TRADING TOOL COMPATIBILITY Part II by Daryl Guppy

This article is in two parts. Click here for Part 1

The next most important issue is indicator compatibility. Determining this starts with a visual chart inspection and is based on the first step in analysis shown above. The chart example shows a rising trend from March through July. In this sense it meets the trending criteria we look for in the first question. However, this stock does not meet the indicator compatibility criteria.
Our reader suggested three methods of managing the trend. They were the count back line, the straight edge trend line and the 2xATR indicator. In assessing the trend we would apply only the first two of these. Our preference is to use the 2xATR as a trailing protect profit stop loss only if the trend develops unexpected momentum. The diagram shows the application.



In a steadily developing trend, shown as A, where volatility, or price changes, remain much the same, we apply the count back line and straight edge trend line. These techniques are used to protect capital in the early stages of the developing trade. They are then quite satisfactorily applied to protect profits as the trade develops.

Some trends, shown as B, the price behaviour changes dramatically. The underlying trend remains intact, as shown by the straight edge trend line. However prices bubble upwards in an explosion of unsustainable momentum. The bubble signals significant changes in volatility. Prices behave differently. The collapse from this bubble is often dramatic, and can also cause a collapse of the underlying trend. For traders who own the stock and who have been managing this as a trend trade, this bubble presents an opportunity to take extra profits. The problem to resolve is how to best protect profits. In some circumstances the 2xATR does this most effectively. This is when we apply this indicator. We do not generally use it to manage trades during a stable trend. In a bubble situation we use a combination of CBL and 2xATR to develop the best solution for protecting profits.

The 2xATR approach is used by Chris Tate for general tend management. This is covered in detail in The Art Of Trading.



Indicator compatibility simply means that our preferred indicator has provided an effective solution to managing the trend in this stock in recent past. The chart shows an example of indicator incompatibility. Our preferred trend management tools are a straight edge trend line and a count back line. On the chart extract shown we show the count back line failure points because we want to highlight how indicator compatibility is assessed.

A close below the count back line, shown as the thick black line, signals an end of the trend and a trade exit. Each time a new high is made, the count back line is recalculated. A close below the CBL line triggers an exit from this trade on the grounds that the trend has an increased chance of failure. The balance of probability favouring a continuation of the trend has shifted.

The problem is that subsequent price action showed the trend did continue upwards. The exit signals defined by the count back line were false. We could not know this at the time. Traders have no choice but to exit the trade because the indicator suggests the up trend has ended.

If we were interested in trading this stock using our preferred combination of the count back line and a straight edge trend line then this chart tells us that this stock is incompatible with these techniques. Here is a most important point and it is relevant to any indicator combination we use. The price behaviour of this stock is not compatible with or responsive to our indicator. This does not mean the indicator fails. It simply means it is the wrong tool for this particular job.

Indicator compatibility is about finding the right tool for the job at hand. Home mechanics who use an SAE spanner on a Metric bolt understand the problem clearly. The tool – the spanner – is an excellent tool, but it doesn’t quite fit the job at hand – tightening a metric bolt. In this chart, the price behaviour does not fit the tools we prefer to use – the count back line. If this tool has been incompatible in the past it is unlikely to be compatible in the future.

There is a trend trade with this stock, but it cannot be effectively managed with our chosen tools.



The chart shows how indicator and trade compatibility are bought together in an effective trading solution. The tools we want to use are a straight edge trend line and a count back line. The objective is to join an established trend so this means that we must be able to plot a straight edge trend line with a good level of confidence. We look for a minimum of three rebound points.

Once this condition is established we then apply the count back line to establish if this has been compatible with trend management to date. The answer is yes and this suggests that this technique will continue to be useful in the coming weeks or months. A selection of previous CBL calculation points is shown by the red lines with red * at the calculation starting point.

Once a stock has been selected based on these compatibility factors the traders attention then turns to other factors such as price leverage, volume and the best entry point. Most times traders have to choose between a number of almost identical trading opportunities. The trader’s objective is to maximise the profits for any trade and this is helped by selecting stocks which offer better price leverage. Stocks trading at lower price levels have the capacity to boost profits more easily than stocks trading at $20 or higher.

Although it is human nature to hunt for a bargain, this is not always a good idea in the market. We have selected this stock because we believe it is in a strong trend. We bet against ourselves if we then wait for a price pullback – for weakness in the trend - before buying the stock. If the opportunity arises our preference is to buy the stock as close to the trend line, or the count back line as possible. We certainly do not want to pay the high price of a short term up trend, but nor do we want to miss out on this stock by waiting for a price collapse. The objective is to buy the stock at a reasonable price that is consistent with its recent trading range.


To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

TRADING TOOL COMPATIBILITY by Daryl Guppy

This article is in two parts. Watch out for Part 2
Although we try to explain the processes of trading clearly there is no escape for the fact that trading is a complex activity. A successful trade brings together many different features. It includes the right selection of indicator tools appropriate for the type of trade. It includes selecting a type of trade that is compatible with our trading style, our emotional reactions and to the way the market is performing at the time. There are always a wide variety of trading opportunities in the market. There are far too many for any individual trader to trade, so we are forced to make choices. The mistake the novice often makes is to search for those trades which offer the most spectacular returns rather than find trades which offer high probability trading situations.

