end to get more confidence but worse prices. That’s the trade-off.Position yourself on the side of the break with higher probability beforeconfirmation, and you get better prices and less confidence. Position your-
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Open-break setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
FIGURE EX9
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self with the bigger crowd after the break, and you get more confidence,but worse prices.This is why, when I feel confident about a trade, I frequently try toget ahead of the setup rather than waiting for confirmation. My win/lossratio usually doesn’t improve by doing so (unless I’m in a win cluster), butmy profit per trade improves for the trades that are successful. This is oneside of the trade-off. When I have entry and receive confirmation, I lookfor an exit strategy. For this, I use my 2-day charts.As you can see from the previous day’s action, there was on PSFTstrong selling from $31.25, marking eventual capitulation into under $30.Therefore, on the principle that what was support would now be resistance, this $31.25 would serve as resistance. Traders stuck with thesehigher prices in the sell-off would be looking to exit near $31.25, tryingto recoup some paper losses. This added to the distribution pressure.You can see on the chart the vertical price movement into just over$31, showing some resistance, as expected. A target was $31.25, butremember that it’s price action that determines how near the target wewant to take profits. If it’s slow into $31.25, it should be easier to getnearer $31.25 for an exit. If we see faster buying which indicates majority participation, then we would want to sell into that buying under$31.25, where we can find liquidity. Offering this out is usually the bestpolicy because price improvement can happen when buying is erratic onthe strong side.My confidence level was wrong for a proper scaling out. I placed ittoo tight at $31.10 on the pullback from $31.45. A better confidence levelwould have been where the line is marked accordingly. There is a basehere, and it’s above our entry trigger of $30.60. You can see a baseformed, then a break of that base leading to our second resistance level at$31.70. Even though I didn’t participate in this move, we see the sameaction. It shows faster buying into resistance indicated by vertical pricemovement. This is again where we would want to scale or take in fullshares (assuming we held shares).So, in review, my entry was fine and based on a solid setup. My firstexit was solid, based on tape-reading principles combined with technicalanalysis. My second exit was not stellar because my confidence level wasbrought in too tight and missed 50 cents or so in potential. Let’s focus onthe lesson learned. Don’t trail confidence levels too tightly just becauseyou are eager to book profit (I’m often guilty of this). Rather, let stockaction dictate where you begin to issue confidence levels and trailingstops. You can always find fault with yourself. You can’t ever find faultwith the stock action. It’s the ultimate truth in intraday trading.
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EXAMPLE 10
Open-Break SetupFirst let’s talk about premarket information. In the morning from 8 a.m. to9 a.m. I’m fairly quiet, just gathering active stocks, which are dictatedeither from an up or down gap or from news that might bring some interest to a stock. At around 9 a.m. I focus on premarket support and resistance levels. At 9:20 a.m. or so, risk evaluations become easier, and Imake my final list the last 10 minutes before the market opens. This isfairly basic preparation. I don’t make predictions about where the marketwill go. My job as an intraday trader isn’t to predict. Rather it’s to defineranges and trade from them.When I watched Finisar Corporation (FNSR), I saw a premarkethigh of about $17.10 and support at $16.85. (See Figure EX10.) For openplays, I like the ranges to be narrow, within 25 cents, before I go one wayor the other. FNSR opened at under $17, and I saw market strength andwanted to look for open-high–break plays. With FNSR under $17, resistance at $17.10, and support at $16.85, I felt this was safe enough. Anentry at $17 or better with a stop at $16.85 was a 15-cent risk. If the priceslipped by 5 cents, I’d still be within my 25-cent risk tolerance ratio.The bottom line represents our open low of $16.95, and entry wasgiven at $17 or better. In this case, the line labeled “confirmation” was thearea that, if broken, had the best chance to see a trend continue based onpremarket resistance. As you can see, the stock spiked right over it, butnot yet benefiting me much for my risk. I wanted to see it closer to $17.40to $17.45 for scalpers. Holders should take half their position off the table.The next spike took the price into $17.40, and, at this point, the riskbecame higher.Spreads were widening, sizes at bids were smaller, and levels werenot thick. More often than not, when this happens, I want to take half,even if the target is not met. In this case, I’m reducing risk. When bids disappear and prices fall too fast against me, I don’t want to have to get ridof a full lot. Fortunately, the stock resumed in my favor after my first half.(See the second circle (A) in the chart.) The volume increased and the rateof price change was nearly vertical, so I applied the tape-reading principle that suggests in this situation to exit another portion or all my remaining shares. The stocks moved to just over $17.80; see the spike in pricefollowed by a decrease in volume. This is where I wanted to take anotherquarter of the position if not the full lot. In this case, $17.65 was a hightarget, leaving me to miss out on about 15 cents more in potential. But,
