Identifying High-Probability Opportunities
Pavel Nikonov is
a long-time TM member who lives in Russia.
It
is a well-known fact that the
more things point in the same direction, the better the chances
for a successful trade. Sometimes it is amazing to watch how different
pieces come together to create an excellent trading opportunity. The
following example shows how a combination of different factors set up the
Semis for a short trade.
The Market
Both the
S&P 500
(
$SPX |
Quote |
Chart |
News |
PowerRating)
and Nasdaq Composite
(
$COMPQ |
Quote |
Chart |
News |
PowerRating)
had good chances of
downside reversals.
1. Markets were in clear downtrends (a) and were setting up
as a Landry-type pullback from lows (b). The last upswings being smaller than the downswings were
reminding us that momentum was still on the downside (c).
2. Both of the indices were testing their 20-EMA which
served as good resistance for a long time.
3. The decreasing volume on increasing prices showed a
few buyers were left (d).
4. There was a
strong combination of sell signals on Market Bias Page.
5. $VIX itself
lost 59% in value in four days which meant that optimism soon followed. A bearish divergence in volatility and an underlying price
(a) ($VIX
made new temporary lows, while the market didn’t make new highs) suggesting that market had
the
potential to decline until equilibrium was reached.
6. NYSE TICK went above 1000 (and sometimes much more
then 1000) for four consecutive days, which often leads to two-three day
declines.
All the above factors
were pointing with a high degree of probability to a market decline. The
other step for traders was to identify the proper sector from which he or
she could benefit most from that decline.
Sector
It is no secret that the biggest benefit traders can take from shorting
stocks is to short members of poorest performing groups in the market.
The Bigger
Picture
1. According to Mark Boucher’s New High\Low List, the worst-performing
sector was definitely Technology (a). (This table reflects a two-week period.)
2. The closer view inside Technology sector for the same two week period shows that the biggest damage was done in Semiconductor group (b).
3. PHLX
Semiconductor index just completed an inverted cup-and-handle formation
on the monthly chart (c) and broke three-year support (d).
Closer View
1. It was not hard to see that after a big reversal day, the major indices were able
to hold their lows the next day while Semiconductors were not (a).
2. Market broke triple bottom support (b), which often offers a high-probability shorting opportunity when
the first rally is over.
3. Market rallied and set up as Landry type
pullback from lows (c).
Individual Stocks
After possible downside potential in the market was identified and after the
most promising sector for shorts was found, the last step was to select the most
promising stocks in that sector. A proven method is to choose the most
underperforming stocks (in case of shorting) in the sector.
Almost all high-volume volatile Semiconductor stocks fit that
category.
A
scan made 07/30/2002 reflects stocks which were setting up as “Pullback
from Lows.â€
All
stocks were trading with more than 500000 shares of 30-day average volume and
more than 4% of 30-day average range.
The strength of stocks was measured by comparing 10-day performance of all members of
the Semiconductor sector to each other. The bottom ten stocks fitting the filter
criteria were selected from
the scan.
|
|
|
|
|
|
|
|
|
|
|
7% |
9141K |
83% |
 |
54 |
|
|
|
7% |
2004K |
64% |
-34 |
53 |
|
|
|
7% |
1453K |
61% |
-37 |
51 |
|
|
|
7% |
12M |
76% |
-33 |
49 |
|
|
|
6% |
3608K |
84% |
-34 |
48 |
|
|
|
10% |
3023K |
168% |
 |
45 |
|
|
|
6% |
9873K |
77% |
 |
42 |
|
|
|
6% |
17M |
112% |
 |
39 |
|
|
|
4% |
1780K |
113% |
 |
31 |
|
|
|
7% |
4489K |
96% |
 |
25 |
All stocks from this list declined — some significantly. For
simplicity’s sake,
the Semiconductor HOLDRs chart (as all stocks
from the group mimicked their proxy) is taken to represent what
happened with Semiconductor stocks after the trigger on the next day (a).
Bottom Line
As shown above, simple but effective
methods can pay dividends for a trader. Spending
time and effort on finding as many pieces of the trading puzzle as possible
can dramatically increase your chances of trading success.
Best of luck with
your trading.
Pavel