Beware Of The Obvious Trade

Back in the 90’s you didn’t need to work hard to make a lot of money.  All you had to do was buy a cool URL ahead of the crowd and then just wait for some conglomerate who was caught up in the dot.com mania to come along and buy it, making you a multi-millionaire.

It happened time and time again.  Drugs.com went for $830,000.  Men.com for $1.3 million. Casino.com for $5.5 million.  And Business.com for a whopping $7.5 million.

I was a little late to the craze, but I’m pretty smart, and I figured I could find grab a URL nobody had thought about yet and then sit back and wait for my payday.  I went through a number of different ideas, but they all seemed to be taken.  Then for some reason, the idea of Star Trek came into my head.

Personally I’m not a fan of Star Trek, but I knew there were a lot of dorks out there that loved it and maybe that would make a URL related to the show valuable.  So I started checking the names I knew.

“Enterprise.com”…nope.  “StarTrek.com”….of course not.  I began to go through the crew members names.  “MrSpock.com”…..nah.  “MrSulu.com”……no.  “MrChekov.com”……taken.  “HanSolo.com”……damn, they were all taken.  Then I hit pay dirt.

I could not believe it.  A chill went down my spine.  How could this name have been missed?

I seriously thought that in the time between when I discovered it and when I completed my transaction somebody would swoop in and grab it.  My credit card even slipped out of my hands as I was trying to buy it because they were so sweaty, but I finally locked it down.  It was mine.

“CaptianKirk.com.”      Woot!

I was so excited that I emailed my best friend, who was in fact a Star Trek geek, to tell him of my coup.  His return reply a few minutes later brought me crashing down to Earth.  Perhaps I should have spell checked my URL before I bought it, he not so gently suggested.

But spell checking was unnecessary.  The fact that a URL with the name of Star Trek’s main character was NOT taken, while URL’s of lesser characters were, should have been a red flag that this score was not what I thought it was.

This same phenomenon has happened to me in the past with trading.  I have bought a stock because everyone “knew” a buyout was coming, only to see it tank.  I have bought an option that I thought was phenomenally mis-priced, only to realize after the trade executed that it was the wrong expiration.  It has taught me that if a trade is too obvious, there is probably something I am missing.

We recently saw a perfect example of this with the $FB IPO.

When $LNKD went public, nobody from the retail side (at least relatively speaking) was interested in it.  It was viewed with some amount of scorn and scepticism, often being talked about like a “second tier” social company.

I remember a number of non-traders in my office watching the first day’s action, who were utterly shocked when the price ran as high as $122 intra-day after going out the gate at $83.00.

They kept watching it saying, “I would have sold some here, up 10 points.  I would have sold some more here up 20 points.  I would have sold the rest of it here up 30 points.  Man, I wish I had bought this at the open.”

Fast forward to the $FB IPO, and they were all chomping at the bit to buy the first tick.  To them the trade was so “obvious.”  If $LNKD, which was the red-haired stepchild of social, rocketed up on its IPO, it just went without saying that the gold standard of social would do even better.  It was also “obvious” to half of America that they could make a fortune flipping this IPO.

Of course we all know how this story has played out since.  $FB may in fact come back and surpass it’s IPO price one day, but a lot of these neophyte traders have become investors on this “obvious” play.

Eventually, with time and experience, you will quickly be able to identify why a trade is too obvious, and discard it.  But if you are not at that level yet, a good rule is to re-check your trade, then re-check it again.  And if it still seems too obvious, ask one of your fellow trading friends to check you, just to make sure you are not missing something.

I Will Kill Myself If Apple Doesn’t Go Up Tomorrow – Tales From A Margin Clerk.

[Last week a reader who had recently come my posts on suicide trades and deadly sins of trading wrote me a very interesting email regarding his job as a Margin Clerk.  He was kind enough to allow me to use it here, though he requested anonymity.]

I’ve been a Margin Clerk for a long time with various discount brokerages and I see Suicide Trades everyday.

