Haggerty Describes A Recent QQQ Trade From Beginning To End
pieces of the trading puzzle in place as possible before
going into a trade in order to enhance your chance of
finding a winner. In this respect, Kevin Haggerty is a
Master Puzzler. In the following trade, Kevin pieces
together the big-picture
background, volatility bands, and intraday patterns to
identify high-probability trade setups.
Don’t be
intimidated by these terms if they are unfamiliar to you.
Forge on and educate yourself by getting inside the head of
one the world’s great traders. It’s worth it. In this
example, Kevin identifies a high-probability tradable bottom
in the Nasdaq 100 on the day after the Fed decided not to
lower interest rates despite abundant evidence of an economy
skidding into recession.
The following is
an example of a trade that did not work out in the sense
that it lost money. But trading is a game of losing as well
as winning. One of the most important lessons to learn
before committing money to a market is to develop an
approach that gives you an edge–and then stick to your
approach. Plan your work and then work your plan. Find a
trade that gives you an edge, plan your exit strategy, and
then stick to it. This ultimately means wisely planning and
sticking to your stops. Sometimes many probing trades will
be required before hitting a winner. Set yourself up with an
approach that gets multiple pieces of the puzzle working in
your favor, as in the trade below.
We feel it is
important to show winning trades as well as
“losing” trades in this forum because the reality
in trading is that you will have a lot of losing trades and
need to know how to handle them successfully. To become a
successful trader, you don’t have to become a good loser.
But you do have to become a skillful loser, deftly managing
your losses.
This example is
also instructive because it shows you how to translate the
action in the Nasdaq 100 cash
(
NDX |
Quote |
Chart |
News |
PowerRating)–an index, or market
measure, and therefore, not tradable–into a trade in the
100 Index Tracking Stock, symbol:
(
QQQ |
Quote |
Chart |
News |
PowerRating).
This is how the
trade set up.
picture Fibonacci from October 1998, to the March
2000 high, to the current Dec. 20, 2000, level).
The Nasdaq 100
Index
(
NDX |
Quote |
Chart |
News |
PowerRating) traded from the October 1998 low of 1063 to
the March 2000 high of 4816.
The 2496 level is
the .618 retracement of the 1063 to 4816 move, a strong zone
that gave us a 23% rally from 2426 to 2991. Since we were
moving back below 2426, the point from which we rallied,
Haggerty was looking for another potential area below the
prior “.618 retracement” bounce point (which in
this case was 2426–Fib figures are not exact).
The move down from
the peak at A (4816) to the B swing low (2897) is 1919.
Since markets frequently repeat patterns, Haggerty was
looking for the AB down-leg to potentially repeat in a CD
down-leg. From point C, an equal down move of 1919 points
would suggest a target point, D, at 2228.
If the pattern
repeats and leg AB = leg CD, then point D is at 2228. This
is a strong Fibonacci “zone.” The swing high at
point C is also a Fibonacci retracement level. Only this
time it is measured from the high at point A. The swing high
at C (4147) approximates the .618 retracement level of the
down leg from A to B. In the next section on volatility
bands, you will notice that the 2228 area is just 3 points
away from the 2.0 standard deviation (95%) volatility band
of 2225.
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width=”542″ height=”327″>
Volatility
Bands
The 1.5 standard
deviation (88%) Nasdaq 100 volatility band = 2269.
The 2.0 standard
deviation (95%) Nasdaq 100 volatility band = 2225.
Haggerty’s
volatility bands are calculations of a stock’s likely
movement based on statistical probability. Annual volatility
expectations (called implied volatility) from options on an
issue are combined with standard deviation analysis to
deduce the expected movement or range (either up or down)
that any given instrument will likely make. Annualized
volatility ranges are then reduced to a daily basis. When a
stock, or in this case the NDX (or QQQs), makes a move that
is statistically rare–here, occurring less than 12% or less
than 5% of the time–than support (or resistance) is
expected as an overstretched move is more likely to snap
back. Positions are initiated against these
“extreme” volatility bands in the expectation that
a stock’s statistical behavior will resume, “reverting
to its mean” as statisticians say.
The 2269 and 2225
levels are the daily calculations Haggerty is looking at in
this example for the NDX.
(See Kevin’s
trading lesson on trading
Volatility Trading Bands in TradingMarkets.com’s
Stocks Education section. For additional information on
this subject, check out the
for Kevin’s personalized instruction on this subject
live at TradingMarkets 2000).
