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The first thing I look at is the stochastic and MACD readingsSUMMING UP MARKET PROFILE MP can be used in all markets. It is based on the statistical analysis of time, price, and volume, and, therefore, it has stood and will continue to stand the test of time. With the advent of markets moving to electronic platforms, MP has suddenly taken on more meaning. Why is this? Everyone is currently trying to adjust to the change of not being able to hear from the floor brokers what the various market participants are up to. What are the locals doing? What about the commercials? Funds? The general public? As more and more markets go electronic, the footprints and actions of these groups are easier to hide, and one of the biggest advantages traders have is lost. However, by using MR, these footprints and actions are picked right back up again, giving the advantage back to the trader who learns how to use this analysis technique. I must emphasize that this chapter on market profile is just thyt-^a chapter on market profile. People are starting to take a renewed interest in MP, and I wanted to provide a brief intro-ductitti for those who don't know anything about it. The setups I've already discussed in this book are used independently of any MP analysis. MP is jast a tool and for anyone who is familiar with this analysis technique, it can be used in conjunction with the setups already discussed. For example; if MP is pointing higher, then a uader can know nothing about MP and still take the 5-minute squeeze as it fines off long. The point of this is that everything out therewhether it is Fibonacci numbers, Bollinger Bunds. Eliot Waves, Market Profile, or whateveris just a tool It is up to the trader to find a couple of good tools that will help them with their overall trading plan, and then establish specific setups and specific money-management parameters for their plays. THE PREMARKET CHECKLISTCREATING A GAME PLAN FOR THE NEXT TRADING DAY In a calm sea every man is a pilot. SPANISH PROVERB LIKE RUNNING A CREDIT CHECK, TO UNDERSTAND WHAT THE MARKET IS GOING TO DO IN THE FUTURE, IT HELPS TO UNDERSTAND ITS PAST Although I base much of my daily trading decisions on specific setups, I also like to analyze how the market has recently been behaving. My goal in doing this is to be constantly aware of the path of least resistance, since I want to set up the bulk of my trades directly along that path. To that end, I have developed a quick daily checklist, and* on Sundays, a more detailed and thorough checklist. The purpose of this is to mentally prepare myself for the trading day ahead. There will be times when my analysis is totally off, but I've found that the act of mentally reviewing potential scenarios before the opening bell prepares me for just about anything. The market can be easy to trade when the going is smooth, but there are plenty of times when the market will throw a curve ball In these situations, it's the prepared traders who consistently come out on top. The first thing I do in this regard is lo look at the markets I'm trading from a top-down approach, starting with the monthly charts and working my way down to the 60-minute charts. In this example I analyze the S&P 500, but I do this with every market that Pm following. In doing this analysis, all the charts I'm looking at have the following indicators placed on them; 1. The 8,21-, and 200-period exponential moving averages (EM A). In the charts shown in the pages that follow, the 8-period EMA is the thinnest line, while the 200-period EMA is the thickest line. I will also look at the 50 and 100 EM As, but they aren't as important to me. 2. A slow stochastic with the default TradeStation settings of 14, 3, 3. 3. A MACD with the default TradeStation settings of 12, 26, 9. 4. A TTM squeeze indicatorthis is the same indicator discussed. MONTHLY CHART ANALYSIS I always like to start off with the monthly charts. Even though I'm going to be doing most of my trading in the futures market, for the stock indexes I will look at the cash index for monthly charts. This is because there is much more history here to view, as the cash index has been around a lot longer than the stock index futures contracts. The first thing I look at is the stochastic and MACD readings. These represent pressures on the market. Is the pressure more to the upside (buying pressure) or downside (selling pressure)? In general, I want to establish positions that are on the same side as the current dominant pressures in the market I am trading. My rule of thumb for this is as follows: The stochastic is the fjeads-up, and the MACD is the confirmation. This brings me to why I place little value on whether a stochastic is overbought or oversold. According to the stochastics in Figure 18.1, the S&P was overbought starting in the middle of 1995, and it stayed overbought until the middle of 1998three long years. During thai time this overbought market rallied by over 100 percent. To me, an overbought stochastic is actually a bullish signif the MACD is also in a buy. This brings me to my next guideline: What Fm looking for is MACD crossovers. The stochastics are valuable in that they will turn first, and therefore they can give me a heads-up that a MACD cross might occur. That said, I don't act on it unless and until a MACD crossover actually does occur. At point 1 the monthly MACD crossed over into a sell signal in May 2000, about two months after the stochastics crossed into a selL Once this happened, the path of least resistance on the monthly S&P chart officially switched from higher to lower. This means that, for longer-term swing and position trades, I would start spending more time focusing on short setups and generally ignore long setups. [ would do this