The Trailer to One Good Trade

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SMB Morning Rundown – September 2, 2010

Today, the Market appears set to open slightly higher. The levels we are watching in the SPY are 109.50 (resistance), 108.00 (support).

Our best AM Idea for today, which we highlighted in our AM Meeting is to get long COST on a pullback to 57.85 with an upside target of 59.25.

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Traders Ask- How Do You Choose What Trades to Focus On?

Thanks for a great job on the blog. Also love Mike’s book.

I just left a prop firm where i could only scalp Eurostoxx 50 futures (like dax or S&P500 futures) to trade stocks in play for my own money, since there are almost no props here trading stocks.

I live in Stockholm (Sweden) and the Nordic equity markets are not yet that “algorized” which also makes me beleive I will have a bigger edge trading the equitys.

Im a tapereader so when I focus on a stock I usually get a idea of what it is doing, but the problem for me is where to place my focus since I suddenly have so many options.
I am trying to find 2-4 stocks in play, but I find it hard know where to place my focus since there might be other plays that I miss, on for example my B list.
How do you guys do it? do you only focus on for example one or two stocks and dont care about the rest?
You of course have the luxury of having more eyes on the screen, but I was hoping you have some recomendation for me since my focus is shattered between all the opportunity around me, making me miss the trades in front of me!!

Do you work with some mindset, rules or method around this problem?

Bella Responds

Great question. Terrific question identifying an area you need to improve. Love how you are working on your game here.

Develop a Trading Road-map before the open. Before the open visualize possible trading scenarios. Identify the set ups that make the most sense for you. Actually rehearse how you will trade the open.

Prepare you mind to be ready for the best set ups for you. What is the stock(s) that are best for you. What are the best prices? What are the best set ups? Visualize the plays you most want to be in with your top ideas. Consider your third, fourth and fifth stocks. Where would you really want to be in with them? What set up? Consider if my third stock is at this price under what conditions will you leave my primary stock.

Rehearse the open. This will help you focus on the best set ups and stocks for you.

Keep working on your game. We all have areas of weakness. There is always a solution. With practice and work comes improvement.

Mike Bellafiore
Author, One Good Trade: Inside the Highly Competitive World of Proprietary Trading

3 Pushes to end a trend: An important pattern illustrated in today’s market action

I tend to write from a more theoretical perspective in these blogs, but today’s market action provides a few interesting lessons.  By way of background, I have not been happy with my trading performance over the past few months.  I am just not achieving the level of consistency in my intraday trading that I know is possible.   In response to the frustration I have been feeling, I have scaled back both the size and scope of mytrading and am now focusing on the broad market by only trading a few hundred shares of SPY at a time.  (This is also a return to my days when I traded S&P futures exclusively.  In this post I will speak in S&P futures points, where each ES point = .10 in SPY.)  My focus over the past several weeks has been working to refine my practical application of the interaction of smaller and larger timeframe patterns, but always using the patterns to get to an understanding of the relative balance of power of the buyers vs the sellers.

(I started writing this to illustrate one simple pattern, but as I’m writing, this post spiraled a bit out of control.  I find myself mentioning quite a few other patterns that are also important, and I think this post actually became pretty good illustration of a pure technical version of Bella’s “What’s in your circle?”.  Technical trading is never as simple as “see this pattern then buy”, but it’s more about seeing evolving market structure to try to understand how the relative balance of buyers and sellers is playing out.  I ended up numbering all of the smaller patterns with numbers in parenthesis, just to highlight what I think are the important, relevant, and repeatable patterns.)

-The big gap up on the open is a welcome sight in late summer, because it sets up a high probability for a directional day(1).  Finally.  I know most true gaps (today’s open outside of yesterday’s range) tend to fail(2) and at least to fill a significant percentage of the range, if not all.  However, I also know that bigger picture the (cash S&P) market has tested support at 1,040 three times over the past two weeks, with good price rejection at the level, we put in what looks like a significant higher low on the hourlies, and there was some strange buying after the close.  In addition, I know what happened overnight with economic released from Asia, but more importantly I saw the price action in those broad equity indexes overseas.  My bias is strongly up for the day, but there’s too much potential for a 5-8 point flush on the open to ignore that possibility, so I have to trade what I see as the price action evolves.

-I actually shorted the new lows about 10 minutes into the day, but was very aware that a standard pattern is to drop the lows, trap some bears, and then go screaming to new highs(3) early in the day.  You have to take the short because there is too much good downside potential, but you have to realize it is probably a trap so it puts you in an interesting state of mind.  I also know potentially significant (in retrospect, that turns out to be a humorous understatement) reports at 10AM today so I will not be holding my full size into those reports, regardless.

-The short was short-lived.  Flipped long a point and a half above my entry a few minutes later as the market held the lows and took out some swing points to the upside(4).  Nice little ding to start the day, and of course the potential for being round-tripped now, but you have to do the right thing regardless of how you feel about it.  Sold enough of my longs into the rally to be very small in front of the number.