The
Pattern
(Dec. 20, 2000)
The Naz 100 [NDX |NDX]
gapped down to a 2251 low on its second five-minute bar.
This is down 4.6% from the previous close of 2400. There is
a 1-2-3 bottom entry on the five-minute intraday chart. The
1-2-3 bottom is basically an intraday double bottom pattern
where “1” is the first low, “2” is the
reaction off the low, and “3” is the retest of the
low, completing the double bottom pattern from which you can
trade off. The 1-2-3 bottoms (tops are reversed) come in
only three flavors: Double Bottom 1-2-3 Lower, Double Bottom
1-2-3 Same, and Double Bottom 1-2-3 Higher. The
“lower,” “same,” or “higher”
pattern is identified by the third wave. This shaped up to
be a Double Bottom 1-2-3 Higher trading pattern.
These patterns
often occur at significant “inflection points”
such as moving averages or trend lines, but in this example
they occurred or “converged” at key
at the 1.5 standard deviation volatility
band.
QQQ
Who?
Since the Nasdaq
100 Index
(
NDX |
Quote |
Chart |
News |
PowerRating) is not a tradable instrument, only a
market gauge, Haggerty traded the Nasdaq 100 Index Tracking
Stock, symbol:
(
QQQ |
Quote |
Chart |
News |
PowerRating). The QQQs trade just like stocks,
only better because there is no up-tick rule, meaning you
can sell short the QQQs just as easily as initiate long
positions. The QQQs value is recalibrated from the NDX–made
smaller–in order to make them a more tradable instrument.
Imagine trading just 100 shares of the NDX at its Dec. 20,
2000 full-value closing price of 2210; the cost would be
$221,000!
The QQQs are
calibrated at 1/40th of
the value of the NDX to make them similar to the price of an
average stock. In doing any calculations or translations of
price from analysis of the Nasdaq 100 Index
(
NDX |
Quote |
Chart |
News |
PowerRating),
divide by 40 to get your QQQs equivalent for entry points,
exit points, stop points, etc.
Assembly
Required
Putting the pieces
of the trade puzzle together, we have a 1-2-3 Bottom entry
on the five-minute intraday chart in conjunction with a
convergence of the 1.5 standard deviation volatility band
for today. This is an attempt to find a tradable bottom. The
Fibonacci zone from the AB leg = CD leg is below this trade
and coincides with the 2.0 standard deviation volatility
band.
The gap down
opening took the NDX down 4.6% from the previous 2400 close
to 2251 equating to “1” of the 1-2-3 Higher
Bottom. 2337 is “2,” and “3” is at 2268.
Kevin got entry in the “first entry zone” off the
1-2-3 bottom because the five-minute bar pattern dynamics
were right. He’s looking to enter in a volatility band area
or a Fibonacci zone–or both–when the bar and price
patterns begin looking positive.
When the
five-minute bar closes above the high of the “3”
bar, then you have your earliest entry. Kevin took a
position in the QQQs at the first entry zone bar pattern off
the 1-2-3 Bottom, a long position at 2297 in the NDX
equivalent to 57 7/16 in the QQQs. The protective stop went
at the low of point “3” of the 1-2-3 Bottom, at
2268, which equates to 56.70 in the QQQs. The market then
drifted lower as market dynamics remained sour. The position
was stopped out.
The next test and
probe entry would come at the next zone: the second
volatility band which also coincided with the AB to CD leg.
He would again look for a 1-2-3 Bottom and a close above the
down (“3”) bar’s mid-point in the zone. At that
point he would be on the lookout for a close above the high
of the 3 bar. Kevin says, “I don’t go in at a certain
number. But the first bar that I get that closes above the
mid-point, I’ll go in over the high of that bar.”
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width=”532″ height=”321″>
Final
Piece
The lesson here is
that it is difficult picking a bottom. Many times it may
take two or three entries or probes before you hit it.
“This is the nature of the game,” Haggerty
confirms.
A final reality is
that the you may have to adjust your trade size to the
volatility. Determine how much you can risk per trade and
factor in the volatility of the issue. Determine your stop
based on the volatility, expanding your stop with smaller
size in more volatile issues. Or, as in this example
utilizing a swing-point low as a stop, you would adjust your
trade size to the amount you have determined you should risk
for an individual trade. Set your trade size so you do not
exceed the amount you have determined you will risk per
trade in your trading plan.
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