Some basics of chart construction. (June 27, 2014)
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I want to talk about some basics of technical analysis, and charting, and how to use various things to improve your trading. First of all, with respect to what the major averages are doing during the day; one thing that I use is the 5-minute chart a lot, it tells you a lot of things, I’m looking at this, I don’t trade the S&P much, I don’t trade SPYs I don’t trade E-minis or anything like that. If a stock is moving up during the day or during the morning it’s important for me to know if it’s going against the grain or not. I other words if the S&P is selling off or weak and I see a stock that’s relatively strong, that’s great, I’ll take that trade, but I don’t have as much of a profit expectation on the long side as I would if the S&P was moving up as well.
However, because this is just an indicator for me, I actually prefer to use a line chart, rather than go with a candlestick chart, you see red and green and all that, but you can really get the same thing without the noise by just looking at a line chart. It’s easy to get sidetracked with red candlesticks verses green ones, and “Oh this is a bearish engulfing pattern”, or whatever. It’s easier for me to just look at this, we’ll take away the 50-day moving average, take away the 200-day moving average because it doesn’t matter; these are obviously not relevant in 5-minute charts.
So I’ll look at this (Monday evening, June 23rd), and you can see how in the afternoon the S&P was moving up. Well that’s really all I care about, first thing in the morning you can see that the S&P was also moving up, here is was at 9:50, 9:40, so we got an initial sell-off here first thing in the morning and then you start to see the S&P start moving up. Well for me that’s all I really all I care about and so I don’t need these candlestick charts, so the best way to do that, to get rid of the noise, is just use a line chart. Now we’re back here to a daily chart with the 50-day moving average, that’s the red line, and then the 200-day moving average, that’s the green line.
One of the most common questions is, “Do you use a simple or an exponential average?” Let’s do something here, we’ll go with an exponential moving average, 50-day moving average, notice there’s not that much difference between the two of them, if you just put them right next to each other there’s not that much difference here. Similarly with the 200-day moving average, if we use an exponential there, you can really see that there’s no real difference in the 200-day moving average, because it’s the average of 200 prices.
So what’s the difference between an exponential where it’s kind of front weighted, where the most recent data points are worth more than those data points that are towards the end of the average? There’s really not going to be that much difference. So I really think that even considering whether it’s simple or exponential, if you’re spending a bunch of time on that you’re really chasing a red herring, because stocks don’t trade so technically that using an exponential moving average is going to give you an edge, or a simple moving average is going to give you and edge.
Simple moving averages necessarily lag a little bit because they’re equally weighted as opposed to front weighted, so I just don’t want you to get caught up in that. One thing that I am definitely resolute about is, with respect to the 20-day moving average, because I use Bollinger Bands and the Bollinger Bands are built around the 20-day or just the 20-period moving average, I’ll always use a simple moving average there. That’s simply because the method that Bollinger Bands are constructed with is standard deviation. Standard deviation is really, really sensitive to any movement. So exponential, simple, it’s not going to matter that much, but a simple moving average is just going to give me really consistent results on that.
Now, let’s look at comparison charts because I’ll use these on some things. Let me just set on up here; so we’re back to a line chart and we’ve got the S&P 500. Now, let’s look at comparison symbols, I did this last Friday on “Fast Money”, I looked at Deckers ( NYSE:DECK ). I compared Deckers ( NYSE:DECK ) with Cabelas ( NYSE:CAB ), you can see what’s happening here. Deckers ( NYSE:DECK ) is the green line, Cabelas ( NYSE:CAB ) is the black line. You can see how Deckers ( NYSE:DECK ), relative to Cabelas ( NYSE:CAB ), is really, really strong, so you can actually set up a pairs trade here, where you’re short one instrument and long the other. In a case like this what you would do is, you would be long Deckers ( NYSE:DECK ), you would buy Deckers ( NYSE:DECK ) and you would short Cabelas ( NYSE:CAB ), anticipating that this relationship would continue; where Cabelas ( NYSE:CAB ) moves down or Deckers ( NYSE:DECK ) moves up.
To talk, for a brief moment, about our favorite market timer Dennis Gartman, when he talks about being long something, the most famous one is, “Well I’m long gold in yen terms so therefore I haven’t been crushed as much as if I had just been long gold in U.S. dollar terms.” What he’s really talking about is actually pretty simple, it sounds kind of complex but it’s not. What he’s talking about is this, I’m short the yen and the money that I took in with my yen short is being used or allocated to my long position on gold. That’s the type of trade that he’s talking about.
So when you hear somebody, actually I don’t know anybody else who would talk about it that way.
