Phil Newton's Break out Strategy

Read More

BANDS AND BANDS AND CHANNELS

Trading bands and trading channel are related. Both chart patterns act as a restraint on price activity, confining it within defined boundaries. The channel defines trend behaviour. The band defines support and resistance behaviour and can be used to set price targets.

The trading channel is constructed with two trend sloping trend lines. These are parallel lines and as with any trend line, their value changes daily. The lines show changing sentiment about value. A trading channel shows the limits of this changing sentiment as price bounces from support and retreats from resistance.

The trading band is defined by support and resistance levels where the value remains constant. These are horizontal parallel lines. Price stops trending and develops a sideways movement. These patterns are more useful because they are used to project upside and downside targets. When price moves above the resistance level then the width of the trading and is used to set the potential upside target.

Both trading bands and trading channels are range-bound chart features. They provide short term trading opportunities as price moves between the support and resistance levels. However the range bound trend continuation of a trading channel is traded differently from the trading band with its potential for trade band breakout opportunities.

By Daryl Guppy

Read More

TREND LINE CONSTRUCTION

Look at the chart display. What is the trend for prices? Quite clearly they are going down. If we already have purchased this counter at $7.50, we should be worried. If we are potential buyers of this counter then the price move or break above $6.70 gives us a reason to buy the stock. The trend line gives us a way to decide which price action is significant, but only if it is accurately drawn.

We use a straight edge trend line to tell us which direction prices are moving and to give us a better way to judge the trend. If prices close under the up trend line then it suggests the stock price is falling. Ideally we would want to get out to this stock, selling it to collect our profits and to protect ourselves against loss. We get this exit signal when there is a close, or a series of closes, below the trend line.

In a downtrend, the line is placed along the price highs. A close above this line tells traders the trend may be about to change direction. This is used as an entry signal. Where we draw the trend line is important because it could cost us money.

When we think about buying a stock many traders try to buy a trend breakout. This is when a downtrend turns to an uptrend and prices ‘break out’ above the trend line. Traders try to buy the stock near the bottom just as the stock price starts to move up. They get a buy signal when the price closes above the downtrend line.

Up trend or down trend, the principles of drawing the trend line are the same. An accurate trend line uses the information available from a bar or candlestick chart. Good trend lines need to use the high or the low prices for accuracy. They are not easy to plot accurately to a line chart.

These are the construction rules:

1) The line is placed along the lows of the price bars or candlesticks in a rising trend. An up trend is defined by higher lows each day. This is the price element we want to track, so the line goes underneath. If prices fall below this line then the trend may change into a downtrend.

A falling trend is defined by the failure of prices to make new highs each day. We track this by placing the downtrend line along the highs as shown in the chart.

2) The trend line uses the extremes of the price bars or candle sticks. This is the high or the low price. These extremes are important because a close beyond the extreme tells traders the trend might be changing. This is an entry, or an exit, signal.

3)The trend line starts at the very extreme high, or low. This is called a pivot point.

4) The trend line should touch the maximum number of possible price bar or candlestick extremities. This means we do not exclude too many, nor do we go for the maximum number of hits. We want to use the trend line as a trading signal, so we are interested in closes beyond the extremes of the existing trend because these give the best trading signals

5) The more often a trend line is hit by price extremes, but not broken, the more powerful the trend line signal. A trend line that has been hit 5 times, but not broken, is very strong. So when prices do close beyond the trend line it is a very strong signal that the trend is changing.

On the chart trend line 1 is a correctly drawn trend line. It touches the optimum number of price extremes. Trend line 2 shows the general direction of prices. Trend line 2 does not give any useful trading signals and prices move above and below this line all the time. Trend line 1 shows us when the downtrend has finished. The close above t trend line 1 clearly signals the beginning of a new up trend and provides an entry signal.

Straight edge trend lines are a very powerful trading signals, but they must be placed correctly. They are used to show the short term trend - perhaps days or weeks - the intermediate term trend - perhaps weeks or months - and the long term trend - perhaps months or even years. Long term trends are best seen on a weekly bar or candlestick chart.

Not all trends are easily defined with a straight edge trend line.