-Now we get the real fun:  A huge rally off the number… 10+ S&P points in a single 5 minute bar.  I know two things:  this is unsustainable behavior so it is probably some kind of buying climax(5), but anyone thinking short after what has just happened, is a complete idiot.  I will hold my small remaining long until I see clear reason to get out, and then will reestablish lower.  I also know that a giant climax after a gap up like this can easily leave us rangebound in a tight range for most of the rest of the day(6), but I know there’s a very good statistical edge for that range to resolve the upside(7), if not today then tomorrow morning.  I also know that, even though people like to think about measured moves, the probability of having a clean measured move off of a climax bar like this is rather small(8), so I will have to be happy with a smaller upside target.  I make a mental note to only short today if I see clear and sharp downside momentum (which never happened).

-Now we get the reason I originally started writing this blog.  A very common trend-ending pattern occurs when a market makes three symmetrical pushes (on any timeframe).  Depending on how extended the trend is, you may start thinking countertrend, but at least you must be very, very careful about holding with-trend positions through this pattern.  The pattern grows out of the standard ABC wave, which itself is a continuation off of a strong impulse move.  When you see the three pushes, it just means that the normal trend leg has reached its expected target.  This is a good warning to not press with-trend positions.  Schematically, the pattern looks like:

3 Pushes: A common trend-ending pattern

As I was holding my long position, I saw the S&P market make 3 symmetrical pushes to new highs(9), the last of which came at noon, which, as we know, is a common inflection point(10).  I was quick to get flat after the inside bar following the third push resolved to the downside(11).

3 Pushes ended the first trend swing up in the S&P today

3 Pushes to End a Trend is a form of buying climax.  I know that there is a chance that this is an actual end of trend which may be followed by a reversal(12), but I also know that I will have to see real weakness before even thinking short(12a?).  For now, the highest probability play is a substantial pullback to work off the overbought condition, and at least a retest of the highs later in the day(13).  I re-establish my long position at the 20 period EMA which simply provides a reference for a point of relative balance in an overextended market(14).  After a very sharp move, the first pullback to the moving average is always worth a shot. In addition, we see a “ragged bottom” which is a sign of classic Wyckoff-type accumulation(15).  Intuition tells you you would rather buy a clean test of support, but intuition is wrong in this case.  Every little test below support was immediately met by buying pressure.  We rallied a bit off that support, so the first pullback is another good spot to add to your position(16).

So now I’m feeling pretty good about myself, and am positioned fully long (ok… fully long and then some) as the market is pressing against new highs at 2PM.  Considering the structure of the day has been a very sharp up move, a long sideways consolidation with good accumulation, I know there is a very high probability of another leg up in the afternoon, and probably closing on the highs(17).  In addition, I see the market pressing against new highs at 2PM, which we know is the ideal time for a breakout(18).  I use this as justification to be overloaded on my long position (mistake #1).

I realize that the Russell is rallying harder than the S&P, which you can see on the chart below by noticing that the Russell is lifting farther off the EMA than the S&P on rallies(19).  If  there was any doubt about which was stronger, the Russell makes 3 attempts to take out the high of the day while the S&P is holding well under.  This is a form of divergence.  We want to see all indexes taking out the highs at the same time for the highest probability of a good rally.  If we see divergence, it significantly reduces our confidence in the rally(20).  In addition, I can see clearly on my 1 minute chart of the Russell that the Russell just made 3 pushes to new highs (you might call it some variation of a triple top), and failed fairly dramatically.  This is bad, bad, bad for long positions(21), but I decide to hold my larger-than-full-size position a bit, just to give it a little more room.  (This is mistake #2, and you don’t need three to do damage.)

The blue line in the chart below is high of the day for both indexes.  Notice how clear this pattern is, but I ignored what I knew was a very high probability pattern.  This is fighting the market, and it is pretty stupid… and the way to really do it right is to do it on larger-than-full-size!  Ugh.  I took a nasty ding out of what had been a pretty good day up to that point.  The market is pretty efficient in punishing mistakes and stupidity.  Of course, the right thing to do was to have sold at least the extra size at the first sign of weakness, to have gotten very small on the 3rd push failure, and to have at least taken the rest off at breakeven.

3 Pushes and divergence at the highs: Mid-day breakout attempt DENIED

The day eventually did break to new highs, which is an important reminder that these trend-ending patterns do not mean the trend is going to reverse.  I did not repeat my mistake and ended the day with a decent profit for the size I’m trading, but easily gave half my day away with one stupid mistake — trading against a high probability pattern.

SMB Morning Rundown – September 1, 2010

Today, the Market appears set to open higher. The levels we are watching in the SPYs are 107.20 and 107.60 (resistance), 106.30 and 106.00 (support).

Our best AM Idea for today, which we highlighted in our AM Meeting is to use 43.90 in X as an inflection point. As a bonus get long INTU above 43.25.

