Friday, February 15, 2019

Trader Notes: Trading Breakouts and False Breakouts

Breakout Traders.

After years of reviewing investing blogs, and sharing experiences and trading styles in chats with colleagues with a lot of trail in this world, I'm sure that (one of) the most popular traders are the "breakout traders". This is a type of trader who uses technical analysis to identify high conviction breakout patterns that can profit on bullish rallies or bearish downtrends. They use popular patterns as the Bohlinger Bands, wedges, head and shoulders, etc to find breakouts that happen at support and resistance levels. Personally, I prefer the most powerful of all: the horizontal linessupport and resistance levels. Yes, simply: price levels.

All traders (day, swings, investors) are exposed to a false breakout or a whipsaw. Markets have many false breakouts below support and above resistance, with prices returning into their previous "range zone" after a brief violation. Whipsaws happens when a sharp price movement is quickly followed by a sharp reversal, all inside a common support or resistance lines. Just after the probable breakout, we could identify another "range zone", a zone of conflicting interests where price oscillates between two boundaries. 

Here we identify four breakout traders styles:
1- Those who want the breakout to occur and make decisions in that direction.
2- Other expecting the range zone to continue, fading the breakout.
3- Aggressive traders, who trigger the breakout only to drive the price back to the range zone.
4- Finally, are those contrarian traders who are waiting for the momentum to wane and immediately trade back in the other direction.
Here I'm going to focus on the first type: how to recognize a real from a false breakout, and in the last, how to capitalize on a false breakout using the range zone and only price action.

Recognizing a Successful Breakout

Breakouts occur in zones of conflict. Both sides of the market are very passionate at these turning points, but no one knows how much force is required to carry the stock into a sustainable trend. Trade carefully a breakout: price may carry successfully to higher levels, or generate a whipsaw, or just do a false move and starts trending in the opposite direction. Risk management is the key to avoid great losses in your portfolio.

Breakouts happen every day, but the more powerful and trustworthy were the ones that occur in three phases clearly defined, involving just price and volume:

1. Action: Price breaks through a resistance (or support) on increased volume. Many inexperienced traders think this move is enough for a sure breakout. Many times it's correct, sometimes could happen the contrary.
2. Reaction: As price expands some ticks, then the buying interest fades, market sell-off and create a pullback. Fresh buyers see the breakout level as the logical point to place their trades. The main characteristic of this reaction phase is decreasing volume
3. Resolution: A new rally begins when it touches the breakout level, with price above the Action phase high. New buyers need to jump in to ensure this resolution phase. If the volume fails this scheme of three phases, false breakouts and whipsaws are generated.

In this daily chart of UNH you can see how powerful the $ 125.50 resistance was: three times could not be overcome between July and November 2016. Only in March 2017 was it able to overcome the level, producing the Action, the first phase of the breakout, with an increase of volume. The Reaction phase is decisive to know which direction the stock will take. It lasted two weeks, after which the price returns to the level of resistance, where the bulls press upwards to complete the Resolution stage with increasing volume. Finally, the stock reach up to $170 level in December (not seen in the chart), confirming the power of a breakout when it meets all three phases. Just price action, with no indicators.

A simple rule: avoid whipsaws

The feared whipsaws, the nightmare of all swing traders, emerge when the reaction phase of a breakout, mentioned above, failed. The size of the drop depends on how powerful are the forces that pull prices back to the resistance level, versus how many bulls try to support the market. These two forces decide the price behavior: sometimes the whipsaw fades out and a successful breakout begins immediately. In that instant, the loss of volatility gives a good buying signal. Always include this indicator in your favorite platform.
Typical whipsaw pattern in this GPC daily chart. After the breakout (1) at $45.50, the price is indecisive of the course to take for near two months (2). Finally, decide an upside movement in (3).  Those two months were a very difficult place to enter a trade. Usually, these whipsaws generate high volatility in the stock, and there is no-rule to manage any strategy there. The best decision is simple: avoid the stock and check other securities.

Taking advantage of False Breakouts

Best than avoid the false breakout, the idea for a trader is to recognize when it happens, and take advantage of this. Alexander Elder, in his book "Coming into my Trading Room", consider that some of the best trading opportunities occur after false breakouts, up or downside. They patterns are similar to tails, only tails have a single wide bar, whereas false breakout can have several bars, none of them especially tall. The rules are easy:

- When the price falls back into the range zone after a false upside breakout, you have extra confidence to trade short. Use the top of the false breakout as your stop-loss point.
- Once price rally back into the range zone after a false downside breakout, you have extra confidence to trade long. Use the bottom of that false breakout as your stop-loss point.

