Stops or no stops – a response to StockSage1

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Yesterday morning I posted “Lessons from a difficult year of trading.” The post detailed three major factors contributing to my current 13 percent drawdown and nine modifications I am making to my trading plan in response to the situation. All successful traders – discretionary and systematic – are constantly on the alert for ways to improve their trading operations.

One of the nine modifications was the following:

Modify my protective stop protocol to reflect increased intraday noise

I have always believed in having protective stop orders in place at all times. I am no longer a strong advocate for this practice. I have been stopped out of too many positions only to see better exit spots within hours or days. Rather, I am now an advocate of the following protective stop protocol.

  1. No stops in overnight markets, including forex
  2. Mental stops based on closing price charts – the use of mental stops requires disciple to follow through with intentions
  3. Very wide actual stops (daytime session) to protect against a “worst case scenario

My friend and peer, Robert Sinn at The Stock Sage responded to my post almost immediately with an excellent piece titled, “The Evolution of a Professional Trader – Stop Loss or No Stop Loss?” Read Robert’s post here.

Robert Sinn, The Stock Sage

Robert is one smart trader and seldom misses a beat. Robert, very wisely, makes the following point:

 “I believe that the use of stops is absolutely essential in short term trading. A trade should have a defined target objective which in turn requires a defined risk. It is too easy to talk oneself into moving a mental stop in the middle of a trade, therefore, using a hard stop (placed shortly after the trade is entered) is optimal over the long run.”

In a subsequent back-and-forth email exchange, Robert suggested that I more fully explain the thinking behind this modification. Great suggestion! So, here it goes.

Stops are essential in trading. Novice and emerging traders should NEVER trade without a protective stop. NEVER! I agree with Robert that using a hard stop is optimal over the long run.

The modification I am making is a rather nuanced one, as I will explain with three points and a chart example.

First, it is important for you to know that I seldom trade a leveraged futures or forex position (although the total value of all my positions combined at any given time will exceed my account value). For example, for each $1,000,000 of account value I am likely to limit a trade to four contracts of Comex Gold, 300,000 to 400,000 EURUSD or ten contracts of Corn, just to provide a few examples.

Second, I traded for decades when overnight markets were not even available – and my performance during those years was actually superior to my performance since 24-hour markets began. I can remember being awakened in northern Minnesota in the middle of a summer night by a thunder bolt, and wondering, “Is it raining in central Illinois…how will Beans open tomorrow?” I begin trading spot forex in the early 1980s, but did not pay any attention to overnight cross rates (except for the Yen) until 2007. I was in the Crude Oil market at the start of the Gulf War. I was in a Gold position on 9/11 when the Towers were hit. I survived these events just fine without 24-hour markets.

Sure, not having an order in the overnight markets will result in an occasional hit. But, I am convinced that the risk is worth it – especially considering the fact I am not leveraged in any given market.

Third, my focus on closing prices is very consistent with orders that were once common place in the good-old days of the exchange trading floor. The electronic exchange has taken flexibility away from traders. How unfortunate! For example, one order I used extensively was an “OCO,” or “one cancels the other” stop, with one component being a hard stop and other component being a “close-only” stop. Here is a real example of how this would have worked in a recent trade.

I shorted the June S&Ps at 1323 on May 17. I always place protective stops a few points above the high of the bar I use to protect a trade. The bar I used for the stop was the May 16 bar, which had a high of 1341.25. My stop was placed at 1343.25. I was stopped out on May 19.

However, my preferred order would have been to place a “close-only” stop against the May 16 bar and a hard stop against the May 13 bar. In the good-old days my stop-loss order would have read…

  • “Buy 10 June S&Ps at 1353.50 stop OCO buying 10 June S&Ps at 1343.25 stop-close only, one cancels the other.”

This order strategy would have kept me in the trade. In a very real sense, this modification of my protective stop strategy is a roll-back to earlier days intended to nullify intraday noise. I will lose more money in those trades in which I am dead wrong on direction, but I will keep from getting chopped up in many more trades.

Yet, I completely agree with StockSage1 in principle that the use of stop-loss orders, all other things being equal, is a must in trading.

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It’s as easy as “ABC” – classic H&S failure in Corn

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Often a pattern failure tells a better story than does a pattern completion.

