Wednesday, December 3, 2008

Cross Currents in Time Make Choppy Waves

I’ve been noting in my updates lately that we are experiencing a lot of “flat” type of activities where the markets are moving back and forth within a range (albeit a very large range). This type of activity is common in wave 4’s and can be seen in all the triangle and megaphone patterns we’ve been seeing lately.

I view these times as VERY difficult to trade as getting the turns right, especially with large overnight gaps, is generally an exercise in futility – one in which trading costs can pile up and add to the cost of one’s mistakes. Thus, picking a good entry point becomes all the more important. ANYONE can enter long almost anywhere in a 25 year bull and “make” money (real or not!). This is NOT that time!

To help pick better entry points, it helps if you can “see” the waves that are always present and are present on ALL time levels, from the individual tick, up to decades and centuries. The tools that we can use to help us “see” those waves are collectively referred to as Oscillators. There are many. My advice is to pick one (maybe two) and stick to them. If you watch too many at once, all you will see are cross currents which can get very overwhelming and work against you making good trades.

My favorite oscillator is the Stochastic. I use the “slow” stochastic version which has two lines, the “fast” and the “slow.” On my charts, below, the fast is the black line and the slow is the red line. You can adjust how “fast” and how “slow” these are. I try to set mine to reflect the people I follow, like Dr. McHugh and Karl Denninger, although there are slight differences between all of ours. The key is NOT how you have them set, the key is setting them one way and leaving them so that you have consistency and can see how it’s working over time.

Regardless of your trading timeframe or the underlying fundamentals, you should always use the technicals to decide WHEN to enter. When refers to time. I contend that everything is made of energy and waves, including our markets, and that waves are occurring on all time frames at different levels. Waves that get in phase can cause amplification and waves that get out of phase can dampen the intensity. Doesn’t it make sense to look for waves that are in phase?

On the very big timeframe we have just begun correcting a multi-century grand supercycle. Thus the overall trend is currently DOWN. That’s why I prefer to play the short side here and will only “scalp” the long side. Waves on the long side WILL NOT be as powerful as waves on the short side UNTIL the correction has fully run its course.

When looking for good entry points I look for the waves to get in synch. The planned duration of the trade is important to consider as you will want to more fully consider waves on the LONGER timeframe if you plan on being in the trade LONGER. IT IS ALWAYS IMPORTANT for EVERY trade to look at the SHORT term waves as you should want to always pick as good an entry as possible.

Below is a series of SPX (S&P 500) charts that begin on the short time frame and work their way up. At the bottom of each chart you can see the “slow stochastic (ss)” indicator which contains a black line (fast) and a red line (slow) – on your own charts you can make those any color you wish.

If you are viewing these charts online, you may click them to enlarge, just hit return on your browser to go back.

This first chart is on the 5 minute timescale – you are viewing the waves as they oscillate ON THAT TIMEFRAME. Note that the fast is just coming out of oversold and is about to cross the slow which is still working its way from overbought to oversold:

The next chart is on the 10 minute timeframe. Note that the FAST just crossed the SLOW out of OVERSOLD and is heading down. That is a SELL signal on the 10 minute timeframe:

Here’s the 30 minute timeframe, the fast is overbought and the slow is approaching overbought:

Here’s the 60 minute timeframe, the fast has just curled down out of overbought and the slow is at the 60 level on its way up:

Here’s the same chart on the daily timeframe, the fast has rolled down out of oversold and the slow is still pointing upwards:

Below is the Weekly timeframe, the fast has just crossed the slow coming out of oversold. This is a BUY signal on that timeframe.

Next we have the Monthly timeframe, this is a 5 year chart. Note that the fast has flat lined in oversold conditions and that the slow is about to join it:

Now we have the Quarterly timeframe on a 20 year chart. Note that the fast is oversold and that the slow has only just left overbought!

This is an 80 year SPX chart on the YEARLY timeframe. Note that we just produced a SELL signal and that the fast has yet to reach the level of 2002, or of the levels in the mid ‘70s or in the 1930s.

There are almost always CROSS CURRENTS that run through time! The perfect trade entry would be going short from ALL timeframes overbought, or going long from ALL timeframes oversold. Guess what, if ALL timeframes here gets too oversold on the slow, you may NOT have THIS market to go long in!

The relationship between fast and slow is interesting. The fast is just that… it leads the way and quickly warns that the wave trend has changed. The slow is a little more cautious, saying, “wait a minute here, this could be a head fake!”

Right now I don’t like the cross currents with a buy signal on the weekly and an approaching sell signal on the daily. The same crosscurrents are occurring in the short time frames. Thus there is no clear direction and it’s a good time to sit back and watch others grind their account values down. Only the very best traders will make headway in this environment, you must be quick or committed to a long term position (hopefully short until the bear market is over) that does not decay in value with time or loses it’s value in relation to the underlying asset like the inverse ETFs do. Good luck!

My best trades are made from times where all the shorter timeframes are in alignment and they, in turn, are in alignment with the longer timeframes. Right now this means being patient and waiting for the 5, 10, 30, and 60 minute timeframes to be overBOUGHT and then going SHORT which is with the direction of the current BEAR market. This entry is much more powerful if you can get the daily and weekly waves on your side. You would have to be REALLY patient to get the monthly also on your side, but when those times present themselves, it’s time to go in with a larger portion of your portfolio.

Once IN a trade, the hard part is determining when to get OUT of that trade! Here, I’ve learned to be patient with the short timeframes but it depends upon whether I consider it more of a “SWING” trade that may last several days or even weeks, or if it is a “DAY” trade that I plan to close before the close. Let’s use a day trade as an example, and let’s say that I caught all the time frames up to 60 minutes in overbought and went short:

I will then watch the 1 through 10 minute timeframes oscillate but will be keying on the 30… It is my philosophy when day trading (especially if I don’t have a reliable exit target) to attempt to “cream” the markets by taking only the middle or first 2/3rds of the move. To do that, I watch the fast and slow on the 30 minute scale and SELL once the fast reaches oversold (don’t want to be a pig!). That is probably not the extent of the move, as usually the slow needs to get close to oversold or actually in oversold in that timeframe. SOMETIMES, however, this technique will make more profits than waiting for the fast to come up and cross the slow to produce a “buy” (which would be time to sell a short position).

There are a lot of techniques and you need to adapt your technique to each time frame as they do not work across the board in the same manner. Once you realize that you are watching WAVES, you can add a little Elliott wave knowledge in to help you make better decisions about entry and exit. Of course using traditional targeting techniques from basic technical work is important too. Never easy, my best advice is to take as much in as you can keeping in mind that the market’s waves are influenced by; the FUNDAMENTALS, the TECHNICALS, and market PSYCHOLOGY.

Best to your trades,