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Open-break setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
FIGURE EX10
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when volume picks up like that, it’s best to offer out into the strength at areasonable level and not try to get the highest tick. The most expensivedecisions are usually made within the last 10 to 20 cents of stock movement. Don’t get caught being greedy and trying to get the highest tick.I am occasionally close to the top ticks, but certainly not everytime—not enough of the time to be greedy. For those who hold a quarterof their original position, they must use a stop-loss strategy. In this case,I identify “confidence levels,” which are areas to which the stock pullsback after making a new continuation signal in the trend’s direction. If thestock breaks the confidence level, I feel the ability of the stock to continuein the desired direction has a much lower probability. For example, afterthe stock broke $17.40, my first exit, I wanted to use any move back tounder $17.50, and closer to 35 cents as a confidence level. This is illustrated by the line “New Confidence Level” on the chart. If a stock breaksthis line, you have two options. You can use the next buying wave to exitthe remaining shares over that confidence level. Otherwise, keep the original stop and look for the trend to reverse. If the stock goes below the confidence level, look for the next wave of buying to exit into. I wanted$17.50 or higher to justify the risk of taking 30 cents more in losses bykeeping a stop at the $17 breakeven level.Unfortunately, there was a big seller holding it at $17.40, and so Inever had the opportunity. The remaining quarter of my shares wasstopped out at no worse than $16.95 to $17 (see the circle on the supportline). This is another good illustration of applying technical analysis principles of support and resistance to complement tape-reading principles forexit strategies. Notice that I didn’t use arbitrary amounts like 25, 50, and75 cents and whole numbers to dictate decisions. I allowed the stockaction, through the form of support and resistance levels, as it dictated, tocreate my confidence levels. This way I brought structure to what mightseem like chaotic movement.
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EXAMPLE 11
Open-Low–Break SetupOn open-break plays, as you know, we try to identify a tight range of 25cents or less, with moderate risk. We also like to watch the premarketaction that occurs 10 minutes before the open to assess support or resistance as we move to the open within a range.PMC-Sierra (PMCS) was a stock in a situation that fit these parameters. (See Figure EX11.) I was short biased that morning, and I watchedmostly for open breakdown plays as the strength into the close from theprevious day hadn’t followed through much in the morning. So I lookedfor open-low–break plays (short setups) rather than open-high–breakplays (long setups).PMCS in the premarket was having trouble breaking $17.50 and wasstuck in a tight 10-cent range of $17.40 to $17.50. This satisfied my rangeparameters. Liquidity was deep enough for me to get a solid fill if thestock set up. This satisfied my risk parameters, because, if PMCS failed,slippage would be minimal.The next thing I looked for was the signal: The break of $17.40 wasthe setup trigger. Traders have two options:1. Wait for the break to occur, hope to get an uptick closest to the setupprice, and then let the uptick buying take you out.2. Enter prior to the signal, which is more aggressive and takes a considerable amount of experience and a feel for the stock.The caveat for the first option is that you might not get an uptickclose enough to the setup price, which would adhere to your money management principles. The upside is that the stock tipped its hand, and, bybreaking support, had a higher probability of a continuing downtrend, soyou know that the short is the way to go.The caveat for the second option is that there is a greater chance thatthe stock will never break support and you will have to stop out becausethe signal for the continuation of the downtrend isn’t given. The upsideis that you get better prices if the signal indeed does present itself afteryour entry. In this case, you enter while things are calm and quiet, making it easier to get your shares. Compare this to the first option in whichyou enter when everyone else is also trying to enter. So your trade-off isconfirmation and fight for shares or no confirmation and easy-to-getshares.
