Why Distortion Can Be Good

As I have been saying for several columns now, selectivity and patience are the keys to navigating this market. Last week I mentioned that I had been using Bollinger Bands as a way to assist me in identifying high-probability setups. When you combine that approach with opening price "distortions," you get a powerful approach.

Take a trade from Hewlett Packard (HPQ | Quote | Chart | News | PowerRating) yesterday.  

Yes, it bucks the overall rule, trade with the trend, but especially on the opening, rules need to be broken. After the opening though, I never go against the trend.

The key thing about this trade (long) was that the S&Ps opened stronger (relatively), and as a result of the break outside the Bollinger Bands, you now have two powerful reasons to initiate the trade. Given that you are bucking the trend, these are trades that you do not want to fall in love with. You are simply there to take advantage of the "overreaction." A good rule of thumb is that the 20-period EMA will be tough resistance or support. Never expect a move above/below. I always exit the position ahead of that level or when the "corrective" momentum slows, like it did in HPQ yesterday.

A colleague of mine showed me this chart yesterday. It simply depicts the current low-volatility environment. Notice how the Average True Range (ATR) of the S&Ps has been on a decline for some time. When the market is like this, it is best to tread lightly. The ATR was not even this low just before the July 2002 fireworks. I am hopeful that an even more explosive period of volatility is upon us. It seems logical to assume that a resolution with Iraq would be the catalyst.

Many of you ask, "If you are only active during the opening hour, what do you do the remainder of the day?" I usually will have a couple of intraday positions working. Naturally, these trades last much longer than my bread-and-butter scalps, but with "drip" price action, I am usually able to pick up gains over the remainder of the day.  For today, I am keeping a eye on these potential longs: (BGEN | Quote | Chart | News | PowerRating) and (VLO | Quote | Chart | News | PowerRating). On the short side, (BRL | Quote | Chart | News | PowerRating).

Key Technical Numbers (futures):

Tomorrow I will share some longer-term themes I am keeping an eye on. With the markets quiet, it is an ideal way to put your portfolio in order and position accordingly.

As always, feel free to send me your comments and questions.

Dave