Tharp's Thoughts Weekly Newsletter (View On-Line)
Market Extremes: Common Themes and Characteristics by D.R. Barton, Jr.
Trading Tip Your Trading Day; Activities to Help You Profit by R.J. Hixson
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The Fundamentals of Trading Success
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Market Extremes: Common Themes and Characteristics
"Markets can remain irrational a lot longer than you and I can remain solvent."
“I should have drunk more champagne.”
-- Both Attributed to John Maynard Keynes
The basketball had just been passed to me on the left wing. The game was tied late in the fourth quarter. It was my senior year at Radford High School and we were playing our arch rival, Blacksburg High School, the team that had ruined our perfect season at the junior varsity level just two short seasons ago.
Guarding me was an all-state football player, which meant that he was a superb athlete with great instincts in any sport. At this particular moment, we were running a set play. My role, once the ball got to me, was to make a decision: shoot if I am open (I was not) or pass to a player cutting toward me from the other side of the lane.
This was our standard set and the guy guarding me had already seen us run this play a half dozen times. In fact, he had almost intercepted my pass the last time we ran it; he was beginning to recognize the pattern of the play.
What happened next was the stuff of legend, a story I will tell my grandkids some day (or at least one I will share with the readers of Van’s newsletter…). I broke the pattern. I faked the pass that I had already made many times that night. Then, with a quick crossover dribble to my left, I zipped past a clearly superior athlete for an easy lay-up.
Pattern recognition had given my opponent an edge earlier in the game. Breaking the pattern turned the table back in my favor for this one play.
The markets play out this same “game” over and over again. The market follows a set pattern with great regularity, one that can be exploited if recognized early enough. And just when market participants get most comfortable, the pattern is broken. Let’s look at how to take advantage of both situations.
A Key Characteristic of Blow-Off Tops
When markets hit extremes, they usually do so for simple reasons. Buyers become overly enthusiastic and price an asset above a sustainable level. There are stages along the way in this process that go something like this:
- Recognition of initial price strength brings in aggressive institutional players.
- More conservative institutions then decide that they can’t miss the move and join in.
- Then retail players jump in “en masse” along with the last of institutions who are forced to have the “hot” asset in their portfolio.
- Finally, the end stage of the buying frenzy is powered by both greed and fear—players adding to profitable positions and the last new comers afraid of missing out on the move.
This pattern of staged entry for groups of buyers gives us reproducible signs of a blow-off top. My favorite indicator of this process is the accelerating rate of rise that we see in this chart that published in this newsletter just days before the 2008 peak in crude oil.
The blue lines under the price bars show a “progressively steeper ascent.” (My technical analysis friends will note that these blue lines are not “true” trend lines since only one of the four offers three points of resistance along its slope.) These lines show the acceleration of the price rise and can be an indicator of buyers coming into the market in clumps.
Two months ago, cotton hit all-time highs and was truly a runaway train! I don’t think I’ve ever been able to draw in five lines of steeper ascent. Price dropped more than 25% in the two weeks that followed and has since climbed to even higher highs.
And now for the kicker: the current equity market is looking like those other blow-off markets. Here’s a couple of charts showing the S&P 500. First, a longer view back to the March 2009 lows.
This gives us a perspective for the longer term trend and we’ve started to accelerate off of the lows set at the end of last August. Let’s take a closer look at this more recent time frame.
The markets really can’t sustain this type of upward movement for long. BUT, we must remember the quote attributed to Keynes—the market can remain “irrational” for a long time. And this is especially true when the massive governmental intervention is still working through the system.
The bottom line comes from our basketball analogy above. Patterns like the acceleration of price slope lines are very good indicators as to what the market is likely to do, and following them can help us locate pullbacks. As I learned in the basketball game, it’s the occasional break of the pattern that can lead to big payoffs.
So how can we play both sides of the trade? Here’s a useful general procedure:
- The higher probability play is to follow the pattern. In this case, play a short after a breakdown below the first or second slope acceleration line from above (depending on how aggressive you’d like to be).
- Then this becomes an “if not A, then B” trade. If it goes your way, fine. If not, you would reverse your position and go long on the breakout to new highs.
This type of strategy can help you play these market reversal points and take advantage of the predominate move (reversion to the mean) while giving you a chance to catch the directional move if the trend continues.
I’d love to hear your thoughts and feedback on this article or about trading and investing in general at drbarton “at” iitm.com. Until next week…
Winter 2011 Workshop Schedule
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Peak Performance 203
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Your Trading Day;
Activities to Help You Profit
We've heard from many of you recently who want to get more specific information about what goes on in Ken Long's live Discretionary Workshop. As an attendee of the first live trading session last September I want to share my observations about the workshop and share the outcome of trading results from the sessions.
Typically at workshops, the instructor presents trading systems in a lecture as he explains and answers questions about the systems being presented. Ken teaches in this style at the Global Systems and the Mechanical Swing/Day Workshops because it is efficient and effective. At the Discretionary Workshop, however, Ken doesn’t simply stand in front of the room and talk about his trades. Rather, he creates a very hands-on and collaborative learning laboratory where individuals work together to teach themselves and the whole group the intraday trading lessons and insights.
It struck me while preparing this article that many items on Ken's list of specific daily trading prep and execution activities from the Discretionary Workshop would be beneficial to anyone trading intraday or swing timeframes—not just those who were interested in his workshop. See what you think.