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FIGURE EX11Open-low–break setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
Two lines on the chart show the open-break range. The circle showsthe entry area. Our entry after a $17.40 break with a stop at a break of$17.50 gives us about 15 to 20 cents in risk, depending on the exact fill.To get a 2:1 reward/risk ratio, we had to be near 40 cents, at least onthe first partial. To add tape-reading principles to this, we looked for fasterselling and a volume increase (spike). This allowed us to cover all that wewanted because we could buy into that strong selling, effectively covering our short at least in partial. You can see this happen on the drop under$17.20 into $16.80, leaving an exit at $16.80 to $17 as the area for the firstpartial for holders and for a full lot for scalpers.We now had half of our shares remaining. After a small base at$16.60, the price spiked up as shown by the white candle and droppedback into support. The stock looked somewhat nervous, so I wanted toexit another quarter of my shares. I had pretty good cushion now, so Iwanted to try to ride this trend a bit more.
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I had more than a quarter of my shares left and a fairly solid cushion, combined with the NDX not able to break above the resistance;PMCS had support at 16 from the previous day, so, from here, I established a confidence level. In this case, it was the high of the range fromthe first $16.20 bottom. The line marked accordingly shows it at justabove $16.40. A confidence level says: If a stock goes over this, then I’mless convinced that the stock will see new lows.As the NDX continued higher, PMCS began to base a bit higher nearthis confidence level. I wanted to use the next selling back into $16.20 toexit the remaining shares. If PMCS went over $16.45, I would be less convinced that I would see new lows, so I would liquidate my remainingshares there.As you can see, the $16.20 area held pretty well as the NDX continued higher. Eventually PMCS reversed slowly back to the upside.This movement illustrates how structure is imposed upon what canseem like random numbers. We see real support and resistance levelsmade by the stock itself, not by some arbitrary thought process of “wherethings should bottom or top” because of nonquantifiable reasons likeprofit-taking pressure or walls of worry.
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EXAMPLE 12
Trading within the RangeTake note of lines H and L on Figure EX12. They outline the daily highsand lows; the high was $2211/16, and the low was $213/8. Also we haveFibonacci lines (Fib), which outline a minirange within the larger range.This is based on action throughout the morning session. All pivots beforecircle 1 were missed as entries because we were watching other stocks wewere playing during the morning session, not because they were invalidsetups. Let’s go to our first setup shown at point 1. This circle representsthe area of a short setup.I defined the low and the high of the range using the low of theretracement from $221/2 and the 62 percent Fib retracement level fromthat. Also, notice the thin line (20MA) moving across $221/2. This addedconfidence that the short setup would be profitable. So we had a setup, butwe still needed to do a few things first. We needed to evaluate risk.Remember that when you are trading within the range, you need to bewareof bid and offer levels/sizes. If the levels are wide, meaning more than 10to 20 cents between the offer and next level, you need to back off becausethey are too wide. If the levels are tight but the sizes at the offer/bid aretoo small, you need to evaluate your share size. If the levels are small,then trading smaller share sizes than your normal full lot is better. Iwatched Corvis Corporation (CORV) during this setup, and I evaluatedthe $217/8 bid. There was plenty of size that, if we identified CORV assupport here, I had no problem buying the low of the range.The same applied on the short area on this play. The offer at $223/16was okay, but the offers at $221/4 and $225/16 had plenty of participation,so that if the play failed, we had no problem taking a close stop. Risk wasmoderate at worst. Now we had entry setup and risk evaluation. Next wedefined an exit strategy. We had two options. The first was to trade withinthe range (for scalpers) or hold for break of the support level, in this case$217/8 or $213/4. (I notice this chart has a bar to $213/4 prior to the definedsupport level at circle 2, but it is a mistake on the part of the data feed.)As the stock broke support (circle 2), the pace never picked up, meaningthat we weren’t as confident that the downtrend was going to be strongand we were possibly in just a range trade. Therefore, we could scalp herefor a range trade at $217/8 or lower. Or we could hold half the position, andexit half the position with the break at the $217/8 level, thus confirmingthat a downtrend was a better possibility for the remaining shares.The technical analysis portion of this confirms that the downtrend is
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FIGURE EX12Trading within the range. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
intact. The tape-reading portion made me less confident in the break of$217/8, which offered a strong downtrend on that break. Volume wasn’tstrong in this case. For holders of the stock, we had options to trail thestop or keep it at no worse than breakeven levels since we provided ourselves with the cushion of shorting the top of the range. Circle 3 representsthe area in which we exited the remaining shares flat at no worse than 1/16because levels were safe enough that exit at $225/16 was fairly easy. So wehad our short within the range finished, with scalpers taking about 3/8,holders taking 3/8 on one portion, and flat to –1/16 on the remaining shares.
