Beyond The Setup — Let Outside Technicals Pump Your Odds
Setups don’t
exist in a vacuum. You must consider the overall market and sector
action. Further, you must consider the bigger-picture technical patterns within
the individual stocks that are set up. Below we will show how to factor in these
outside influences into your trading, using recent examples.
What’s The Market Doing?
The first question you should ask
yourself is, “What’s the market doing?” Is it going up? Down?
Sideways? It is trading above/below its moving averages? Is there momentum? Are
there setups in the overall market? Bigger-picture patterns?
For instance, on 04/25/01, the Nasdaq
formed its first pullback from highs after rallying over 35% (low to high). This
action also sets up a low-level cup and handle formation. Further, notice that
the 10-day simple moving average and the 20-day and 30-day exponential moving
averages have crossed from downtrend proper order1 (10-SMA<20-EMA<30-EMA)
to uptrend proper order (10-SMA>20-EMA>30-EMA). On a even shorter time frame,
notice that on 04/25/01 the index closed well (near the top of its range) after
closing poorly (near the bottom of its range) on the prior day. This is known by
Jeff Cooper as a 180.2
The S&P 500 sets up in a similar
fashion. Notice that it is in it first pullback since rallying from lows, it
formed a cup and handle, the moving averages have turned up and after a poor
close (a), it reversed to close well (b).
Check Market Timing Systems
Now that I know that the market is
poised to rally on a pattern basis, the next thing I do is to see if any of the
short-term market timing systems that I follow are triggering a buy signal. In
historical backtesting, these systems have shown a 60%-80% chance of correctly
predicting the market over the next two to seven days. They include TRIN Reversals,
3Â the Connors’ Vix Reversal (CVR) Systems (including the CVR
III, 4 which I
co-created with Connors, and the CVR III-Modified, 3 the Oscillator Swing
System, 3 and the CHADTP.5
In looking to these systems, I
see that on 04/25/01, a CVR I signal is triggered: The VIX hits a 5-day (plus)
high (a) and reverses to close below its open (b).
Check The Sectors
Now that I know the overall market is
poised to rally, I then look to the individual sectors to see which sectors are
poised to rally. Sector action is vitally important as sectors can often
outperform or even trade contra to the overall market. Here, I look for the same
patterns and momentum described with the indices.
In looking to the sectors, I see the
semis
(
$SOX.X |
Quote |
Chart |
News |
PowerRating)Â are in first pullback mode after a sharp rally from
lows. Notice the moving averages and the price action also sets up the sector as
a Bow
Tie. On a smaller scale and like the overall market itself, notice that the
sector reversed to close well, after closing poorly on the prior day.
Another sector of interest on 04/25/01
was the biotechs
(
$BTK.X |
Quote |
Chart |
News |
PowerRating). Notice that it formed a pullback, a big-picture cup and handle and also was able to reverse a poor close
(a) to close
well (b). This action suggests that the sector was poised to rally out of the
pullback/cup and handle formation. One thing to consider though, in looking to
the left side of the cup, I notice that there is overhead resistance. This must
be factored in when considering a trade in the sector.
Finding Setups
Now that I know that the overall market is
poised to rally and that biotechs and semis are the sectors most likely to
benefit from that rally, I then look to individual stocks within that sector.Â
In my analysis of the semis, I see
that Triquint Semiconductor
(
TQNT |
Quote |
Chart |
News |
PowerRating) (mentioned in my 04/25/01 Stock
Outlook)
has shown strong momentum from lows–nearly tripling in value. The stock also
had Trend Qualifiers, 5 such as gaps, strong closes, and wide-range bars
higher. Notice that the stock forms a pullback and a bullish outside day. Also
notice that it, like the overall sector (see above), was able to reverse a poor
close (a) to close well (b). This action triggers a Bow Tie entry and suggests
that the stock will continue to resume its uptrend.
In looking for setups in the biotechs,
I see that Protein Design Labs
(
PDLI |
Quote |
Chart |
News |
PowerRating) is in its first pullback since
doubling from lows. During this uptrend, it had Trend Qualifiers such as strong
closes, wide-range bars higher and a gap higher. I also notice that it closed
well–reversing the prior day’s sell off. This action suggests that it’s poised to
resume its uptrend.
Position Management
Unlike Ron Popeal’s rotisserie
roaster, in trading, you can’t “set it and forget it!” You must take
an active role in managing your positions. In addition to placing initial
protective stops, this involves taking profits and trailing stops. If you’re
fairly new to my trading style, now might be a good time to review the general
concepts I use here, in my articles on Money
Management under Traders’ Lessons. In addition to those rules, you have to
consider the stock’s technicals, the overall market and sector action.
Both stocks trigger an entry and are
profitable over the next few days, but, notice that on 04/30/01, the biotech
index clears its recent highs (a) but is beginning to show some signs of
stalling as it approaches recent overhead resistance (b).
