Morning Cup of Jo - Trading Mailbag
Gotta love the technicals!
This morning from Ollie's Diner I felt it apropos to share a continuing conversation from "The Butte" regarding my approach to entering a short and long position as a trend trader. Yesterday one of my new Crested Butte friends sent the following e-mail.
It was great meeting you in Crested Butte! While we were sitting at "The Slogar" waiting for the artery cloggers, you were kind enough to share with me some of your strategy to enter short positions. Using the ubiquitous black straw, you showed me an up trend line (I HATE ungridded table cloths). You stated if a stock was in an uptrend and then broke that trend on decent volume you entered into 1/3 short position. When/if the stock made it back to the trend line on thin volume, you added another 1/3 to your position. Finally, if the stock broke down from there, you added the final third to your position. If it broke back above the trend line, you were out. If this is not correct, please clarify.
My question is this: Does this strategy work in reverse? More specifically, a stock in a downtrend breaks up through it on volume and a long position is entered. When/if the stock retreats back to that line on thin volume, then add more to the long position. I'm using the graph of the trannies you included in your piece this morning as a template. I realize we didn't discuss the time factor as to how long it may take for the stock to return to the initial trend line. Also, the chart of the transports has no volume indicator on it as a confirming factor. I suspect this will work but I wanted to check with the author before thinking about its inclusion in my rather small arsenal of strategies.
Thanks, Kevin! I hope all is well with you and your family. Peace.
Minyan Dean "They're always missing teeth" Mendes
First of all, thanks for the question - it's a good one!
Second - I pen this piece solely as a demonstration of how I enter trades and is NOT intended as a recommendation on either of these two stocks. On that same note, this is purely technical in nature and doesn't bring in any of the corresponding trading metrics you always see Todd talk about.
I'll start with an example of a short trade.
The short trade begins with a stock in an uptrend that has accelerated well above its trend. The following step is to look for the Stochastic, RSI and/or MACD divergence. Once this occurs, I believe, an opportunity may present itself. The next step is to look for technical patterns. In the Pep Boys (PBY:NYSE) example you'll notice a double-top forming with a neckline right at the 50-DMA. Now you have two marks in the plus column. When the neckline breaks I enter the 1st 3rd of the short position with a very close buy stop (Point A). As for volume, in a short trade it's important but not necessary. It takes a bulldozer to push rocks uphill but they can fall on their own accord.
Many times the stock will retrace the first drop from the neckline and retest old support, now resistance (Floors & Ceilings). This is where volume becomes important. You want to see relatively light accumulation volume on the retest. In this case PBY retested conjoining resistance of the neckline and prior upward sloping trend (Point B). This is where I enter the 2nd 3rd of the total position.
The final 3rd is entered once, in my mind, absolute confirmation comes in (Point C). This is the point which corresponds to the low point from the first drop from Point A and coincidently the 200 DMA. What you need to be careful of and watch for is a momentum divergence at this level. If it appears it could be a Road Sign of a northbound turn. If all goes well, your dollar cost average on the short is now about $25.00. The stock is currently at $15.75. Not too bad for a 4-month trade.
Personally I stick with the trade until otherwise notified technically. I let the market tell me when to get out of the trade. So far, so good.
However this didn't answer Dean's question. "...does this strategy work in reverse?"
Yes, Dean it does. Let's take a look at my Long trade example:
Apple Computer (AAPL:NASD).
I'll make this explanation somewhat brief considering we already have the concept.
First - Stochastic Divergence at the bottom - something may be looming ahead
Second - Double Bottom pattern with neckline at the 50 DMA
Third - Neckline break on better than average volume (This is where I believe volume to be important - Bulldozer) - Enter 1/3 trade (Point A)
Fourth - Pullback on light relative volume - enter 2nd 3rd (Point B)
Fifth - Breakout from first run-up from Point A, which corresponds to a larger Cup and Handle base -- buy final 3rd (Point C)
Sixth - Stick with trade until otherwise told technically
If all goes well, your Dollar Cost Average in the position should be around $23.00. At current prices this would be a 43% gain. As Todd would say, "Noice!"
I hope this helped!
Until Next time...
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