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The next play was the breakout. I liked it long on the breakout(which costs a stop loss in the end). We had a continued retest and failureof that $221/2 level. The trend began to go slowly higher, futures began tolook a bit stronger, and I felt a break of $221/2, with a tight stop, was a reasonable play. In hindsight, the chart shows us that range trading was stillmore profitable. This is the “buy low, sell high, short high, sell low” strategy, using defined ranges. So we took the setup on the breakout trade withan increase in volume at the high and the test and retest failing and finallybreaking. We identified the market maker FBCO as our seller at $221/2. Acouple of blocks went off as the market maker lifted, and the marketimproved a bit. There were plenty of buyers, support was stable near$221/4, and the majority of the signs for a safe breakout play were there.Plus, I had a good feeling at the time that we’d see a move over $23 onthe break. As we had a $221/2 break, the setup was confirmed, and entrywas taken on the confirmation or before for those more confident of thetrade than I was. The risk evaluation remained moderate as levels werestill tight and sizes were good enough that 1/16, no more than 1/8, wouldhave to be given up on the stop if you were a bit slower than most.Next I defined my exit strategy. Since this stock didn’t provide mewith at least a 1:1 reward/risk ratio, I was forced to plan my stop loss. Iused $223/16, the last Fib level on the retracement from the $221/2 level. Ihad less conviction that the stock would continue up if it got below thatlevel. Circle 4 represents breakout confirmation. Circle 5 represents stopconfirmation. During stop loss, traders often wonder, “Do I hold it andwait for stop-loss confirmation? Or do I exit before it goes through thatlevel? If I wait for confirmation, what if I can’t get out at 1/16 to 1/8 belowthe stop price?” Fear of a greater loss begins to take their focus away fromwhat the stock is doing. They become so focused on how much moneythey are going to lose that they lose sight of the stock action.All this adds to the noise in your head about whether or not you exitbefore the stop is hit. Two options are available in this case. Mechanicallyspeaking, the stop price is simply a price that says if the stock starts selling (assuming long) at this price, the trade has less of a chance to continuein the direction that would make your position profitable. A break of thisprice confirms that you need to be out of the trade. That’s mechanical. Theprice you exit at is personal; it’s mental and needs to be decided calmlyand without hesitation or regret. This is a function of your execution abilities. If you are just learning executions, you don’t have experience in howto get out of stocks that are below stop prices or in certain types of fasteror erratic selling. This adds to the fear of greater loss and greater noise inyour head because you don’t know whether or not you exit at x price. The
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way to get over this is to trade smaller shares so that an extra 1/4 pointdoesn’t kill you, and it allows you to exit the trade, relieve a bit of stress,and then watch the stock’s action. Then, in the next trade, you panic less,and you have less fear that the stock will move 1 point against you.Eventually, you lose this fear as you accept that you will not always getthe best exit or always stop at the best stop price. Sometimes, slippageoccurs. It’s part of the nature of trading.To review trading within the range, as shown by CORV example,there are a few steps to remember. First, define the range you want. Eitheruse the smaller range or the daily high or low. The range is dependentupon your time frames. Second, do your risk evaluation. Make sure thebid (long trade) or ask (short trade) is safe enough that a break won’t killyou on executions. Third, try to use the low or high of the range for entry.If you can’t, feel free to hit a price a few cents away. Fourth, once in,define your exit strategy. Fifth, define a profit strategy if applicable. Scalpwithin range, a half lot at confirmation, hold a half, and so on. Sixth, ifyour trade is to be a stop loss, do not panic or feel that you blew a stop ifyou have to give up an extra few cents on confirmation. Do not let the stoploss (the “How do I get out?” fear) distort your reading of the trade. Onetrade should never make or break you. Over the course of a month or year,it’s the average gain or loss that matters. A few cents here or there on atrade exit will not matter. Just don’t take huge hits that force you intobankruptcy. Once you make the decision to exit, exit at a price that is easiest to get, even if you give up a little to do so. Use the stop-loss price asa guide. Last, learn to trust your thoughts on when to enter and exit. If youcan’t trust yourself in trading, you fail to understand yourself and provideyourself the opportunity to succeed.
