176PART THREE Practical ExamplesEXAMPLE 8Finding Entries in a Strong TrendEarly in my career,

176 PART THREE Practical Examples E X A M P L E 8 Finding Entries in a Strong Trend Early in my career, I couldn’t tell you how many times I got angry at see-ing the market rising strongly, while I hadn’t made one trade or owned anything on the long side. It was truly frustrating. I see this in many traders whom I talk with. The question always seems to be: When the stock is rising, where should I get in? Let me go back several years and give you an answer that I was given by a self-proclaimed stock guru. If the stock is rising, just buy it and watch it go higher. You can guess how many times I bought the top. I’d need about the fingers and toes of 10 readers of this book to help me count, maybe even more. This is clearly not the right answer. We need a specific reason for entry. Many times, when stocks are trending all by themselves, against the better movement of a market indicator that is stuck, it’s often difficult to have confidence in such plays. And it’s difficult to identify areas for entry because we are not con-fident when the overall market is narrow. This stems from the idea that we play probabilities, and, over time, our probabilities tell us that trying to play this or that setup, hoping we get the one or two that do actually move, is usually a losing proposition. Let’s take two stocks that were moving on the same day, despite NDX inactivity: Inrange Technologies (INRG) and Manugistics Group (MANU). I will go over exactly what it is that pre-vents us from entry as well as where there are higher probability areas for entry should a trend continue. As you can see, in Figure EX8a we have an open range, indicated by two lines labeled 1 and 2, that fits well into our risk parameters for open-break plays. However, because of the previous day’s fades and a very nar-row day, we wanted to back off open plays. There were 4000 stocks that opened, but how many open-break plays did well? Not many, and with aggression levels relatively low on this particular morning, I wasn’t looking for things like INRG or MANU to occur. On INRG, we saw how the circle A signaled the entry for the long setup with a stop at the low end of the range. What we saw next is what I was alluding to earlier, the hardest part of the move. If we missed our entry near $7.65, we would be looking for another entry, but where? Anywhere, and hope the stock continued higher? Obviously not. You can see from the ascending line from about $8 to $8.90 that there is nothing in this whole move to justify an entry. Rather, we needed some type of PART THREE Practical Examples 177 F I G U R E E X 8 a Trading trend confirmation. (RealTick graphics are used with permission of Townsend Analytics, Ltd.) move, pause, or base, and then we would push higher. This is what we had in area C. This gave us more confidence for two reasons. First, if the base is shallow, then the selling pressure is not strong and/or someone is supporting this stock. Second, a break of the high after this base says that there are still enough willing buyers around to indicate that the long side is still the right side, a higher probability. In this case, we had two options. We could buy the low of the base or the break of the high assuming it was within our risk ratio parameters. Did I want to short it? Only if I saw that base broken or if I had seen a possible double-top scenario. This is why it’s not a good idea to short the first spikes on stocks, trying to nail the first top. Trending stocks like INRG or MANU can kill you if you try to fade the move. Rather, on uptrending issues, you need a base broken or a double-top type of movement to confirm that a short-side trade is a better probability. Do stocks come off the first tops? Sure, but 178 PART THREE Practical Examples the probabilities don’t support this over the longer term. You will end up finding yourself doing that “loss, loss, loss, profit” thing by trying to nail the first top each time. In the case of INRG, we had a base to work with. It was a bit wider than we’d like for a full lot, but we now had a reason to buy other than, “Buy it, it’s rising.” We had a low and a high. If we held the low and broke the high, we had structure built in. Now as we moved into the area marked D, things became “choppy.” We saw a spike over $9, a small retracement, a move into a new high, and then selling back under the area where the price spike occurred. No real support or resistance was clear in this box area. It was not a good base, as we had in range B. If we bought the break at $8.90, we’d have scaled out or taken a full lot to pro-tect profits, as shown in box D. Where INRG went from that point was much less of a probability, so it was better to lock in a profit. The main point on this is that rather than get frustrated because the stock goes without you, you need to understand that all stocks move; all stocks have potential. But not all stocks provide setups that are familiar to you or your