This is just what we have in the case of new crop December Corn. As of last week it appeared that Dec. Corn was forming a H&S top pattern. On Wednesday, May 11, the market completed the top pattern (the “A” in the story). On May 12, the market had a minor upside reversal, but remained below the neckline. On May 13, the market poked back above the neckline intraday, but closed below the neckline. Then on May 16 the market spent the entire day above the neckline, followed by a strong gain on May 17. This is the “B” in the story and confirmation that a bear trap had been sprung.

I consider H&S failure patterns to be very tradable chart developments. The advance today, May 18, penetrated the May 10 right shoulder high and officially completed the failure pattern. This is the “C” in the story. Support should be solid at 664.

The target of 733 is based on projecting the distance between the April 26 high and the May 12 low (which is 69 cents) upward from the right shoulder high of 664. The market should probably not take out Wednesday’s low (652-3/4).

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Flags flying at half-mast – a sign of death!

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 Risk On – Numerous charts show signs of a pending decline 

In the markets, as in real life, flags flying at half mast symbolize death. A number of half-mast flags and pennants in the raw material markets indicate that the steep decline in early May was just Act 1 in a two-act play. The flags are symbolic of the intermission between the Act 1 (the first decline) and Act 2 (the next phase of the bear trend). 

Bear flags or pennants are present in the following markets: 

  • Crude Oil
  • Heating Oil
  • Gold
  • Sugar
  • Soybean Oil 

Crude Oil and Heating Oil display classic pennants. Rallies toward the May 11 high (while not necessary) would be an excellent shorting opportunity. The target of the pennant is Crude Oil is 84.80.  

The target in Heating Oil is 2.5060.

The Gold displays chart construction similar to the energy products with two exceptions. First, there is potentially enormous support under the Gold market in the form of a previously completed 4-month continuation inverted H&S pattern. However, old support sometimes has a way of disappearing. Second, the huge volume on May 5 could indicate accumulation buying by strong hands. However, if the energy pennants lead to a strong decline it will be difficult for Gold to hold up in a Risk On/Risk Off market environment. 

Sugar also displays a classic bear pennant. This market is in a well-established bear trend and has been since early February. Notice that the pennant in the October contract is forming just below the neckline of a 5-month H&S top. The target in October Sugar is 17.83. 

If my analysis is correct in Soybean Oil, the current pause in the form of a flag should be the last support before a sustained markdown in price. Once this flag gives way, prices should trend to 45.60. (Caveat: The pattern in Bean Oil could prove to be an extremely bullish continuation H&S pattern. Traders need to be flexible on this one.) 

Additionally, a number of other markets present technically bearish potential. These markets include:

  • Russell 2000
  • S&P 500
  • Silver
  • Corn
  • Soybean Meal

The Russell 2000 is hovering right at the major 8+ month trendline. A violation of this trendline would indicate that the bull trend since March 2009 is seriously aging. The initial target would be 770 as part of the transition from bull market to bear market. 

 

A confluence of technical developments can add to the legitimacy of a breakout. There are four factors that could trigger a sell signal in the S&Ps simultaneously by a decline below the May 6 low. First, the 2-month cup and handle bottom would fail; second, the 2-month trendline would be violated; third, the May 2 Ben Laden blow-off would be confirmed;

and, finally, the hourly chart symmetrical triangle would be completed. 

I touched the third rail in late April when I announced that Silver was in the bubble phase. I was tarred and feathered on May 1 when I pronounced the previous week’s volume (7.5 years of global supply) was a strong sign that Silver had topped. The market has found support in the low 30s and a bounce into the low 40s is possible as Silver develops its own half-mast bear pattern.

New crop December Corn has traced out a H&S top. It would not be unusual for Corn to top now.

The seasonal chart shown indicates a strong tendency for new crop Corn to top in May or June.

Finally, the daily chart of August Soybean Meal displays a very clear possible descending triangle. A close below the recent lows would complete this pattern and establish a target of 300.

Adding all things up, the period just ahead could be a tough life for raw materials (and stocks).

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It’s 1…2…3 strikes you’re out!

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The S&Ps have a possible top

When it comes to classical charting, it is always best when a multiplicity of developments occur. Such is the case in the S&P right now. There are three (if not four) chart developments that could support an important change in trend.