We prefer trade opportunities which offer higher than average returns, but these are in addition to the high probability trading situation. We like chart patterns because they point the way to high probability trades. Stocks that pass this filter are then selected on the basis of higher potential profits. We do not start with potential profits and hope for high probability.

Compatibility of technique and indicator selection is very important for success. A reader wrote to us during the week. He noted that he had learnt that when he buys a stock he has to manage its trend. This is correct and at the core of almost all trading opportunities. The trend may be very short term, as in an intra day trade. It may persist for several days or weeks, as with position trading. Or it may prevail for weeks and months as was common with many stocks between 2004 and 2007. Each of these opportunities is a trend trade, but each calls for different types of management and tools.

The reader continued, noting that he can manage the trend using the count back line, straight edge trend line, the 2xATR indicator and Darvas boxes. Although this is correct, there is an important division in this list. The Darvas approach is a stand alone approach that does not incorporate any additional indicator tools such as trend lines.

The reader asked which of these tools is good to use and which tool is most commonly used to manage the trend? If there was a simple universal answer then trading would be a much easier profession to master. The answer relies on easy to use indicators, but complex combinations that are custom designed to suit each individual. Many people will use the same collection of indicators, but each will apply and interpret them in slightly different ways. Each trader will manage the trade in different ways, reacting to growing profits, or small losses in ways different from other traders. The result is a completely different, and perhaps successful trade, based on the same stock. The current series of notes on finding the trader’s edge is a practical demonstration of these differences.

This combination complexity should not deter new traders, but it is important to be aware of it. The selection of type of trading techniques which are compatible with your personality and preference is an individual issue. The solution also changes as you gain more experience in the market. In these notes we skip this aspect of trade selection and assume you have found the type of trending situation that you are comfortable in trading. Once this first step has been taken the next most important issue is behavioural compatibility.



The MBL chart from more bullish times is a good example of the initial decisions made about stock and indicator compatibility with a trading approach. Many stocks are in the breakout stage of this trend development. When traders look at this chart they have two choices. One choice is to decide what type of trading opportunity exists with MBL based on the past 2 to 3 months of price activity. There are a variety of solutions, including short term rally trading, counter trend trading, or perhaps taking a put warrant or short side trade. These answer the question: What type of trading opportunity exists on this chart? These are all valid solutions, but they are not our solution.

The question we have to answer is about compatibility with trend trading. The question we have to answer is this: Is this chart a trend trade? This is the second choice we have as traders and that is to decide if the stock is compatible with our preferred trading technique. Our focus in these notes is on trend trading approaches so the answer is a clear “No.” For much of 2003 MBL was compatible with trend trading techniques. Since October 2003 this had not been the case with MBL. We do not need to decide what is the best trading method for this period. We simply need to note that this period is not suitable for trend trading. The nature of the trend changed, and the nature of the price action changes after October. It is pointless attempting to make any of the trend trading techniques fit this chart.

The foundation of a successful trade rests upon selecting a chart or stock with a behaviour pattern that suits our trading approach. A trend trade is built around stocks that are moving steadily upwards. The point at which we identify this compatibility will change. Initially MBL was a breakout trade as the previous downtrend ended. Sometime in this period other traders noted the potential for a trend trade. This is indicated by the way the trend trade line starts at a midpoint in the breakout trade segment of the chart display. There is no clean cut off point or date that says this is a breakout trade and this is a trend trade. Aggressive traders recognise trend trades early. Conservative traders wait for much longer before accepting a new trend is in place. This effects their entry point, and the level of profit achieved from the developing trade.

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

CLASSIC AND CONTINUATION CHARTS by DARYL GUPPY

In the newsletter we use several varieties of chart displays. This includes two colour candle stick charts produced with GTE charting. The standard candle display with Metastock and many other US derived programs is to give a four colour candle chart. This, along with our recent articles on candle stick trading methods, has prompted many questions from readers so we look at the differences again.

We also use two colour bar charts. These are different from the two colour bar charts in Metastock and some other US based charting programs and this has left some readers confused. What they see on their screen is not the same as they see on our chart extracts.
The reason is the same as the reason for the difference in the candle charts. Some bar chart displays show Gann continuation charts. This is not quite as important with bar charts because traders do not use a collection of specific bar relationship patterns for trading. However it does impact on the way you see the chart.

INDICATOR – CLASSIC AND CONTINUATION PRICE DISPLAYS

The price bar and the candlestick are the basic ways of displaying price action. They show the open, high, low and close prices. The classic, or original, display examines the relationships between the open and the close on a single price bar or candle stick.

A Gann continuation chart examines the relationships between the prices of today and the prices of yesterday. This type of chart display is also called a swing chart display. The difference in display is very important because it has significant impact on the way we use charts for analysis.

APPLICATION
The classic bar chart display uses today’s open and close to determine the colour of the bar. When today’s close is higher than today’s open, the bar is shown as an up day – usually blue. When today’s close is lower than today’s open, the bar is shown as a down day – usually red. A classic candlestick display only has two colours, usually green and red, or blue and red.



The continuation bar chart display is an adaptation of Gann analysis techniques. In this display the definition of an up or down day depends on the relationship between today and yesterday. An up day is when the close of today is higher than the close of yesterday – usually shown as a blue bar. A down day is when the close of today is lower than the close of yesterday. Other price relationship combinations are shown as filled or unfilled candle sticks.



