Sunday, April 26, 2009

Advanced Stock Trading- Part 6


This weekend was a perfect sunny day. I woke up late in the morning and was breakfast at my local diner, when my phone rings.
It was Bob.

Bob: Hello Sanjoy! Would you like to go to Master Wong's place?

Sanjoy: Sure! Get your car and meet me at front of my house.

At Master Wong's place, the assistant led us to his living room.

Master Wong was seated on the floor. Another gentleman was with him. He was short, plump and had a jolly smiling face.
They was watching the full wall high definition television. A sumo wrestling match was in progress in the television.

Master Wong: Hi Bob, Sanjoy. Meet my friend, Mr. Lee. He is a marketing vice president in Japan. He just came last night at 1:00 AM. Bruce, was it 1:00 AM or 2:00 AM?

Bob: Hello! Nice meeting you. Your first name is Bruce? Like Bruce Lee the Karate expert?

Bruce Lee: Oh my!! You are the millionth person to tell me that. Yes! That is my real name. Serious! After Bruce Lee became famous, all the bullies in my school used to beat me up just to boast that they have beaten up Bruce Lee.

Sanjoy: Which company do you work for?

Bruce Lee: You see that Sumo wrestling going on television. I market Sumo wrestling events. I go to big companies and market these events and get them to sponsor these events. Sumo wrestlers are big celebrities in Japan, just like base ball players or boxers here.

Master Wong: Lee, at present, I am teaching Bob how to trade. Just a few weeks ago, I taught him the "FIGHT UNTIL DEATH" technique.
Bob, can you describe this technique?

Bob: Sure. Here, the bulls and bears fight among themselves. Both get weaker and weaker, but they refuse to give up. We can see that the chart makes a triangular pattern. In the end, one of them concedes defeat, so either the stock breaks out on the upper side or breaks down.


Master Wong: Correct, and because the bulls and the bears get weaker and weaker, and you can see the chart goes on tapering in a triangular pattern.

Sometimes, the bulls and bears still maintain their strength instead of getting weaker and weaker. If they both fight and struggle but maintain their strength, the stock chart does not taper off into a triangle pattern. It forms a rectangular channel pattern.


Master Wong: Now, let me teach you another pattern. Imagine that there is a boxing match between Mohammad Ali and Mike Tyson.

Bruce Lee: Oh! Master Wong! They were both great boxers but they were in different eras.

Master Wong: Oh yes, I know that. Just imagine that both are young and are in the boxing ring. Who would win?

Bruce Lee: It will be difficult to say. Ali was the greatest boxer of his time. Tyson was also good when he was in his peak state.

Bob: I still think that Ali would defeat Tyson.

Master Wong: OK!, Let us assume that Ali manages to hit Tyson two three times. Now, Tyson is running away from Ali in the ring. Can you imagine this? Tyson is feeling that he is about to get defeated. Then, Tyson makes a gesture and two of his friends from the crowd get into the ring to help him.

Sanjoy: Hey! That is not fair! You can not call your friends to help you in the ring.

Master Wong: Let us imagine that you can call your friends to help you. Now, Tyson and his two friends proceed to hit Ali. Now, it is Ali's turn to be afraid. He tried to run away from Tyson and his two friends. Then, Ali calls his friends for help. Three friends of Ali jump into the ring. Now, Tyson and his group is outnumbered. Ali and his friends proceed to beat up Tyson and his two friends.

Bob: Now, Ali and his group is winning.

Master Wong: The story is not over yet. Tyson calls four more of his supporters for help. They jump into the boxing ring and start beating Ali and his three friends.

Bob: This is going nowhere. It will be so difficult to predict who will win this funny match. In the end, the person who can get the maximum number of supporters will win. But, we can not predict who has the maximum number of supporters.

Master Wong: EXACTLY! This is what I wanted to hear from you. I will show you a stock chart pattern where this scenario happens.

Master Wong motioned his assistant to bring the drawing board and drew the following.


Master Wong: See the chart here. As the stock goes up, the bears who are getting defeated panicked and called for other bears to support them. As more bears jump into the battle, the stock dives down and the bulls take a beating.

But, then the bulls call other bulls for help and more bulls jump into the battle and the stock then jumps up till the bears and their buddies overpower the bulls again.