until the monthly MACD went back into a crossover buy, and that happened at point 2, nearly three years later. Once this occurred, I started focusing more on long swing-trading setups and generally ignored most short trading setups. Remember, I'm talking about swing and position trades here, not day trades. The snapshot of this chart was taken on April 5, 2005. At point 3,1 can see that the stochastics are trying to roll over into a sell. What does this mean to me? It means that, potentially, the MACD could roll over into a sell. However, at point 4 we can see that the MACD is still in a buy. For me, this means that, for longer-term swing and position plays, I will still continue to focus on the long side until the monthly MACD rolls over into a sell. 338PART THREE Heading Back into the Real World of Trading The next thing I like to look at is the key moving averages. First I will look at the 200-period EMA just to see where that is in relation to the current market prices. This is the strongest moving average and represents serious support or resistanceit was enough to stop the crash of 2000, as seen at point 5. In this current snapshot of the S&P. the 200-period EMA is way down at 849.60 and isn't much of a factor in the current market conditions. However, the fact that the market is trading above this level is bullish. What is more relevant to the short term is the relationship between the 8- and 21-period EM As. The first thing I'm looking for is to see which moving average is on top of the other. If the 8-period EMA is on top of the 21-period EMA, this shows that the path of least resistance is higher. If the 8-period EMA is trading below the 21 -period EMA, this shows that the path of least resistance is lower This crossover is a confirming indicator for the MACD, as the MACD will fire off faster. I like to use these moving averages in my entries. In this regaid, I will use these moving averages on the monthly charts just as I described how I use them on the daily charts in Chapter 16, where I will buy pullbacks or short rallies to the 8-period EMA. In this current chart, at point 6, I can see that the S&Ps are trading right at their 8-period EMA. Since the 8 EMA is trading above its 21 EMA, this is a buy zone. I also like to look at where the 50 and 100 EMAs are located, but I don't place as much importance on them in terms of establishing a trade. I will use these more as targets as opposed to entry points. The last thing 1 look at is the squeeze. Most of the time the squeeze is not doing anything, so I just glance at it to see if it is in the process of setting up a move. However, when it does fire off, as it did at point 8, this takes precedence over everything else. When the squeeze is on. then I'm in this trade until the squeeze is no longer valid. At point 7 you can see that a long squeeze occurred in early 1995. This signal fired off at the beginning stages of one of the strongest and most enduring rallies the S&P has ever seen. To that end, I like to know when a squeeze is in play. I never fight the squeeze. For this current chart, there isn't a squeeze play that has fired off or is even developing. Monthly squeezes are a rare occurrence, with only two of them in the last 10 years. WEEKLY CHART ANALYSIS Once I am done with the monthly chart, I take a quick glance at the weekly chart (see Fig. 18.2). Note that here I have switched back to the ES futures contract, because with the weekly ES chart, there is enough data to get accurate information going back a few years. All the same guidelines apply. What I'm most interested in here is what is happening as of today, April 5, 2005. We can see at this point that the weekly chart has been in a MACD sell for about a month, and during this time the S&P has fallen by about 60 points. The stochastics at point 3 have taken it on the chin and are oversold. Remember, however, that I couldn't care less about that. What I'm interested in is the weekly MACD at point 2. Is it turning higher? No, it is still in a sell. In addition, the squeeze at point 3 has three black dots. This is not a signal, but it is a heads-up that a squeeze is in progress, and I want to pay attention to which direction this eventually fires off. Finally, I look at the moving averages at point 4, and I can see that the 8 EMA has crossed below the 21 EMA, a bearish development. We are right at the 21 EMA. What to do here? This is what I call a mixed market. The monthly chart is bullish, and the weekly chart is bearish. In this situation, the sell signals on the weekly chart will create buying opportunities on the monthly chart. This is an important distinction to understand. Just because the weekly chart is in a sell doesn't mean that the world is coming to an end. Yes, it absolutely creates shorting opportunities, but the monthly charts are still in a buy, and this means that the longer term path of least resistance is higher. I want to point this out because typically this type of situation creates many bears and many negative attitudes, because a weekly sell signal can generate a devastating beating to bulls. But, in the bigger scope of things, I'm looking for the weekly chart to turn higher and move back in line with the monthly chart. The best trading opportunities occur when the weekly charts line back up with the monthly charts. For setups, the weekly chart is still in a sell, meaning that short setups are appropriate. However, before I would set anything up, I would want to first look at the daily charts to see if the pressures on this timeframe are lower or higher. DAILY CHART ANALYSIS Although I will use the monthly and weekly charts to help me determine the path of least resistance for swing and position trades, it is the daily chart that I drill down to in order to get my specific entry