This means that a day where price opens today at $1.00 and closes today at $1.50 can still be shown as a DOWN day using a Gann continuation chart display. It is very important to know what type of bar chart display you are using so you can decide if it is appropriate for your analysis.

The two chart displays shown above use exactly the same price information for each display. The classic charts are shown on the left. The continuation charts are shown on the right. The analysis messages delivered by the different displays are quite different, even though the price information is exactly the same.

Many default candle stick displays are also Gann continuation displays. This is very dangerous for analysis. Candlestick chart pattern analysis is based on the classic candle stick display that uses intraday-day price relationships. GTE Charting allows users to select Classic or continuation chart displays.



TACTICS
• Use classic bar chart display for pattern analysis and understanding trend behaviour
• Use classic candle stick display charts for the effective application of candlestick analysis.
• Use Gann continuation chart displays for swing trading analysis.

RULES
• Use the correct chart display for the trading analysis technique you are applying
• Select one style of display and stick with it. Do not frequently change display styles. This will create analysis confusion.
• Use classic candle stick charts for candle stick pattern analysis.
• Do not use candle stick continuation charts for candlestick pattern analysis
• Swing trading analysis uses continuation charts
• Classic candlestick display only uses two colours, traditionally black and white candles.
• Continuation candlestick display uses a mixture of two colours and filled and unfilled candles.

ADVANTAGES
• Using the correct display for the selected analysis method enhances success
• Treat with suspicion candle stick ‘experts’ who use candle stick continuation charts
• Treat with suspicion swing trading ‘experts’ who use classic chart displays
• Some people find it easier to understand price activity using a bar chart. Others prefer a candlestick chart. This is a matter of personal preference and has no indicant trading advantage

DISADVANTAGES
• Using Gann continuation candlestick display will lead to incorrect candlestick pattern analysis.
If you want to use 2 colour candle displays in Metastock please refer to our June 6 article in the newsletter that explains how to do this.

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

CNBC – FOLLOW THE DRAGON TRAIL by DARYL GUPPY

Who follows and who leads in markets? The answer is surprisingly different to the answer most people assume is correct. Intermarket technical analysis is a useful strategy tool for asset allocation. It’s also a useful tool for working out what may happen in the future. It’s too easy to look at markets in isolation, or to use outdated assumptions about market relationships. This is lazy thinking and in a changing market environment it can cost a fortune.

We publish hundreds of charts each year in our financial newsletter publications and in columns for international and Chinese financial media. The chart below is the probably the single most important chart you will see in 2009. You will need to put aside lazy thinking and assumptions to fully understand it.

This is not a technical chart. It’s a combination of 3 indexes, each displayed as a single line. Unlike many comparative charts the indexes have not been rescaled to a single starting point so we can see relative performance in percentage terms. This is not significant.

The charts have been time adjusted so it is easier to compare the behavioural characteristics of the three markets. We use the Dow Index and the Australian ASX S&P 200 XJO index as representative of markets outside the US. The DOW and XJO charts have been time shifted to the left so the absolute market lows of March 2009, match the time of the absolute market low in the Shanghai Index in October 2008. This type of time shifted display clearly shows which market is a leader and which markets are followers.

This chart display confirms that 2009 has seen the most profound change in market dynamics in more than half a century. Put simply, China leads and the DOW follows.

The blue line shows the performance of the DOW index.
The black line shows the performance of the Australian ASX S&P 200 XJO index.
The red line show the performance of the Shanghai Index.

The DOW is now at 10,000 but how important is this in terms of global market behaviour? The DOW is following the behavioural leadership of the China market. The 10,000 equivalent for the Shanghai Index is 3,000. The Shanghai market reached this level and briefly powered above it before developing a trend correction. The Shanghai Index remains in trend correction mode and is using price and time corrections. The price trend correction is the sudden index fall of between 15% to 20% from 3480 to 2750. The time correction for the trend is the extended sideways movement over the past 10 weeks. The important relationship is not the comparative percentage returns, but the comparative behaviour.

We need to watch carefully because there is a high probability our markets and the US market will follow this China market leadership behaviour with a lag of several months. This suggests a trend price correction in the order of 10% to 15% followed by a period of sideways trading as the market applies a further trend correction using time.

Analysing and understanding China market behaviour is absolutely critical to any market strategy. China leads, the DOW follows the behaviour and other markets tag along further behind. Watching China gives investors a glimpse of the potential future. It is absolutely essential to developing any long term portfolio investment or planning.

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

INDEX BRIEFS – NIKKEI, JAPAN by DARYL GUPPY

The Nikkei has two important features. They are best seen on the weekly chart. The first is the series of trading bands. These provide support and resistance levels. This pattern of behavior is similar to the patterns seen with many other regional indexes, but the Nikkei is less developed. The upper edge of the current trading band is near 10400. The market consolidated in this area and is now retreating from this resistance level. The lower edge of this trading band is near 9000 and this is the new downside target. Traders will look for support consolidation in this area.

The second feature is the uptrend line starting from the March low. The position of this line was confirmed when the market developed a successful breakout above the long term downtrend line. The drop below the new uptrend line is bearish. This uptrend line intersects the trading resistance band level. The failure of the market to push above this level and to remain above the uptrend support line sends a stronger bearish message. There is a low probability of a rally rebound developing prior to a retest of support near 9000. There is also a low probability the market will easily move above the resistance level near 10400.