When you hear somebody say I’m short something in such and such terms or I’m long something in such and such a terms, what they’re talking about is pairing the two together. The short trade that they’re in, that money that they’re taking in by actually selling something, you’re borrowing it from your broker and then you’re selling it on the open market; so that money that you’re taking in you’re allocating to creating a long position.
The idea is that if the position that you are short continues to move lower and the position that you were long continues to move higher you’re going to be making more money than if you had just gone long, in this case Deckers ( NYSE:DECK ), than you would had you done it along with a short of Cabelas ( NYSE:CAB ). Similarly if you just short Cabelas ( NYSE:CAB ) you’re going to make money, but you’re not going to make as much money as you would if you had actually gone long Deckers ( NYSE:DECK ) at the same time, so you’re making money on this widening gap here as opposed to just the move down. It’s actually a pretty simple thing it just really sounds complex.
Now, let me go back to something that I did today on Tesla ( NASDAQ:TSLA ). Intraday, this is how I will multitask basically, still be able to trade, but I’ll multitask and the way I do that is with these intraday alerts. They work great for me if I bracket them because it allows me to focus on other things as opposed as having to watch something all the time and then wait for the move. Instead I’ll set up kind of an “if then” hypothesis where if the stock moves to such and such a level then I’m going to think about closing out my long position, or I’m going to think about shorting, or whatever.
So for example on Tesla ( NASDAQ:TSLA ) during the day like in the morning right up here, I don’t know that this was the exact format that I used, I forget, but it will work for our purposes. Okay, so let’s say we’re long Tesla ( NASDAQ:TSLA ) all the way up, then we see this red candle here where it looks to me like well okay this upside momentum is waning here, might get more of a pullback; so I close out my position and then what I would do is, I’d look here, the high was 238.00. Now, I’m out, if the stock starts moving higher I might consider getting back in, but I’m out and I’m happy with that.
On the other hand if the stock starts moving lower I may consider shorting this stock; not in this case because Tesla ( NASDAQ:TSLA ) on the daily chart is breaking out so you’re not going to short something like that, let’s not be stupid, let’s not try to focus so much on one ticker that we feel like we’ve got a game every single move. But on here for example I might look at this and say okay, the high was 238.00, the low was 235.87, so I want to know if that range is broken because then I might take action.
So I would set an alert at say 238.05, then I’m going to get a trigger, I’m going to get an alert when the stock surpasses this level up here, 238.00. You can see it would have been triggered up here, so in that case maybe I would have gone long, maybe I wouldn’t, I didn’t as a matter of fact and I explain that in the Strategy Session video on Monday the 23rd. But then I’d also want to look down here and if Tesla ( NASDAQ:TSLA ) starts falling below this candlestick, because it’s outside the upper Bollinger Band here, it’s not going to last for too long, so maybe I would consider a short; 235.87 is the low of this candlestick so I might set an alert at 235.80.
Now I have got this bracketed, here’s the high, here’s the low and I’ve got this bracketed. Now in this case the stock came up a little bit, at least I saw it, I didn’t do anything with it but at least I saw it down here, down a little bit I didn’t do anything with it but at least I saw it. Down here, the stock came down a little bit, I didn’t do anything with it, but at least I saw it. What’s important is what’s happened in between. What’s happened in between here is that while the stock was oscillating around I was able to get other work done; maybe I’m looking at other positions.
We can look at this on a couple of other things, how about Facebook ( NASDAQ:FB )? Facebook ( NASDAQ:FB ) here at 9:45, peaked up here at, we’ll say 65.00 and then it started selling off. So I’m long Facebook ( NASDAQ:FB ) and I’m okay with that. What I want to know is maybe I should add to the position. I’m not going to add to it on this down draft because I’ve got other stuff to do, I’m not going to sit here and look at Facebook ( NASDAQ:FB ) all day, it’s a waste of my time when it’s easy enough to do this; 64.98, hey, why don’t I have a trading assistant and I’ll tell my trading assistant, tell me when Facebook ( NASDAQ:FB ) gets to 65.05 until then just sit down and be quiet, by the way go get me some coffee.
Okay, so I’m not going to get that alert, I’m totally ignoring Facebook ( NASDAQ:FB ), I don’t even care about it until up here, hours later when the stock opens at 65.06, goes up to 65.09 and then maybe I go long. Again, the point is that during this time I’m not wasting my time on Facebook ( NASDAQ:FB ), instead I’m doing something else. So this is how you can be a more effective trader if you can look at more things. But looking at more things doesn’t mean being fixated on more things. I want you to think about setting price alerts and any software package has this, I don’t care which broker you’re trading with you will be able to set price alerts on those software packages. In fact you can set them for free, you don’t even have a brokerage account, you go to Yahoo Finance and you can set them.
