Catching the Big Trend Early

One of my favorite set-ups is looking for a quiet market, one that is not trending and in which the volatility is now low. It is even better when you are able to find a market that exhibited high volatility before the market became quiet.

Swing Trades or Catching Tops and Bottoms

Yes, I know, no one can catch tops and bottoms…wrong! You can; it just may take a few stop-outs before you hit the real bottom or top. Usually, it takes no more than three tries to finally catch a trend that is good enough to profit from. Generally speaking, look to see if the average true range of the swings on the time frame you are trading will make you enough money to be profitable -- even when taking into account a few stop-outs before hitting the right trade.

If you’re not finding any worthwhile swing trades, try using the previously described technique of catching a significant trend. If you’re day trading, and especially if you’re using a one-minute chart, look at the average true range of the swings and see if swing trading makes sense on that small of a time frame.

It is very possible that you can trade the swings perfectly and still lose money when the swings are not wide enough to produce enough of a profit. If you find this happening to you, either switch to a different entry technique or switch time frames until the swings are large enough to give you a chance.

Add-On Patterns

Use these to add on to a current trend. Remember: Only add on if the trend is profitable, and then you can stay within your risk parameters. Any time you move a stop either to reduce risk or lock in profit, you, technically, can then look to add on to your current position. Never add on to the point where your risk is greater than your original risk on the initial trade entry.

In the Applied Reality Trading® system, we favor “Pyramid Trading Points®”, “ART® One-Bar Reversal” bars and the “ART® Two-Bar Reversal” patterns after brief trend corrections known as “pull-backs” as “add-on patterns.”

ART® Chart # 16

Note that I like to use trend lines or regression channels to determine trend direction, as well as, at times, setting stop points once I’m in a trade. The Pyramid Trading Point is the best way to determine trend! Before you are really able to draw in your trend channels, you will need at least one confirmed Pyramid Trading Point to have formed in order to confirm a trend.

Using Stock Groups and Sectors to Better Your Odds

This is for the equity traders and stock option traders. Looking at the groups and sectors of the individual stocks traded is another technique to help stock traders decide what to trade and what signals have strength behind them.

Two approaches can be used here. One is called a “Top-Down” approach and the other is called a “Down-Up” approach to choosing the markets to trade. Let me explain the differences.

The Top-Down Approach

When using this approach, the trader starts the analysis at the “Group” and “Sector” level and works his or her way downward to the individual stocks. Traders using this approach first look at the stock sector charts and use our patterns and stock-picking techniques to analyze the sectors first. Then, they analyze the Groups and pick the best individual stocks to trade. Thus, the name “Top-Down Approach.”

An example of how you might use this approach with our techniques would be to look for sectors that have been quiet for awhile. Then, you would look at the quietest stock groups within that sleepy sector. Then, choose the best (that is, the longest-sleeping stock) in that group and use Pyramid Trading Point to enter.

Another way to use this top-down approach would be to look for the strongest-trending sector, up or down. Then, you would wait for an ART Reversal to form, find the best group in the sector and, finally, zero in on the best stock that has also formed the pattern you are looking for.

The Down-Up Approach

With this approach, the trader finds the stock first, analyzes the group and, finally, looks at the sector to see how the stock is behaving in relationship to its peers. This can be very helpful when you are getting a signal to go long on the individual stock, but the volume is a bit low, so you may be wondering why the volume is not appearing.

If the group and the sector are both in a down trend, and your individual stock is generating a long position on low volume with no positive news out, I would question going long. Again, if it is in play by momentum traders or position traders, you will see significant volume on the time frame you are trading. The more the volume, the more players are participating.

This down-up approach has saved me many times from going into the market when it was not ready to move or was being manipulated on low volume by the professionals, such as market makers and the like. Real trends take outside paper coming from off the floor to move prices significantly, as in a trend.

In other words, many traders worldwide need to participate in order for a significant trend to develop. Also, note that significant trends occur when traders from many different time frames are participating in the trend.

Outside Paper

To further your trading education, let me define the concept of “outside paper” coming into a market. Outside paper refers to trades coming away from, or off the trading floor.

Four different types of outside paper come into the markets from outside the trading floor ranks. They are as follows:

Outside Paper from Long-Term Investors: These orders come from retail brokerages, mutual funds or individual traders using long-term weekly charts to make their trading decisions. When these traders commit to the market, it usually indicates longer-term trends are in place, and the fundamentals of a company are healthy. Short-term news usually does not have an effect with this group of traders, who are known as investors.

Outside Paper from Position Traders: These orders are from retail brokerages and traders known as “position traders” or “swing traders.” Trades are usually based on daily charts and, at times, 60-minute charts. Short-term news events can affect these trades.

Outside Paper from Intraday Swing Traders: Usually, the orders from this type of trader go through a retail or direct access brokerage. These traders can trade during the day and may, at times, hold favorable positions overnight. Trades usually last from a few days to many days, depending on market conditions. News events affect these traders.

Outside Paper from Intraday Scalpers: These traders’ orders are primarily handled by direct access firms. They are only in trades for minutes, maybe up to 30 minutes, depending on market conditions. Scalpers usually use one- to five-minute charts, and some of them trade stocks using NASDAQ Level II as well. Scalpers usually incur many trades each day and rarely keep a trade overnight. They would fit the classic day trader mold in the sense that they like to go home flat with no positions at the end of the trading day. This type of trading is not for the weak-hearted and is typically blamed for the intraday noise and volatility in the markets.

The most significant trends occur when long-term traders get involved at the same time the position traders get involved in either buying a position or selling one. This ideal scenario usually results in strong trends pulling in the momentum traders and position traders, further adding to the strength of the trend.

Short-term players usually don’t stay that long in a market and get out at the first signs of weakness in a trend; this is what causes a trend to correct. During these corrections, longer-term players who view the correction as an opportunity either to get out of a bad position or buy into a good position again push the trend in its dominant direction.

The interaction of the market players is what causes markets to move up and down.

When you use the ART top-down or down-up approach, you can get an idea of who is involved in that stock you are about to trade. If the sector or group is not performing well, chances are the long-term investors are not buying now. They maybe holding or waiting to buy, but they are most likely not buying a down-trending sector or group. It is very possible that they have sold their positions already.

Basically, this is why bullish trading swings remain small until sectors turn around. Without the investor group’s money to add buoyancy to a stock in a poor sector, smaller, short-term traders can then cause these stocks to sell off more dramatically by shorting the stock, especially if the significant money is not buying the stock at that time.

By keeping trading techniques and ideas as simple as possible, the trader can quickly confirm a trade without getting confused or bogged down with too much information to make a trading decision.

When I look at groups or sectors, it does not take me more than a few quick minutes and sometimes less to confirm a signal. It needs to be that quick, or you will never use it, especially if you’re trading intraday. Don’t forget: You can use intraday charts for groups and sectors too if you have intraday data for them.