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EXAMPLE 13
Drop-Base–Implosion (DBI) SetupThe first thing we see in Figure EX13 is a nice downtrend from $633/4 to$62. I was not watching this stock to play either the downtrend or thereversal from $62. But it provides a good lesson on capitulatory sellingthat leads to a reversal. You can see the corresponding volume bars risingat the point of reversal.From this we see a reversal point at the $627/8 area. So we had aminirange defined at $62 to $627/8 (R1 and R2). The second test of the lowheld. If we were looking to trade within the range, we could enter the tradeat $621/8 with the stop under the $62 low. As you can see in this graph, thevolume was a bit erratic. We earlier described a situation in which a lowervolume on a price rise creates a scenario in which the downtrend is stillintact. Volume in this case did not pick up tremendously at the $621/4 area,and there was a little shelf of three bars at $621/2 that was serving as resistance off the second test of $62. At this point (area 1), I entered the short$621/4 with a stop at $621/2, assuming a risk of 1/4 point— 5/16 point atworst. As you can see, this trade stopped me out (circle 2) because theretest and break of $62, which would have kept the trade valid, did notoccur.I was forced to take a 5/16 loss on the trade as the $621/2 price levelwas eaten too quickly for a fill. As the stock moved higher to the minirange high again, I had a reasonable and fair play to short the second retestof the high. However, in this case, one of the two things needed wasn’tpresent for the short: Buying was slowing, and this supported a decisionto short the minirange high. However, the offer was thin, and, if anypickup in pace occurred, the stock would be a higher execution risk, muchlike it was at the $621/2 level.This is the difference in trading just off a Level 1 or a chart only andseeing depth off a Level 2. In this case, I did not see depth, so maybe Iwould enter and look good. However, all too often, not being able to seedepth is a detriment to short-term trading. And the few stocks that jumpon you will outweigh the converse side of the issue.Next we started to see the slide off the $627/8 area picking up paceagain. Any retest of the low would be the third test, and, with paceincreasing, I felt it was reasonable to look for another short entry. We sawa test of $62 and a small bounce that allowed me an entry. At this point,the same setup occurred, an entry near $621/4 with a stop at $621/2 (area 3).
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FIGURE EX13Drop-base–implosion (DBI) setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
This time, the price broke on increasing volume. If it didn’t break, I wouldhave taken a stop at $621/2 or $629/16.The break of $62 confirmed that the downtrend was still intact, so Istarted to plan my exit strategy for the position. Scalpers normally want toexit short positions at the first signs of strength, which, in this case, weredefined in the area where the horizontal line 4 is. The $615/8 to $6111/16 areawas fine for scalpers taking 1/2 point or so depending on the executionlevel. I chose to bid half my shares near the $611/2 level, since the stockwas showing a bit of a support level in the $611/2 to $613/8 area. Taking 1/2
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to 3/4 point on half of the position was reasonable for the risk assumed,which was 1/4 to 5/16 point.After I took a profit on half my position, I lowered my stop to thebreakeven level on the remaining shares. With any buying at $62 to $621/4,I would exit the rest of the position with a small profit or a flat trade. Asthe trade continued moving in my favor, I looked for capitulation sellingto close my position. From about 2:50 to 3:10 (14:50 to 15:10) EST, I sawincreasing volume with the stock dropping faster. This is where I had thechoice to take full shares on the trade or to lower the stop to about $611/4.Notice that the $611/4 area is the area that broke, sending the stock to under$61 (circle 5). I elected to take the rest of my profits near $603/4.