On the same date, the semis are acting
OK but are still short of their recent highs and did begin to tail off a bit
intraday (a).
On the same day, Triquint approaches
its recent highs but is just short of breaking through. It did close slightly
off it daily high (a) but so far, hasn’t done anything wrong.
And so far, PDLI hasn’t done anything
“wrong” either. However, you can’t ignore the fact that its
approaching its old highs (a) and overhead resistance.
On the following day Triquint takes
out its recent high (a) but is now in a zone of overhead resistance
(b).
PDLI looks like it may be getting into
trouble. Notice that it fails to clear its prior high (a) and is stalling in the
area of overhead resistance.
On 05/02/01, the semis fail to take
out their recent high (a) and tail off to close poorly (b).
The biotechs also fail to take out
recent highs (a). This has them stalling below the area of overhead resistance.
Looking to the overall market, on
05/02/01, the Nasdaq forms a Hanging Man7 in the area of recent highs and
longer-term highs and overhead resistance (a).
The S&P 500 also formed a hanging
man (a) near its recent and longer-term highs.
Moving forward, we later see that this
day becomes the exact swing top (a) of Triquint.
And, the highest closing price
on PDLI before it begins to implode.
In Closing
As you can see, setups don’t exist in
a vacuum. You must take into account the overall market and sector action. You
must be fully aware of the bigger picture technical patterns within the
individual stocks. It doesn’t end there, however, you must then monitor the
stock, market and sector to manage the positions.
Q&A
Q. You
emphasized studying the market and sectors. How do you find setups, once you know
which sectors you want to focus on?
A.
I keep a small database of stocks which I tool though each night. From this,
I’ll take notes if any stocks are setting up within that sector. I also run
scans to look for setups. Further, if I think a sector is really poised to
rally, I might just tool through the majority of the stocks in that sector that
are suitable for swing trading.
Q.
Suitable for swing trading?
A.
It must be priced high enough, it must be volatile enough, it must be liquid but
preferably not too liquid, it must show persistency and so forth.
Q.
Can you elaborate?
A.
I could, but then I’d have to kill you. Seriously, it’s too much to cover in
this forum. I spent a whole chapter in my book3 on these factors alone. I’ll plan
on doing an article in the near future which will cover this aspects in more
detail.
Q. Above
is the first time I’ve seen you use candle charts. Is this a new area of study
for you?
A. No,
I studied candle charts years ago. I was probably one of the first people to
purchase Nisson’s book6 ten years ago.
Q. Do
you still use candle charts?
A. Yes
and no. When I see certain patterns occur with bigger-picture technical
patterns, I tend to take notice. For the most part, I use standard O/H/L/C
“Western charts.” I can usually pick out the most relevant candle
patterns out of the Western charts.Â
Q. Why
not use candle charts then?
A. I
began working closely with Jeff Cooper about four years ago. I viewed and still
view him as one of the best chart readers in the world. Being “old
school,” he uses standard Western charts. In order to be on the same
“page” as him, I switched back to Western charts from candle charts.
Q. Back
to the subject of this article, are there any other things to consider when
looking at setups, sectors and the overall market?
A. Yes. Good
traders tend to anticipate market action. For instance, on
04/24/2001, the Nasdaq pulled back to the gap/2000 psych support level. It
closed poorly but so far, really hadn’t done anything wrong. On that same day,
the biotech index also closed poorly but was still acting constructive by not
breaking down. Cephalon
(
CEPH |
Quote |
Chart |
News |
PowerRating), a biotech mentioned in my stock outlook on
that day, managed to close well in spite of the sector being down. This action
suggested that it was poised to rally out of a cup and handle. Those who traded
this setup know that it was up 3 points on the following day and rallied
nearly 10 points over the next four days.
Also, if you are nimble and willing to
watch a screen. You can establish a day trade position with the intent of
turning it into a swing trade. On 04/25/2001, the biotechs began to turn
intraday. PDLI opened flat but held (a). Once it started moving, you could have
got in as a day trade and placed a tight stop right below the morning range.
This would have given you a 2-3 point “head start” before a potential
swing trade would have triggered on that same day (b) or on the following day as
shown in the above article.
Q. Where
can I find more about swing trading?
A. I
thought you’d never ask.
Footnotes, References and
Additional Reading
1See article on Bow
Ties.
2 Hit and Run Trading, Jeff Cooper
3 Dave Landry On Swing Trading, Dave Landry
4 Connors On Advanced Trading, Larry Connors
5 Investment Secrets Of A Hedge Fund Manager, Connors/Hayward
6 According to Nisson in Japanese Candlestick Charting Techniques:
“If the market opens lower the next day, those who bought on the open or
close of the hanging-man day are now left ‘hanging’ with a losing
position.”
Here For A Free 1-Week Trial To Dave Landry’s Daily Swing Trading Alerts
How To Trade Dave Landry’s Best Strategies