I was a call center rep in 2001, who was told he was now a Margin Clerk. The Margin Clerks couldn’t keep up with the volume, and I was sent over to help out. They handed me a list of about 250 accounts with calls under $25,000 and told me to start dialing in order to clear as many as I could before Clerks started selling.

During my first week, I had a college guy tell me he would kill himself if $AAPL didn’t go up tomorrow. He was a 22-year-old college guy who had bet all the tuition money his parents gave him on $AAPL. I immediately told the Supervisor, who looked at me and said, “You think I care? Worse case, it becomes an Estate account. Now, keep calling.”

So, those 22-year-old college guys blowing up their 5k accounts at Charles Schwab-like firms do kill themselves. To be honest, I don’t know if the college guy killed himself. There were so many Margin Calls back then you didn’t remember names. I do remember $AAPL went down further the next day.

I do remember some names, though.

I remember the farmer’s wife who called crying, when she figured out her husband had cash advanced any credit cards he could get to cover his margin calls. He had also leveraged the farm. She was in her late 50s and a stay at home mom whose husband took care of the finances.

She figured it out when the collection agencies started calling and she took the pile of mail her husband had started ignoring to her bank account manager. She was desperate to get her husband to stop trading, but knew if she confronted him it would mean divorce.

I remember the guy who killed himself over a 50k account. It was his life savings that he’d put into “safe” mortgage-backed product in 2007. Ironically, the bank paid out his Estate a year or so later and his widow got all the money bank.

There are others, but I’ll move on. You asked about rules, so I’ve got some.

1) Unless you drive your car with your eyes closed, don’t enter market orders outside of market hours. You know how many $FB trades I saw on IPO at MKT? Nuts…

2) Triple-leveraged ETFs are not buy and hold. Learn how percentages work. 10% down doesn’t equal 10% up. I’ve watched a lot of clients lose their life savings trying to hold things like $FAS & $FAZ when they went against them.

3) Don’t trade “size”. Size does matter – it’ll blow you up really fast. I watch people on Twitter talking about trading “size” all day and I shake my head. They talk about it like it’s a badge of courage, when it’s the badge of the fool. Size = concentration. That’s great when you are going up, but when you go down – you will die.

4) Don’t change your investment plan on the fly. I see people all the time start with an investment plan, only to change it for the worse. A) They decide they are a Trading God, because their account is going up, so everything they buy must go up; or B) They are losing money and get desperate to make it back. Usually, it’s A then B. As time goes on, they take on greater and greater “size” and greater risk.

I cannot count the number of accounts I’ve watched blow up doing this. Look through your transactions. If last year you were trading a diversified blue chip account, and now you’re concentrated in a few “sure-thing” OTC bets – think about it.

5) The money you lose is real – it’s not just numbers. If you actually had to hand me $100 bills instead of keystrokes, would you make that trade? If you were down that much at a casino, would you walk away? Think about it before you press verify on the next order.

6) I’m not your friend and I don’t know you. But, I might be the only reason you stay solvent. Lots of people bitch about that stock that the Margin Clerk sold at the 52Week low, only to watch it rebound the next day. What they don’t talk about are the positions we force people out of all the time that continue to deteriorate. If I’m calling you regularly, you are doing something wrong.

 

Have You Defined Your Blog Rules Of Engagement?

My good friend Jeffrey Ishmael has brought his blog CorpFinCafe back to life after a two-year self-imposed hiatus.  Jeff is a wicked smart CFO of a major retail apparel manufacturer as well as a kick-ass cyclist.

His blog is about the financial issues that public and private companies deal with from a compliance, investor, and social media standpoint.  His first “re-grand opening” post is entitled, “Have You Defined Your Blog Rules of Engagement.”  Here is a taste…

With a recalibration in mind, let’s take a look at some of the more basic ground rules that should be in place for a blog for a corporate finance professional:

  • Specific numbers should never be discussed, regardless of whether it is already in the public domain or not. Leave that to the reporters.
  • If you find yourself working for a public company, refrain from discussing, even generally, initiatives or change management, regardless if it might be in the past.
  • If working for a private company, make sure you have an understanding of the culture and how your writings might be viewed by management…as a liability or a signal of the value you bring to the company.
  • Even if you don’t work there, is it appropriate to discuss your efforts there and the initiatives/improvements you managed. There are a few companies in my resume that I simply don’t discuss in this forum.