system. This is the difference between a pro and an amateur. A pro can let a stock move from $20 to $30 without an entry because nothing is familiar. An amateur will see the move from $20 to $30 and wonder, “Why didn’t I buy it?” The MANU chart shows the same thing (See Fig. EX8b). We had the open-break play, which we didn’t play because of the low aggression level. Circle A shows the setup for this and the two lines on the bottom establish the range. As we moved up to $12.30 or so, we finally got a lit-tle pullback and a base. This is the range marked B. Traders could buy the low of that range as a cushion and look for a break of the high, or they could buy the breakout of that high base. The next movement from $12.30 to $13.20 offered incredible potential, but not a familiar setup. We had basically a vertical price movement with few characteristics of a base with which to enter. So, while the amateur sees MANU go from $12.30 to $13.20 and feels frustrated, the pro sits patiently, looking for another base to trade from. Being that the stock was still in an uptrend, we looked for a long setup. We saw a base from $13 to $13.20 and looked for a break of this range in order to be more confident in a long setup continuation. MANU just sat. Was this base building a certainty? No, it was a higher probabil-ity. Could we break down from this base? Sure, and those who were short-oriented could look for a break of the low of this base with a stop just over the high. But imagine being the one who tried to short it on the initial spikes discussed in INRG. You’d have stopped out at $12.50. Then again PART THREE Practical Examples 179 F I G U R E E X 8 b Trading trend confirmation. (RealTick graphics are used with permission of Townsend Analytics, Ltd.) at $12.70. Maybe again at $13. Finally, again, you are short at $13.20, and you see 20 cents in potential. So you go, stop, stop, maybe stop again, and finally you see poten-tial. Unless you have emotional control here, you will short the stock again, looking at a fourth stop on the same stock, hoping that the poten-tial will outweigh the last three spikes. Meanwhile the stock sits in this range, creating frustration that a potential 20 cents on the short won’t cover the stops you’ve already taken. Moving on a win/loss percentage that, in this case, could very well be 25 percent with your profit not com-ing near your loss. To me, this isn’t the best use of your trading capital and can certainly ruin your trading mindset. This again is the difference between trading at any level for whatever reason versus imposing struc-ture, ranges, and the like into your trading so as to identify similar setups that have higher probabilities to work over time. 180 PART THREE Practical Examples E X A M P L E 9 Open-Break Setup An open-break setup requires much confidence and fast, if not automatic, decision making. I don’t normally recommend such plays to inexperi-enced traders because they require skills that most newer traders don’t possess. First, let’s go over what exactly this setup is. 1. Risk must be defined by a range of 25 cents or less (at times you can stretch this to 30 cents depending on the action, but this is rare). 2. Watch for the range to be broken either on the high side or on the low side. 3. If the stock breaks high, go long with a stop at bottom of the range. 4. If the stock breaks low, look for a short with a stop at the high end of the range. 5. Look to partial out at a 2:1 or less reward/risk ratio. 6. Scalpers look for 1:1 reward/risk ratio. Peoplesoft (PSFT) shows a good example of the open-break setup (see Fig. EX9). You can see on this chart the support and resistance lev-els from the previous day into the close. Many times I use this kind of sit-uation to help me if the stock is staying within this range in the premarket activity for open candidates. PSFT was staying in the $30.40 to $30.60 range and looked stable on the sell side. From the previous day’s sell-off, we had a fairly slow and stable uptrend into the close, so I wanted to remain with this trend for the open play. This is why I chose the long-side bias, rather than the short side. As the day opened, our resistance at $30.60 held, and we lost $30.40, hitting $30.35 before the stock made its move. The prints below $30.40 were minimal, and, therefore, to me, selling wasn’t really that strong. In this trade, with a stop right under $30.35, the support level would be the entry. This kept me in the long-side bias, which is where I wanted to be, and it provided me with a reward/risk ratio of under 25 cents. If the action broke, I’d be looking to scale out somewhere in a 2:1 or lower reward area. In this case, I got a break, which was confirmation that an uptrend move at the open was higher. Those who wait for confirmation tend to get more confidence but worse prices. That’s the trade-off. Position yourself on the side of the break with higher probability before confirmation, and you get better prices and less confidence. Position your- ... - tailieumienphi.vn