Wednesday, October 06, 2010

Buy the first test of support, never the second

Our veteran subscribers have read this line literally a hundred times in the last four years, "Buy the first test of support, pass or short the second test".     We love buying support if it's the first time it's been tested in a long time (for example over 2 months).  However if support is tested again within a short time-frame (less than two weeks) then it automatically becomes a short alert.

As we wrote about VMW this morning before the break of the 50SMA -- it's not good risk-reward to buy the second test of support (or major moving average) when it comes so close to the previous one.

All the examples here are similar pattern.   Monday tested 50SMA and bounced.  Wednesday tested 50 SMA again and broke down.

Tuesday, October 05, 2010

Target Trades

Most of our trades fit in the following categories:

1)  breakout of resistance long
2) breakdown of support short
3) resistance short
4) support long

but we also have one more strategy we like to use called a "target trade".   If you've followed this blog for the last four years you've seen us make this trade countless times -- most recently on XME 53 and GS 148.5.

Basically a target trade means you take a position well under the actual alert with the conviction that the alert will at least trigger.    You don't know whether the break-out will fail or be successful but you do have conviction that it will at least trigger.

To make this strategy work well you have to make sure several  conditions are met:

1) the alert spot is very clear and has many eyes looking at it.

2) done in a benign trending market

3) you're buying in a range-bound base that is not extended and has support near-by (so you have a natural stop relatively close by on a swing basis). 

To look at specific examples look through the XME GS links above but to sum it up -- here's an example:

Stock HCPG is basing very nicely under 50 -- it's come close to touching that number several times and you have had an alert there for weeks.   The market acts well and the sector to which HCPG belongs has been acting strong.  The stock is not extended.    You have a good feeling that 50 will trigger -- however it's becoming a crowded trade and you know there's a chance of break-out failure.  You have conviction that 50 will trigger but you are not sure whether the break-out will work or not. What shall you do?   Get in before.  So you buy a swing position at 47.89 within the range of 46-50 with a stop under 46.    If you are a new trader we recommend just having a pre-defined stop.  If you've been doing this for a while then we recommend the same as what we ourselves do, and that is to trade around the position in order to be able to withstand pain and not get chopped out.  If the market weakens, put on short index hedges. 

The next day market gaps up and stock HCPG makes a fast run for 50 on the opening bar.    If the set-up is excellent and the volume is significantly above average, and it's a sector move, then if you wish you can add to the position and move stop up to above break-even.    However most of the time all ducks do not line up and what we prefer to do is to take some off into the number to lock in profits.  Why?  Because our conviction was about the stock actually hitting the alert, not what came after it.   This is what we did on XME 53 (which worked well since the breakout actually failed) and this is what we've done on GS 148.5 ( a move we've telegraphed for our readers for the last 6 days on the trend-line break).    Remember that once the alert actually triggers your primary goal has been met -- therefore after a trigger, NEVER let the trade become a losing position.   

Remember -- spots which are technically very clear serve as magnets -- in our experience they almost always trigger.   What happens after they trigger however is much less clear.   

It's a strategy that works very well if you're patient enough to use it only when the conditions of the trade are met.

Daytrader tip: In extremely benign trend days with excellent breadth what we also often do is to simply go through our alert list and buy whatever is close to triggering.  Why?  Because alerts (based on support and resistance), act as magnets.   Hop on the steel ball rolling towards the magnet, take some off when magnet meets ball.

Monday, October 04, 2010

The Mighty Goldman Sachs

Update:   we are selling some of the swing position into this BoJ market ramp and taking a more conservative position.   Moved stop up to today's lows to protect profits (146) and are going to try to sit on the rest of the position until at least 153/200 SMA.  Sold more 149.8, moved stop up to 148.5 break.

We posted this chart last Wed -- writing that we would go long on any trend-line break.  
We are swing long GS and have traded GS long every day since the trend-line break (usually pair trade long GS/short BIDU or long GS/short TNA). 

Nice move from trend-line and now basing under 50SMA/148.5 resistance which has been tested three times.   This is a defined range with very good risk-reward.    We have a good entry and are comfortable sitting in anticipation of the break-out.   What if it weakens?  We would reduce size on a move down through the 100 SMA and 142.5.  Why wouldn't we bail completely?  Because if GS weakens we would add TNA short hedge.

      GS important stock for the market -- keep these levels on your screen going forward this week.

The strategy of adding a hedge is an excellent tool for keeping you in a trade that you like, but that is causing you short-term pain.  For example we came into today long GS, seeing the weakness on good breadth we daytraded short QLD TNA in order to stay long GS and follow our plan.  We covered the shorts but left the long GS position intact.  If we go through 113.2 tomorrow we will do the same -- but probably with enough size this time to make us net short.   Why?  Simple -- the more times support is tested, the weaker it becomes as the buying pressure wanes with each test.

If you love a plan and don't want to be head-faked out then do short-term hedges around your position in order to stay in the trade.   

Market Talk

Updated chart. Copper stalled at resistance, looking for pullback to at least first trend-line (yellow).   We'd only be buyers of a pull-back to the trend-line at this point and would not engage in any potential breakout trades.

On Friday we wrote "Note the change in the angle of descent -- usually a sign that a short-term bottom is near."  Watch for this to unfold this week and to repeat what we said on Friday, if you're heavy long in commodities, not a bad idea to take some off the table.

If we do get a bounce in the USD then of course it will be a good test of our favorite commodities.  As we noted in our newsletter this weekend there are a lot of names in the sector that are setting up but many are extended -- any pullback and base here would make them much stronger.

We haven't had a sell-off across all sectors for a while -- the pattern has been one of rotation.   We'll see if today will be any different and whether any money rotates back into tech.  We will also be watching less dollar sensitive sectors such as financials (we're long GS swing which we would take off in any strong breadth selloff).   The bulls aren't going to feel any fear until we get a broad sell-off across the board with no rotation.

The following two charts exemplify the rotation that we saw coming in September.

The Nasdaq hasn't done anything in 10 trading sessions.   Will money rotate back into it now as the USD finds its footing?   Our guess is no -- tech is dead in the water until at least earnings season.

Meanwhile look at the move in the drillers in the last 10 trading sessions.   Text book rotation. 


We have no interest in tech names at these levels as we still find them much too extended for good risk-reward.   However if there is a sell-off in tech we would be looking at some support spots in the near future, for a trade.

We plan to go in more defensive mode this week and wait for earnings season to make any aggressive longer-term bets.