20. Once we were unable to break over $20 on the open and thenbroke the previous day’s support as well as open support, the short sideshould have been taken for a position with a stop at the break of the openhigh. Once the entry on the short side was filled, we needed to look for aprofit strategy based on the previous day’s support levels. In this case, wehad a support level near $19.50. If the trade had begun to move into thisarea, we wanted to be looking to exit in full for smaller profits on a largershare size.In this example, we wanted to be aware of the majority action behavior. In this case, we saw faster selling into $19.60. This was illustrated bythe more vertical price movement to the downside associated with the volume increase on the sell side. Given that we were seeing exhaustion on thesell side, it was time to cover into that faster round of selling for a quick2:1 reward/risk ratio or less. In this example, the $19.50 support levelgave us an area in which to look for erratic behavior, indicating majoritybehavior. Once we saw this type of action moving the stock into the$19.60 area, it was time to enter the cover order and look for a fill to exitthe position in full.We see on this chart that after the open faster selling, the stockrecovered and moved back to the entry level, showing that any remainingshares had a lower probability for profitability and would have been exitedat no worse than the breakeven level.
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EXAMPLE 30
Open-Low–Break SetupThis is an example of an open-low–break short setup on F5Networks, Inc. (FFIV). It leads to a good reward/risk ratio, but it alsoshows a degree of missed potential because of traders taking faster profits at higher levels. (See Figure EX30.) The open range was from $20.30to $20.55 (shown by two lines). Once the stock began to lose the $20.30level, a short position was initiated with a stop at the high of the range,$20.55.Given that we had our stop-loss strategy in place, we needed to belooking for areas of exit based on our risk tolerance. If we wanted to takefaster profits for a 2:1 reward/risk ratio or lower, we would have looked
FIGURE EX30Open-low–break setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
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for faster selling into the $19.75 level. The stock shows erratic behavioron the sell side, and thus a good area to exit the trade. At 9:45 a.m. we sawan increase in sell-side volume and a more vertical movement to the$19.60 level, offering the opportunity for covering into that level withnear the 2:1 reward/risk ratio.Traders who were looking for something more substantial out of thetrade would be looking for faster selling under that $19.60 support.Should this $19.60 level have been broken to the downside, we wouldhave brought our stop to breakeven levels once we began to scale out ofthe trade. In this case, we had some faster selling into the $19.30 area; thiswas associated with the little volume spike just before 10:15 a.m. As weheld this level, what we should have done and what we did were two different things.By rights, traders should have brought their confidence level to theretracement highs at $19.75 and looked for a break of the support near$19.30 for a downtrend continuation signal. Instead, at the second test ofthe $19.30 level that held, the exit in full was taken.What happened next was that the trade made a lower high, broke thesupport level near $19.30, and then hit a capitulatory movement, taking itto the $18 level, which made the exit near $19.30 seem somewhat foolish.Hindsight can be quite a killer sometimes. However, don’t let it deteryou from trading on your discipline. I firmly believe that for every missedprofit like this one, there are 10 other trades where you are happy enoughto have taken the profit when you did and actually increased your accountover time rather than waiting for trades with bigger profits. Essentially,take the home runs when you can, but don’t beat yourself up about missing a few. One trade should never make or break your account. Trading isa sequence of events that slowly builds your account up over time.Missing big profits here and there won’t or shouldn’t affect you much.
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EXAMPLE 31
Drop-Base–Implosion (DBI) SetupThis example illustrates a solid downtrending stock on Medimmune(MEDI) after the 30-minute lows were broken. (See Figure EX31.) Thissituation is described as the DBI setup in earlier chapters and examples.Because we have discussed this setup many times, we left all the levelsand points of reference on the chart unmarked. So it is up to the reader toidentify them.We essentially had a tight base near the $26.30 support level, which,when broken, offered the short setup trigger. The base formed was thesupport at $26.30, and resistance was just above $26.40. In this case, withbarely a 10-cent stop-loss range and the stock being liquid enough, traderscould utilize a larger position size because the stop level was smaller compared to other trade setups that normally show a 25- to 30-cent range.