And…

Great, so you’ve just taken away a lot of my day-to-day experience that I can write about…what do I have left? When it comes to strengthening your skills as a Finance professional there is no shortage of topics that you can choose that can continue contributing and impacting your personal growth.

  • While you’re going to be part of a larger “reporting” group, you can always choose new developments in accounting topics that are of particular interest to you.
  • Discuss situational experiences with colleagues at other companies, what they were challenged with, and the strategies they employed.
  • Are there any recent books related to your functional area to write a review on?
  • Are there any industry or professional summits that you attended which would be of interested to your readers?
  • What professional organizations do you regularly contribute to? I’ve been a member of FEI for 3-years and expanded my contribution to the Board last year, which has provided some great discussions and content.
  • Are there any recent magazine articles or interviews that you have an opposing view on.

Give it a look.

“Have You Defined Your Blog Rules Of Engagement?” via CorpFinCafe.

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What bclund is, is the intersection of markets, trading, and life (with some punk rock, pop culture, and off-beat humor mixed in).

How You’ll Know When A Tradable Bottom Is In Place

The talk for weeks now has been about this market and how oversold it is.  Everybody is looking for a bottom.  Let me rephrase that…everybody is looking for a tradable bottom. One has yet to arrive.

Will it come tomorrow?  Next week?  A month from now?  I don’t know Babs, but I do know this; it’s the wrong question to be asking anyway.  It’s not “when” will the bottom come that you should be asking yourself, but “how will I know it?” when it does come.

The short answer is “you won’t,” at least not with any quantifiable tool or indicator.  This is one of those times in trading when you can take your MACD’s, and oscillators, and overbought/oversold indicators and put them in a box with your bell bottom pants and Members Only jacket, because that is how out of touch and useless they will be.

The reason for this is because price action is not normative during the bottoming process, and thus (temporarily) changes the mechanics of a market, which skews most indicators. Oversold indicators can stay oversold for a long, long time.  Price can extend a long way away from moving averages.  Double bottoms, support levels, and other price regulators become irrelevant.

The only way you can recognize a market bottom when it’s happening in real-time is to feel it.

I know, can you believe that I actually just said that?  Mister “risk/reward ratio” guy.  Sir “quantify your trading” man. Mademoiselle “pretty boy”…wait, strike that last one.

But it’s true.  Take a look at this chart of the $COMPQ from yesterday and the tweets I made regarding finding a bottom.


Neither of those tweets were particularly heroic, nor were they really actionable.  But I did get a number of emails asking me what I was looking at in order to say what I did, when I did.

The best reply I could come up with was, “that was the way the market felt at the time.”  It sounds weak I know, but finding the actual bottom is not a quantifiable process in real-time, which is why it makes it one of the most dangerous times to be trading.

Feel is something that can’t be taught, it has to be learned, and not everybody learns it the same way.  It’s intangible.  It’s ethereal.  It’s The Jimi Hendrix Experience.  It’s taking a jazz drummer who plays behind the beat, combining that with a rock guitarist who plays ahead of the beat, and throwing in a first time bass player who plays right on the beat, and having it come out sounding like magic.

So in that context, I can tell you a few subjective things that I have found over the years that tell me when a bottom is near:

  • The streams and media will go from “we’re near a bottom” to “we will never find a bottom.”
  • Certain perma-bulls will go bearish, and certain perma-bears will crow that they are shorter than they have ever been.
  • Morning drive time DJ’s will spend the first 15 minutes of each show talking about the market.
  • Rumors of forced liquidations, margin calls, and heavy redemptions in big hedge funds will start circulating.
  • Lawmakers will start grandstanding, acting as if anything they can do will stop the market decline.
  • You will see a ton of “oh my God, look at (insert well-loved stock here)” tweets.  Think $AAPL.

There are also two relatively more objective things I look for when determining the actual real-time market bottom.