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Rebuilding Confidence

One of our young traders did a nice job today of rebuilding his confidence.  He started off the month of August on fire seemingly unable to have a negative day.  His confidence grew and he began to take on more risk.  I noticed that when he had his first negative day of the month that he overtraded a bit in an attempt to get positive for the day.  What trader hasn’t done that before   Over the course of the next couple of weeks he overtraded a few more times and gave back a good chunk of his monthly profits.

Today, he drew a line in the sand with respect to his trading behavior.  One, he decided that he would only focus on THE MOST IN PLAY stock of the day.  And two, he would only take trades with very favorable risk/reward (greater than 1:5).  I am happy to announce that he put together a very nice day with a ticket average of around 70.

We were chatting after the close about the trades that he made and whether there were areas he could have improved upon his execution.  This type of post game analysis is very important and should not be confused with second guessing oneself or playing Monday morning quarterback.  The crux of your analysis should be related to sound trading rules that you have established for yourself and whether you executed on these rules correctly.

And for those who are curious as to which stock he traded just scroll down to the blog about our “Best AM Idea”.

And The Real Reason For That Losing Trade Was……..?

Look at the chart above.  Say you shorted RIMM below 45 and got stopped out at 45.16, develop a reason for this loss and then continue reading.

Ok great to have you back with us.  Today during a teaching session Bad A$$ Mike shared a trade he made on the Open getting short RIMM below 45.  Steve whispered in his ear before the opening bell that 45 was a big level and it had downside potential.   Bad A$$ Mike had other ideas but he flipped to Steve’s right before the open.   He shorted below 45 and got stopped out.  Reviewing his work, the subsequent two points of down and frustrated he concluded,”I didn’t give RIMM enough room.”

I rose from the back of our training room and sauntered to the front.  ”That is not why this trade did not work,” I challenged.  Then I asked a series of questions to our traders to elicit the real reason why this trade did not work for Mike.   I will offer the cliff notes version.

1) Bad A$$ did not evaluate the importance of the 45 level for him.  I asked him on a scale of 1-10 how important the 45 level was for him and he had no answer.

2) Bad A$$ did not know that there was fresh potentially negative news with RIMM.  I asked him if there was fresh news in RIMM and he claimed there wasn’t.  @vontrading corrected him.

3) Bad A$$ did not consider how weak or strong the overall market was.

4) Most importantly Bad A$$ missed the best short which was below 44.80.  RIMM went above and below the level but then finally broke this pattern.  There is a subset to support plays.  One is shorting when a stock breaks its range below and above the level.   Know your subsets.

Bad A$$ did not have a feel for the Big Picture with this trade.   And he missed a subset of a support and resistance trade.  But this had very little to do with his stops and had everything to do with his process.   When you reflect on your trading get the real reasons for your losses correct.  This will help you make the necessary adjustments so you progress.  Finally the answer is not always wider stops.

Mike Bellafiore
Author, One Good Trade: Inside the Highly Competitive World of Proprietary Trading

SMB Trade of the Week-MDT

Watch Mike Bellafiore in this short video discuss SMB’s Trade of the Week. SMB’s new video series for StockTwits TV first released exclusively on the iPad, details trading patterns that are consistently used on SMB’s trading desk. Mike Bellafiore, partner at SMB Capital and author of One Good Trade: Inside the Highly Competitive World of Proprietary Trading (Wiley), discusses Shorting a Weak Stock Below Intraday Support in MDT.
We hope you enjoy!

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Also, check out SMB on youtube for more SMB Trades of the Week!

SMB Morning Rundown – August 31, 2010

Today, the Market appears set to open lower. The levels we are watching in the SPYs are 106.00 and 105.30 (resistance), 104.30 and 103.00 (support).

Our best AM Idea for today, which we highlighted in our AM Meeting is to get short MON at 54.80.

Don’t forget to follow us on Twitter.

A “Cloud”(y) Day

This AM I tweeted that VMW was a long if it was holding above 80.  VMW got on my radar last night when I saw an article on the WSJ site that it was investing in the “cloud”.  For those of you who aren’t aware of the “cloud” it is the buzz word du jour with respect to technology firms.  Even if you aren’t a primary provider of cloud technology services it probably would serve you well to throw out a press release or two about how you are helping customers move there as it will cause a nice bump in your stock price.

Buzz words have always been important with respect to short term movements in stocks.  Back in the 90s “B2B” was all the rage.  Then there was “nanotechnology” and in more recent years “alternative energy” firms were just killing it for awhile.  Once you know the key words that are attracting the momentum players attention you should be on alert for trading setups that might occur in a stock that becomes associated with such buzz.

Back to the VMW trade.  The second tweet about VMW observed that we needed to see some real volume come in to confirm the up move above 80, which would be the precursor for a much larger move in the stock.  The reason why volume is important in this particular example is it would be an indication that some major momentum players were moving into the stock and most likely intended to push it higher in the days ahead.  But the volume never materialized and I was stopped out for a small gain when it broke its intraday uptrend.

Syposis

1. pay special attention to stocks on a day a story is released that contains key “buzz words”
2. indentify important support/resistance levels in the stock for potential entry points
3. only lay into the stock if their is significant volume driving it through key inflection points