Bob: Hey! This shape just looks like a microphone. This is so confusing. I do not know whether to buy or sell. If I buy then if the bears call more of their friends, the stock will go down and suffer loss.
If I sell and the bulls call their friends for help and the stock moves up, I will again suffer a loss.

Master Wong: Yes! Absolutely correct. So, here is the rule. If you see this MICROPHONE pattern or a broadening triangle pattern, just stay away from it, because you never know which side would win.

Sanjoy: Master Wong, is there no way you can trade this?

Master Wong: Heeh, Heeh Heeh!! There are ways to trade this, but I wanted you to understand the background of how this pattern is formed. Once you master the basics then we will go to advanced concepts. Bob, did you understand how this pattern is formed?

Bob: Yes, I understood this pattern perfectly and I can recognize this pattern in a stock chart. It will be shaped like a microphone or a broadening triangle.

Master Wong: Perferct. Here is how to trade this.See the following figure. Here, the bulls called their friends for help and the prices started to go up. Suddenly, the prices just turned around and then started to go down again.

Bob: Uh Oh!! This is a bad sign.. The bulls, even with help of their friends could not go up. The bears will surely defeat them this time.

Master Wong: Correct. You can just short the stock when it starts going down and place stop loss at the peak formed. Did you understand this?


Bob: Yes, I understood it.

Master Wong: Now, look t this figure. The stock had gone up, when the bears and their friends returned to push the stock down. However, suddenly, the stock turns around and goes up. Now, this is a bullish sign. The bulls have defeated the bears and their buddies.

Bob: If I may say so, you should buy the stock when it turns around like this and place the stop order at the point shown. Am I correct?

Master Wong: Absolutely! You got the idea. Mr. Lee, how do you like our training session.

Bruce Lee: Wonderful. Very educative. I wish I could also trade, but I am traveling all around the world. Most of the time, I am on the place. So, I do not have time to check the stocks daily.

Master Wong: Lee, These stock patterns which I teach work on all time frames, since they re based on the behavior of the crowds. So, you should try trading using a weekly or a monthly time frame. Then, you can just go over your charts every week end instead of every day.

Bruce Lee: Aaah haah!! That sounds like a good idea.


Master Wong: Bob, here is your next assignment for the week. Go through all the charts in your watchlist and search for this microphone shaped pattern.
See if you had a trading opportunity or not. Most of the time, you would not be able to buy or short. But if there is a failure of the bulls or bears, then you can trade.

Monday, April 20, 2009

Advanced Stock Trading- Part 5


The next week, I and Bob went to Master Wong's house to meet him.

Master Wong was sitting near the swimming pool.

It was a perfect pleasant and sunny weekend and it was fun to sit near the pool.

Master Wong: There are two types of swimmers who use the swimming pool.
One type of swimmer comes near the pool and directly jumps into it.
The other type of swimmer is more careful. First, he comes near the pool, then dips his toe in the pool water to see how cold or how warm it is.

If the pool water is too cold for him, he goes away and does not swim.
If the pool water is warm, he slowly goes and submerges into the swimming pool.

Bob: Yes, I know. I am of the second type. I always test the water to see if it is too cold or too hot for me.

Sanjoy: Oh! I am of the first type. I just plunge into the pool. If the water is cold, your body will get used to it and you will not feel cold after some time.
But it is more fun to just jump in the pool and not think about the temperature.

Master Wong: The reason I am telling you about this is because that is the behavior different stocks exhibit when they cross the 50 day moving average. As you know the 50 days moving average is one of the most important indicators watched by traders and financial institutions.

When the stock crosses the 50 days moving average, it can do it in two ways. And I will explain how to deal with each situation.

Master Wong asked his assistants to bring a drawing board outside.

He then drew the following.

Here is a typical stock that touches the 50 days moving average many times. It touches and then moves away and then touches. Ultimately, it breaks down and then goes below the moving average,

If you see this, do not short at point A or point B.

You wait patiently for the stock to come up again. Usually, if the stock is so hesitant to go below the 50 days moving average, it will again test and jump up and try to touch the 50 days moving average after crossing it from below.

Note that at point C, it tried to go up and touch the 50 days moving average again, but failed and is going down. You should SHORT the stock at point C as it offers the point of minimum risk.

Later, the stock makes a lower high and a lower low at point D, which is a sign of down trending stocks.

Bob: Oh! I see. This is a new way to look at the stock.

