 went to $141/8 and stalled. I had an inkling thatdistribution was still an impression, so I wanted to look for a short setup.In this case the range was $133/4 to $141/8. The play from point B (onFigure EX1) on the scalp reversal leads us to the range defined.This is shown by lines R1 and R2. Now traders have two options.They can short the high of the range, or they can wait for confirmation ofthe break of the low and try the short. As we’ve said before, trading theconfirmation is tougher, because the uptick rule doesn’t always allowentry into the short. When I find reasonable chart resistance and the highrange resistance is solid, I have no problem taking a short entry at the highof the minirange. In reviewing the trade, I set the stop a bit wider than ithad to be: $141/2 seemed to be 1/4 point higher than where I would haveliked to have it, but hindsight is 20/20. I used $141/2 mainly because it waswhere the stock began to slow on the tape on the run-up. Fibonacci analysis says that $141/4 would be plenty. Either would be fine, depending onwhich you choose to follow.As we failed to break $141/8 a few times, I began to get an intuitivefeeling that it would drop below the support we’d defined, so we wentwith shorting before the confirmation of the breakdown. This was at$1313/16 to $137/8 depending on where we could get in. I think we saw mostat $1313/16, which was fine. Now that we had entry, we looked for an exitstrategy. Once again, we were using support principles as well as tapereading principles to define the strategy. The break of the $133/4 supportlevel and then the $135/8 level (as resistance at the open became supporton the pullback) confirmed that our downtrend was intact.Once we got confirmation, we looked for fast selling/volumespike/price spike to cover at least half the shares. When the stock broke$135/8, selling began to pick up. When it broke $131/2, it became very fastand erratic, offering a great place for scalpers to exit and for holders toexit at least half. I would have liked it to break $133/8 for a move to near$13, but when the volume increase on the tape showed us a signal, wetook it. From this point, we still had our stop at $141/8 on the remainingshares unless we trailed it tighter to breakeven, which was reasonable. Forthose holding, we still had a tight range, one from which we had no ideawhat it would do from that point. With half our shares remaining, as long
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as the risk stayed low, we had no problem holding with the stop plan setand looking for a possible breakdown.I often find it interesting how our position can dictate what we wantto see. Don’t let your position dictate what you “want” to see; see what isin front of you. What is in front of us is a stock stuck in a tight range,almost evenly matched. But the short position seems to dictate the shortside bias. In this range, there is nothing more you can determine from thecurrent action other than “it’s stuck.” Let it do what it wants to do fromhere and take a stop or more profit. Or, if boredom outweighs greed, thenyou have the option of exiting with a small loss or gain.In summary, our initial impressions were based on accumulation/distribution principles. Reality allowed us to go long for a nice playand to scalp for little profits. The short setup offered us entry on a rangedefined. In each exit, tape-reading principles were defined, shown, andprofitable.
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EXAMPLE 2
Entry on PullbackFigure EX2 is a chart of Extreme Networks (EXTR). It shows an example of a pullback into a support area off the move of over $24 on a fairlynice volume climb that moved with the market. When I’m bidding support areas, these are the questions I ask myself:Risk evaluation—does the stock have tight levels and enough size participation at these levels?What route would work best in this situation for what I’m seeing on thebid?
