I give you a lot of information every morning. But how should you use it? I know it isn’t easy. I have done this for many years, and it is still tricky at times. But you can do it if you follow a set of rules – namely “your” rules as you develop them over time. That is a subject for another discussion.
This morning, for example, I look at the daily chart, and I see a labored advance in an overbought market. The rally yesterday and this morning occurred on weak internals. It was a tech thing once again. The tech generals advanced, but the soldiers remained at the base camp. That makes it difficult to take the hill at 4700 (470 on the SPY).
But I also remind myself that we bottomed a minor cycle on the 10th, and we are in a period of seasonal strength for stocks. The market often rallies a bit before the Thanksgiving Holiday. Also, the market has been in an uptrend overall. I use this context to resolve any doubts in favor of higher prices.
When you drill down to the hourly chart, you see a head and shoulders reversal pattern to go higher, which broke out Tuesday and was retesting at the close yesterday. The right side of the pattern is in a triangle.
Whichever way the triangle breaks is your guide to the initial direction. And, to make it interesting, you have to watch for a fakeout. That means you not only have to wait for the breakout candle to close, but you should also wait for the close of a follow-through candle. That reminds me of the axiom; the more confirmation you have of a turn, the greater your risk to stop under the swing low out to your left.
Once the market takes a direction, you always have the overnight high/low and yesterday’s high/low, as applicable, to conquer. That is always the case. But each morning, I try to highlight the most critical signposts I will be watching in my daily plan, which may be these or other levels. I am looking for the price where I believe a cluster of buyers or sellers will show up. Sometimes it can be several levels close to each other, setting up a small range of support or resistance.
That is what trading is all about. You project where the buyers or sellers will show up and use that level to get on board when a pivot occurs. A “pivot” means that the price stops one-time-framing higher or lower as the case may be.
Say the market is falling. Once you have a candle that has a higher low and higher high than the candle to your left, then a pivot is usually at hand. When that occurs at one of our previously identified levels, you have the recipe for a trade. And it is the same in any time frame.
There is more to the story. You have to have a target and understand measured moves. But you can learn the techniques. How each candle behaves in the progression gives you hints about trend strength. For example, how far does the next candle invade the previous one? If it isn’t much, you have a strong trend and vice versa.
Today, I am slightly bullish but also cautious based on the weakness of the last few days and the overbought levels on the daily chart. What does “overbought” mean?
Plot the 21-period Exponential Moving Average (EMA) on your chart in any time frame. Looking at the chart visually, you can see how far above or below the EMA price has traveled. Over time it becomes evident when the market gets too far away and needs to snap back. I could trade any day plotting that line alone and knowing my key levels.
I always do my best to keep an open mind. The chart above is the hourly chart of the SPY. Add a digit, and you have a similar futures level. But let’s go with the SPY for now. You have a strong support zone from 466 to 467.50. The initial breakdown target from Tuesday’s high is 466, but we could see a pivot around 467.50 first (roughly 4670 on the futures).
Out to the right on the chart, you will see the volume at price in a sideways histogram. Wherever the peaks occur is a volume cluster that the market needs to climb over. The market usually finds support or resistance in the valleys surrounding each peak. To progress, the price needs to move through the valley to the next ridge. When I write about “acceptance,” I am referencing this progression. The volume and time at price help to guide you as you navigate to the identified support lines.
Note from the chart above that the market closed yesterday on the hourly 21-EMA and daily 5 EMA. The red dotted line is our 5-day EMA stop line from the daily time frame. To head south means we take out those two crucial levels. Closing candles below yesterday’s low at 467.40 (4670 on the futures) also ends the one-time framing higher on the daily chart. That is a significant change in tone and your line in the sand today. Translate that to your five-minute trading chart, and it will be a steep fall and an excellent short.
Of course, the best short is where the market already pivoted lower above, but the market ran out of time for a day trader, and, usually, I’m not particularly eager to hold overnight. Things can change by the morning, as they already have today. As mentioned the past few days, the market is not at a safe level for swing trading long, and it is too soon to establish a confident swing trade short.
A pivot higher and breakout above the triangle requires conquering the red resistance lines marked on the chart above, which takes us back up to test the all-time high, which essentially requires taking the hill at 470 (4700 on the futures). From there, you could ride the reversal pattern measured move up to 475 (4750 on the futures). So you target that range and see how the market behaves.
Remember, the market likes to travel in 50-point increments at a time before it consolidates again. So 4700 (470), 4750 (475), 4800 (480), etc., are always vital levels. Take everything off your chart, and mark those levels. Then step back and look at your long-term chart. You will see what I mean. Price pauses and clusters around those prices.
So now you see my plan for the day. The only question is whether the overnight trading gives me any clue as to how the market will open and whether to trade earlier instead of later. The market will gap higher at the open. It will be a true gap, so Gap Rules apply. With the imbalance of buyers and nearly 100% long inventory overnight, there will likely be a fade at the open. How the market handles this fade tells you a lot. No fade; it will be a strong day and time to get long. Slight fade and a move back through the open also begets strength. Gap and crap? Well, not so good, right?
The market starts bullish this morning, slated to open above 470 (4700 on the SPY). We need to close candles above that level to have the best chance of achieving a new, all-time high.
Good trading!
A .F. Thornton