A SHORT TERM S&P TRADE

I particularly like this S&P example. Maybe it's because ofthe money I made trading it, or maybe it's because it's such an illustrative example. One thing's for sure; it's indicative ofthe way I've approached trading S&P since 1985. It's the way I like to interact with volatilemarkets.

GENERAL DISCUSSION:

First we will consider the context for the trade. Then, we'll examine how trade psychology and market mechanics play their role. We will go through a step by step process, showing each aspect ofthe Trading Plan and how it was implemented for this low risk, high profit, hit-and-run experience.

TREND:

From the following daily Chart 15-10, you can see we've been above the 25X5 for months, above the 7X5 for over a week, and it's obvious from the price action that we have been and are currently above the 3X3 as well. Therefore the daily Trends are all up. Furthermore, based on the value of the various DMAs, they are likely to remain up "tomorrow," unless we get a very severe break in price.

7/5 MA = 51174, Q (basis OSC= 7) = -43.40851 25/5 MA - 50858, Q (basis OSC = 7)= -70.42389 3/3 MA = 51578, Q (basis OSC =7)= -8.71582

Price of 52849 would produce Q+MAX(OSC = 7)= +100.2139 Price of 49990 would produce Q+MAX(OSC = 7)= -144.8575

Before we go to the next step, I want to digress for a moment to explain the numbered printouts associated with this chart 1 . To begin with, the chart was printed as of "last night's close," the day before the trade took place. The group of numbers below the chart shows the Oscillator Predictor values at various prices. We are most interested in the maximum Overbought and maximum Oversold levels.

A price of 52849 would produce an "historically" maximum Overbought level of +100.2139. The abbreviation used for this is Q+max . "Historically" refers to the last six months. The maximum Oversold level would be achieved at a price of 49990, which is a Detrended Oscillator value of-144.8575. Ifyou don't have the Oscillator Predictor, you can use alternative methods described in CHAPTER 7.

OVERBOUGHT AND OVERSOLD ANALYSIS:

Ifyou take the three peaks of the Detrended Oscillator and average them together (86.57 + 100.20 +77.57, divided by three), you get 88.11. I typically eyeball the values and estimate an average. Let's use 90. The Oscillator Predictor point shown in Appendix Q for this value produces a price of 52730. Conclusion: this contract is going to be at a maximum stretching point tomorrow, if it achieves a price anywhere between 52730 and 52849. As of the close (last night), we were at about 62% of maximum Overbought, so this number was high enough to bear watching.

DIRECTION:

I don't see any obvious Directional Indicators in play, with the possible exception of Stretch. What I mean is that when I looked at this chart on the night before the trade took place, I concluded that there were no Double RePos, RR tracks, Head and Shoulders, Failures etc., but that it was possible we could end up with a Stretch before tomorrow's action was over, since we were approaching Overbought. I hadn't calculated any expansions to the upside, or resistance Fibnodes, so I wasn't sure if Stretch was a real possibility. Nonetheless, this was duly noted and attached to my S&P clipboard.

TRADE IMPLEMENTATION:

The next morning the market opened strongly by gapping up, then it made a nice .382 retracement back to the 52230 level and continued on to the upside. You can see this by skipping ahead to the five minute Chart 15-16. Given the context, the only possibility early in the day was to play this market to the upside.

Look at the MACD/Stochastic on the daily, hourly, and half-hourly charts. They all pointed up until at least 13:00.

The problem with taking a long position, however, was that price was reaching very high Overbought levels. Therefore the risk that it would not continue higher was significant.

Okay, everything I talked about so far is the context for the trade. This is the kind of reasoning I go through on each and every trade. It is how I evaluate my risk/reward. It is how I determine whether or not I want to play a given market. The bottom line was that I had strong downtrends forming on intraday charts after reaching a significant Overbought level.

Also, any profit objective on a long entry would have to be close. The bottom line was that the risk/reward ratiojust wasn't positive enough for me to get involved. Given these facts, my focus was on the bond market, since the day trading opportunities there were much more favorable.

After a good day trading the bond market, I took another look at the S&P. It was about 14:15 to 14:30. The high stood at 52745, clearly in the highly overbought range. I noticed that by 14:00 both the MACD and Stochastic on the half-hour chart were in a sell mode and the Stochastic on the hourly was also in a sell. The hourly MACD was approaching a sell. All these facts taken together told me we had an excellent chance for a rout to the down side before the day ended, catching all the (long side) Johnny-Come- Latelies unaware. Given the look of the Trend indicators at about 14:15, if it were going to happen, it would take place soon.

TRADE PSYCHOLOGY:

Before getting into the details of entry and exit, let's evaluate the psychology of the market at this point in time.

