What The Failed Bounce May Mean

  • August 6, 2003
  • Rob Hanna

For a
while yesterday it really looked like we were going to get
a nice bounce off  support levels.  The S&P actually traded within one point of
the 360 support level I’ve been discussing.  The Nasdaq came within ½ point of
the minor 23.6% Fib retracement level, and the Dow found its bottom just below
9000.  From about 10:30 until around 3:00 the averages stair stepped higher. 
With the VIX being stretched to the upside and now flashing several CVR signals,
I really thought we might get at least a day or two of buying.  Alas, it only
lasted a few hours before sellers came back with a vengeance and sold right up
to the closing bell. 

This leads me to believe a few things:

  1. The bounce failed.  If the
    market can’t go up, it’ll probably go down.  Therefore, if the selling
    continues tomorrow morning, we may take out today’s levels as if they weren’t
    there.

  2. The VIX is still high
    compared to recent levels.  Therefore, I still believe there is a real bounce
    coming.  I just don’t know when.  Probably soon.

From a trading standpoint, I
think the easiest way to play it may be to wait for the bounce, and then look to
get short.  Whether we take out 960 in the S&P before or after this bounce
occurs doesn’t matter to me.  I believe we are going through that number either
way.  The one thing that could change my mind is if the market bounces and
volume comes in strong.  Any sign of a weak-volume bounce and I’d look to find
some short entries.

On a sad note, I had to say goodbye to one of my favorite intermediate-term
swing trading stocks today. As Dave Landry says, the goal of any swing trade is
to turn it into an intermediate-term winner. I believe the best way to do this
is with stocks that exhibit strong fundamentals and intermediate-term technical
patterns as well.  Lexar Media
(
LEXR |
Quote |
Chart |
News |
PowerRating)
was a good example of this.

On May 29, LEXR poked above the top of its six-month basing formation on strong
volume. Rather than following through right away, it formed a nice 3-day
pullback. Since a decent handle didn’t form before the breakout, some
intermediate-term traders may have considered this a high handle.  Swing traders
would have seen the pullback entry.  The three-day pullback on declining volume
during a strong uptrend (14-day ADX was 49, and DMI+ was greater than DMI-)
provided a textbook swing trade entry on June 4.  The entry was around $7.50 and
the stop would have been around $6.85. 

As this was a fairly loose stop percentage-wise, reduced shares would have been
appropriate. After taking partial profits to cover costs, and moving your stop
to break-even, stops were able to be trailed up until today. You’ll also notice
that all of the pullbacks identified with the blue arrows would have provided
similar and successful opportunities. Over the course of two months, you could
have built up a decent position with very little risk. With the ADX remaining so
high and the DMI+ always above the DMI-, the trend was always in place. By
simply moving your stops up below the lows of the most recent pullback, huge
profits were available. 

The most recent pullback low was around $13. If you had your stop below the 7/29
low around $12.40 to give it a little more room, and exited today, the first
five trading opportunities would have provided terrific profits.  The sixth
possible entry (7/30) should have been at least a scratch with proper money
management, and if you tried to enter yesterday on the most recent pullback
(probably not a good idea any way — 1)pullback too short, 2)stock too extended),
you would have a small loss due to the gap down. 

The initial entry would have provided nearly a 65% return on the
intermediate-term portion if you stopped out this morning (based on the $12.40
stop).  Not bad for a swing trade.  By concentrating on stocks with solid
intermediate term fundamental and technical characteristics, you’ll have an
easier time finding “home run” trades.  That said, as you can see from the
volume today and the huge price drop, when it’s time to say goodbye…say goodbye.

Goodbye. (Until Monday.)

Rob Hanna


robhanna@rcn.com

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