Each morning at the workshop in September, 17 traders reviewed the prior day’s preparation and considered trading scenarios for the day. Prior to the market open, the entire group analyzed the recent market direction and volatility. We looked at market gap activity and the follow through patterns after those gaps. We considered each possible gap/follow through scenario and how we might trade each of the given the possibilities.
The group then looked at recent sector action and how those sectors might move dependent on what the market did. For example, if the market was up for the day and commodities continued their strength, there might be opportunities in commodity-based ETFs, material-based stocks and agricultural-based stocks.
As part of their trading plan, each person wrote a list of trade candidates based on their individual assessments. All of the people in the room split off individually or into groups of two or three prior to the market open.
As the market opened, the group watched while both Ken and individuals provided their opinions. As the morning progressed, teams or individuals entered trades; they called out the particular stock or ETF, the entry price, and the stop price. They also called out when they exited each trade. Ken kept track of every trade during the day. It amazed me that in spite of the group consensus about the overall market and areas of opportunity, there was great diversity among the groups.
At various points during the trading day, Ken provided his commentary on what he was seeing in the market. He made some trades and provided his reasoning. At other points, individuals or teams would discuss with the entire room their trade logic or what they were seeing. Like trading, the day seemed to fly at points and drag at others. Well, it wasn’t like trading, it was trading.
After the market closed each day, every group explained all of their trades—including the results and the lessons learned—to the rest of the class. Personally, I found the end-of-day debrief as one of the two most valuable parts of the course. The environment was supportive and highly constructive. There were lots of lessons for everyone as we taught each other. Before we left each evening, we prepped the trading plan for the next day (the other most valuable part of the course, for me). Seeing how Ken prepares for the trading day and learning how to make my own plan with a different format has been invaluable for my day trading.
Ken put together the following detailed list of 20 activities that the group and individual traders accomplished each day. Some of these are Discretionary workshop specific but I believe most of these activities are applicable to any trading routine. In the text in italics, I have added in the value I believe you would get from taking these actions.
Activities and Benefits
- Reviewed the 10-page daily trading plan reports.
You learn to find the meaningful information for intraday trading from Ken's reports and how to use that.
- Prepared multiple trading scenarios and appropriate strategies for large and small gaps in both market directions.
You are ready for the trading day with a number of trade ideas, regardless of what the market does.
- Examined key price levels using support, resistance, and pivot points.
You identify key points where the market has a higher probability of bouncing or surging through.
- Framed trades in multiple time periods and with multiple patterns.
You select only potentially profitable trades and discard trade ideas that did not show sufficient reward-to-risk.
- Filtered opportunities to apply "turbo" techniques to engineer intraday trades from mechanical trade patterns.
You take advantage of already identified opportunities on a shorter term basis.
- Stalked different intraday patterns and execution of swing trade entries.
You exercise patience as you wait for the trade setups to develop.
- Examined opportunities—informed by risk management—that offered pyramid position sizing strategies both for scaling in and scaling out.
You see what kind of intraday trades make good candidates for scaling position sizing strategies to dramatically improve your results.
- Applied appropriate intraday position sizing strategies.
You learn how to manage your money for multiple intraday trades. Ken’s approach has been honed over the years. It makes intuitive sense and Ken has proven it to work well.
- Analyzed the market in 30-minute segments as the trading day developed.
You can find some recurring patterns in market behavior relating to the time of day.
- Developed continuation trades.
You identify certain intraday trades that show strength enough to carry overnight.
- Applied gap statistics to properly size day positions being carried overnight.
You understand that gaps present a significant risk and they require you to analyze the risk and resize the position to incorporate that risk.
- Debriefed and analyzed daily trades and opportunities.
You see how different ideas and trades translates into results.
- Developed trading "narratives" to guide evolving trade patterns.
You create the logic as to why some things are happening, which helps you make some sense of the market and sector moves.
- Applied statistical analysis of daily trade batches.
You analyze your trading results in a way that you can use when you get back home.
- Debriefed trading psychology of markets and trades taken.
You comprehend the intense effects that your emotions can have on your trading.
- Managed emotional states and energy levels during the trading day.
You also comprehend the cycles and changes in emotions and energy during the day, how to notice them, and how they affect your trading.
- Collaborated throughout each day for constant learning opportunities.
You are learning all day long—not just when Ken makes a trade.
- Learned how to use the Tortoise trading chatroom and mastermind for continued progress after the workshop.
You have access to a similar trading/learning environment as in the workshop after you return home.
- Heard multiple perspectives on the trading environment from seasoned, experienced traders.
You listen to and learn from everyone in the room rather than just the instructor.
- Encouraged each attendee to work with his/her own equipment, accounts and trading environment.
You use the same tools and accounts you use back home, which allows you to focus on learning.
Our Trading Results
Day 1: The group traded entirely long on a day when the market lost 1%. It opened with a gap down and had one strong up-move during the day.
|Day 1 Statistics
Day 2: The market presented a different profile on Day 2. The group controlled risk well, and remained open to multiple R winners on the right side (profit). The group carried over four swing trades on strong finishes, which if all closed out on Day 3 at the open (an unlikely probability), would have provided an additional +4R for the trades entered.
|Day 2 Statistics
These results were outstanding! Granted, we don’t know what kind of opportunities the market will throw at the group in February. We do know, however, that given Ken’s trading experience and ability to facilitate a very strong learning environment, attendees will be richly rewarded with valuable knowledge about a proven process of intraday discretionary trade planning and execution.
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