FIGURE EX31Drop-base–implosion (DBI) setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
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Once the trade setup was triggered on the break of support, with astop loss in place, we needed to look for a profitable exit strategy. In thiscase, with a 10- to 15-cent stop-loss risk level, a simple move into $26.10to $26.15 would yield a scalper’s exit with a 1:1 reward/risk ratio.According to tape-reading principles, majority action tends to be moreerratic than minority action, so we looked for faster selling into this level.You can see on this chart that we got faster selling to $26.10 and then areverse back into resistance.The important aspect of this behavior is that, on the retracementback into the highs, volume stayed relatively light and the trade wasunable to break back over the $26.30 level with any conviction. The principle that what was support should now act as resistance held true, as the$26.30 support level was behaving as a resistance level, and the downtrend was still intact. Those traders who were unable to get a profitableexit on the first move into $26.10 now had a second chance as we saw thetrade move lower to $26.Movement to $26 showed a sharper price drop, which offered plentyof opportunity to exit for those looking for smaller profits on a full exit ofthe position and who were unable to exit earlier. Next we saw anothertight base at the $26 level that tried to retrace and moved back to $26.10,which was former support that was then serving as resistance. This againshowed that the downtrend was still intact and those traders who wereholding for higher reward/risk ratios were safe to hold while looking fora move under $26 to scale out. What we saw next was a more verticalprice drop with a volume increase to $25.75. This was where traders wereable to scale out at least half their original position. Once this profit wastaken, it was important to begin a trailing-stop and confidence-level strategy. In this case, we had a $26.10 resistance, which was the level thatserved as a distribution point off the $26 support. This would be our trailing stop. Then we had our $26 support area that was broken and whichoffered a move to $25.75 where traders could begin scaling out. If thetrade were to retrace back over $26, then we would be less confident thatthe trade could continue lower. So we would use the next round of sellingunder $26 to exit the remaining shares.The next part of this trade shows how a plan well made is often notwell executed. It happens to the best of us. In this case, we saw a littlebreak of $26.10, in effect, taking our trailing stop. After the trailing stopon the rest of the position was taken, we could see that the support at$25.75 was taken out, and faster selling to $25.60 was offered for greaterprofitability. However, as our trailing-stop discipline took us out of thetrade, we were unable to grab that extra profit.
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One important point on this is that you shouldn’t let the outcome ofone trade alter your trading discipline. One trade does not make a system,and, while this trailing stop didn’t allow for greater profits, over time,sticking to your discipline will save you from disasters. It’s the aggregateresults that matter, not one trade.
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EXAMPLE 32
Cup-and-Handle SetupThe situation shown in Figure EX32 is another good example of a cupand-handle setup, this one on KLA-Tencor (KLAC). We saw the stockbasing nicely through the lunch period. Then at around 2 p.m. it began toform the start of the cup. During the retracement of the cup, we saw thevolume begin to pick up a little. Normally, we would want the activity todie down when it forms the bottom of the cup. But this is art, not pure science. Learn to look at imperfect setups as opportunities.Once we got our cup formation, we moved right back into the resistance at just above $43. From this resistance, we saw a small, narrow baseformed at above $43. This was the handle that eventually led to the longside trigger entry. In this case, the entry was taken at no higher than$43.25 with a stop at $43, the bottom of the handle range. Again, volumeindications suggested that our uptrend was intact as it increased as thestock increased. When we began to see euphoria as defined in our tapereading principles, we had to begin to partial out. In this case, we saw alittle spike just before 3 p.m., the 15:00 time period, into $44. This waswhen we needed to take at least half our position in profit.Then we saw the volume spike at about 3:10 p.m. coincide withresistance at $45. This was when we needed to decide whether to take aquarter of our position or exit in full. The decision to exit in full was, inhindsight, not the best exit. However, deciding while things are happening and reviewing a chart are two different things. The trade still gave agood $1.75 per share on that last half of the position.Those who held the quarter of the shares left, needed to trail theirconfidence and stop levels. In this case, with the pullback from $45 into$44, we would then place a stop at breakeven and a confidence level at$44. If the stock broke $44 again, then we would have to use the nextround of buying to exit the remaining shares. If we couldn’t get this buying, then we would exit somewhere between $43.25 and $44, dependingon the action. In this case, we made a base at the close, so that we couldexit under $46 or decide to hold the remaining portion overnight to see ifthere would be a gap up the next day to sell into at a price higher than $46.These are each valid decisions that need to be made as we see these volume/price correlations throughout the trade.
