At its core, all of our investment and trading algorithms incorporate two factors. The first and most important is price action. Price action is a science in and of itself. I continue to encourage people to consider Al Brooks’ trading courses and books on price action. There is no better teacher I know, and he leaves no stone unturned. You might want to load up on coffee first, and sequester yourself for a few months, but it is well worth the effort.
Everything else is context. Investors and traders must interpret all price action in context. Cycles and investor sentiment play a role. Volume colors the interpretation. Seasonality can be crucial to accurate forecasts. Of course, there are other vital issues like strength, breadth, and momentum. Then there are the algorithms; they are checklists of all of these issues prioritized into a computer program.
If I were to combine price action and context into an ideal trade setup, my favorite long trade is developing and notated on the daily S&P 500 Futures chart above. The timeframe does not matter – I see the trade on the 5-minute charts all the time. But the trade does not often present on a daily, weekly, or monthly chart. When it does, as it is on the daily chart now, It is a powerful setup and has a high probability of success.
The setup starts with a short-covering rally off a swing low as price demonstrated on October 6th and 7th. The price rises and closes above the Navigator Algo trigger. A yellow buy arrow paints on the cross. Also, the price closes above the 20-period Future Line of Demarcation (“FLD” see J.M. Hurst’s work on Sentient Trader) and makes an equal measured move above it. I discussed this development a week ago on these pages. (Lately, the price has just blasted off the swing low, forcing traders to chase it. The trade never has a chance to materialize).
Then, the price comes back down to test the low. We get the green arrow as we tuck into the FLD and Navigator Algo trigger line and bounce. Of course, this means that the former low holds on the retest, as confirmed by a pivot. That is the buy. As of the close today, we can check almost all the boxes on the S&P 500 index daily chart, except the confirmed pivot.
Taking out the last two session highs (10/11 and 10/12) at 4365 for a few hours and into the close would cement the pivot as a final buy confirmation. That also conquers the 5-day line (our stop line from yesterday) at 4360.
But the price would also have to fight through the 21-day line (4375), 50-day line (4385), and the roundie/downtrend line (4400). That is no small task, and I would not blame anyone for just riding the trade to any one of those levels and getting out. However, the upside projection target is 4450 for the braver among us. From there, the price could even challenge the old highs. Is that even possible? More on this below.
It is noteworthy that should all of this transpire, a reverse head and shoulders pattern would present on the daily chart with a projection to new highs. One can only hope so if taking the long trade, but it is a bit too early to speculate. For now, carry the potential forward in your narrative.
Below us, the 21-week line at 4318 is the mean for weekly prices and support. The weekly mean gave us the recent lows, cradling the price and cementing the potential double bottom. Notably, the 21-week line often provides support in an intermediate decline.
What about context? We are coming into monthly options expiration Friday, marking a zone (slightly before or after) for recent swing lows. After four down days, the market finally registers oversold, quite an accomplishment over the past year.
Add this too: longer-term fear indicators are at bullishly pessimistic levels we have not seen in a year. The news is dire. Vaccine opposition, supply chain problems, inflation, etc. As Ben Franklin once said – “buy on the cannons, sell on the trumpets.”
Seasonally, we often see significant lows established in October. As well, the 80-day cycle low appears to be in place as of October 7th.
Naturally, I am licking my wounds a bit for getting stopped out yesterday (10/11), but that is irrelevant now. You fail in this endeavor unless you move on. Flexibility is the key. Anyway, stops have saved my bacon on more than one occasion, so I never regret them. Successful trading and Investing is about applying the probabilities and managing risk.
How could new highs even be possible? I never know, but the market always finds a reason. How about spectacular third-quarter earnings – as they begin to roll out in the next few weeks? No doubt, they will be caveated by forward “inflation/supply chain problem” guidance. But the market focuses on good news when it wants to go up. FOMO kicks in as each milestone mentioned above is achieved on the daily chart.
If the market achieves new highs, I will attribute it to continued and accommodative Fed policy. Don’t get caught up in the tapering or any other talk. Fed chatter will be plentiful. Take your cues from action, not words – and price.
Could this long trade fail? Of course. There is a 30% to 40% chance. That is not small. If so, the 200-day line is a good target. We reset rather than regret. No whining.
The Founders Group will consider getting aggressively long on any sustained move above yesterday’s high – at least for a swing trade. Now you know why.
A.F. Thornton