By Daryl Guppy

Read More

THE RELATIVE STRENGTH INDICATOR AND DIVERGENCE

Technical indicators are constructed by manipulating some aspect of price such as a moving average of prices over a 10 day period. The Relative Strength Indicator (RSI) tries to anticipate a change in the trend. This is a leading indicator of a trend change. The results are used to deliver messages about the strength of the market. It is called an oscillator because the indicator readings are converted into percentage results which range from 0% to 100%. The position of each day’s indicator reading gives the trader an indication of the strength, or weakness, of the existing price trend.
The RSI is calculated by monitoring changes in the closing prices of the stock. The number of higher closes is compared to the number of lower closes for the selected period. The RSI compares the internal strength of a stock by looking at the average of the upwards price changes and comparing it with the average of the downward price changes. The results are expressed as a percentage, providing the upper and lower boundaries. The plotted results oscillate between these two levels and give traders information about the speed and acceleration of the changes. Traders use either a 14, 9, or 7 day period in the Relative Strength Calculation.
In this sense the RSI is very similar to a stochastic and uses similar principles. Where the stochastic quantifies the ability of the market to close near the high or the low of the day, the RSI quantifies the strength of the way the market moves higher, or lower. The over-bought and over-sold signals are the same as any oscillator, although with an RSI they are traditionally set at 70% and 30%.
The most significant trading signal delivered by any oscillator style indicator is a divergence signal. This sounds complicated but it just means that the significant valley patterns shown by the RSI trend in the opposite direction to the significant valley patterns as shown by the price line chart. A valley is created by two distinct lows that each precede a rally from a downtrend. This builds a valley in the price chart. The lows of these valleys are joined with a short trend line as shown.
The corresponding lows on the RSI indicator are also joined by a short trend line. When the RSI line slopes differently from the price chart line, a divergence occurs. When these valleys form below the 30% area on the RSI, or form peaks above the 70% level, they are most reliable. Oscillator activity between these levels is not used to find divergence signals. Divergence signals give the trader an advantage by confirming an entry into a downtrend as it weakens and just before it turns into an up trend. It is also used to get out of an up trend as it weakens, and before it collapses into a downtrend. The divergence signal does not occur every time a trend changes, but when it does, it delivers a strong confirmation signal that a trend break is likely.
RSI divergence signals often appear in advance of a trend change, but they are not very good at suggesting the time of a trend change. The divergence signal may appear just as the trend changes, as in the chart extract, or several weeks before. Traders use the RSI divergence as an early warning signal to enable them to prepare for a trend change.
When the RSI and price chart lines move in the same way we get a confirming signal that the existing price trend is unlikely to change. These signals are not very important because we can get the same information from just looking at the chart.
The RSI is one of the very few oscillator style indicators where trend lines and support and resistance lines can be effectively used. These are used as signals to confirm the trend shown on the price chart. When other chart patterns suggest action, then the RSI trend line might also confirm this. When the RSI is used like this it does not give the trader any distinct advantage.

-By Daryl Guppy

Read More

Gap Trading Tips

1. Know the zone! Where the gap opens relative to prior day support and resistance (e.g. Open, High, Low, Close) will greatly influence its probabilities of filling, as well as the optimal placement of your stop and target.
2. It’s a three legged stool. To maximize profits focus on gap selection, stop placement, and target optimization. It takes all three.
3. Don’t try to kiss all the pretty girls (or guys)! With gap trading, it pays to be selective. So, when in doubt, sit it out.
4. The return may not be worth the risk. Just because a gap is small and has a high probability of filling does not mean that it is worth trading. Profit expectancy, not probability of winning, is the key.
5. ‘Tis the season! Understanding the historical calendar tendencies of your market can help affirm a winning setup, as well as help you avoid losers.
6. The worse it looks, the better it works. And vice versa (most of the time). Don’t let pre-market action overly influence your decision to fade a gap or not.
7. The news is noise. Don’t worry about the financial or economic news that caused the gap. It will only add unnecessary confusion and second-guessing.
8. Low hanging fruit is the sweetest. Entering at the market open catches all the easy winners. Waiting to enter after the open misses the easiest winners and catches all of the losers.
9. Like money sitting on a table... Many gap setups are prone to continuing through the prior close after filling. Know the personality of your gap setup and when to hold through the gap fill for an extended target, or when to close before the gap fills.
10. Size matters. Trade the position size that does not overly stress you, financially or emotionally, even if you have three or four losers in a row.
11. Watch out for the BLUDs. Fading gaps Below the Low of a (prior) Up Day is only profitable about 50% of the time historically.
12. The three amigos. Don’t forget about the other two gap plays: “Forget the Fade” (i.e. go-with) and “Fade the Fill.” They can add winning setups to your trading tool box.
13. Focus on the horizon. Let the long term probabilities work to your advantage and don’t try to guess which trade will work or not. Have a plan, follow your rules, and accept that losers are the cost of doing business.