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Cup-and-handle setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
FIGURE EX32
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EXAMPLE 33
Cup-and-Handle SetupThis example of Intersil (ISIL) is a cup-and-handle setup. (See FigureEX33.) As we watched this trade from the opening, we saw stable sellingto about $17, and then what we call a rinse effect happened on the breakat $17. A rinse effect is when a stock barely moves out of the risk parameters, which takes traders out of their positions, and then the stockresumes the desired movement, after the traders take their stop loss. Wesaw sharp movement, which could be characterized as a minicapitulation.After this occurred, the stock regained its foundation and then movednicely back to the $17.45 resistance area. The action from $17.45 to$16.80 and back to $17.45 formed the cup of this trade. The handle, represented by the two diagonal lines, showed a base forming near the $17.45resistance.
FIGURE EX33Cup-and-handle setup. (RealTick graphics are used with permission of Townsend Analytics, Ltd.)
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What was happening was a blow-off event followed by a well-supported reversal. Aggressive accumulation was happening in this case, asthere were hardly any pullbacks on the way back into resistance. Once wereached resistance, the bullish resolve was about to be tested. We knewthis because a base from about $17.35 to $17.45 was formed. The bullswere still in charge. A break of $17.45 would confirm the handle part ofthis formation as a good breakout trigger. We saw the breakout at $17.45,and this moved the stock to $17.85 or so. Upon seeing this breakout,traders would have entered prior to the trade setup trigger with a stop at$17.30 or on the break of $17.45 and hoped to get filled on their full sharesize.As the trade began to get euphoric, meaning that there was a panicon the buy side as shown in the vertical price movement associated withthe volume increase, we would look to exit into this at least partially. Inthis case, an exit above $17.75 would be the most likely on at least halfthe position. A confidence level would then be placed at just under $17.45on the principle that what was resistance should now be support. If thisfailed to hold, then the rest of the trade would be exited at no worse thana breakeven level if we saw enough buying back at over $17.45. If thetrade fell deeper, then it would be exited at $17.35 on the remainingshares, cutting into the profits we made on the first half of the position.You can see that the latter case occurred, and we were forced to exit theremaining shares below $17.45 as the stock hit our stop price of $17.35 at11:45 a.m.You can also see that it was wise to take the stop as this stock continued lower into the close and would have wiped out all our gains had wenot stuck to our stop-loss management.
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GLOSSARY
ARCA (Archipelago) Very popular so-called active ECN. It not onlyposts trader bids and offers but also actively works orders by tryingto match them with those of other ECNs and market makers.Black Box A nondiscretionary system that allows an individual to tradeentry and exit signals without understanding why those signals aregiven.BTK Biotechnology index.Decimalization Switch of the increments of price from fractions to decimals. It limited volatility to a certain degree. It had a big impact onscalping strategies. Before decimalization, stocks were trading in1/16– 1/8 increments, which equaled 6 and 12 cents, approximately.ECN (Electronic Communication Network) ECNs allow traders to posttheir own bids and offers to a central order book to provide liquidity.Instinet was the first of them. During the market boom of the late1990s, many new ECNs appeared.ISLD (Island) One of the biggest and most popular day trader ECNs. Itprovides great liquidity and lightning speed.Level 2 Presentation of Nasdaq data in the form of a box containing colorcoded bids and offers posted by market makers and ECNs. For awhile, Level 2 was described as a tool offering retail traders opportunities equal to those of market makers. It became less significantwith the introduction of decimalization in the spring of 2001.NDX Nasdaq-100 index.SelectNet Order-routing system which allows traders to negotiate theirorders with market makers electronically. With the introduction ofSuperSOES in 2001, it has lost its role with retail traders.SOES (Small Order Execution System) For a while this system was amajor weapon of day traders, allowing them to execute their ordersagainst market makers with lightning speed. After some rule changesit lost its significance. It was replaced by SuperSOES in the summerof 2001.SOX Semiconductors index.Times & Sales (T&S) Presentation of Nasdaq data in the form ofscrolling; trades are usually color-coded. Shows size, price, and timeof each trade.249