FIGURE EX2Entry on pullback. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
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What is my stop price?Where is my first resistance area if this pivot works?Where is my last resistance area if this pivot works?What is the share size based on risk evaluation?EXTR was a stock that could get ugly at times, and fast selling oftendecreased size participation causing at least one-eighth in slippage, if notcloser to one-quarter. Therefore I decided that 500 shares was my risk tolerance, not a full 1000 lot by any means. I entered a bid at $223/4 with anISLD order, since I didn’t see much ISLD size ahead of me at this level.The reason I chose $223/4 was that the market was making a fairly reasonable pullback off its wave of buying and I didn’t feel that firstFibonacci level was the best price on relatively slow selling.I wanted some faster-paced selling to take me to the 50 percent or 62percent level instead. I used the 50 percent level at $223/4 as the area whereI saw the increase in selling (see circle A on volume chart) which broughtthe stock to $223/4. The bid was thick at $223/4, so I felt safe enough that,if I was wrong, I wouldn’t get hammered on my stop with a 500 order. Iplaced it on ISLD. I was second in line hoping for a panicky seller to hitme. As it turned out, I wasn’t filled and didn’t have time to reverse and hitthe offer when it did hold at $223/4 and bounced. I wasn’t willing to buyhigher than $2213/16 and the best available was $227/8. I got filled with my500 shares, so then it was time to go with a stop-price strategy. I was usingthe last Fibonacci level at $227/16 for this purpose, figuring that if it lostthat price, I would not be confident in the uptrend. So I risked about 3/8 onthe trade.The first resistance area was $231/4, which, if filled, would havegiven me my 1:1 reward/risk ratio if I had to take it. The last resistancewas just over $231/2, and you can see how $233/4 was showing fairly goodresistance (see circle B on Figure EX2). So my downside risk was $227/16,and my upside target areas were $231/4 to $233/4. Using tape-reading principles, buy when other traders are scared (fast selling, capitulation) andsell when they are hungry (fast buying, euphoria), offer out into strengthin areas you feel comfortable with, should it provide a profit potential. Thebreak back over $23 to $231/4 ran into resistance but held $23 well enoughthat it had a chance to get closer to the upper target range near $231/2. Forthe scalpers, exiting into strength under $231/4 was fine. Holders werelooking for a move back to upper resistance and a possible breakout.Holders had two choices. First, they could exit half their shares intofirst or last resistance areas and raise the stop on the remaining shares,looking for a break of the high. Second, they could hold the full lot with
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a tighter trailing stop and failed break of high, and exit into a trailing stop.If the stock broke to a new high, they could offer out into new highs asthey feel most comfortable, raising a stop along the way. In this case, wehad a break of the first resistance near $231/4, with $23 holding, so weexited half into that buying, bringing the stop to just under $23 on theremaining shares. After it failed to break $233/4, I chose to bring the stopto $231/4 to lock in profits since it wasn’t clear whether a new high wouldbe reached. This was a decision I had to make in the moment, althoughhindsight tells me I should have kept it under $23. This is not important.You trade how you decide, not how you should have decided. For holderswith no trailed stop, the break of the high eventually occurred taking theprice to near $243/8 (area C on Figure EX2) or so before going loweragain. The holders had the option to trail their stop again or exit into thatbreak of the high strength. On a day like this, where the market is desperately trying to hold and strength is uncertain at best, I have no problemexiting into an onrush of new buyers. If you like the trade, you can alwaysreenter again into another support area.To summarize: We found support areas defined by Fibonacci lines,used tape-reading principles of faster selling into a support area to findwhere to bid. If fast selling didn’t occur till the last Fibonacci, fine, bid itthere. If selling never picked up, I was less inclined to play congestionbottoms. Then we exited into strength, scalpers near first resistances,holders, at least half anywhere from first to last resistance, hold theremaining shares with a trailing stop and look for break of high. If wewere so inclined, we could have held the full lot with a trailed stop tighterto lock in profits. Finally, we could have trailed our stop on what wedeemed necessary and what we were willing to risk should the stop get hit.Don’t second-guess yourself. It just erodes your confidence and trust inyourself. When you lose these, you lose an important edge. Once the tradeis complete, review it for a bit, keep it in your notes, and move on to thenext.
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EXAMPLE 3
Jump-Base–Explosion (JBE) SetupThe trade illustrated in Figure EX3 was taken during a period when ourprevious 2 days had shown a nice uptrend, slow and relatively calm, indicating to us that we are seeing a fair market accumulation on many issues.We had two negative events from Cisco Systems (CSCO) the day beforethe trade and in Yahoo! (YHOO) the day of the trade. Both were absorbednicely by the broader trend. The day before the trade CSCO interruptedthe uptrend at midday, but the market regained its trend after the negativeevents from CSCO and YHOO were absorbed. On this day, we had a gapdown that was met with the same continuation of the uptrend we were seeing. During phases such as these we look for pullbacks and breakouts toenable us to participate in the trend. At such times we frequently buy highand sell higher, which may sometimes be a tough thing for many peopleto do. In this case, buying pullback to support levels and waiting for newhighs is reasonable.As we noted, the market was showing a nice steady uptrend.Commerce One (CMRC) was one issue that was participating, as you cansee in Figure EX3. Therefore, we had to identify areas for entry. The circle A illustrates the beginning of the most recent uptrend and an area thatwe happened to miss for entry. The steady volume is shown by the barbrackets in the volume section. This suggests that interest continued onthe slow uptrend climb. After missing the move from the $201/4 area, wesaw a nice base in the stock near $21. The two lines R show our range of$21 to $211/4. Here we have determined the range for our trading. Therewere a few prints to $2015/16 during this time period, but very few sellsoccurred at these prices. If this trade was not going to work out, we hadtwo choices on the stop. The first choice was selling at $2015/16 and notwaiting for confirmation. The second choice was to wait for all of the$2015/16 to be eaten and then take a stop loss at $207/8.The first thing traders should do is evaluate the risk. If $2015/16 goes,would we be able to get out at $207/8 safely? If yes, then we have to wait for$2015/16 to get eaten, possibly hitting a market maker with size or an ECNwith size. In the worst case, our exit would be $207/8. If no, then we don’twait for too much selling at $2015/16 to trigger our stop. In this case, if$2015/16 looks unattainable immediately, find someone at $207/8 to hit, anECN or a market maker with size. So, now we had our stop loss defined. Asyou progress in your trading, you can figure all this out in a matter of seconds. You bring up a stock, see levels, and know if a stock is risky or not.