via - http://www.thegapguy.com

Read More

9 Rules for Trading Divergences

There are nine cool rules for trading divergences. Learn 'em, apply 'em, and make money. Ignore them and go broke.

1.

In order for divergence to exist, price must have either formed one of the following:

Higher high than the previous high
Lower low than the previous low
Double top
Double bottom

Don't even bother looking at an indicator unless ONE of these four price scenarios have occurred. If not, you ain't trading divergence, buddy. You just imagining things. Immediately go see your optometrist and get some new glasses.

2.

Okay now that you got some action (recent price action that is), look at it. Remember, you'll only see one of four things: a higher high, a flat high, a lower low, or a flat low. Now draw a line backward from that high or low to the previous high or low. It HAS to be on successive major tops/bottom. If you see any little bumps or dips between the two major highs/lows, do what you do when your significant other shouts at you - ignore it.

3.

Once you see two swing highs are established, you connect the TOPS. If two lows are made, you connect the BOTTOMS. Don't make the mistake of trying to draw a line at the bottom when you see two higher highs. It sounds dumb but peeps regularly get confused.

4.

So you've connected either two tops or two bottoms with a trendline. Now look at your preferred indicator and compare it to price action. Whichever indicator you use, remember you are comparing its TOPS or BOTTOMS. Some indicators such as MACD or Stochastic have multiple lines all up on each other like teenagers with raging hormones. Don't worry about what these kids are doing.

5.

If you drew line connecting two highs on price, you MUST draw a line connecting the two highs on the indicator as well. Ditto for lows also. If you drew a line connecting two lows on price, you MUST draw a line connecting two lows on the indicator. They have to match!

6.

The highs or lows you identify on the indicator MUST be the ones that line up VERTICALLY with the price highs or lows.

7.

Divergence only exists if the SLOPE of the line connecting the indicator tops/bottoms DIFFERS from the SLOPE of the line connection price tops/bottoms. The slope must either be: Ascending (rising) Descending (falling) Flat (flat)

8.

If you spot divergence but price has already reversed and moved in one direction for some time, the divergence should be considered played out. You missed the boat this time. All you can do now is wait for another swing high/low to form and start your divergence search over.

9.

Divergences on longer time frames are more accurate. You get less false signals. You will also get less trades but your profit potential is huge. Divergences on shorter time frames will occur more frequently but are less reliable. I personally only look for divergences on 1-hour charts or longer. Other traders use 15-minute charts or even faster. On those time frames, there's just too much noise for my taste so I just stay away.

Read More

MOVING AVERAGES: TRADING PATTERNS

Running Cup and Handle

The cup-and-handle (1) is typically a major reversal pattern that often precedes large rallies. It is formed when a stock sells off, bottoms, and then begins to rally, creating a "cup." After the rally, the stock drifts lower, forming the "handle" of the pattern. According to William O'Neil, who popularized the pattern, the best cup-and-handle candidates are stocks that already have staged a strong rally.

One way to measure the “strong rally” would be to use the 50-day moving average. As long as a stock remains above the 50-day moving average, it can be considered to be in an intermediate-term uptrend. Therefore, cup-and-handles that formed at or above the 50-day moving average are dubbed “running” as the market continues to “run” while the pattern is formed. The theory is that it combines a bottoming/correction formation with trend -- the best of both worlds.

Chart 1: Running Cup and Handle. Notice the cup forms at and above the 50-day moving average. Source: The Tradehard Guide to Conquering the Markets.

Expansion Pivots

As mentioned above and in previous articles, the 50-day simple moving average provides a point of reference for many institutions and large traders. Jeff Cooper has observed that “a stock will trade around its 50-day moving average for a period of time, and then without warning explode either to the upside or downside. This explosion often follows through for at least a few days…”(2). His strategy looks for a wide-range day that occurs in a stock that is trading at its 50-day moving average and then seeks to enter a position in the direction of that expansion.