levels. Figure 18.3 shows the daily chart of the S&Ps, and now it is time for me to set up a trade. The first thing I notice is that the stochastics at point 1 are turning higher. I then of course look to the MACD at point 2 to see what it is doing, and it is also trying to turn higher, though it hasn't quite done it yet. At point 3 1 see that the S&Ps have held a test of support at the 200 EM A. However, at point 4 the 8 EMA is trading below the 21 EMA, which is negative. The squeeze also doesn't help me out because there aren't any signals on it at this time. Okay, so now I have a bullish monthly chart, a bearish weekly chart, and a bearish daily chart that is trying to turn bullish. Can I do anything with this? There really isn't a clear answer here. It's time to keep on drilling down. Let's visit the 60-minute chart. The 60-minute chart reveals a bullish stochastic at point 1, and when I check the MACD at point 2,1 can see that the MACD is also pointing higher, which is bullish (see Fig. 18.4). In looking at the moving averages at point 3. 1 can see that the 8 EM A is trading above the 21 EM A, which is bullish, but the market is below its 200 EM A, which is bearish. Is there a trade here? Take a moment before reading on and figure out what you would do in this situation. 1 want you to take a trade based on what we've just talked about. Would you go long or short? What's your entry level? What's your stop? What's your target? Spend a few minutes on this before moving on TO the nexi paragraph. Today is Tuesday, April 5. 2005. Here is what I'm going to set up for tomorrow, Wednesday, April 6, 2005. I'm going to set up a buy order at 1183.50, right above the 8-period EM A. Since this is a 60-minute chart, I'm going to use a target of Vi of 1 percent which is 5.9175. I will round this up to 6.00, which would make the target 1189.50. This is right below the 200 HMA, which is a good place for a target. If the 200 fcMA had been below my target, then I would not lake the trade. My stop will be 2.95875 (% of 1 percent), which I will round up to 3.00. This makes my stop 1180.50. This is just below the 21 EMA. If we get up Vi of 1 percent in the play (three points to 1186.50), I will move my stop up to the 21 EMA and trail it from there. If this looks familiar, this is the propulsion play described in Chapter 16. For my swing plays, I want to play them in the direction of the path of least resistance according to the MACD. The monthly charts are higher, and the daily chart is about to turn higher. Two of the three timeframes are pointing higher. Then when I drill down to the 60-minute chart, I see one of the setups that I utilize staring me right in the face. So I set it up. Simple as that. However, before we get too excited about a potential play, let's double-check the path of least resistance by looking at two more charts. DAILY RSI CHART ANALYSIS While the previous charts give me an idea of the overall buying or selling pressure, as well as give me an indication of key levels I need to be watching out for during the next trading day, there is still a piece missing. What 1 want to see next is if there are any bullish or bearish divergences in the seven-period relative strength index (RSI). These are a heads-up to a pending market reversal. In Figure 18.5 we can see that at point I at the top of the chart, the S&P made a nice rally into the end of 2004, However, if we look at point 1 at the bottom of the chart, we can see that the seven-period RSI was making lower lows, while the S&P was making higher highs. This is a massive bearish divergence and essentially is a heads-up that the current rally is not going to last. That's great, but how does a person enter that trade? That is a great question. Think a minute before going on to the next paragraph and decide what you would do in this situation with the tools you've learned so far in this book. The market is rallying, but there is a bearish divergence. I'm looking for the market to fallhow do 1 enter? There are a couple of different ways to enter. Plays described in this book that worked well in this situation are discussed (Scalper Buys and Sells), 11 (Bricks), 15 (HOLP and LOHP), and 16 (Propulsion Plays). This comes back to the fundamental basis of my whole trading planeven if I feet 100 percent sure ttiat tfie market is going to roil over, 1 will not establish a short position until one of my setups generates a short signal. Now if we got to point 2 in the upper right-hand portion of the chart* we can see that prices made lower lows. Then if we look to point 2 in the lower right-hand portion of the chart, we can see that the RSI made higher lows, creating a bullish divergence. This sets up a potential reversal in the markets, meaning that I want to focus on the long side. This confirms that the play we just set up in the last section with the 60-minute charts is the right way to go. 60-MINUTE RSI CHART ANALYSIS On this 60-minute chart (see Fig. 18.6) there are two bullish divergences in place within the current market action. I've marked one of themcan you find the other one? The one I've marked shows the RSI making higher highs, yet prices have not made higher highs. This is bullish. The RSI is essentially leading the market higher The second divergence takes place when the ES made lower lows on April 1, yet the RSI made higher lows. This is a bullish divergence and also positive. After looking at both these RSI charts, we can clearly see that the long side is the path of least resistance in the short term. What if I'm wrong? What if news about oil hits tomorrow, driving it higher by $5 a barrel and that kills the stock market? Then I'm stopped oul. Next trade. This is about putting the odds in your favor, not guarantees. |
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