The trading band extended from near 7500 to 9000. The trading band is used as a projection method and sets an upside target near 10400. This is a nominal target because it does not coincide with any previous support or resistance level. However it has proved to be a more significant resistance level than the historical 10,000 resistance level.

Regional markets have moved in double trade band projections. Using this method the next resistance level is near 11800. This is near to the strong historical support resistance level at 12,000. The rapid market fall from near 12,000 suggests there is little resistance to a rapid rise in the market. Once the market is above to move above 10400 here is a high probability the market will move quickly and smoothly to 11800 to 12000.

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

INDEX BRIEFS – TAIEX, TAIWAN by DARYL GUPPY

Eight weeks ago we said the key figure for the Taiwan index is 7400. This is the long term historical support level and it will act as a resistance level. The market did move above this level but it is now developing a consolidation pattern. The lower long term resistance near 6700 has been overcome and this area will provide support if the market retreats strongly from the lower edge of the consolidation area near 7300. The upside target for a sustained breakout above 7400 is near 8100.



On the daily chart the long term GMMA is well separated and shows good investor support for the developing trend. It has shown relatively little compression as the index retreat developed in early July and again in early August. There is some strong trading activity but it uses the long term GMMA as a support level.

The strength of the trend is shown by the good separation in the long term GMMA. Trend strength has been confirmed as the upper edge of the long term GMMA moves above 7300. A lower edge move above 7100 is confirmation of trend stability and sustainability.

The rapid rise of the trend has stabilised and traders can look for regular rally and retreat behaviour within the context of the longer term uptrend. This is a strong market, but a rapid retreat to support near 7100 is possible.

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

INDEX BRIEFS: SENSEX, INDIA by DARYL GUPPY

The Sensex is best seen on a weekly chart with upper resistance levels are easily seen. The most important feature is the uptrend line. The break below this line changed the function of the line. This is now acting as a resistance level for the rising trend. We expect to see the index rise to this line and then retreat from it. Support is provided by the value of the lower edge of the long term GMMA. This is best seen on the daily chart.



The primary resistance level for the current rally is at 17,500. A retreat from this level may develop a sideways consolidation pattern with support round 15,500. The key danger in this trending behaviour is the volatility retreat such as that seen in August.



The daily chart shows good support from the long term GMMA near 16200. The lower edge of the long term GMMA is near 15500. This is a steady and well supported trend. Traders can apply Darvas box trading techniques to buy as new highs and breakouts from new highs are created. The value of the long term trend line is well above the current index activity and this leaves room for fast rallies.

The key feature to watch in any market retreat is the reaction of the long term GMMA. If there is developing indications of compression it suggests trend weakness. Traders need to be alert for a significant test of support. Increased compression in the long term GMMA will confirm a major tests of trend strength.

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

OVERNIGHT GAP TRADE MANAGEMENT II by Daryl Guppy

Continued from Part 1...

DAY 2 EXIT

This is a two day trading strategy. Day two is about profits. There is no intention to extend this trade into a third day. Prior to the open our focus is on the order lines. We look for evidence that buying pressure is continuing. There are two ways to determine this.



The first uses the estimated match price. This is set at $0.61 and represents a gap above the previous day’s close. It is not a real gap above yesterday’s high, but it does suggest that the upwards move is likely to continue.

The second considers the balance between buyers and sellers. These figures take into account all the orders in the order line. This includes some very old buy orders which have little chance of execution at $0.42 and lower. However, the balance is tilted very heavily towards buyers with 1,581,150 of buying volume. This includes an undisclosed buyer sitting at $0.57. It is unlikely that prices will fall to this level, but the presence of this large buy order provides additional support for continued momentum during the day. If this buyer is really that interested in PEM then he may well decide to chase prices higher.

If the undisclosed order was on the sell side it sends a bearish signal. The sell orders total 625,625. The line is shorter than the buy line and confirms continued bullish pressure on prices.
Prior to the open we lift the stop loss to the same level as yesterday’s close. At worst, if triggered, this will lock in a 3.45% return.

Exit management calls for close monitoring of intra-day price activity. Early in the morning prices test $0.63 as a support level. Our stop loss is lifted to $0.63, locking in a potential 8.62% return.

During the day prices hit $0.66 on low volume, and then pull back from this level. In the late afternoon sellers flood the market with orders at $0.65 and $0.64. This suggests that the momentum generated by the gap on the previous day is losing strength. Our objective is to do the best we can on the day, and in the face of this selling pressure we meet the bid at $0.64. This exit locks in a 10.34% return. A few trades later, prices drop to $0.63 which would have triggered our stop loss exit.



Prices do climb back to $0.66, but they close on just a handful of trades. The volume traded is not enough to close our position.

These trades return significant short term gains. They are more effective that day trading strategies which rely on buying near the low of the day and selling near the high of the day.

These gap trades reduce overnight risk because they rely on a continuation of demonstrated momentum. When traded with the advantage of price leverage these trades can return 5% to 15% on a 36 hours trade. The strategy is straightforward but the execution calls for well developed trading discipline.

> Related Articles:
OVERNIGHT GAP TRADE MANAGEMENT I
OVERNIGHT GAP SELECTION Part 1 and Part 2

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

OVERNIGHT GAP TRADE MANAGEMENT by DARYL GUPPY

The gap trade may be executed using ordinary stock, or using a derivative, such as a CFD. The derivative increases the return from the strategy. It also increases the risk in the strategy particularly if the CFD is based on bid-line triggers rather than traded price.

