Kevin Haggerty Describes A QQQ Trade From Beginning To End
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 |
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PowerRating)–an index, or market measure, and therefore, not tradable–into a trade in the <>Nasdaq 100 Index Tracking Stock, symbol:
(
QQQ |
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PowerRating).
This is how the trade set up.
The Nasdaq 100 Index
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NDX |
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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.
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 <
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<
QQQ Who?
Since the Nasdaq 100 Index
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NDX |
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PowerRating) is not a tradable instrument, only a market gauge, Haggerty traded the Nasdaq 100 Index Tracking Stock, symbol:
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QQQ |
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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
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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.”
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.