Chasing The Tiger Trade, Part 3: Why Timeframe Controls Everything

• January 20, 2003
• Selwyn Gishen

Hello again, fellow Tiger trappers.
We ended the discussion

last week with how all the components of a
trading strategy are related. This point is so important that I ask for
your indulgence to repeat it:
Risk to reward is affected by size. Size is affected
by volatility, which depends on selection. All these factors determine how you
choose your timeframe. They’re all
related. Selecting the right timeframe therefore means that the timeframe chosen
is appropriate for the total strategy which, of course, must take into account
your own personal objectives. Hence setup, stock selection, risk control and
opportunity are all dependent on the timeframe selected.

Timeframe is the starting point for assembling the four components of my
strategy, namely:

1. The
   dynamic setting up (why)

2. The
   selection (what)

3. The
   reward to risk (how much)

4. The
   exit and entry setup (when)

Simply
put, if you are trading in a five-minute time frame with both your targets and
stops calculated on a five-minute chart, your stock selection may be based on
volatility or travel range, i.e., stocks that are capable of making more than a
$1 move in one day. You could also take a break out on a

Slim Jim setup in either direction based on the five-minute chart, which a
longer time frame trader would not even consider because there may be no Slim
Jim pattern on the 30-minute chart. So time frame will govern selection, setup
and risk-to-reward characteristics. Shorter time frames tend to produce
lower-risk trades but with lower reward potential unless they are used to
fine-tune entry into longer timeframe trades that have the ability to produce
much larger rewards or “tiger trades.”

Let’s
look at a potential reversal trade that could start as a day trade and which
could lead into a “tiger” trade, so to speak. By “tiger trade,” I mean a trade
that will probably last longer than one or two days and which is capable of
producing 10 times the reward to risk.

I
typically trade two types of strategies, a reversal or, if I miss the reversal,
then pullback into a trend. So here is my method for finding a potential “Tiger
trade.” In this example, I am looking for a reversal. Tigers often hide at the
tops of cliffs or the bottoms of valleys, so this is where I go looking.

Step
1. I
start by scanning for highly liquid stocks that trade with a 50-day average
daily volume greater than 500,000.

Step
2. I scan the results of Step 1 for new lows and new highs. I look for 10-, 20-
and 60-day new highs and lows. I want to catch the tiger moving into a territory
from where it can go no further and will have to retreat. When making new highs,
the tiger will suddenly be confronted with “bears” that it never knew existed at
those levels. The bears will chase the tiger down the cliff and then, when
making new lows, it will encounter “bulls” that it does not expect and
accordingly the “bulls” will chase it up the cliff. Of course not every tiger
making new lows or highs will reverse and of course they can go on to make even
more new highs and more new lows. But if I want to trap the “tiger,” the trade
with the lowest risk and the greatest potential reward will have to be at a
reversal point. So I start to stalk all suspect tigers on the new lows or new
highs list. This may take days of stalking, so stay focused, be patient and be
prepared.

Step
3. Once I have a list of potential tigers selected, I then look at each one on
a daily chart and I pay close attention to GAPS or VOLUME and the BAR of the
day. I want to find exhaustion or climax or key reversals, etc.

Step
4. I then look for HARMONIC patterns, namely whether the stock has been trading
sequentially from key reversal zone to key reversal zone and how long each wave
is relative to each other in magnitude and time. All of
this is done on the daily chart which helps me to anticipate where the
tiger is hiding. By doing the analysis after the market, at my own leisure, I

can set
the trap easier than if I tried to do it on the fly or in the heat of the chase.
While it is true that the “second mouse gets the cheese,” it is also true that a
“patient cat will get the mouse.” Just be sure the cat doesn’t get you first.

Step
5. After I select a few potential tigers, I focus on my standard “Time Frame.”
I zoom in to the 30-minute chart. (I use 30 minutes to calculate my risk-to-reward ratios and to figure where to put stops and take profits.) Once I
complete my calculations, I then draw my “lines in the sand.” These lines may be
a regression channel or an 8 period EMA offset or perhaps a trend line over the
two most recent pivots. I then switch down to a 13-minute and a 3-minute set of
charts and I watch these on an intraday basis.

Step
6. I set the TRAP to catch the Tiger by leaving a limit order in the market at
my pre-determined level. If the market does what I hope it will do, then I am in
the chase and the process of managing the trade begins. I already know where I
will exit the trade if the tiger turns on me and my stop order is also placed.
Sometimes I wait a little to let the price move enough distance from my entry
point before I actually send the stop order. However, if the Tiger turns on me
immediately, I do not hesitate to “pull the trigger” to protect myself.

Here is
an example of chasing a tiger trade. I am only showing daily charts. You can
look at 30-minute charts on those days to get more clarity.

Fleet
Boston
qualifies as a liquid stock as it trades more than 500,000 on an average day. It
made a new high on 12/02/02 and volume spiked up while the candle turned black.
This was telling me that there were bears in the territory that may chase the
“tiger” down the cliff.
On
further examination, I measured the retracement from the May 15 high to the
October 8 low and noticed that the 50% level was at 27.16. This coincided with
the downward sloping 200 moving average. I drew my line in the sand across the
lows and measured my entry point at $26.30 and my stop at $27.60. This was a
risk of $1.30. I figured the tiger could retreat to the $25 break out area or
perhaps the rising 50 moving average at around $22.50. The reward was a
potential $3.8 against a $1.30 loss, a 3:1 ratio. This is a small tiger but
worth the shot.

The
next day I get entry on a gap down.

On
12/06/02 Fleet Boston gaps down on the open and I trail my stop to $25.50,
approximately 50% of the prior bar. I get knocked out on 12/12/02. The tiger tuned on
me and I ran for cover. My profit $0.80. I should have covered when the market
gapped lower on 12/06/02. Should of, would of, could of. You know the story.

So what happened to the
tiger that got away? It climbed for a couple more days then retreated back to my
original target at the 50 moving average on 12/31/02. This would have been a
good time to close out as the tiger had moved as predicted. Profit would have
been approximately $2.40. Why didn’t I hang in there? I lost my courage and
conviction. Perhaps I was seeing profits dissipate. Emotions, emotions,
emotions. The three worst troubles for a good tiger trader!

So this
is how I chase a tiger. Obviously there are better examples of tigers out there,
but I picked one just to show you the motions I go through to catch a tiger. In
this case, there was the rising 50 moving average which could limit the move.
Bulls love to sit on rising moving averages and it is difficult for a retreating
tiger to get past them.

But
tiger hunting is fun and potentially very rewarding. Like everything in life, it
is part art, part craft and part intuition. The big rewards come from the big
bets and that is the subject of the next article followed by the final one in
the series on developing courage, confidence and discipline.

To
summarize so far in the series, we have used the tiger-hunting metaphor,
determined our trading style to match our personalities, set our goals and
objectives, and coordinated our methodology based on time frame. This may be a
good time to read or re-read the whole article
if you have not done so yet. Finally we have pursued a
tiger trade that turned out OK. So now it’s back to the unicycle for more tiger
trails.

See you
next week.

Part
1 — Setting Objectives
(If I don’t know where I’m going, any road will take me there. — Apologies
to Alice in Wonderland.)

Part
2 – Choosing Your Time Frame

Part
3 – Why Time Frame Controls Everything