It’s almost impossible to hit a bottom without a massive price/volume spike down on a 5-min chart.  Some call this a “flush” but I like to call it a “puke” because people are literally “puking” out their positions, causing this market action.  Watch for it.

But the real nail in coffin for me is price action that makes all my charts “jump.”  Meaning that long red bar in the hard right hand bottom that moves so fast it re-scales all your charts simultaneously.  They literally seem to be “jumping” towards the bottom of your monitors. It’s hard to articulate, but it’s kinda in the vein of what Supreme Court Justice Potter Stewart said to describe his threshold test for pornography, “you’ll know it when you see it.”

If you keep these factors in mind and spend enough hours looking at the markets, anybody should be able to develop their own “feel” and have a reasonable chance of being able to tell when a tradable bottom is in place.

The 7 Deadly Sins Of Trading

Trading is wrought with all sorts of trading sins, any one of which can lead you down the path to making a suicide trade.  And although there are probably hundreds that I could come up with, these seven are perhaps the deadliest ones to avoid and help make my post title sound more liturgical.

Playing Earnings –  Holding into earnings is just begging to be hit over the head with a black swan.  Not unlike playing Russian roulette, even if you have the odds on your side, in the event that things go against you, the effects can be so devastating that your account may not be able to recover.

There are complex ways to play earnings with options that can limit your downside, or help protect the profit of an existing open position, but for the average trader it is just best to be flat or have a very small position going into an earnings call.

Pulling Stops – Every 5% loss starts with a 1% loss.  So does every 10%, 25%, 50% and 100% loss.  Just don’t do it.

Trading Tips – I have probably been give more than fifty “sure thing” tips since I began trading.  The thing about tips is that they always sound like they have rock solid provenance, yet the vast majority of them are a bust.  Don’t be fooled by the story or the storyteller, who may actually believe the info they are telling you.

Once I got a tip on Home Base, which a friend assured me was going to be bought out by Lowes.  His “source” actually saw the deal memo on the desk of the CEO’s secretary. They eventually went BK.

Another tip I once got was that Platinum Software was going to get bought out.  This tip came from the cousin of Platinum’s CEO, and it turned out to be true, they did get bought out.  Unfortunately it was a “takeunder” where the target company gets offered less per share than it is actually trading for.

Stay away from trading off of tips.  Remember that line in Wall Street where Gekko asks Bud Fox, “What are you, 12th man on the deal team?”  By the time you hear about a tip, Bud Fox (pre “I bagged the elephant Marv”) will look like an insider compared to you.

Technical Rationalization –  This is a sin that those who use technical analysis are often guilty of.  To better explain it, let me channel the spirit of my dinner guest from last Friday night.

“It’s not so bad.  It’s not so bad.  It’s not so bad.  It’s not so bad.  It’s not so bad.  Hey, why is that bclund guy ripping open my abdomen and pouring drawn butter all over me?”

In trading terms it work like this…

“My stock failed a breakout, but it’s still in the upper end of the range.  It’s still holding the 5ema.  The 9ema.  The 20ema.  It’s still holding the trendline.  Still above a support level.  It’s below the bottom of the Bollinger Band.  Still above the 100sma.  The 200sma.  Still trades on an exchange.”

You can always find a technical reason to hold a losing stock if you want, which is why it is critical to use price action and money management techniques in tandem with technical analysis.  Don’t allow yourself to rationalize away your account equity bit by bit or you will end up in worse, and less delicious shape than my lobster friend.

Chasing – Very rarely does chasing in any aspect of life pay off.  You chase fashion and you look like a Project Runway reject.  You chased that girl around in college and now you’re married to her, so that didn’t work out too well (note to self, remember to duck when entering the house tonight).  It’s no different when trading.

Here is the thing about chasing; there is almost no way that you can chase a stock and still be able to use good risk/reward ratios on the trade.

By definition, if you are chasing a stock it means it is breaking out (or down) through a congestion zone,  a S/R level, or a pattern, all of which you key off of to set your risk ratio. The farther you have to chase a stock past those inflection points, the larger your risk factor becomes.  Even worse is the psychological aspect of chasing.