Management of the gap trade covers two days. Broadly they can be described as the entry day and then the exit day. The analysis for this strategy does not start until 20 minutes after the open of the market. By the time the analysis is completed the market may have been trading for an hour. This means that prices may have moved well above their open. If we are particularly lucky, price may have experienced a retreat as often happens after an initial market rally.

The important point is to remember that the success of this strategy rests on entering the stock on day 1 with the objective of exiting the trade on day 2. Rather than attempt to buy the bid it is more effective to hit the ask. The order screen shows a bid at $0.57 and the ask at $0.58. Getting a position is more important than haggling about the entry price. We take the entry at $0.58.

In this trade we miss the low of the day set at $0.56. We miss it because we are still involved in analyzing the potential trading candidates. This is significant if our focus is on trading the extremes of price action. It is less important in this strategy as our objective is to capture a portion of the price movement. We continue to stress this because so many traders feel cheated if they miss the price extremes. This attitudes blinds them to many other successful trading strategies.

Success depends upon running a tight stop loss. Using the low of the day we set a stop loss 1 tick below this level. A tick is the minimum price move permitted in the stock. With PEM, prices move up or down by one cent at a time. There are no half cent bids. Our stop loss is set at $0.55. This is an automatic stop loss. This has several advantages. The first is that the stop is executed automatically so you do not need to sit in front of the live screen all day. This automatic execution overcomes the temptation not to act. It is an artificial boost to discipline.



The second advantage is the speed of execution. Traders who use mental stop loss points have to watch the screen all day. Once the alert is sounded as a trade takes place at the stop loss price they must contact their broker. This means ringing, or logging onto the net, bringing up the screen, locating the stock, creating the order, and then clicking the sell button. The time from the stop loss alert to order execution may be a minute or more. In that time it is possible that prices may have slipped several ticks below the planned exit point, creating an unexpected large loss.
There are several critical features of this strategy. Rapid stop loss execution is one of them which is why I use an automatic electronic stop loss order.

It takes time for news to travel through the market. PEM has gapped upwards on the open, but it drifts sideways for an extended period. In the afternoon a new flood of buyers come into the market. They temporarily lift prices to $0.62. Some traders start to take profits at this level, and their selling drops prices back to a close at $0.60. Our objective is to remain in the trade, so we do not chase this rise as a selling opportunity. However, the rise provides the opportunity to lift the stop loss and shift the trade into a breakeven opportunity.

The initial, or morning, stop loss is placed one tick below the low for the period. The afternoon stop loss is placed after prices start to pull back from the high. The objective is to protect our capital. Lifting the stop loss means that the worst outcome is a break even trade – unless prices gap down past the stop on the next day’s trading. However, with a gap open today and a higher close on increased volume this is an unlikely outcome.

In a position trade – a trade designed to be open for days or weeks – it is sufficient to set a stop loss at the end of each trading day. On an intra day, or short term trade, there are significant advantages in shifting a stop loss several times during the day. The first shift should provide total protection for capital. Later shifts should start to lock in profits, and this is the first step on the second day of the trade. Stop loss points are only lifted upwards. They are never lowered.

Will continue in the next article...

> Related Article: OVERNIGHT GAP SELECTION Part 1 and Part 2

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

OVERNIGHT GAP SELECTION Part 2: Trading Article by Daryl Guppy

Continued from Part 1...

Alternatively we use the JustData snapshot service. We take the first available snapshot of market data at 11.30. This downloads all open, high, low and close prices to that point in time. From this data we can assess the difference between the high of yesterday and the open of today. We then run the Metastock gap exploration scan shown at the bottom of these notes. The filtered list is printed and the charts created with GTE. Speed is not important, but nor do we want to take too long to make this initial assessment. Of the 53 stocks in this example, only 8 meet our conditions.

The next filter is volume on the previous day in particularly, and over the previous week in general. We are planning to trade crowd enthusiasm, so we expect to see some evidence of this on the day prior to the gap. The appropriate volume depends on our trading objectives. If we want to trade $5,000 position size then we accept a lower volume than if we want to trade a $20,000 position. We need some evidence that there is sufficient volume to support our planned trading size.



If this is supported by trading volumes during the week then it is an added advantage – a double tick. This is not a critical factor. Many of the best gap trades happen when volume floods the market. The previous week, or weeks of trading activity may be very low. The stampede changes that. This is why volume on the day prior to the gap open is more important than volume in the previous week.

In the next column I include the bar pattern. An excited crowd will close prices near the high on the day prior to the day. This is the most bullish pattern. A close above the open is the next most bullish. A close equal with the open is acceptable, but it must be supported by other bullish factors, including a very strong Guppy MMA relationship. A close lower than the open is the least effective chart pattern. This a crowd that lost enthusiasm and this makes it unsuitable for our strategy based on continued enthusiasms.

The final note in this first selection process is the trend pattern. This combines both Guppy MMA analysis and recent trend direction. The best pattern is a straight edge trend line pointing upwards. The next most bullish is a rising trend that has shown a small retracement. The current gap open signals a resumption of the up trend. This may be extended to include a retracement followed by a sideways move and then a rebound from the consolidation pattern.

The least attractive opportunity is created by a breakout from a downtrend. Instead of a gap trade, this becomes a breakout trade using gap strategies. The danger in this type of trade is that the rally may collapse when it hits a resistance level. There is a higher probability of a rally being overwhelmed by sellers. There is less probability if this is a trade that takes place in an established up trend. The desperate need to sell to cut losses or lock in small profits on the first breakout has usually disappeared.