Master Wong: Yes! And then there are other type of stocks. They just PLUNGE through the 50 days moving average.

When a stock plunges through the 50 days moving average, it indicates that the big traders are desperate to sell the stock.
For those stocks, you should short the stock as soon as it plunges through the 50 days moving average.

Bob: But, how do you define PLUNGE?

Master Wong: If the length of the stock price bar is much longer than the previous 8 or 9 bars, it means it is a plunge.
So, you have to look at the range (which is the difference between high and low of the bar)

Bob: Oh!I see. In the figure, at point A, there is a bar which crosses the 50 days moving average on a huge range. This bar is larger length than the previous 8 or 9 bar.
So, I would short at the next bar after point A.

Master Wong: Correct. Also, stocks having this type of pattern can be detected using DreamTai.
After you load the stocks, DreamTai opens a browser window and show different stocks with different strategies.
This strategy is one of the strategy detected by DreamTai and the stocks which satisfy this pattern are displayed on that browser page.

In short, now you know how to handle a stock when it crosses the 50 days moving average.
It it crosses on a large range, you can short it.
It it goes slowly below, you wait for it to retrace up and then short it.

Next time, I will show you some other patterns to profit from.
Here is an assignment for you. Go through your stock lists in DreamTai and try to identify stocks which are moving through the 50 days moving average on large ranges.

Sunday, April 12, 2009

Advanced Stock Trading- Part 4


The next week, I and Bob went to Master Wong's house to meet him.

We were at his study admiring the painting on the wall.

"Did you watch any James Bond movies lately?"

We swung around.

It was Master Wong.

Bob:Yes, I have seen many Bond movies. Why?

Master Wong: Usually, in the end, there is a fight unto death between the hero and the villain. Of course, in the end, Bond always wins.

Today, I will show you patterns which show the fight to death between bulls and bears.Only one of them will emerge victorious.

You will be able to see and profit from this pattern easily.

What you have to do is to wait patiently till the battle ends and then go with the winner. Usually these are high probability trades.

Normally, when a stock is in an uptrend, it will have a higher high and higher low,

But if the bears become powerful, they will prevent the bulls from having a higher high.
However, if the bulls are not willing to surrender, you will see higher highs, as the bulls are fighting from below to push the stock up while the bears are fighting from above to push the stock down.

This will result in a triangular pattern.

In the end, only one of then will win.
If the bull wins, the stock will break out on the upside. Then you should buy the stock and place stop loss on the other side of the triangle.

If the bear wins, then you should see a breakout on the down side. You should short the stock and place a stop loss buy order on the other side of the triangle.



Sometimes this takes the form of a rectangular channel.
In this case also, both the bears and bulls are equal in strength, so the market just chops along in a rectangular channel.

It will make equal highs and equal lows.
What you have to do is to wait for a breakout and trade that. If the breakout is on the upper side, you buy and place stop loss at the other end of channel.

If the stock breaks on the downside of the channel, you short and place the stoploss on the other side of the channel.

See the examples.



By the way, did you notice that the 20 days moving average has risen above the 50 days moving average for the Dow Jones Index. It means that the market has just turned bullish.
Next time, I will show you some other patterns to profit from.
Here is an assignment for you. Go through your stock lists in DreamTai and try to identify stocks which are forming triangle or channel formations.

Sunday, April 05, 2009

Advanced Stock Trading- Part 3


The next week, I and Bob went to Master Wong's house to meet him.
After lunch, we went to his study room.

Master Wong: As I told you last time, as long as a stock has a higher high, it is in an uptrend.
If a stock makes a lower low, it is in a downtrend.

So, suppose there is a stock making a series of higher high and then it makes a lower high. Can you tell what does it imply?

Bob: It means that the stock has changed direction from uptrend to downtrend. Correct?

Master Wong: Not exactly..The answer is..Maybe the stock has changed trend..It may go sideways or it may go up again, but it is not behaving in the ideal manner. The ideal uptrend is a stock making a higher high and a higher low.

If the stock betrays the trend by making a lower high and a lower low, we can no longer trust the stock and should watch it carefully.

Bob: What do you mean watch it carefully?

Master Wong: By that I means that I would either stay away from such a stock or if I want to short it, I would risk very little. For example, if I normally buy 100 or 200 shares, I would buy just 25 to 30 shares just to test the market.
There is nothing wrong in using small quantities of shares to test the market and monitor it. In fact, the famous speculator, Jesse Livermore used to test the market by trading small quantities and when he was confident that the trend is intact, he used to trade thousands of shares.