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EXAMPLE 14
Stop LossLet’s now look at the Yahoo! (YHOO) trade on which I took a stop loss.(See Figure EX14.) This is an interesting trade because it ended up doingwhat I needed it to do after I took my exit. The interesting thing here isthat it did this on action that didn’t support the same setup and reasoningthat I had on my previous entry. In other words, it gave a valid entry fora set of reasons. I was stopped out. Then it reversed to profitability, butthose reasons weren’t there this time.We opened the day with specific NDX targets for support and resistance. We had 1500 as support from the previous day and then smallupside resistance at 1515 and 1555 as more major resistance in the shortterm.
FIGURE EX14Stop loss. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
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As we approached NDX 1500, we backed off short ideas and playing within a range. So instead of breakdowns, I was looking for reversals.You can see some stronger selling on YHOO into $18.05 and a bit of avolume spike indicated by the circle in the volume section of the chart.This tape-reading principle, tied to the bias of the reversal in the NDX,made me go with a long-side position and look for a reversal signal. Ientered long at $18.10.As the stock moved back into that $18.30 resistance represented bythe resistance-level line, it failed, as noted by the circle. This started methinking that the trade would not work because, also at this point, theNDX was trying to stage an uptrend reversal.Next we saw faster selling to new lows, just under $18, while theNDX uptrend was still intact. This gave me no confidence in YHOO toreverse at this point. If it can’t reverse with the rest of the market, to me,it’s on its own merits—trading without regard for the general marketdirection—and I have no confidence in trying to play it in the direction ofthe broader market.So this cost me a stop loss because it didn’t act the way I needed itto. You can see in this chart at the bottom near $18 that the stock finallydid what I needed it to. You can see a series of higher highs and higherlows as represented by the numbers 1 to 5.Why didn’t I buy it at $18? Because, if it couldn’t rise over $18.30when the NDX was moving higher, why would I expect it to rebound touptrend reversal signals now? At this point in the trade, $18 or $17.90 orwhatever gave me no confidence to reverse, because it couldn’t reverseearlier. So I missed it.What happened from $18 to $18.60 was what I wanted to have happened from the $18.10 entry. It just didn’t happen, so I took my stop lossbut held my approach intact. I can’t second-guess my reasoning. I canimprove it. But I can’t second-guess it. This is a great lesson that showsthat sound reasoning does not always lead to profit. It also shows that thesame reasoning in one situation can often make us miss out on opportunities in others.It’s a game of probabilities that over time will make it possible notto care about one YHOO trade. Stick to your discipline, your system thatyou know works for you. View the trades that don’t work out as simplelosses, nothing else. They don’t make you a bad trader, a bad reader, or aloser. They simply are losses inherent to the system—to any system.
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EXAMPLE 15
Drop-Base–Implosion (DBI) SetupThe trade illustrated in Figure EX15 was a short setup at $38.75. Scalperswere looking around $38.30 to exit in full and holders to partial. For holders, the next target for profit would beat $37.70 for the remaining part ofthe position.As you can see, a series of lower highs formed which led to a breakof support, as shown by the two lines forming the descending triangle.Once the support broke, by going with the trend, we looked for a shortentry marked by the circle with a stop, in this case no worse than $39.05,which was the last range high before the support broke.This range was a bit wider than I liked for our normal trading andthe stock was a bit too volatile, so I elected to use a half lot to stay withinmy money management principles. We see that the trigger setup wasgiven, entry was taken with a half lot, and we started looking for an exitstrategy. In this case, I looked for supports/resistance areas from the previous day because the intraday chart doesn’t allow me to see anythingbelow the current intraday range support. This is similar to individualswho use large time frames for the overall trend and then small time framesto look for entry, like in a swing