Market Overview

We hit the nail on the head last week and if you followed the odds hopefully you were able to scrape out some profits from a few of the short runs. We felt that the odds favored the market would “run into overhead supply that may slow or stop the prior weeks run”, but to watch for “lots of volatility with shorter runs of a few days”. And this is exactly what we saw. Our STH told us the odds favored lower prices to start the week, and Tuesday was definitely a down day as the Dow was down 200 pts during intraday trading, the Nasdaq down 80 and the S&P down 23.

To the average trader, this looked like a time to run for the hills, but as a trained trader, we saw plenty of opportunities to get in on moving average bounce entries. For example, the S&P closed Tuesday right on its 10 dma with a reversal bar and continued to find support and buying opportunities at the 10 dma through the rest of the week, as did the Nasdaq at its 10 dma, while the DJ-30 made similar moves on its 50 dma. Without a doubt, this was the institutions stepping in and buying with large volume. What does this week have in store for us? Let’s look at our STH & LTH to get an idea.

Long Term Herd
The LTH is still overbought, but has plenty of upside room to run. Watch for the institutions to continue to buy at the DMA’s. Keep a tight stop, but don’t hesitate to pull the trigger on short 1, 2 & 3-day runs.

Short Term Herd:
The STH odds favor higher prices to start the week as we could continue to see short rallies carry over from last week.

Bull Market Status:
Bull market still in a confirmed uptrend. Let the rally continue.

Stocks & Trade Ideas

Facebook – FB has given us a series of reversal bars last week and is presenting strong odds for higher prices to start the week.

Alphabet Inc. (GOOGL) found support on Wednesday with a reversal bar entry and has been rallying up since. Buying opportunity this week as odds favor higher prices to start the week.

Alibaba – BABA continues to rally along its 10 dma but has pulled back to show buying opportunities recently. It still favors higher prices this week and has plenty of room to extend upward..

Amazon – AMZN odds favor higher prices to start the week.

Apple – AAPL has been getting hammered since the news release of its most recent Iphone but has entered the buy zone. Keep this on the radar, but odds favor we see October come before this stock proves to reverse its course.

Tesla – Tsla is showing a 50 dma bounce entry. Odds favor higher prices as this is a strong stock and market leader.

Powershares QQQ Trust – QQQ showed sideways price action and profit taking last week as we expected and looks ready to rip this week.

Netflix – NFLX doesn’t seem to drop below its 10 dma for extended periods, plenty of buy opportunities last week and more to come this week. Odds favor higher prices.

Microsoft – MSFT also found higher prices this week as we anticipated in last week’s newsletter. It found major support at its 50 dma on Tuesday and went on to gain 2.3% for the rest of the week. Odds favor sideways to down on Tuesday.

 Tech Sector – XLK should be considered as buy opportunities at the MA bounces. Easy entries for short runs and quick profits. Odds show higher prices this week.

Trading Psychology

Assessing the Probability of the Next Market Move: A Trader’s Best Practice

 

Trading presents many challenges to traders. One of the greatest challenges is accepting and operating in trading’s environment of risk and uncertainty.

Daily Life

In everyday life, many things appear routine and commonplace. Our days go by generally consistent and orderly. If something unexpected happens, we tend to view it as a ‘surprise.’ If we do think about the probabilities surrounding that surprising event, we judge it as unusually bad luck and a momentary anomaly. Things will soon return to ‘normal.’

We Don’t See the Risk

We fail to see the randomness of life and that surprising events could have occurred at any time and that we are constantly at risk (albeit a low risk). Take, for example, driving a car. The everyday risk of driving seems very low. We get in our cars, go to work, go shopping, or go out for dinner and think little of the risk. If we do have a car wreck, we see it as an “accident” – it happened at random, a fluke. It was not a normal occurrence.

Trading Is Different

Trading forces us to change our perspective on probabilities if we are to be successful traders. Every day we trade, we leave a world where surprise events occur infrequently for a world in which the unexpected is the norm. Mark Douglas pointed out that “every moment in the market is unique” and “the market can do anything.”

What he meant is that market events are more random and difficult to foresee because we never have complete information and market participants are constantly changing. Thus, the same trade setup that worked perfectly yesterday may easily fail today.

There is Always a Probability of Loss

The key idea is that in every trade we make, we always have a level of risk that is certain. This is very different from our day-to-day lives where risk seems infrequent, temporary, and arises in an “accident.”

Mental Skills Important

Reducing risk in trading’s uncertain environment requires strong mental skills and awareness of common mental traps. Overweighting recent events and believing they factor into the current trade is one such mental trap. A string of winning trades, for example, may make a trader feel bulletproof and lead her to think an increase in position size is warranted when it is not.

Not only is risk increased but probability is ignored. The trader is operating like they do in the everyday world. Concern for risk evaporates. The fact that every trade has a certain probability for loss is forgotten. When the supersized loss occurs, it feels like an accident.

Align Yourself with the Probability of Market Movement

Knowing the common mental traps is essential. Knowing how to put yourself in harmony with the probabilities of market movement when taking a trade is equally important. This means taking trades consistent with background conditions, knowing what the next market move is likely to be, identifying the “danger point” and entering as close as possible to that point, and understanding what needs to happen for your trade to work.

Understanding background conditions means knowing market structure and where and how price is currently trading within that structure. When price is showing signs of weakness at known resistance as seen in the chart, for example, the savvy trader is alert for signs of a market reaction. A downturn becomes more likely than a continued rally. The question now becomes: Are buyers exhausted and will sellers step in? How will this unfold?

As the trader watches the market push up towards the resistance highs and sees little volume behind the push, the sign that buyers are exhausted is recognized. The danger point is identified (i.e., just above the resistance highs). The danger point defines the risk. Should price trade and close above this level, the trade is cancelled.

Enter Near the ‘Danger Point’

Price action around the danger point shows not only are buyers unable to advance price higher, but also sellers are stepping in. The likelihood of a reaction has significantly increased. Trade entry occurs near the danger point as sellers obviously push price down and price closes under the resistance highs. The path is clear for a drop. This is the line of least resistance and the most likely next move in this market. Price then falls with sellers clearly in control.

The above trade shows how a trader can assess the signs of buying and selling to understand where the probabilities of the next market move lie. The trader seeks signs of buyer verses seller control near the edges of market structure where a reversal is likely and the danger point can be defined to reduce risk.

By assessing the market in this way with probabilities fully in mind, the trader reduces the potential for loss by avoiding low probability trades. We never have complete information and can never be certain, but we can put the probabilities on our side by paying attention to market structure, who has control, the danger point, and what the next move will look like.

This was a great read I found earlier this year and really serves as a reminder to stick to the systems and go with the setups. Rationalizations are not founded in facts and will only serve to hurt your chances of trading success. If you exit a trade early, don’t get upset and rationalize it. Instead, remember to “trade and learn” and center your focus on becoming a better-disciplined trader.

Source: Dayton, Gary. “Assessing the Probability of the Next Market Move: A Trader’s Best Practice.” Trader Planet. December 28, 2016. 

Best wishes to anyone affected by the hurricanes down in the south and Puerto Rico. My prayers are with you.

All the best,

Coach

Randall Hudgens

(805) 837-9211
www.StockOptionCoach.com