When chasing you often feel you are “missing out” on a move, which puts you not in a mental position of power and control, but of weakness and helplessness.  That is not a good mindset with which to enter and manage a trade.

Avoiding Decisions – A very good trader I know once told me that whenever he began cleaning his office, he knew he was in trouble in a position.  It was a defense mechanism and his way of avoiding having to make a decision about an open trade.

“I’ll just give this position some more room,” he would say, and then organize his desk, empty his wastebasket, and neaten up his bookshelf for 30 minutes or so, hoping that when he came back to his screen his position had righted itself.  More often than not, it didn’t.

I have heard of successful traders who put on trades and then turned off their computers or even left their offices until near the close of the markets, the most famous being Ed Seykota from the ‘Market Wizards” book.  But these traders had stops and often target orders live and in place before they “checked out.”

They were avoiding the markets in order to “take themselves out of the trade” and let it work, not to avoid dealing with a position that was going against them.

Bottom Picking – The problem with bottom picking is that it can work for a while.  Even if you don’t pick the exact bottom of a stock or the market, you can sometimes get in close enough to the bottom and then make some good money when the rebound comes.  This gives you a false sense of security that you know what you are doing and deceives you into thinking you have a sound methodology, even though you really have no methodology at all.

It always works until it doesn’t; and not unlike trying to play earnings, the losses when it doesn’t work are so devastating that they can end your trading career.

When the markets are imploding, the key is to wait until you think they have hit bottom, and then wait a little bit more.  When you think it’s getting bloody, wait for more blood.  When you think the financial structure of the markets is about to collapse, kick back and have a beer for a while.  But most traders don’t have the patience for this, nor to they have the discipline to take small initial positions, saving enough dry powder to add when the first “bottom” fails.

Hey, I said “seven deadly sins” but I am a giver, so here is a “bonus” sin.

Blaming – There has always been somewhat of a “blame game” in trading, but in recent years it seems to have reached epic proportions.  Brokers, market makers, HFT, algos, analysts, The Fed, Bush, Obama, Greece, hedge funds, the list is endless of who I see getting the blame for people losing money in the markets.

If you blame anybody but yourself for your losses you are destined to blow your account up and get washed out as a trader; it’s as simple as that.

Time Doesn’t Heal All Wounds In The Market

In 2001 I was “the bomb.”  I mean I was the big swinging dick, the axe in the markets, the “schnitizel.”  That’s what the cool kids say, right?

My god-daughter was born just two-years earlier and I was in love with her.  I decided that I would do the god-fatherly thing and guarantee that her college education was totally paid for.

It would be easy because I knew them markets baby, and I could trade them like a pro. There was this hot stock called $CSCO that was having a temporary pullback. Buying it at $30.00 was  friggin’ steal.  Besides, I had sixteen years until my god-daughter would be going to college and by that time $CSCO would be probably at $5,734 per share.

It didn’t quite work out for me like I had planned, which I was reminded of when John Chambers, or as I like to call him “The Spectre of Death,” announced earnings yesterday that will put $CSCO back to 1998 prices.

I have a lot of ground to make up in the next six years, but I think I can do it.  And now I have to focus on my own kids college education which is 12 and 15 years away respectively.  But I think I have that one clocked, as I just put some money in $NFLX and $GMCR.  By the time my kids are ready for college, well those stocks should be.

 

How Pain Can Make You A Better Trader.

[Note: This is the analog post to my recent “How To Master Trading Discomfort To Improve Your Results.”  Traders will relate differently to each post, but the goal is to use the one that fits your personality best in order to improve your trading.]

I have to say that I really enjoy reading the comments on my blog.  Instead of the usual trolls that tend to inhabit most public blogs, I seem to get a pretty cool mix of people who have something nice or useful to say.  And sometimes a comment provides the inspiration for a new blog topic, like the one I got from “Alex” the other day on my “5 Rules For Trading A Reversal Hammer” post.

This is a good setup, I’ve seen it happen a lot. Usually I am on the side selling at the point when all the sellers are exhausted though.

I feel your pain Alex, cause I have been there a number of times myself.