Master Wong took a chalk and went to the blackboard.
Here is what he drew.

[[fig 3.1]]

Master Wong: See the figure. The stock was in an uptrend and was making a higher high and higher low. Then it made a lower low. This immediately indicates that the uptrend may be over and there is a possibility of Downtrend.

This is a bearish sign.

Modern day technical analysts call this pattern Head and Shoulders pattern, but you can now find this pattern just by looking if the chart makes a lower high and lower low.

Bob: You said that this MAY means that the stock is in a downturn. When could you be completely certain that the stock is in a downtrend.

Master Wong: Why? I had taught you that principle. It is very simple. If the 20 days moving average goes BELOW the 50 days moving average, then and only then the trend changes to a downtrend.

[[fig 3.2]]

So, after the downtrend is confirmed (when 20 days moving average moves below the 50 days moving average), you can short the full quantity of shares instead of just shorting 25 to 30 shares.

Bob: So, when do we short if we know that the market is not in an uptrend.

Master Wong: You should short at the next lower peak. If you want, you can add to your position at each of the lower peaks.

[[fig 3.3]]

Bob: OK! What happens if after a series of higher highs and higher lows, we get a lower high but a HIGHER low? Or if we get equal highs and equal lows?

Master Wong: Relax! You are jumping ahead. There are other patterns I have to teach you. This session is only to master how to analyze the market structure.

Bob: Fine! Let me bring up the chart of Dow Jones Industrial Average and let us try to analyze it.

Bob prints out a chart of the Dow Jones Industrial Average and begins to draw a line connecting the peaks and valleys of the chart.

Master Wong: Bob, why don't you try analyzing the market structure of the chart?

Bob: Sure! Before point A on the chart, the market was not going in any specific pattern. It is neither making a higher high nor a higher low. I do not know what this pattern is.

Master Wong: Relax! Just ignore this for now and continue. I will teach other profit producing patterns later on.

[[fig 3.4]] CLICK TO ENLARGE

Bob: OK! At point A it made a lower low. So, it is not in an uptrend. It may go in a downtrend. However, as the 20 days moving average is still above the 50 days moving average the downtrend is not confirmed. I should risk a very little amount if I want to short..Correct?

Master Wong: I prefer to stay away from market whose structure is unpredictable. If you can not resist staying away from the market, just risk a small token amount..say 25 shares or so..

Bob: OK After point A, the 20 days moving average went below the 50 days moving average. So, the DOWNTREND WAS CONFIRMED!!.

Master Wong: Yes! Now we can short higher quantity at B because we are now confident the trend is definitely down.

Bob: Then, C, D and E are lower highs and lower low. These are perfect places to add to your short position. That is, you can short more stocks at these points.
Then, at E, F and G and H, the market makes higher high. This means that the trend is no longer in a downtrend. The uptrend was confirmed at point H, because the 20 days moving average goes above the 50 days moving average.

Master Wong: Yes! That means that you can be confident and go long.

Bob: Yes, but unfortunately, that uptrend does not last and you get a downtrend again.

Master Wong: If you had placed a stop loss, you would have been stopped out.Always place stop losses to control your risk At any time, do not risk more than 2 percent of your total capital on any trade.

Bob:At I, J and K we had a lower low and the downtrend is confirmed.

Master Wong: So, we can go short at these points with confidence.

Bob: Then we had a higher high at L and M.

Master Wong: What does this mean?

Bob: This means I would get out of all my short positions and stay out of the market.

Master Wong: Correct! Also, if your are adventurous, you can buy just really very very small quantities of shares around L and M because they are making higher high. However, the Uptrend is NOT CONFIRMED till the 20 days moving average goes ABOVE the 50 days moving average. Till that time, we are just guessing that the trend may go up.
The only thing we are sure is that the trend is no longer the ideal downtrend and is not making lower highs and lower lows.
So, the behavior of the market has changed. If you want my advice, I would prefer to stay away from such markets where I can not guess the behavior.

Bob: This was great! Now, i really understood how to analyze the market structure.

Master Wong: I am glad that this session is useful to you. Let us meet next week and discuss further.

Bob and Sanjoy: Thanks Master Wong. See you next week.