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FIGURE EX3Jump-base–explosion (JBE) setup. (RealTick graphics are used with permission of TownsendAnalytics, Ltd.)
Over the years, the most common question we get is how to knowwhether to buy or wait on volume spikes on breakouts. The answer is that,if a stock shows strong volume into resistance and the volume spikes atthe resistance, I’m not inclined to buy this break.At this point, the buying is usually exhausted and does not have thestrength to carry the stock over the break. Or the break is weak, and weare better off trading pullbacks. If the stock shows a nice steady climb ora nice base and we see a volume spike as resistance is being eaten, I’minclined to buy this break. The difference is that interest on the break rep-
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resented by the volume comes from reasonable support, not a strong movein which buying may have already been exhausted in getting to the resistance level. In this case with CMRC, the latter applies. We had a steadyvolume with a reasonable base near $21. The risk was relatively low sincesizes were good and the levels were tight. So a break of the high was areasonable trade. The entry as represented by the circle B in Figure EX3shows the entry. Circle S1 on the volume bar shows the volume spike.This indicates interest and that breakout was likely to occur.It is important to remember one of the trading mantras: Tape reading creates higher probabilities, not certainties.Now that we had our stop loss defined and a plan ready, we enteredthe trade. We enter either before the break with conviction for the breakor try to enter at the break price. If you miss the break price or better, it’sup to you to decide how far above the breakout price you would want togo. Normally, I wouldn’t chase a breakout play higher than 3–5 cents,depending on the risk. However, in some cases, I’m willing, but onlyrarely, to go higher—closer to 5–10 cents.During this movement, I would have liked CMRC to hold above $21for the remaining shares. We had an entry and we had a stop plan. Nextwe needed an exit strategy. Tape-reading principles tell us to watch priceand volume spikes. Scalpers exit full lots into these price/volume spikes,where the first signs of resistance occur. Holders have two options. Theycan sell half their shares into the first spike and, in some cases, raise thestop to breakeven or keep a full lot with the original plan. In the CMRCcase, we opted to take half our shares above $211/2, with $219/16 probablybeing the best possible exit area. See point C on Figure EX3.Taking half positions assumes that you have enough shares to makeit worthwhile. For example, trading 200 shares would not be worth thetrouble. Trading 500 shares is more reasonable. And trading 1000 sharesis an excellent move. At this point the scalpers were out of the trade, andthe holders were out possibly half their shares. The next thing we did waswatch for pullback support. Notice that the price move and the volumespike (as described earlier) usually lead to the end of the oscillation. Thisis why we exit into these areas. We also have an exit strategy on theremaining shares.Now we wanted to have our remaining shares with a stop at the lowof our minirange which was defined before. This could easily have failedand cost us a stop on the remaining shares. However, we saw good bidsupport at $21 and not much selling to jeopardize the stop. This is a trying period for many. Do you exit or hold? The answer depends on you andyour tolerance for executions. I felt the size of the bid and the lack of sell-
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ing as it got to $21 made it reasonable to hold. At that point, we had tolook for retest of the high and a break over that for the remaining shares.We were looking for the volume spike once again.We wanted to sell the remaining shares into the next spike becauseit was nearing the end of the day (just about 10 minutes left) and I didn’twant to hold the stock overnight. The stock made a move near the previous high and broke on reasonable volume with the greatest price spikerepresented near $22, at which point we’d most certainly be out with theremaining shares (see area D and circle S2 on Figure EX3). This is a goodillustration of volume spikes offering us clues to exit. CMRC behavednicely. During this phase of the break of $215/8, traders had the choice ofexiting the remaining shares into the first volume spike test near $213/4. Orwatching for support on the pullback and waiting for another break of$213/4. Action was such at $213/4 that selling continued to be absorbednicely and eventually broke the $213/4 level, offering us a chance on thevolume increase to exit our shares anywhere we wanted between $213/4and $22. This example demonstrates the application of tape-reading principles to enter and exit on the breakout play.