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INDEX
Accumulation/distribution relationship,95–106decreasing volume reversal and, 102–103euphoria/capitulation and, 96–99passive accumulation/distribution and,103–106practical example of, 146–150shallow retracement trend confirmationand, 101–102trend beginning and, 99–100trend confirmation and, 100–101Adages, negation of, 67–72ADC Telecommunications, 206–208Adobe Systems, 232–233Adtran Inc., 223–225Aggressive method of entry, 110Alpha Industries, 158–161AOL, 146–150Applied Micro Circuits, 193–195Average winner/loser, in trading journal,31–33Baruch, Bernard, 67Blown stops, 7Breakout trades, 117cup-and-handle, 130, 133, 223–225,244–247fading, practical example of, 232–233Bre-X, 11–12Broadcom Corporation, 229–231, 237–238Brocade Communications, 234–236Buy low, sell high idea, dangers of, 69–70Capital, trading, amount to risk, 66Capitulation, practical examples of,158–166, 171–172, 174–175,226–228Capitulation sell-offs, 117–118Capitulation setups, 130, 134, 135Capitulatory stage of trade movement, 96Charting, of trading account, 29–30trading journal and, 30–33uses for, 33–35
Cisco Systems, 154–157Confidence, developing through experience, 20–24Confidence levels, 91practical example of, 217–220stop losses and, 121–122Conservative method of entry, 110–111Consolidations:multiple, 142time factor and, 142Converse Technology, 214–216Corvis Corporation, 189–192Cup-and-handle breakout setups, 130, 133practical examples of, 223–225, 244–247Decimalization, 17Detachment, need for, 52–53Developing traders, 52–53, 56, 60Direct-access brokers, 15–16, 57–58Distribution, accumulation and (seeAccumulation/distributionrelationship)Double-bottom scenarios, 143Double-top scenarios, 143Drop-base–implosion (DBI) setups, 124, 129practical examples of, 167–170,193–195, 198–200, 206–208,214–216, 241–243Early speculators, 67–68ECN arbitrages, 94Edge, finding, 72–74Electronic Communications Networks(ECNs), 100Emery, Henry, 67Employee Solution, 6–7Emulex, 65Entries:finding in strong trends, practical example of, 176–179methods for, 109–113on pullback, practical example of, 151–153251
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Index
252
Euphoria, practical examples of, 172–175Euphoria stage of trade movement, 96Expanding trading range, 141–142Experience:for finding edge, 73learning through, 20–24need for, 47–48Extreme Networks, 151–153Fading breakout setups, practical exampleof, 232–233F5 Networks, Inc., 239–240Fibonacci levels, 167Finisar Corporation, 183–185Hain-Hain Celestial Group, 201–205Inrange Technologies, 176–179Intersil, 246–247Intuition, 75–81definition of, 75–76disappearance of, mantras for, 77–81traps associated with, 76–77The Intuitive Trader (Koppel), 59JDS Uniphase Corporation, 65, 209–210Journals, trading, 30–33Jump-base–explosion (JBE) setups, 124,125–128practical examples of, 154–157,201–205, 221–222KLA Tencor, 244–245K-Tel, 21–22, 23, 24Learning to trade:requirements for, 47–48stages in, 51–57, 60–62Lefèvre, Edwin, 16, 59Liquidity, low, stocks with, 69Livermore, Jesse, 59, 92Losses:bigger than profits, 70holding losing trades and, 70–71recovery following, 79
Magee, John, 24Majority, minority and, 93–95Manipulators, 11–12, 67Manugistics Group, 176–179Market, fallacy of trader’s need to knowand, 44–46Market action, risk associated with, 65–67Market makers, 53Mature traders, rules for and mindset of,83–85Medimmune, 241–243Mental strengthening, 49–50, 51–52Mindset, 9–10, 47of mature trader, 83–85Minority, majority and, 93–95Model trader, creating in one’s mind, 36MPIDs (market participation identifications), 158Myths, debunking, 67–72Narrow trading range, 139–141Nasdaq:decimalization of, 17matching chart of portfolio equity to,33–34Neill, Humphrey B., 16–17Netiq Corporation, 162–166Network Appliance, 211–213News, perception of, stock prices and, 5New traders, 51–52, 54, 55–56, 60New World Restaurant Group, 54, 55Open-high–break setups, 130, 131, 132Open-low–break setups, 130, 131, 132practical examples of, 186–188,211–213, 229–231, 237–238,239–240Overtrading, 68–69, 81Overture Services Inc., 226–228Partialling, 118–119Peoplesoft, 180–182Perceptions:of news, stock prices and, 5of one’s own trading, 26–27trusting one’s own, 43Personality, traders’ application of, 50–51PMC-Sierra, 186–188Portal Software, 146–150