FIrst, the late April breakout from the 9-week cup and handle pattern has not resulted in follow through. The top of this pattern was tested hard on May 5. A move below the May 5 low would be a failure of this pattern. Possible strike 1.

Second, the daily chart displays a trendline from the March low. While I am not a big fan of trendlines, when a trendline violation occurs simultaneously with other developments it grabs my attention. Possible strike 2.

Third, the intraday chart displays a clearly defined 5-point symmetrical triangle top. Possible strike 3.

Importantly, a decline below the May 5 low would complete all three developments. There is one other important technical factor worthy of note. The Ben Laden top now appears to be a clear blow-off. The market has been unable to trend back into the range of this reversal day.

I will short this market if the May 5 low is penetrated. The target would be 1243. I remain long the Nasdaq from April 20– and am very close to being stopped out of that trade.

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What Now, Silver Cow?

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Just for fun, yesterday I did a snarky post on a very short-term “pie-in-the-sky” forecast for Silver. I called for the bounce to stop between 39 and 42 (actual high was 39.47) followed by a decline to below 33, then a rally to 42. The lines on the chart below were drawn yesterday morning.

So far so good. Pure luck…if I am right it will be pure luck. A wild guess! A hail-mary pass! I admit it. Of course, I am far from right yet. Alot can happen. The Silver market (and any other market) can do anything it wants to do whenever it wants to do it and it would not surprise me. The Silver market is NOT accountable to my whims or wishes or wild guesses.

I had a number of folks challenge my forecast, wanting to know on what technical or chart basis I would come to such conclusions.

I have no idea if I will be right — like I stated above, I was taking a wild swing in the dark — but I will share with you my reasoning (right or wrong).

My price scenario was based purely and soley on what I thought the market had (has) to do to most severely punish Silver bulls, more specifically, Silver bulls that are long above 40 per oz. My secret is out! I have told it all. My market call had NO basis in technical analysis. Period! My career as a classical chartist is over. I have sinned against my craft. I created a scenario that was based on what I thought the Silver market could do to most demoralize the johnny-come-lately Silver bulls.

I could have also created a price scenario of what I think the Silver market could do to most severely punish the Silver bears. Perhaps I will share this in the days to come. Perhaps a “punish-the-bears” scenario is the real agenda of the Silver market.

The truth be told, I could care less which scenario comes to pass. I have no vested interest in Silver. I am a trader. I trade price, not market biases, not fundamental scenarios, not Fed doomsday events, not the future value of the US$. And by the way, the last time I checked the U.S. Dollar is not traded in the Silver pit. Never has been. Never will be. There is an actual contract for trading the Dollar.

That’s all for now, folks.

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Silver – What’s next short term?

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Most chart patterns fail and then morph into larger patterns in a process I call “redefinition.” This is especially true of intraday charts. They are extremely unreliable.

With this in mind, here is my best guess on the short-term chart structure of Silver.

On the daily chart, a major top is in place. I keep hearing people talk about waiting for a decent break to buy  — about catching the next upleg in the market. Unbelievably, many “investors” are still bullish on Silver. To me this is a gigantic red flag. Conventional wisdom (i.e., the prevailing view of the marketplace) holds that Silver is in a significant correction within a much larger bull trend. The bias of investors (those not wiped out by the first decline) is to be long.

What we know for certain is that a parabolic move ended in massive record volume in Silver trading (futures and ETFs). This is a sign of a top. The burden of proof is on the bulls. In fact, should the market rally and make a new high it would be one of history’s great shorting opportunities. People have attempted to convince me that Silver was not in a parabolic move. WHATEVER!!!!!

Make no doubt about it, Silver has topped. If it has not topped, it will be many, many months before a legitimate bull trend can re-emerge.

Short term, the hourly chart displays an advancing channel. I believe that a bear market correction to the $39 to $44 zone is possible, but not on this leg up.

More than likely the market will have a further downward correction, perhaps even making a new low for the decline, before a more serious rally into the low 40’s can occur. From a market psychology standpoint, a decline to the low 30’s followed by a rally into the low 40’s would get the bulls all excited again — just in time to be slammed once more.

Then the market should drop into the mid 20’s.

