Monthly Archives: February 2015
I wanted to take some time to talk about one of the most power components of Rob Smith’s In the Black strategy that I used to capture a whopping $41 profit in Pharmacyclics yesterday. Let me preface this by saying that I had no idea the firm would explore a sale, but using this strategy got me into the stock and allowed me to hold on until the news broke and capture a large move.
An inside day occurs when a stock’s trading range stays entirely within the previous day’s trading range, which is a simple enough explanation from a chartist’s perspective. But let’s think about what an inside day means from an economic perspective. An inside day means that buyers nor sellers could establish an edge in the marketplace. The demand side of the asset could not establish a higher market value, while the supply side could not establish a lower market value. In other words, buyers and sellers have created an equilibrium in that asset, which means that when an inside day’s high or low price is breached, an entire participation group from the inside day is on the right side of the trade. For example is Stock ABC has an inside day with a high of X and a low of Y, and the following day ABC moves higher than X, every buyer of ABC from the previous day is on the right side of the trade, while every seller is on the wrong side. It’s a simple enough explanation, but many market participants seem to forget the supply and demand aspects of trading, since a stock is an asset that is no different than any other, in the simplest of terms.
So let’s look at PCYC. On 2/24, PCYC put in an inside day with a high of 188.70 and a low of 183.42. PCYC is above the monthly and weekly opening prices, meaning buyers are active in the stock, so there’s reason to believe that stock will move higher if 188.70 is breached. When PCYC opened on 2/25, it pierced through 188.70, and I began buying around 189. Within the first hour of the day, PCYC ripped to 198, and I was able to take some profit along the way. The stock pulled back as low as about 192.40, but I had taken profits on the initial up move and was comfortable holding. Later that day, news broke that PCYC may be exploring a sale, catapulting the stock and triggering a halt. I quickly pulled up my monthly chart to evaluate PCYC’s broadening formation.
If you click the chart, you’ll see that PCYC has two key triangle resistance levels on its monthly chart – with the first being around 188-189. Having broken through this level, I turned to the next highest point for a feasible exit once the halt was lifted, which looked to be around 230. Within minutes, PCYC had re-opened, and the stock moved as high as 231.09, with my sell order being filled at 230. In strat-talk, we call this price movement “to the tick-tock-ticky” on the broadening formation, as you can see the up move in PCYC came almost exactly to the top of the triangle. While there was no way I could have predicted the completion of this move in one day, the In The Black strategy enabled me to identify a buy point on PCYC, as well as identify an exit strategy when news broke. As they say, chance tends to favor the prepared.
The other big mover from the day was Lumber Liquidators LL. This stock had earnings and gapped down in the morning before rallying to new highs. News broke that LL was to be the subject of a negative 60 Minutes report and a potential investigation into the firm’s business practices, and quickly was swept from nearly $70 to $52 in less than an hour. Unfortunately, I did not catch any of this initial down move, but I began to watch LL as it built inside bars on the 30 and 60 minute charts. LL put in three consecutive inside bars on the 30 minute chart, representing consolidation and the building of an equilibrium. The third inside bar was breached to the upside, but knowing that the stock was red on the month, the week and the day, my bias remained to the downside. After briefly breaching the inside bar to the upside, LL turned lower, setting up a reversal bar. A reversal bar occurs whenever an inside bar is breached to one direction, fails, and closes back within the range of the inside bar. In this case, the inside bar was breached to the upside, failed, and closed inside the range of the previous bar, so I looked for an entry to the downside. I got in early at 57.30, and the reversal strategy kicked in when LL took out 56.36, the bottom of the reversal candle on the 30 minute chart (see below).
From here, I was able to take some profits on the way down while trading around the position (adding and subtracting) using subsequent inside bars on the 5 minute chart. Looking at the daily chart, I identified potential downside as low as $50 (or thereabouts – see below). Though I continually walked my stop down as LL moved lower, I placed a bid to cover my short at $50.30. LL moved steadily lower throughout the afternoon, breaching below $50 by the end of the day, filling my order at $50.30 and netting $7 from my original entry (with several additional shorts and covers along the way).
This blog was started with the best of intentions – like many ideas in this world – but life has a way of taking over. In the last 18 months, life has changed dramatically. I’ve taken on much more responsibility at my day job, rented an apartment with my girlfriend, bought a dog, and (most importantly) proposed to my girlfriend and am in the midst of wedding planning.
However, this space was meant as one to examine, critique and discuss the markets, investment strategies and trading methodologies, and that’s exactly what I intend to do with this re-launch. My day-to-day approach to the markets has changed dramatically over the past several months, adopting a new strategy that I’ve been learning and tweaking for several months. It’s far from perfect, but I wanted to share its basic principles.
Since May 2014, I’ve been learning a strategy developed by veteran market technician (and fellow Chicagoan) Rob Smith, who operates a trading room at T3 Live. The foundation of Rob’s strategy is simple: eliminate market noise, and focus on aspects that we can define, quantify, analyze and execute on. The pillars of Rob’s strategy are simple:
1) Time Frame Continuity
2) Broadening Formations
3) Inside Bars
These principles are not in order of importance – each principle has equal value within Rob’s strategy. In order to identify high probability, low risk/high reward trade set-ups, it is imperative that we evaluate a stock (or any security, for that matter) in the context of these three principles. I will touch on each concept briefly, but the goal of this blog is to expand on this strategy gradually, and perhaps convince you to check out Rob’s room and join the community of “In The Blackers” that he has fostered. Finally, in today’s entry, I’ll examine these three concepts in the context of a trade I executed today.