Long side players have been rewarded day after day. Many have doubled and tripled up positions attempting to make millions out of a few thousand. Few participants are using profit objectives: after all, the books tell you to let your profits run, to let the market take you out. Some players are so confident, they've thrown In a stop and gone to the golf course. Others who have gotten out at a nice profit are so frustrated at the profits they've "lost" (greed), that they have gotten back in with larger positions to "make up for" their "error" in getting out too soon.

MARKET MECHANICS:

If you know anything about market mechanics, you'll know that by midday there are a bazillion stops under the low of the day at 52230. You also should know that's the area where the locals will be gunning for stops if we get any kind of Movement south. To make that last statement more understandable, here's what happens. They (the locals) sell the market mercilessly on the way down and when the sell stops are hit, they buy them, after, andduring the panic, thereby getting flat and achieving a nice profit. Where do you think all the Mercedes, Jags, and BMWs come from in the MERC'S parking garage? It's their job to facilitate trade, provide a liquid market, and buy Mercedes, Jags and BMWs. Traders offthe floor don't realize it's our job tojoin in with them. So here's how we do it.

Let's assume you've looked at this trade late in the day, as I did. Notice, you had a little Wash and Rinse at Point 3 '*', another encouraging sign to the down side. By the time it was 14:30, a strong down wave had developed. FibNodes Focus and Reaction Numbers are labeled on Chart 15-15. Notice the Confluence area 52467-52480. Selling a reaction back was as easy as it gets.

Selling "K" was an ideal and "safe" area to take a shot at the down side. You could select any one of a number of "Bushes" stops, but at a minimum I'd hide my stop above the '*'.382 Node at 52501. There would also be nothing wrong with selling the first Node back (box 1) at 52423; instead ofthe Confluence area. It depends upon how aggressive you are. I chose to sell at the lower end of Confluence at 52465 and also to sell stop the low at the Focus Number F, 52350 (chart Point B). While I normally don't initiate orders on stops, i chose to do so in this case, because I knew there would be some locals and intraday players closing short positions (buying) at the old lows 52350, 52320, and 52230. I also knew my broker commanded enough respect in the pit to get me filled reasonably well, if any ofthese buy orders manifested.

While my minimum expectation for the trade was to take out the low ofthe day at 52230, I quickly calculated the expansion down, which yielded an OP at 52070. This expansion is detailed in Chart 15-16 and shown in the accompanying FibNodes printout.

TAKE A PRECALCULATED PROFIT OBJECTIVE FOR THE TRADE

Why did I choose the OP? Well, the COP was just below the low of the day and that's where all the sell stops were. If we hit that point there was no way the COP would hold. The XOP at 51826 was a mile away and I reasoned that before reaching it there was likely to be a throw back rally. The OP was most likely to be hit by the simple process of elimination.

Let's look at the way the trade worked out. The Confluence area, where my initial sell order was placed was hit to the tick at 52465. What's more interesting, however; is the second entry at 52350. )

ADVANCED COMMENTS:

Notice the time and sales 2 Chart 15-17 and the way the market fell. From 52390 at 15:06 to 52335 at 15:07 there wasn't an up tick. Exchange rules say you aren't due a fill until you get an up tick (on a sell). That happened at 15:08 at 52340. That's where my second order was tilled, at 35. Now look at the action several minutes later. Note 15:12. We go from 52300 to 52190 in one tick! We continue with the glide ratio of an anvil to the 52100 area. It's no accident support finally came in 30 points above the OP! Let's take another look at the five minute Chart 15-16. You'll see the test of the 52100 low was at

When I know I'm trading really well and in tune with the market, this is the way things go. Hit the market on an extreme in a throw back rally, never suffer pain, and take profit in just a few bars. If you think that this sounds just too good to be true, use these strategies for a while and see for yourselfjust how close you can get to the "perfect trade." It might surprise you.

A QUESTION:

This sounds fantastic. Doyou always trade like this?

Sure... I always sell highs, I always buy lows, my stops are never hit, I own Chicago and New York. My bid is in for Singapore and I'm looking for a retracement!

52075, just one tick above the OP! What happened was that the 52100 test, down to 52075, was just enough to wash out the stops below 52100 and reach solid support at the OP. So how did I handle it?

When I saw the tick from 300 to 190, it was Pampers® time! Hundred point ticks weren't all that common at the time. I called the floor to see ifthe tick was correct. Their voices were hoarse and shaky. The order clerks told me there was a trade or two between those two numbers, but that a panic was occurring. "We're not 'arbing' orders, it's so crazy," was what the clerk said. The noise level was extreme. The clerks were concerned with errors, and rightfully so. Before I got offthe phone we were at 52100 and since that was just a few ticks above my closing profit objective, and since there was a panic going on, I "canceled replaced" and closed at market. Many of my students and my trading friends would have been delighted to see a 110 point tick in their favor. For me it was the ticket out. That old saying about Fools and Angels ought to hang on your trading room wall.