Chart 2: Expansion Pivots. This set-up looks to enter on follow-through after wide-range movements at the 50-day moving average.

Holy Grail

In Street Smarts, Connors and Raschke showed that strongly-trending markets often retrace to the moving average before re-asserting themselves. If you think about it, this makes sense as markets often thrust/correct and then thrust again -- similar to the pullback pattern. Essentially the set-up looks for a strongly-trending market as measured by high ADX followed by a retracement to the 20-period exponential moving average. They jokingly dubbed this pattern the “Holy Grail”.

Chart 3: The Holy Grail. The pattern seeks to capitalize on a resumption of a strong trend as measured by a high ADX reading after retracements to the moving average.

Daylight Breakouts

Often, markets will trade around the moving average. They will have a slight rally (or selloff) and then return to the moving average. This is known as reversion to the mean (average) and has been discussed in previous articles. On occasion, the market will break free and begin to trend away from the moving average. While looking for a long-term trend-following system for the commodities markets, I notice that these trends or breakouts from the moving averages are often preceded by a period of at least two days, where the lows (for uptrends) or highs (for downtrends) fail to touch the moving average. This “gap” above and below the moving average was dubbed “daylight” by a fellow trader as you could see “daylight” in-between the price bar and the moving average. The original system, The 2/20-Day EMA Breakout System(3), used a 20-day exponential moving average and is described below in figure 1. Once the entry qualifications were met, a buy entry was placed above the two-bar high. Short sales are reversed. Setups for the pattern are shown in Chart 6, February 2000 Gold Comex.

Figure 1: The 2/20 EMA set-up. Source: Technical Analysis of Stocks and Commodities, December 1996 Issue.

Chart 4: February Comex Gold. Notice the 2/20 EMA Breakouts (or “Daylight” Breakouts) requires the market to trade above the two-bar high of the set-up for longs and below the two-bar low for shorts. If the market fails to pass these points then there is no trade.

Like most trend-following systems, Daylight Breakouts are prone to large drawdowns (losses to equity) when traded on a purely mechanical basis as markets only trend about 30% of the time. However, when used on a discretionary basis, combined with money management and/or additional technical indicators (i.e. a strong underlying trend) it can be a useful tool. Also, you might consider varying the lengths (and types) of moving averages used depending on your trading style. For instance, short-term traders may consider using a 10-period moving average whereas longer term traders may consider a 50-period moving average or longer.

Conclusion and Series Summary

In the first part of the series we defined the different types of moving averages. These included the simple, weighted and exponential moving averages. These different types of averages essentially behaved the same except in strong trends and breakouts when the weighted and exponential moving averages tended to “catch up” faster to current prices. In Part II, we looked at the characteristics of moving averages such as reversion-to-the-mean and the drop-off effect. We also looked at general uses which included support/resistance or reference points and using the slope of the moving average to measure trend. Finally, we showed more specific set-ups which seek to capitalize on these features.

So which moving average or set-up is best? It all boils down to personal preference and trading style. I encourage you to study the different types of moving averages and the above set-ups. Modify them to your liking or create your own methods.

By David Landry

Read More

200-Day Moving Average

STOCKS ABOVE THEIR 200-DAY MOVING AVERAGE

In today's article I will discuss another key item that I use to gain a comprehensive picture of the state of the overall market--the percentage of stocks now trading above their own 200-day moving average. (To avoid repeating this long phrase, I'll just refer to this indicator as "% above 200.")

The concept here is simple. The 200-day moving average is perceived to be the dividing line between a stock that is technically healthy and one that is not. (To review how to calculate a moving average, please visit this link.) Some traders use the simple moving average for this measure. Meanwhile, others employ exponential moving averages, which give more weight to recent data. A stock that is trading above its 200-day moving average is said to be in an uptrend and is being accumulated; one below it is in a downtrend and is being distributed.

On the surface, it seems as though the higher the "% above 200" goes, the more bullish the market is (and the lower it goes, the more bearish). In practice, however, the reverse is true. Extremely high readings are a warning the market may soon reverse to the downside. High readings reveal that traders are far too optimistic. When this occurs, fresh new buyers are often few and far between. Meanwhile, very low readings signify the reverse; the bears are in the ascendancy and a bottom is near.