Time Frame Continuity
When we discuss time frame continuity, we want to evaluate a stock in terms of the four major time frames: month, week, day and hour. Identifying how a stock has performed on a monthly, weekly, daily and hourly basis allows us to identify whether buyers or sellers are a) active on a given time frame and b) firmly in control of that stock’s particular movement. Ideally, we want to identify stocks that are moving in the same direction on all four of these time frames. In other words, the best opportunities tend to lie in stocks that are trading above the opening price registered on the current monthly, weekly, daily and 60 minute candlestick. If a stock is above all of these opening prices, we consider this stock to be in full time frame continuity to the upside. Buyers are firmly in control of this stock, and we should look for opportunities to enter this stock long. The converse can be said for the downside: when a stock is trading below the opening price of the current monthly, weekly, daily and 60 minute bar, we consider the stock to be in full time frame continuity to the downside.
While many traders will talk about stocks making higher lows and lower highs, one thing that Rob has identified in his years of studying charts every night is that securities will always trade in a series of higher highs and lower lows. Even if a stock is in a steady uptrend from, say, $80 to $100, somewhere along the way that stock will make a series of higher highs and lower lows on some time frame. While this may seem irrational, it helps to analyze this statement from the perspective of supply and demand. When a stock reaches a new high, it means that a new group of buyers have been identified above the previous high. Eventually, that buying pressure exhausts, and the stock retreats. This new group of buyers becomes trapped, and this will create pressure to the downside, either on a short-term time frame or a long-term time frame. Inevitably, the stock will eventually get pushed towards a previous low, whether it’s a recent low on a 5 minute chart or a major inflection point on a monthly chart. As the stock pushes towards this low, those buyers at highs will succumb to the selling pressure, drive the stock to a new that is bought up, and the stock will resume higher until it reaches the next new high. This series repeats itself, which creates a formation that can be fit into a triangle.
The first two principles are crucial in terms of understanding whether we should be looking for long or short opportunities. When a stock is near the bottom of a broadening formation and above the opening prices on the major time frames, we know that there is a possibility that all sellers who wish to sell have executed their orders, and the stock could resume upwards. In order to initiate a position in a stock, we look for inside bars. The inside bar is simple – the previous bar’s high and low prices are completely with the range of the bar that was printed just before it. These bars represent an equilibrium in trading: neither buyers nor sellers are in control of the stock, but a resolution is coming. We can look to initiate a position when that equilibrium breaks. In other words, when the high of an inside bar is breached, we can look to buy, and vice-versa on the downside. When game planning for a particular day, I tend to start by looking at stocks that have put in inside days – meaning the day’s high and low price are entirely within the previous day’s trading range.
The Strategy in Action
Today, one of the stocks I planned to focus on was Zillow Z. Zillow, an internet stock that will occasionally trade sympathetically with housing stocks (given the nature of Zillow’s business as a real estate search engine), put in an inside day yesterday (2/10), meaning an equilibrium had formed. Let’s look at $Z on the monthly and weekly time frames.
Looking at the monthly and weekly charts, I can see that $Z is at the bottom of a broadening formation on both time frames. $Z is building an inside month, which isn’t ideal, but it is above the opening price on both the monthly and weekly time frames. Based on this information, my bias today was on the long side, so I began to look for entries as soon as the market opened. Opportunities (inside bars) can be found on any time frame, but the idea is to align as many signals as possible to increase your probability of success. Let’s open a zoomed in, 1-minute chart.
When $Z opened, it put in a 1-minute hammer, followed by a 1-minute, inside bar. 1-minute bars are not ideal entries, but if a stock is volatile enough, they can be used as entry signals. My initial entry was small, and I got long at $103, when the inside 1-minute bar broke to the upside. At this point, $Z had still not broken the inside day high of 103.28. Once the stock broke that level, I added more long at 103.40, and the stock began to work higher towards $104. For me, I like to lock in some profit as quickly as possible, then look to re-add or place a stop either at break even or at some lower level of profit. Now, let’s look at the 30 minute, 60 minute and daily charts to identify where $Z could potentially go.
You can see on the 30, 60 and daily charts that $Z was trading roughly in the middle of its broadening formation in the beginning of the day. Knowing this, I took partial profits at $104.25. However, the stock began to consolidate around the $104 level, and began building more inside bars on the 5 minute chart. $Z built inside 5-minute bars at 8:55 CST and 9:05 CST that I was able to make two additional buys on. From there, the stock ran towards my “triangle resistance” in the 30 minute broadening formation of roughly $106, and I scaled out at $105.50. $Z ended up building another 5-minute inside bar at 9:15 CST, and I was able to get back in the stock and ride it through $107. At this point, the stock had run as far as my 30 and 60 minute charts had suggested, and I was satisfied to take roughly 3 points out of $Z in the first hour or so of the day. $Z actually rallied close to a second triangle resistance on the daily chart before retracing much of the move in the afternoon. Using the strategy, there were also opportunities to execute on the short side, but I’ll spare you further reading.
In the future, I hope to highlight trades like this in the realm of Rob’s strategy, and will likely provide a market commentary post or two along the way. Your feedback is always welcome, either in the comments section or at firstname.lastname@example.org. It’s great to be back, and thanks for reading!