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253
Price, correlation with volume, 98Profits, losses bigger than, 70Pullbacks, 100entry on, practical example of, 151–153Qiao Xing Universal Telephone, 63–64QUALCOMM, 221–222Range breaks, stop placement and, 120Range trades, 117practical example of, 189–192Rate of volume, 92Reality traders, 53–54, 60–61Regular method of entry, 110Regular trading range, 137–138, 139, 140Reminiscences of a Stock Operator(Lefèvre), 16, 56, 59Research in Motion, 171–175Resistance level, taking short position into,234–236Responsibility, accepting:intuitive trading and, 78trading for a living and, 41, 42–43Reversal, practical example of, 211–213RF Micro Devices, 168–170Risk:evaluation of, 64–65market action and, 65–67in scalping, 19Risk management:importance of, 8–9profit limitation and, 63–64Risk tolerance, 63stop placement and, 116Rumors, 11–12Scaling, 118–119Scalping, 16, 17–20psychological implications of, 18–19risk involved in, 19scalp setups and, 18tools and methods of reading and, 18Scared money, 25Scenarios, using to improve trading, 46–47Setups, 107–113, 123–136capitulation, 130, 134, 135with consolidation, time factor and, 142cup-and-handle, 130, 133, 223–225,244–247
Setups (Cont.):drop-base–implosion, 124, 129,167–170, 193–195, 198–200,206–208, 214–216, 241–243entry methods and, 109–113fading, 232–233jump-base–explosion, 124, 125–128,154–157, 201–205, 221–222open-break, 130, 131, 132, 180–182,183–185, 229–231, 237–240trader’s action when signals are generated and, 135–136Shares, number to trade, 8–9Short of the range resistance, practicalexample of, 234–236Shorts, 71Siebel Systems, 217–220Smart money, 17SOES (Small Order Execution System), 94State of mind, intuitive trading and, 78–79Stocks:gathering information about, 43–44with low liquidity, 69movement of, 24Stop losses, 25–27, 80, 115–122blown, 7confidence levels and, 121–122factors determining placement of, 115initial placement of, 116–118practical example of, 196–197risk tolerance and, 116stop trailing and, 118–121trailing, 118–121, 217–220Striving traders, 53Strong trends, finding entries in, practicalexample of, 176–179Systems, limitations of, 41, 43(See also Tape reading trading system)Tape-Reading & Market Tactics (Neill),16–17Tape-reading trading system, 89–106accumulation/distribution relationshipand, 95–106limitations of, 89–90majority versus minority and, 93–95overview of, 90–91tape-reading principles and, 91–92Teaching, satisfaction of, 57–59Technical analysis (TA), 107–108Technical Analysis of Stock Trends (Magee), 24
Index
254
Trade movement:capitulatory stage of, 96euphoria stage of, 96Trades:losing, holding, 70–71number to make, 68–69outcome of, as reflection of trader, 8recording number in trading journal, 31significance place on single trades and, 7–8Trading, seeing as a fight, 9Trading capital, amount to risk, 66Trading for a living, 37–48accepting responsibility for one sactions and, 41, 42–43need to learn and, 38–39systems and, 41Trading journals, 30–33Trading ranges, 137–142Trading within the range, practical exampleof, 189–192Trailing stops, 118–121practical example of, 217–220Trans Texas Gas, 20–21Trends:continuation of, practical example of,209–210
Trends (Cont.):movement in the channel, stop placement and, 120–121strong, finding entries in, practicalexample of, 176–179(See also Accumulation/distributionrelationship)20-period moving average (20MA), 167
Uncertainty, 45–46
Veritas Software, 198–200Volume, correlation with price, 98
Winners, allowing to run, 80–81Winners/losers ratio, in trading journal, 31
Yahoo!, 154–157, 196–197
Zeldovich, Yakov, 50
ABOUT THE AUTHORS
Vadym Graifer emigrated from the former USSR during the transitionto a capitalist economy when increased, unwanted Mafia involvement inbusiness affairs made day-to-day living more difficult. After fleeing theformer USSR, he settled in Canada and chose stock market trading as aprofession in his new society. He lost 75 percent of his trading capitalbefore discovering the principles of tape reading, which allowed him tobecome a successful trader, providing a better life