Jan

Investing Systems Research Lab Blog for Week of January 9th, 2012

Finally we are back to a regular schedule with the first full week of trading for 2012, and the market gearing up for Earnings Season.

We actually got the Santa Claus/Year-end/New Year rally, with the S&P 500 adding about 75 points since the close on Dec. 19th. That’s a pretty big move in 12 trading days.

Those of you that have been with us for a while can never accuse us of being ‘complacent”. When it comes to the overall market, I never really trust it.

While most of the talking-heads in the traditional financial media seem to be optimistic, I am getting a little wary up here in the “resistance zone”

Last week started off with a big gap-up into the green area on the chart below, then essentially traded sideways. Last week we had several days that started off with a big drop, then mid-day recovery.

Here’s a look at the 60-minute chart of the S&P.

The chart above shows about a month of trading and you see that the last time the S&P was in this area was all the way back in late October. You can see what happened subsequently…

Last week the market had the “seasonals” on it’s side as well as typical New Year positioning. Technically speaking the S&P is above the 20-day, 50-day and 200-day moving averages and this is very positive, however I think it might be due for a little pullback.

I could be wrong and this recent strength might carry into this week, but as I mentioned last week, it needs to break out of the top of the green area and move above 1300 to prove it wants higher. But then, looming right overhead is the “big kahuna”. The downward sloping trendine drawn from the highs of 2011.

Here’s a daily chart with a green arrow pointing to this trendline.

I think it’s unlikely that the market will attack that trendline this week. I’m looking for some sideways consolidation, perhaps a small “cycle-down” first.

We’ve been watching different triangles here for a few months, but this one is the biggie. The market needs to break above that major trendline before I’m convinced it can make a significant move up. The funny thing is that by next week, the trendline and the top of the “resistance zone” will likely be converging, just in time for earnings season to really gear up.

As long as the price stays above the upward-sloping trendline that forms the bottom of the rising channel, the market is in a primary uptrend. If for some reason it breaks it to the downside, down the road…things could get ugly.

I expect these two trendlines to contain the price action this week, then it should get really interesting…

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Two weeks ago we reviewed the Trade Plan in MNTA, which worked exactly as planned.

This week I wanted to review the trade in ABMD, which didn’t work out the way we intended. It’s actually a great example of some pitfalls that are very common when swingtrading, especially when trades are planned in advance and “set in stone”.

When we originally created the Trade Plans software, we had some logic that said a trade can “only get filled on a move up – a green candle”. However in real life trading, this wasn’t really feasible, especially setting up the trade in advance, programming it into the broker before the market open. So we decided that “a fill is a fill”, though we still would prefer to get filled on the way up since most trades look for a break-out of a range or trendline.

It really cuts both ways…sometimes a stock will gap over the entry and pull back just enough to fill the order before reversing and moving up in the intended direction. Sometimes it continues to fall, as in this example.

Since the market gapped up big to start the week, several of the trades we had on deck gapped so far out of range they would have been deleted right at the open.

Here’s a look at the “ugly fill” on a 60-minute chart.

You can see prior to the entry the stock had a nice trendline break and the 17 was coming up to meet the 43. The stock had been trading in a sideways range and was poised to move up and break above the green horizontal entry line.

Instead, it gapped over the entry, then began selling off with the overall market and fell right back into the sideways area. It drifted around for a couple days then finally hit the stop.

The larger view on the 60-minute chart below shows a better picture of what the setup looked like and shows the big move up the last time it was in a similar pattern.

In late November it had a similar trendline break, traded sideways briefly then made a huge move up. This time the same pattern was setting up and the sideways consolidation went even longer, which we took as a sign the pattern had a good chance of repeating.

The stop-loss was at 17.85, just below the upward sloping trendline across the lows.

So this one didn’t work as planned however I think it’s instructive, mainly due to the fact that it would never have filled had it not been for the big gap-up in the overall market to start the week. The open was an “outlier” and not really a valid breakout up through the horizontal resistance.

Let’s look at one more chart of ABMD to get an even larger picture. This 60-minute chart shows the stock was in an overall uptrend, had a decent pullback and looked ready to “cup back up”. It also demonstrates how “in the big scheme of things” the small zone between the entry and stop was relatively tight.

ABMD had an average daily range of 3.5% over the previous 20 days, so a 5% stop was very reasonable. Heck, it might turn out to have been too conservative.

Nevertheless, this is a good example and lesson that you will always have stop outs when trading stocks. It comes with the territory…

Based on the current chart and the fact that the stock didn’t cycle back up, it almost looks like a potential short now, if it breaks below the November low.

Ok, so now that we are familiar with the pitfalls of entering trades on red candles, let’s move on…

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Normally here I would talk about how gold and silver are the only real money. Or perhaps discuss the latest macro issues that we have to worry about. Or even mention how “Every morning that I wake up and the Global financial systems hasn’t collapsed, is a good day”. Perhaps mention some tidbit about seasonality or correlation between assets.

Other times I will talk about a trading strategy or a trick I use to make money trading stocks. Sometimes I show some stocks or sectors I’m watching or any changes in the overall market environment.

Then of course I generally bring some good trade setups to watch …

But this week I wanted to do it a little different by showing you the setups staged in the back-end of the Trade Plans software in the Research Lab.

As the system identifies potential trades, it sets stops based on a “logical” area on the chart. Many times the stop is a bit wide for the targets we use, so the trade does not necessarily pass through to the “Waiting Trades” page.

These setups require that you actually open a daily chart of the stock, looking at about 6-months to a year of data. The potential trade plans are a very “zoomed-in view” of the recent price action and don’t typically show the big picture.

Here’s an example of one that was staged last week but did not get activated – it didn’t pass all the filters, even though it worked well. We talked about this one Friday on the show.

Here are some that have been identified for this week. Be sure to pull up a longer-term chart…

Keep in mind that these are “preliminary” staged, and potential setups at this point.

As you know, we won’t“ stage” 6 Waiting Trade Plans on any given day. We try to keep them “actionable” so you don’t have to pick and choose.

Our system will likely identify another 6 before the market opens Monday, so we have to do additional analysis to try and identify the two or three that have the highest probability of hitting the Targets without taking too much risk.

It’s not uncommon for a stock to have a very volatile trading pattern and an average daily range that exceeds 3%. In these cases, a 5% stop will get hit a lot, simply due to the normal price fluctuation of the stock. You don’t typically set a 4% stop on a stock with an average daily range of 7.8%…

The Trade Plans system also sometimes finds setups that have potential to go a LOT higher than Target 3. This is another thing to consider on ones that seem to have wide stops.

Of course the overall market generally dictates which get filled and how they move subsequently. If the market begins a “cycle-down” next week, it will likely take most stocks down along with it. The correlation of most stocks to the overall market is very high right now, actually the highest in decades.

So there are a few ideas to watch. be sure to look at the bigger picture on the charts and see if any look good to you.

You might see a couple of these next week in the actual Trade Plans on the Waiting page, or we might find a few better ones as we continue to run the analysis.

I thought it would be fun to “change it up” this week and show some setups from the back-end rather than the normal setups I mark-up on the charts.

We will see you right before the market opens Monday morning in the Research Lab on the Live Broadcast page.

We can talk about these and other swing trades and we will take the stock picks from the Live Grid and see if we can find some good entries and trades…

Cheers!