I always remember the trades I lost big on or the poker hands where I got a bad beat because the pain of loss is more acute than the joy of winning.  Pain makes more of an impact on me, which I think is just human nature.

Think about it.  If you walk down the street tomorrow and ninety-nine people smile and say “hello” as they pass you, but one A-hole sneers and says, “what are you looking at jerk?” who will you remember at the end of the day?  The ones who made you feel warm and fuzzy, or the one who made you say “ouch”?

Many of life’s lesson, both big and small, never really seemed to “stick” when I was younger until there was some pain associated with them.  For example, pushing in a half opened tab on a beer can with your thumb is perhaps not the wisest move; yet I did it all the time in my younger days.  That was until once while on vacation in Australia I tried to do it with a frosty cold can of delicious Victoria Bitter lager.

Pro Tip: Blood and beer don’t taste good together.

I often look at the small crescent shaped scar this incident left me with and remember what an idiot I could be (…okay, still can be) at times.

It was hard to make this photo not look phallic…!

I know a lot of great traders who have a “zen-like” way of approaching the markets, and are able to trade pain free, but for the rest of us, pain can be used to make you a better trader.

The hammer reversal setup that Alex was commenting on was one I had read about and had been explained to me too many times to remember, but that is not what finally got me to understand it and how to trade it.  It was being on the opposite side of that trade and experiencing the pain of getting in too early that finally rang my bell.

It seemed that just when I got to the point of max pain and finally closed my position out for a loss was when price reversed, which was just like dumping a ton of kosher salt into an already gaping wound.  But that pain focused me, and each time it happened I figured out a little bit more about what I was doing wrong.

Even to this day, in a fast moving market where I am looking to play a bounce,  I will sometimes take a very small position, as small as 25 shares, in order cause me a little pain.  In this scenario, stop loss and risk/return concepts are irrelevant because the $ loss is so insignificant.

But it’s not the $ loss that causes me pain, it’s being wrong.  A small position going against me, causing some pain, will once again focus me and makes me better able to find the correct setup to add to the tester position and make it a full position.

Pain is very powerful if you know how to use it.

If you are trading bad, racking up losses, causing yourself pain, don’t thrash back into the markets trying to make it go away, or throw your keyboard, or yell at your wife. Instead, don’t do anything;  just hold that pain.  Imprint it into your head so you remember what it feels like.  And think of how nice it would be to avoid that pain in the future.

Now use that as motivation.  Go through your trades tick by tick.  Remember what your mindset was contemporaneously and identify flaws in your thinking and execution.  Take each of your losing trade charts, drive your ass down to Kinko’s, and get them blown up and printed out.  Mark these charts up and hang them right over your trading screen as a reminder of the pain they caused you and what you can do to avoid that pain going forward.

And of course the ultimate goal is just that; to get to the point where you don’t need the pain in order to trade successfully.  But until that time, The key is not to fight pain, but to harness it and use it to your advantage.

 

10 Fascinating “Then And Now” Facts About The NYSE


1792 -There are five securities traded in New York City.  Three are government bonds and two are bank stocks.

Now – There are approximately 8,000 listed issues on NYSE Euronext.
___

1823 – Fredriksen Lunde, my great, great-grandfather emigrates to the U.S. from Sweden.  He passes on buying a seat at the NYSE as he feels capitalism is “a fad.”

Now – Every year, on the anniversary of his passing I visit his grave and throw lingonberries at the headstone.
___

1886 – The Exchange experiences its first million-share day on December 15th.

Now – NYSE Volume yesterday was 3,564,732,250.
___

1942 – A membership sells for $17,000, the lowest price in the twentieth century.

Now – Before going public the highest price paid for a NYSE seat was $4 million on December 1st, 2005
___

1952 – The NYSE, in its first shareholder census, finds that 6,490,000 Americans own common stock.

Now – Stock ownership peaked when 67% of Americans owned stock in 2001, and as of 2012 sits around 54%.
___

1974 – Trading hours are extended from 10:00am until 4:00pm.