Full disclosure: I have no position. I have no bias to defend. I don’t really care where Silver goes. I am perfectly ok if Silver goes to 5 or to 100. I don’t care if my next trade is short or long. I only care that sometime in the next 12 months the Silver market will give two or three low risk/high reward chart setups.

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Silver — history repeating itself

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Three reasons why Silver might be close to a temporary bottom (within a larger bear market).

  1. There will be support at the trendline from August and January lows. Today could end up as a reversal day.
  2. Small investor may be washed out — this is needed for a rally to occur. SLV had record volume Thursday at 294 million shares. More volume than SPY. This volume represented small investors liquidating, not accumulating. The buyers were people who took profits last week. Sorry, small investors, this is the way the raw material markets work.
  3. The top in 1980 would indicate a rally from here. The rally should not exceed $39 to $42. Do not be confused — Silver is now in a bear market.

Soybean Meal — building a 2011 top

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“Cops raid the brothel” — part 2

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I left out an important part of history in yesterday’s post on Silver…that is, the origination of the phrase: “When the cops raid the brothel, everyone is arrested, including the piano player.”

I first heard this phrase at the CBOT in early 1980 in direct reference to the Silver market collapse. On the chart below you will note that Silver topped at 5056, dropped quickly to 3025, recovered to 3970, then was destroyed to 1080 and eventually 4 (that is $4 per oz.) for a total decline exceeding 90 percent.

The reported reason for the decline was the failed attempt to corner the physical market by the Hunt brothers of Texas. Today’s equivilant would be a combination of JP Morgan and the small speculators through the ETFs. The CFTC stepped in January 1980 and hiked the margin requirements. The rest was history.

The real reason for the decline was that Silver had no business being at $50, that Silver is a COMMODITY, and that commodities have boom and bust cycles.

Many, many investors got wiped out by the drop. During a meeting at the CBOT, a member made the statement, “Isn’t it too bad that not only the Hunts got wiped out, but little investors who had nothing to do with the manipulation also lost the family farm.”

To this comment, and old-time trader made the statement…”Well, you must remember, when the cops raid the brothel, everyone gets arrested, even the piano player.” I will never forget the phrase or the meaning of the phrase.

By the way, the conventional wisdom during the advance of 1979 (extending far into the 1980s) was not much different than it is today. Inflation concerns, worries about fiat currencies, fed policy, etc. These were the reasons the small investor bought Silver then and the reason they bought Silver in this cycle. Margin call after margin call later, the small investor always plays the role of the piano player.

By the way, a good way to play Silver in stocks is to short the ultra long, AGQ. Of course, pick your spots and use stops. Even if Silver develops into a broad trading range, AGQ will decline.

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When the cops raid the brothel, everyone is arrested, including the piano player

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Silver prices cannot go down, after all, the US$ remains weak! The fed is out of control…inflation is brewing…my macro model calls for further gains…China is still buying…my canary is sick…my mother-in-law bought a new Honda, etc., etc., etc.

This is all I heard as a result of my posts on Silver in the past week. Now, I want to be cautious not to crow, because those who crow end up eating crow down the road.

But the reality is this — Silver is a commodity. As a commodity, Silver is subject to boom and bust cycles, just like Sugar, just like Soybeans, just like Coffee. There is nothing special about Silver. Do you believe me yet?

Let’s put this decline in Silver into perspective. An $11 break in Silver is worth $55,000 per Comex contract. This is equal to a $550 move in the price of Comex Gold, an $11 move in Soybean prices, a $2.20 move in the price of Copper, a $1.46 move in Coffee prices…should I go on?

The Silver market presently is about one thing and one thing only…margin call liquidation. Silver prices have nothing to do with everything people told me would drive prices higher. Silver prices are about thousands of small speculators long above $45 per ounce.

The commodity market behaves like a living, breathing entity. The market instinctively knows when a group of investors are in trouble. And when a group of investors are in trouble, it is like a brothel raided by cops. Everyone gets arrested.

This phase of liquidation will not last forever. But it will last until every small speculator long above $45 per ounce is forced to liquidate. Every last one. Only then will Silver be able to experience a sharp counter-trend bounce. But make no doubt about it, the bounce will be counter-trend. When the bounce occurs an entirely new group of investors will jump aboard thinking the bull market is once again alive and well. These investors, too, will end up in a brothel raid.

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