This afternoon I tweeted that price was insufficient to confirm a move and that you need time as well. What does this mean? As traders we attempt to capture a new trend in the market we are trading. One of the most commonly used signals for a new trend is a powerful change in price. I have heard many traders refer to this as a change in “character” of the most recent trading pattern. This change in character is not sufficient to cause me to commit a large amount of risk.
Why not? Because a quick impulse move to new price levels are often the result of a temporary supply/demand imbalance in a market and the market will revert to its mean soon thereafter. Confirmation of a powerful impulse move comes when the new price level is sustained for a period of time. Once I see the sustaining of the new price levels I will begin to commit a more significant amount of risk for a possible new trend.
Take a look at these two examples from today. The first was in AAPL, which drove powerfully from 453 to 457. There was a quick momentum trade in this move, but the question I then needed to ask myself is this the beginning of a new trend. I used 457 as my barometer. If AAPL could sustain price above 457 for 20+ minutes I would be willing to commit more than a small amount of risk to a long position. If not either remain flat or hit out of a small feeler position as AAPL trades lower.
The second stock is CLF that showed signs of a short-term bottom yesterday. Today it traded above yesterday’s resistance area and had a powerful impulse move to the next short term resistance area at 21.50. It was a nice 80 cent momentum trade. For me to be interested in a bigger picture trend I needed to see price hold above 21.50. This did not occur so committing more than a de minimus amount of risk at prices far above the previous 20.70 resistance does not make sense from a risk/reward perspective.
Steven Spencer is the co-founder of SMB Capital and SMB University and has traded professionally for 16 years. His email is [email protected]
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