But I want you to get in the habit of using those alerts because again, they allow you to multitask and also, and this is more important, they will keep you from doing stuff that you don’t want to do. You’re out of the trade, you’re out of the trade, and you’re saying, I might want to get back in if “X” happens, so you set up an alert for “X”, that way you take your emotions out of it; you’re not sitting there and then ultimately you get distracted, or you look and see one particular move that does not satisfy your requirements but you just get a bad case of the can’t help its, “Oh my gosh, I’ve got to buy this stock, I think it’s going to go back above that level.”
So you get into the trade and it doesn’t work for you, you close it out at a loss and then ultimately you wind up kicking yourself. By the way, how many times have you made some good money on a stock, say first thing in the morning and you’re all yippee ki yaying and you’re very, very happy about that, “Oh my gosh I made a great trade here,” and then you get this sense, well let’s do that again, that felt so good to me I want to do it again. So you want to go back to the well and make the same trade on the same stock again without really understanding that the big moves come first thing in the morning. Here on the downside you get a big sell off and Tesla ( NASDAQ:TSLA ), as I mentioned, you get a big upside move first thing in the morning.
Let’s look at SolarCity ( NASDAQ:SCTY ), first thing in the morning, here, 9:45, down here, 9:35, so the stock closed here at 4 o’clock, it comes all the way down to here and then during the first half-hour of trading the stock moves over 4 percent, this is when you’re making your trade. If you’re messing around with this stuff you can make money, I’m talking about day trading here, you can make money, how much is this? From bottom to top you made 1.73 percent as opposed to 4 percent on this. Now you’re not going to catch the exact bottom and the exact top, but I would take the in between of a 4 percent move any day; but when you’re down here and you’re really just chipping around for 1.8 percent from bottom to top you’re going to be lucky to get 1.0 percent frankly.
So what I want you to do is get in the habit of using these alerts and then get out of there, get out of a stock, spend some time looking at the overall market, spend some time cruising around looking at daily charts, look and see what’s moving. Let’s go here for example, while my trading assistant is looking at Tesla ( NASDAQ:TSLA ), and Facebook ( NASDAQ:FB ), and various other things, I’m back here looking at the sectors. On the daily chart, my alerts are working for me intraday and I’m saying “Huh, metals, it’s been a while since those have been a top performer.” Then we’ve got energy, well big duh, of course.
Technology, well that’s been pretty strong lately, and so from there I’d want to look at some of the big large cap names in tech, like Google ( NASDAQ:GOOGL ), I could see an intraday move on Google ( NASDAQ:GOOGL ), but I wouldn’t be able to see it if I’m fixated on Tesla ( NASDAQ:TSLA ) or Facebook ( NASDAQ:FB ). So you look here at Google ( NASDAQ:GOOGL ), the stock closed here at 566.00, it came down a little bit this morning, I was looking at this but I didn’t trade it, ultimately it comes down. Let’s say you’re buying this green candle here, well you’re making a nice trade here, 1.0 percent you can say, “Well that’s not that much,” well if you’re trading call options a 1.0 percent move from 564.00 up to 570.00ish, that’s a month right there, I mean you can make a lot of money trading calls on this if you’re seeing it.
But if you’re focusing on some of these other movers during the day, waiting for your chance, waiting for your chance, you may get that chance, but you may not. The whole idea of trading is, think about it as predator and prey, do you want to be the predator or do you want to be the prey? If you’re the predator you’ve got to kill something before you eat it and that means looking around, keeping you’re head on a swivel, looking at a lot of different things. Use your trade alerts, think about them as trading assistants and you’re going to find out that number one, you see more things when these things should be seen; and number two, you don’t do as much dumb stuff, and we all do dumb stuff.
I actually taught an hour long session at the recent “Invest Like a Monster” conference in Las Vegas, and it was called “Technical Analysis Applied”, but really the working title was “How Not to do Dumb Stuff.” So I want you to keep that in mind when you’re using your software, and when you’re trading. It’s so easy to be hyperactive, by setting alerts you will avoid hyperactivity and you will be more efficient. You will only take action, you will only consider taking action when there’s actually a choice to be made. And you will be amazed at actually how few choices there are to be made; we just tend to try to make choices wherever we can because, “Oh my gosh I’m not making money I’ve got to trade harder.” No you don’t have to trade harder, you have to trade smarter.
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