So, now that we understand the significance of very high or low readings on this indicator, we need to determine exactly what levels represent high and low readings. To interpret this indicator, four parameters are key: 20 and 40 on the low side and 70 and 90 on the high side. Throughout the last 20 years, readings around 20 have consistently marked key reversal areas. As the chart below shows, the 20 level marked Wall Street's bottom in October 2001, late July 2002 and October 2002. (I've circled each of these reversal areas below). With this in mind, when the % above 200 nears the 20% level, swing traders should be on the alert for a sharp, V-shaped reversal.

When the percentage of stocks above their 200-day moving average hits 20%, the subsequent rally is often capped at the 40% level. This level provided resistance in August 2002 and January 2003 and correlated with bear market rally peaks. When the official bull market began in March 2003, the number of stocks above the 200-day moving average decisively broke out above the 40 level. From there, it trended higher for the remainder of the bull market, ultimately reaching a peak just above 90.

On the flip side, swing traders should be very cautious when the number of stocks above their 200-day moving average goes above 85%. Historically, readings in this area have precipitated either a major correction or a bear market. The reading above 90%, which lasted through February and the early part of March 2004, was the most extreme reading I could find going back seventeen years to 1987! When it reversed in early April of 2004, it led to the official bear market signal.

When a reading peaks above 85%, 70% becomes an important support level. A break of 70% after the percentage figure has hit the high-80s or low-90s is a warning that, at the very least, an important correction is unfolding.

Swing traders can also examine the % above 200 using trendline analysis. The most effective way to do this is to draw trendlines on both the underlying NYSE (New York Stock Exchange) chart and the % above 200 chart. A break in the % above 200 trendline will provide you with confirmation of the message given off by the underlying price chart.

What is the indicator currently saying? Recently, we've seen a massive deterioration in the stocks trading above their own 200-day moving average. In early April 2004, the % above 200 indicator broke its up trendline. At that time, the number of stocks above their own 200-day moving average sat at historically high levels just below 90%. However, it has since fallen to 44%! That is an extremely rapid drop. So far the decline in price as measured by the NYSE has been relatively limited. It seems likely that price will need to catch up with the % above 200 indicator.

At 44%, the decline in the % above 200 indicator does not appear complete. Remember, it normally takes a reading near 20% before the market is oversold enough to turn around. That kind of bottom seems at least a couple of months away. Historically, the 40% level has seldom provided a platform from which the market has managed to mount a reversal.

In judging which way the overall market will move next, swing traders have a variety of tools at their disposal. Among them are price charts and indicators such as RSI and stochastics, both of which are based on price. In addition, over the past several months I've introduced you to a host of other measures that you can use to interpret the overall market. In the next installment of this "Inside The Black Box" series I'll connect the dots and will weave together these overall market indicators into a cohesive picture.

Good trading!

Dr. Melvin Pasternak
Editor
The StreetAuthority Swing Trader

Read More

How to find breakout stocks

There are many ways to find breakout stocks. My method consists of two discrete scans, which each must pass before I buy a stock. Many investors depend on technical analysis alone, while others depend on fundamental analysis. I depend on both. The two parts of my method scan for technical and fundamental soundness.

1) Technical scanner
This is the first scanner to run. The scan consists of finding all stocks that are breaking out to new 52-week highs on very high volume. The technical scanner is necessary because I only want to invest in stocks that are taking off. I don't want to waste my time with sleepers.

2) Fundamental scanner
The fundamental scanner is key. You don't want to just jump into any stock that is breaking out, following the momentum trade of the day. If you did this you would find yourself constantly 'behind the 8-ball'. The fundamental scanner checks many fundamental aspects of the companies behind the stocks that passed the technical scan. Things like Sales, margins, return on equity, earnings growth, institutional ownership, etc. This is absolutely necessary. In order for large funds to get excited about a stock, there often needs to be great fundamental growth behind the company.

If a stock passes both scanners then I simply buy it.

Taken together, this is how you find breakout stocks that are going to make you a lot of money. Of course, managing a trade once you have invested is another story all together.

via - stockchat.com

Read More

James16 price action patterns

James16 price action patterns

Read More