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EXAMPLE 4
CapitulationCapitulation indicates public participation on the sell side. Traders tend towant to exit at any price they can get, as they sell in panic mode, givingup on their positions. You can see this in any time frame. The two components we want to see are:Faster selling on a surge of volume and paceVertical price dropFaster selling suggests that the majority is now selling in aggregate,thereby exhausting the selling. Plus, following the assumption that themajority is usually wrong, when members of the majority participatetogether, it’s time to act as a contrarian, in this case, on the long side. Thevertical price drop shows that there is no one willing to bid into that selling pressure. Market makers show enough to mark their liability or theirneed to make a two-sided market, but they don’t stick around for long.Eventually, as the selling becomes exhaustive, we see the phase of passiveaccumulation. You know that this is happening because it is often difficultto establish a large position in a snapback reversal.In aggressive accumulation, one or more MPIDs (market participationidentifications) are looking to support a stock in a slow uptrend, while tryingnot to alert the public to their intentions. They absorb a lot of selling pressure,and pullbacks can be shallow as these aggressive accumulators are looking tobuild a bigger position, ready to unload to the public when it hits it on the buyside. So with capitulation, the smart money causes passive accumulation tohappen, and we try to participate. As with any setup, these are based on probabilities. We present here two figures that show three separate occasions forcapitulation with only two offering the chance for profitability. Don’t thinkthat one set of circumstances will always yield a profit. There are always outside events that can skew any setup. In capitulation, maybe there is an aggressive distributor who is not letting a stock rise. All we can do is see the event,adjust for our risk, and see if we get good profit potential.The first stock is Alpha Industries (AHAA) (See Figure EX4a). Youcan see a fast-selling phase from $28.25 to just below $25.50. This marksthe left side of what we refer to in capitulation as the V bottom. The twocircles on this chart mark both things we need:Faster volume selling; you can see the volume spike.A more vertical price drop from just over $26 to just under $25.50.
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FIGURE EX4aTrading capitulation. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
At this point, it was up to us to find our entry. This is often the mostdifficult case because this is a conceptual setup. There is no situation incapitulation that says that if you see so many bars at a base, then it’s timeto go long. The snapback doesn’t allow for this. You have to use a littleart in this entry, and it’s often difficult for many people to buy into suchuncertainty. Until you get comfortable with a setup where there is no “settrigger entry,” use small share sizes or try to paper-trade it a bit. Getused to the idea of buying into contraction. There’s no reason to pushit. On AHAA, the entry price and entry size had to be based on risk factors. AHAA tended to have wide levels, and size wasn’t always big. Iwould play no more than 500 shares in order to stay within my risk tolerance. And I’d exit half and half or in full depending on how the stockreacted.So, how did I find my exit targets? The first area of exit is usuallywhere the more vertical price movement begins. This is somewhat alongthe same lines as our trend-continuation setups: Suppose a stock makes a
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base and then falls. Once that support is broken, that usually becomes ourresistance. This is the same case in which the vertical price movementbecomes evident. You can see on AHAA that we had a small base near$26, so if there was any sharp movement back into $26, we’d exit at leasthalf and quite possibly in full because this kind of stock tends to be erratic,and sure profits are a bad idea. We were patient and held, then we lookedback higher and saw another same type of base at just above $26.50. Thisis where the stock made a stronger top before making a shallow pullback.This is the next area where I would have sold the remaining shares. Ofcourse, it’s easy to say what we “should” do. But Figure EX4a provides abit of structure to the trade, so that you aren’t seeing a bunch of confusingnumbers and wondering why or where to exit.Now let’s look at the Peregrine Systems (PRGN) trade (see FigureEX4b). The highest circle on this chart represents the idea discussedabove: With faster selling from $17 to just under $16.50, we see a hugevolume spike. Entry would be under $16.50, and we needed to look for a
FIGURE EX4bTrading capitulation. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