Now – NYSE Arca pre-market 4:00 am to 9:30am EST.  Regular NYSE trading until 4:00pm. Arca Extended Hours 4:00pm to 8:00pm EST.
___

1993 – Daimler-Benz AG becomes the first German listed company.

Now – 421 non-U.S. companies valued at $ 11.4 trillion trade on the NYSE.
___

1996 – NYSE listed company Oakley ($OO) misses earnings and massively gaps down, cutting my trading account in half.  The stock never recovers.

Now – I only wear Ray Bans.
___

2001 – Decimal pricing of all NYSE stocks is fully implemented, ending the practice of trading in fractions used for two centuries.

Now – Pricing regularly goes six places past the decimal (i.e. $44.419900).
___

Now – I decline to buy $FB at its IPO and ridicule the stock as overvalued and “a fad.”

2052 – I am sent to the “home” after punching my adult grandson in the mouth when he asks “hey grandpa, why didn’t you buy $FB in the years before they bought $MSFT, $IBM, $AAPL, $BIDU, and $GE, becoming the biggest company in the universe?”

5 Rules For Trading A Reversal Hammer

There is a school of thought that a trader should focus on one or two “bread and butter” type set-ups and get as good as they can at them.  It’s something that I used to read about on Trader X and the Wall Street Warrior’s blogs, and I have come to totally agree with.

I have found one of the more reliable intra-day setups is to buy off of a reversal hammer, however there are a few rules I follow in order to raise the percentages is my favor.

1.  There has to be an “aggressive” downtrend preceding the hammer; in fact the more violent and bloody the better.

2.  You want to see a large volume and price spike on the candle before the hammer.  This is key because it usually means that the last group of longs are “throwing in the towel” en masse.

3.  The hammer has to reverse in/at a previous support level.

4.  The hammer has to be green, and the closer to a hammer opposed to a doji the better.

5.  The overall market direction should be up, flat, or slightly down.  Trying to catch a reversal hammer when the broad market is down big on the day is a losing game.

This chart on $AAPL illustrates an almost a perfect reversal hammer set up.  The only negative is that the actual body of the hammer is not as big as I would like it to be.

Some traders think that you should wait for an inside consolidation bar after the hammer before you buy the break, but I don’t agree.  The dynamics of a hammer reversal, with the spike down on volume and price, as well as the long tail of the hammer itself, should mean that all sellers are exhausted, at least temporarily, and price should move back up fairly strongly.

A consolidation bar tells me that buyers are not easily overpowering sellers, and that the hammer may just be a temporary pause before a new round of sellers come in.

Once you have bought the break of the hammer’s high, if you are a conservative trader, you should take a partial when price touches the 9 EMA.  If you are an aggressive trader, you could take a position based upon 50-75% of the hammer’s length instead of the total length, and also take a partial at the 9 EMA.

The most conservative way to play a hammer reversal is to not buy the break of the hammer, wait for price to bounce, settle back down to the support area, and form a second hammer.  You could then buy the break of that hammer.

 

How To Place More Effective Stops

Having been on both sides of the aisle; the trader side and the brokerage side, I think I have a different perspective on the this issue of stop placement than most.  During the course of the day I see a lot of what goes on in the soft underbelly of trade executions and I also talk to a lot of traders who initiate those executions.

One of the complaints that I often hear from retail traders is, “I can’t believe it, they hit my stop and then ran the stock right back up.”  This is definitely one of the most frustrating things that can happen to a trader, and when I hear it my empathetic response is…

“No duh?   Of course they hit your stop, they knew right where it was.”

But they are not supposed to be able to see your stops right?  And if they can’t see them, then how can they go after them?

More on that in a minute.

First let me take a moment to clarify who “they” are.  To tell the truth, I don’t know who “they” are, but I watch “their” actions every day.  They could be market makers, specialists, bots, HFT’s, Algo auto-traders, a combination of all of them, or just the market mojo driven as a whole by the spirit of the late Paul Lynde.

It doesn’t really matter what the mechanics of it are, it’s just the results of those mechanics that matter.