We want crowd enthusiasm and trend strength.

The eight candidates are reduced to six, although we have included PCE in this example. Normally we would eliminate PCE because it is a rally breakout in a strong trend. It has a low probability of success.

We are left with three final filters. We shift from the chart to the live depth of market order lines. The first uses the current order line to determine the volume of trading activity. The best relationship has three characteristics.

a) More buyers than sellers.

b) good trading volume on the buying side. We want to be able to place our order.

c) A reasonable spread between the bid and the ask. If it is too wide we either have to wait for prices to pull back, or pay more than we should to get hold of stock.

PEM and BRY meet all these conditions. The spread with PCE is too large. The buyer wants to pay $0.24 but the nearest seller is asking for $0.345. This spread eats away at the potential profits in this strategy, so we ignore it.

ABK has very low trading volume. Our order would dominate the market. SSI has more buyers than sellers, but the order line has low volume.

We are looking at this screen up to forty minutes after the open of trade. Our strategy is based on continued crowd enthusiasm so this should show up in two ways. The first is a continued increase in prices, or at least, not a slip back to the level of the previous day’s high. Secondly, there should be lots of activity in the stock. We want a large enthusiastic crowd fighting amongst themselves to get hold of stock.

This is the penultimate filter. Those candidates with active trading go to the top of the list. RBT which met the order line conditions, fails this activity test. Forty minutes after the open, only a few trades have been completed. There is no crowd here.

The final filter is price. Our preference is to select the opportunity with the best price leverage. A $0.10 stock is preferred to a $0.50 stock, or a $1.00 stock, all other factors being equal. Lower prices mean there is more opportunity for a substantial price rise today, and tomorrow. It increases the percentage return from the trade.

From this list we select PEM because we believe it has a stronger chart pattern than BRY.

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

OVERNIGHT GAP SELECTION I : Trading Article by Daryl Guppy

The strategy for this trade was discussed last week. The objective is to capture the momentum of an excited crowd and trade its continuation overnight and into the next day. The strategy recognizes that it is unlikely that we will identify a gap trade before it happens. It is also unlikely that we will be able to buy stock at the opening gap price. Instead the trader waits for gap confirmation, then buys the stock. The intention is to sell on the next day. We expect other traders to be attracted to this gap trade when they see the gap on the end of day download. This includes traders who already own the stock, and traders who are searching for gap, or price volume breakouts.

The objective is to sell on the next day when we consider that the buying pressure is declining. Enthusiasm may carry prices higher next day but unless this is part of an extreme momentum trade, the most likely result is that prices will peak during the second day and then decline.



The strategy does not call for an exit at the top of the second day, although at times the exit may occur near this level. The strategy recognizes that it is more likely that we will capture prices as they fall back from the peak of the day. The potential returns range between 5% and 20% or more. Returns are lower when trading stocks, but higher when trading warrants and other derivatives. The objective is to take a low risk overnight trade and collect a quick profit.

For success the strategy requires access to live data and live trading screens. It also calls for good stop loss execution. This is best achieved using automatic electronic stop loss conditions and where necessary, contingent orders. The technology is available, and it helps make these strategies more successful.

SELECTION

Opportunity screening starts with the WebIress market heat screen. The scan does not start until 30 minutes after the open of trading. This gives time for every stock to have traded, and allows us to find all those stocks which have gapped on the open. These show up as bright green patches because the opening gap creates a higher percentage gain. The search compares the close of yesterday with the open of today. Not all of these candidates will meet our requirements of a gap between the high of yesterday and the open of today.



The gaps identified in this screen range from 1.53% to 50%. The MOL gap in this example is 35.88%. Our interest is in gaps greater than 3%. The screening process starts by eliminating stocks that do not meet our gap requirements. There is no easy way to do this. We start by making a full list of stocks that have gapped up. We immediately eliminate any below 3%.

Watch out for Part II...

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

NEW OIL TARGETS by Daryl Guppy

The behaviour of the oil market has changed dramatically in the last few weeks. Oil has retested the upper level of the trading and consolidation band. The market is establishing a new resistance level and this changes the upside price targets. The NYMEX (New York Mercantile Exchange) Crude Oil weekly chart is the most effective way to observe the impact of these historical trading bands and the nature of the oil trend behaviour.

The lower level of the current trading band is near $58.00. This is an historical support level. The upper level of the current trading band is between $68.00 and $70.00. This is also an historical resistance level. The oil price moved above this level in 2009, June and reached a high near $72.00. This was a temporary breakout. The price fell and retested support near $58.00.



The recent price move to $72.00 shows bullish pressure is retesting the resistance area between $68.00 and $72.00. A retreat from near $72.00 will confirm a new resistance consolidation level between $68.00 and $72.00. The drop below $68.00 may test the lower edge of the long term GMMA. The new resistance level at $72.00 is very important because it effects the upside target calculations.

Currently the next historical resistance level is located near $78.00. The next higher historical resistance level is near $88.00. During 2007 to 2008 the oil trend moved between trading bands. Each trading band was about $10.00 wide. Using the history of support and resistance this gives a new upside target of $78.00 which is $10.00 above the historical resistance level at $68.00. The historical levels are shown in black lines.

