Trading an Irrational Market – Part 2
Dear Trader,
Today is part two of my explanation of why you NEED to be getting dirty in the market with hand-to-hand trading.
When you are in the heat of the moment, you’re in the trenches of the market – you may only have a few moments to recognize a pattern forming before a stock takes off in one direction or the other.
If you miss that window on a stock you are interested in, well.. you may just miss the profit of a lifetime.
Worse yet you could miss the window on a stock you currently own and your position takes a nosedive – nobody wants to watch that happen, and trust me I have been there in the past.
The only time those moments can be positive is if you figure out exactly what you missed and the money missed or the money lost is just your tuition to the school of trading.
So, today I want to take a moment and go through my standard chart setup with you.
After all, if you don’t know what I am saying or looking at how can you hope to learn from my experiences in the market?
This technical chart setup will not only allow you to analyze where the market has been, it will also allow you to see where individual stocks and ETFs are heading.
Once you finish this letter You should be able to look at any chart and have a reasonable understanding of the security’s next move, this is the first step of becoming the formidable trader you have always wanted to be.
First things first –
The Baselayer
My standard chart always starts off with the Moving Averages (MA).
I typically use three Moving Average lines –
You will see them above.
The three that I use are the 20-day MA (blue), 50-day MA (green), and 200-day MA (red).
Now, all three of them are vital as they all tell you a different story about the stock.
The 20-day is a little faster moving than the rest – I refer to it as the traders’ trend line.
What the 20-day is actually telling you is what the faster traders are doing. You will be using this line to follow the breaks up and breaks down that will typically bring a bit more volatility behind them.
For example, back in August the position shown broke below the 20-day MA on this chart, when that happened, we can see the chart become much more choppy and it immediately took us down to the 50-day MA line.
This brings us to my personal favorite of the group – the man in green – the 50-day MA.
why is this my favorite you might ask?
Let me give you a little history lesson.
ten, maybe 15 years ago, is when I started doing my analysis on the Moving Averages. I started by looking at the S&P 500 and found that when the 50-day was trending lower there was a 67% or roughly ⅔ chance that the next day they would close lower.
The same is true when you are going the other direction, a bullish 50-day results in a ⅔ chance that it will close higher.
If I were to only be allowed to trade with one indicator, the 50-day would be my go-to.
Last up on my Moving Averages – the 200-day…
This is a longer view of the market.
You’ll see a lot of the media covering this line because they want something a little slower to follow.
To me, it is an indication of how the investor is going to play the market. When I say investor I don’t mean a month or two – I mean the Warren Buffets of the world who are going to hold a stock that is going up and dollar cost average when it goes down and only get out when they want a little walking around money.
The too far to fast indicator
The next thing to add to your chart is an indicator that will tell you if a stock had quickly moved in one direction or the other resulting in its price becoming overvalued or undervalued
That is right I’m talking about the Relative Strength Index (RSI) –
If you want the technical definition of the RSI along with two fancy $4 words you can whip out at your next cocktail hour, here it is –
The RSI indicates whether a stock has become overbought or oversold.
Simple enough but just to make sure we are on the same page –
An overbought stock will have a price that has been run up and you should expect there to be selling pressure from those who got in early as they start to take their profits. This will bring the stock price back down to a ‘normal’ level.
Conversely, an oversold stock has been beaten up and tossed to the curb by enough people in a short period of time that the stock is now undervalued. This means you will start to see an influx of buyers scooping the stock up for a discount. This newfound support for the stock will drive the price up – again – bringing it back to its ‘normal’ price.
In either event, this is an example of a mathematic equation called mean reversion, where any set of data will want to fall within a specific range – the mean – any deviation from this is considered an outlier.
With that said, there are two important numbers for you to remember when looking at RSI…
30, and 70. When the RSI drops to 30 it is oversold, and when it goes to 70 it is overbought.
This one really is that simple just remember what will happen to a stock that is overbought or oversold and you’ll know how to react to those readings and trade accordingly.
The only thing that is different about the RSI on my chart compared to other traders is I use a 21-day rather than a 10-day. This just means it takes more for my RSI chart to move because I want my oversold stock to truly be oversold. If it hits the mark on my chart you know you’re golden.
Stay between the bands
This is where things start to get really interesting when reading charts.
The Bollinger Bands!
The Bollinger bands are in blue – they tell me when volatility is starting to come into play.
A break or even a touch of the Bollinger bands tells me the price activity on any given stock is starting to become unusual.
As I am sure you know by now – if you have been around the market for more than a few weeks – volatility is a trader’s best friend… If a stock isn’t moving there is no money to be made, or is there?
There are times when these bands actually tighten to a smaller-than-normal gap between the two. This tells me that it might be time to get in on something…
You see when the bands tighten in this fashion, it is typically followed by a moment of extreme volatility allowing you to grab profits quickly.
It’s not guaranteed that the volatility is going to send the stock up, I want to make that clear. To find the direction this volatility explosion is going to go you will need to differ to other indicators – in most cases the Moving Average lines to find the trend in the stock or ETF.
The real magic happens when you toss them all on the same chart. It is able to give you just about all of the data you need to make a trade. Of course, there are a few things missing such as volume and open interest to help judge the liquidity of a stock. That is for another day.
This will give you the framework to start reading charts and finding your own trades. You might even find a trade or two when I do my ‘Charts by Request’ segment in the mornings. As always if you have additional questions, ask them.
One last thing before I let you go. My Double Your Money challenge Kicks off this Tuesday at market open so you only have a little bit of time to join me before I begin teaching all of my new members how to double their accounts in 60 days with my slingshot method.
Of course, we have an action-packed week starting with a watchlist that will hit your inbox tomorrow. Take the tools I have given you today, put them to work with my watchlist and you might just find The trade I am looking to make for my first Double your Money trade. The only way to know If you got it right – Is to be there on day one
Comments
October 29 2022