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retest of the high. As you can see on this chart, the setup didn’t yield aprofit. It might provide a scalp, but most likely it would provide a stop.Once again, we’re dealing in probabilities, not certainties. The price wentvertical, the volume spiked, and an entry signal was seen. But it failed. Sothe cycle repeated, but this time it got closer to $15.50. The two linesshowing the V indicate more vertical price movement from about $16.25down to $15.50. So as the stock bounced off $15.50, we had two smallresistance areas. One just below $16, where we could partial out, and theother right near $16.25, where we could have taken the remaining profits.The fact that the stock got back to $17 was quite amazing, and I definitelyshould not have taken full profits on it. I like to scale out into first and second resistances on these kinds of stocks because they offer the better probabilities to get full profits.The AHAA and PRGN situations don’t prove this exit methodology.However, the same ideas apply: With faster selling volume, the price wentvertical. This is the time to look for a long-side entry. Determine wherethe vertical price movement begins and scale out into that. If you haveenough patience, use that last resistance as a confidence level. If it breaksit, you can trail your stop or use the next round of buying to exit into. If itcontinues to break resistance levels, the way PRGN did, you can use thatlast resistance as a new confidence level. This is really a personal choice:Where do you scale out? However, if you follow technical analysis andtape-reading principles, you can manage to find the optimal points forboth entry and exit. Optimal points in this case are those that work mostoften and are not necessarily the best for each given trade. It’s in this thatwe can be more confident in the probabilities of our trade.Notice also that we aren’t believers in, “Loved it at $28; shouldreally love it at $25; value being created; a certain percentage down.”Such statements are opinions about the worth of the stock. Not once haveI mentioned the worth of a stock in this whole discussion. The worth of astock in intraday trading is the expression of an opinion; we could careless about it. Our job is to view the relationship between price and volume, and capitulation alerts do a great job of this, showing how the majority panics all at one time, and the smart money looks to profit off thatmajority participation.
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EXAMPLE 5
CapitulationAs noted earlier, capitulation is one of the foundation principles of tapereading. It simply means that selling becomes exhausted as the publicstruggles to “get out at any price.” The public capitulates; it gives up.Keeping with the idea that the public is usually wrong, the minority looksfor a long-side reversal. Two things present the entry signal:Price decline in a sharp, almost vertical mannerVolume increase in a sharp spike, showing that the sell-side volume isapproaching or has reached its peakLet’s apply this principle to Netiq Corporation (NTIQ). (See FigureEX5.) The range, labeled A, is about $27.50 to $28. You can see signs ofcapitulation as the stock drops into this range. We have a spike on the volume chart to the sell side in combination with vertical price movement tothe downside.This would be a reasonable area for entry in the capitulation phaseexcept for one thing. A trader’s first consideration must always be risk.Risk evaluation is top priority. Remember our saying that amateurs evaluate profit potential, and pros evaluate risk? On NTIQ, liquidity at thislevel was really thin, meaning that sizes at each level were small and thedepth of the stock had gaps between each level that were too wide. As thisstock was falling, it was even thinner than it was at the real bottom. It wasone that I wouldn’t trade even 500 shares because it was just too thin froma liquidity viewpoint.However, had I gone in on the capitulation phase at point A, then mytrade would have been a stop loss. Chances for a fill were not easy becausesizes from the $27.70 area were very small and stock action was erratic atbest. Had we gotten filled by bidding into contraction, the most we wouldhave gotten was about $28, certainly not worth the risk. And we’d haveheld the position looking for a move over $28.25 or so. This didn’t happen and we saw new lows.As the stock continued lower, we wanted to be looking for thatfaster-selling capitulative phase movement:Price gets more vertical on the downside.Volume increase on the sell side is apparent.We wanted stronger sell-side volume than we saw in the $28 area.As the stock approached this next low on faster selling, we would enter
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Capitulation. (RealTick graphics are used with the permission of Townsend Analytics, Ltd.)
FIGURE EX5
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again with only 500 shares, because liquidity was still relatively thin. InFigure EX5 the bottom print ended up at about $24.30, so if that broke, Iwould have been looking to exit with a stop just below that support level.Remember that we always have stops in place because the market isn’tabout certainties. Faster selling doesn