The character of the oil market is changing as the new uptrend develops. This change will be confirmed when the new resistance level at $72.00 is also confirmed. In this new environment the price targets change.

If a new resistance level is confirmed near $72.00 then it increases the width of the trading band. The new trading band would use the historical support near $58.00 and the new resistance high level at $72.00. The height of the new band is now $14.00. The behaviour of the trend in oil uses the trading bands to set the next upside target.

A breakout above the new resistance level at $72.00 gives an upside target near $86.00. The next higher target would be at $100.00.

The nature of trend behaviour in the oil market does not change. The trend moves in trading bands. Price consolidates inside the trading band, and then a price breakout develops. The upsides target is calculated using the width of the trading band. The character of the trend behaviour has not changed but the position and width of the new trading bands has changed. This sets higher upside targets when the breakout trend continues.

If we use the historical trading bands it would require three trading band consolidation periods for the oil price to reach $100.00. If we use the new trading consolidation bands it requires only two trading band consolidation periods for the oil price to reach $100.00.

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

6 to 21 Part II Strategy by Daryl Guppy

Click here for Part 1

We start the strategy with a basic understanding of the relationship between risk and reward as shown in the diagram. Blue chip stocks are those which have the capacity to return 10% to 20% in a single trade. These figures are moved up a little in a bull market, but in general these are the types of returns we aim for with a blue chip stock. Trades may last months or longer with these stocks. Note that it is the return from the trade that defines the category. It is not the quality of the stock, although it is fair to say that most blue chip stocks also have a large capital base.

• The mid cap stocks are capable of returning 30% to 50% in a single trade. In a long term trend they may return much more, but our focus is on a single trade that may last weeks or months.
• A speculative stock is capable of returning 50% to 100% in a single trade. Typically these trades will last days or weeks. Some last months, but this is unusual.

As we move from blue chip trades to speculative trades, the risk increases. Speculative trading opportunities generally carry greater risk than blue chip opportunities. This is partly a function of volatility, and partly a function of momentum. Fast movers can also drop quickly. Slow movers can drop steadily for months on end as people discovered with banks in 2008. . The speed of the collapse does not diminish the risk in the trade. The risk is diminished by the activity of the trader. The trader who does not act on a stop loss signal automatically increases the risk, and the size of the loss, in the trade. The primary difference between blue chip and speculative stocks in this sense is that most times the blue chip trader will have more time to make a decision.

The obvious and enticing way to grow our capital quickly is to trade the speculative stock opportunities. If we only do this, and pyramid the returns from each trade into the next trade then we can grow capital very rapidly. Unfortunately it does little to protect our capital. With each new trade our capital and profits are exposed to the same level of market risk as when we first started. This is the gambler’s approach and is a short cut to ruin unless your luck holds.
The resolution to this problem, as covered in Share Trading, is to use only a fraction of capital in the high risk trades. This strategy uses speculative profits to add to capital.

The process is shown in the diagram. Our starting capital - $6,000- is divided into a 1:2 ratio. Two thirds of the capital - $4,000- is allocated to a blue chip trade. This is not going to earn a great deal, but it should earn better than bank interest which is the other alternative use of our capital. There are two objectives. One third of the capital is allocated to a speculative trade. This means the position size is $2,000 and this is about the minimum size trade that is realistically possible. This is the size of the RFE* trade example. It is this minimum size, coupled with the 1:2 ratio that gives us the minimum size for starting capital - $6,000.

To primary objective is to protect our capital. This is achieved by allocating more to blue chip stocks than to speculative stocks.

The next objective is to grow capital quickly by taking greater risk in the market. This is achieved by using a smaller proportion of our capital. This small proportion grows slowly as our total trading capital – profits and original capital – increases.

The profits from each trade are added to our trading capital. The diagram shows a successful speculative trade. The profit from this trade is swept initially into our bank account.



This profit becomes part of the total trading capital available. As a new speculative trade is opened the profit from the original speculative trade is added to the capital used in the next speculative trade. This is an aggressive Egyptian pyramid approach designed to fast track capital growth.

Although this is potentially a very profitable strategy, it is also a strategy that carries a higher level of risk. This is managed firstly by using tightly defined stop loss points and entering trades as close to the stop loss point as possible. We discussed techniques for this in recent newsletters.
The second way this risk is managed is by stopping this pyramid approach once we reach $14,000. The objective is to quickly reach the $14,000 level. Once this level is achieved, the capital ratio changes to the 1:2:4 ratio. This puts 1/7 of capital in speculative stocks, 2/7 in small or mid cap stocks, and 4/7 into blue chips. Again, the shift to this new ratio is based on the minimum acceptable trading size of $2,000. Applying 1/7 of trading capital to a $14,000 account gives a position size of $2,000.

Once $14,000 has been reached the next objective is to reach $21,000. At this level the combined impact of the speculative and mid cap trades can add significantly to the growth of trading capital. Growing capital is like pushing a heavy load. At first progress is slow, but as momentum builds the speed increases and it appears to take less effort to obtain a better result. As capital grows, the leveraged impact of speculative and mid cap trades increase and capital grows quickly. The difficult part is getting from $6,000 to $21,000. Over the next few months we will show some of these difficulties in real time. The skills learnt in this process underpin long term trading success.