The bottom line is that many entities in the market benefit by volume, and they do anything they can to create that volume, like triggering your stops with only a quote instead of an actual trade which I have written about before.

This type of market action has changed the rules of trading, and let’s face it, the rules of trading have always been pretty dicey to start with.

If you had a 50/50 chance of a certain trading rule holding up in past markets, it’s now more like 25/75.  Of course I am just pulling those numbers out of my ass, but you get the point; the market has changed, and you have to change the way you trade it, especially when it comes to placing stops.

Let’s start with an illustration that I painstakingly created in a very high-end program called Microsoft Paint.

In days of yore, the way this trade would have been played out is that you would have waited until a double bottom was put in at point B, entered on the bounce, and put a stop in below the red line.  If your trade did indeed fail and stop you out, it would normally continue on down to new lows.  But that’s not how it works anymore.

More often than not, before the trend completely reverses and moves back up, you get one last shiv, as price quickly drops below the double bottom to point C, and then just as quickly reverses back up above the support line and continues to run higher.  This is when I hear the retail traders start to holler about their stops being hit, run, liquidated, or “spanked” depending on what they are into.

So can they see your stops and go after them?  No they can’t, not in the sense you think they can.  In past days if a large human participant wanted to try to run the stops, well they didn’t have to be a genius to know where everybody and their brother put their stops.  Just by looking at a chart and understanding human nature they could figure that out.

Today in the world of robo-trading, “they” know the same thing, it’s just that they are programmed to know instead of having a live human being drive the strategy.

So “No!” Mr. and Mrs. retail trader, they are not running your 100, 500, or even 1000 shares of XYZ, they are running the 10’s of thousands of shares of XYZ that they know are sitting just below the double bottom of the day.  And if you are buying a breakout, it’s basically the same concept.

Price runs up, pulls back, bases, proceeds to break to new highs, but then pulls back to point C and the wehewqlkg etoetdg=reegr.g.gge;wp  %$$%()SSQds…….

Sorry my cortex just snapped from repeating myself for the millionth time.  I don’t need to belabor this point, you get what I am talking about here.

So the big question; how can I put in more effective stops?  There are basically three ways to do it, each of which I will make up a random and important sounding name for.

The Johnny Sokko And Giant Robot Method:

This involves adjusting your position size based on a “stop plus” methodology.  Normally by knowing the spread between your entry and your stop below support, you divide that into your max $ loss per trade and that is your position size.

But based on the new market dynamic you need to add a “plus” factor to your stop, in essence making your position size smaller, but giving you a better chance to not get shaken out on a run of the obvious stop level.

What you use for a plus factor depends on what type of asset class you are trading, the specific traits of the instrument in that class, and the overall market tenor.  A suggestion would be to start experimenting with a fixed percentage of the ATR and adjust depending on the results you see.

A Rainbow In Curved Air Technique:

Here you would actually anticipate the run of the stop area at point C on the above charts and put a limit buy order there.  Basically you are not buying support anymore, you are buying “support minus.”  What your minus amount is once again would need to be experimented with, but as a variation you could break your position into two or three limit buys in a range below support.

The advantage to this method is that if you do get filled below support and price does not rally back over that level, you can be reasonably sure that support has truly failed and price will continue lower making your stop out a no brainer.

The Larry Tate Experience:

The last method is a hybrid of the previous two for those that worry they will “miss a move” if they try to buy below support.  I mean what if price never gets there and they don’t get filled right?

Instead you take a half position on the bounce off of (or past) point B.  If price continues to run so be it, but if it makes a stab past support to point C, you have some dry powder to grab the second half of the position.

This ultimately gives you a better average price, and once again allows you more room for price to run back up before stopping you out, though not as much room as the “Rainbow” method.

Conclusion:

It is a common saying that trading is “chess not checkers,” but these days it is more like that 3D chess game that they had on Star Trek, with a helping of Dungeons and Dragons, and some poker thrown in.

You can no longer think in a “logical” way and have to be able to modify the traditional trading rules when it comes to stop placement and trade management.  And even more critical is the ability to think on different levels, many moves ahead, and be willing to evolve your methodology for the ever-changing market.