As noted the speculative trade in RFE was closed with a 19.33% profit. This added $391 to speculative capital. The next speculative trade will use $2,391. The blue chip component of the 6-21 portfolio is yet to be opened. A new speculative position will be added when opportunities arise. This is not a process of close one trade and jump into the next. It takes time and care to build from a low capital base. We will show these trades in the case study report as they develop through the Guppy Newsletter.

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

6 to 21 Strategy Part I by Daryl Guppy

I can still remember my first contact with a broker. The message was blunt. “If you haven’t got a minimum of $50,000 to start with then I am not interested.” The broker’s arrogant contempt struck a raw nerve because I felt I had as much right to make money in the market as anybody else. His comments spurred me on to understand the market, the money making opportunities, and the vital role that money management and risk control plays in trading success. In many ways, this broker bears responsibility for all the books that I have written because my objective is to cut through the arrogance of entrenched market money to show how these opportunities are available to everybody.

I started with $2,000 because that is all that I had available at the time. It was not money that I could not afford to lose. It represented a very significant part of my savings. Losing it would hurt a great deal and that immediately focused my attention on risk control. This was not a gamble. It was a well considered plan to make my capital work hard. $2,000 is not a good ‘grub stake’.

$6,000 is closer to the bare minimum required for trading because it gives the trader the ability to practice some risk diversification. Growing this capital to $21,000 is the first important step in market survival. Once trading capital reaches $21,000 it is much easier to spread the volatility risk across several open positions to protect and grow capital.

Some people continue to sneer and suggest that it is virtually impossible to grow capital from $6,000 to $21,000. This self defeating attitude is guaranteed to deliver trading failure, and failure in many other aspects of life. No one pretends trading the market is easy. It is jot. It requires more discipline than many people have. It requires a willingness to work, and work hard. This is no gamble, and there are no short cuts. This upsets many Australians who love the Tattslotto approach to life and the markets where lots of money comes for little work. When they discover making money from the market requires more work than buying a tattslotto ticket they give in – and they decide that no one else can make money from the market because it is rigged, manipulated or controlled by insiders and those in the know. Their self defeating attitudes become self fulfilling.

The market remains the most effective legal place to grow capital through the exercise of risk management techniques and personal effort. Over the next few months we will be running a simultaneous case study portfolio designed to show how capital can be grown from $6,000 to $21,000. We will be using only ordinary stocks – no derivatives of CFDs.

We start the case study with a sample completed trade in RFE*. Readers may remember that this stock was covered in the Chart Briefs section a few weeks ago. At the time we noted that one of the staff at Guppytraders held an open position in the stock. We use that trade as the starting point for the $6,000 to $21,000 case study. The trade was closed on Thursday. The chart shows the entry and exit points. The trend was identified with a Darvas box breakout. The trade was managed using a trend line. Trade entry was as price rebound from the trend line near the lower edge of the Darvas box.



Success rests upon the way we approach risk with this small starting capital. This is the most important factor. Because when we start, our focus is always on protecting capital. Usually it has taken some time to gather the capital, and we do not want to lose it. This throws up an important contradiction which any trading approach must resolve.

The way to grow capital quickly is by trading stocks which promise a higher return per trade. These are stocks with greater volatility. They can move up dramatically, and move down dramatically. This increases the risk of loss if the trade fails.

An important caveat here. This increases the risk of loss only if the trader follows a buy and hold strategy. The market experience in 2008 clearly demonstrated this. The returns from many managed and superannuation funds also confirmed this.

The first powerful impact of risk management is understanding that the trader manages risk. The market does not manage risk. The ‘I’m in for the long term’ approach believes that the market manages risk, so simply by waiting any losses can be managed. The market creates a risk environment which we manage through our own actions.

Resolving this contradiction and reconciling it with the need to protect capital involves two steps. The first is to classify stocks according to their volatility. Rather than create new categories for this, I used existing categories – blue chip, mid cap, and speculative – as a shorthand. This decision has plagued me ever since and has been a source of confusion for some readers of Share Trading. The second is to allocate capital in a way that maximizes returns within a money management structure that protects capital, and which grows capital as a result of trading activity. This is the essence of the 6 to 21 strategy.




To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.

Hong Kong Hang Seng Index Analysis

The initial upside target of 20,000 mentioned in the last Hang Seng Index notes has been achieved. The best way to look at the Hang Seng is to use a weekly chart. The long term resistance level is near 21,000. There are no technical barriers to the rise from 15500 although a weekly flag pattern did develop. This is not a clear flag pattern, but it can be used to confirm the upside targets of 21000.



The upside targets were established using the trading band behaviour of the Hang Seng. The width of the trading band is used to calculate potential downside and upside targets. A breakout above 15500 gives an upside target near 20,000. This is near to historical support and resistance near 21,000. The market has moved quickly to these levels so the is a higher probability of a significant retreat once resistance near 20,000 to 21,000 level is achieved.

Traders will look for loss of momentum and consolidation within this resistance band.
A move beyond 21000 has an upside resistance target of 23500. This is based on the upper level of the left hand shoulder pattern that was part of the longer term head and shoulder pattern. This strong trend is underpinned by the growth in the Chinese economy so traders will also watch the Shanghai Index for indications of weakness which will transfer to the Hang Seng.

To read more articles and commentaries from Daryl Guppy, click HERE

***

Article contributed by Private Trader, Market Expert, Trading Coach and Best-Selling Author Mr. Daryl Guppy. For more articles and commentaries from Daryl Guppy, click HERE.