He explains the dynamics of a false breakout: "after price hits a resistance, the professional traders (the ones who holds your orders) know there are many buy orders above the resistance level, generally of traders looking to buy a new breakout, and others are protective stops of the short sellers. A false breakout occurs when pros "organize a fishing expedition" to run stops. For example, when a stock is slightly below its resistance at 60, the floor may start loading up on longs near 58.85. As sellers pullback, the market roars above 60, activating the buy stops. The floor starts selling into that rush, unloading longs as prices touch 60.50. When they see that public buy orders are drying up, they sell short with confidence and prices tank below 60." As usual, professionals and machine algos manage the stock market trades...

In November KO reached a peak at $47.50, then attacked that level in January and rallied above $48.50, only to sink below the old peak a few days later. The false upside breakout (in the yellow circle) marked the end of its bull market. Back experiences said you can short with confidence in $47 level with a stop-loss in $47.50 for a profitable trade.
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Wednesday, February 6, 2019

Watchlist Update: CREE, MRVL, UBNT, YNDX

Market Pulse.

Despite world economic slowdown, the rally continues unstoppable in Wall Street, and now the SP500 SPX is testing its important SMA200 average, that probably crossovers these days due to the crazy momentum it's having for near six weeks. Isn't clear why but the rebound is powerful. Seems that the US government shutdown ends for now, Powell and the more dovish FED, and the slow advances in Trade War negotiations are enough arguments for the stock market to climb 16% since its bottom in December 26th, overcoming the 61.8% of its Fibonacci, and definitely enter in bull territory. Time to check some stocks of my February' watchlist.

Cree Inc. CREE, $51.87

After profit-taking in CREE and waiting for its earnings, as I post recently here, now I'm again long in this stock, because of its nice results and bullish indicators. Its Q2 widely beats the market (EPS $0.23 vs $0.15 estimate and $0.01 loss a year earlier, Sales $413M vs. $408.8M estimate, from $367.9M a year ago), and its Q3 guidance is mixed. It was the data I expected. Also can benefit with the growing cannabis industry, with it heating products.
Today have completely recovered its fall since August and is testing its highest close since July 2014 ($52.83), with +20% race this year. Another good news: Oppenheimer raised its priced target to $59 from $53 keeping its outperform rating due to strong silicon carbide demand and improved operational performance. With a P/C=0.214, and taking advantage of its low implied volatility, isn't a bad idea to buy some calls, at the money, for the long-term.

Marvell Technology MRVL, $18.31

Marvell is a semiconductor provider of application-specific standard products. The Company is engaged in the design, development, and sale of integrated circuits used by a variety of global customers in the home automation, wearables or automotive, that's the "Internet of Things". From lows at $7.4 in January 2016, MRVL had a great rally until March 2018 ($25.18), starting there a solid  correction. Since December is recovering, testing this week its SMA200 average, but its recent outlook was not well received by investors. They report a weaker than expected demand for storage controllers and expects the weakness to continue into Q1. Today, a downgrade from Craig-Hallum reinforced the market sentiment, not bearish but neutral.
Technically, the 38.2% of its Fibonacci at $18.50 is now a complicated resistance to overcome. But, in this case, the fundamental data was decisive to stay neutral in this stock until its next earnings report on March 7th. Possible short in the short-term.

Ubiquiti Networks UBNT, $109.59

As I mentioned in a 2018 postUBNT is one of my favorite stocks.  But for me, after an amazing 2018, is time for taking profits, just before Thursday, its Q3 earnings. Their fundamentals are still fine, but I perceive certain exhaustion in its stock price: volume is decreasing, and the $115 seems to be a difficult level to overcome. Also, its MACD has a clear divergence with price, that its peers in the industry (as PANW or FNSR) didn´t show.
Definitely is a good stock for the long-term with place to grow, but I prefer to wait for earnings results to proceed in the short-term.

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Monday, February 4, 2019

Trader Notes: Trading the Volatility. Part 2

The VIX and its inverse relationship with the markets.

The VIX, as a contrarian indicator, is an incredible weapon for technical traders to determine extreme conditions of bullish or bearishness of the market, using its inverse relationship: when the market is rallying, the VIX tends to drop; when the market is tanking the VIX tends to riseSmart and serious investors use it to bet against the crowd when its greed (or fear) levels are high. And mainly, they use it as protection or hedge for its investments.

The VIX, also known as the 'fear gauge', measures the frequency and intensity of changes in the SP500 in the short-term (30 days), through the implied volatility IV of its at-the-money call and put options. A level below 20 generally indicates a bearish or complacent market, while reads above 30 are generally associated with a large amount of volatility, and mean that investor fears are taking place. 

Smart traders usually "buy bargains" when volatility is high, taking advantage that the crowd is panicked closing positions: in a market sell-off, they are more inclined to buy VXX (the ETN that replicates the VIX behavior) puts or SPY calls as protection or as a speculative position without too much concern for the prices they have to pay. On the other side, with low volatility, and as long implied volatility is low, seems a good opportunity to buy VXX calls or SPY puts at reasonable prices as a protection for our portfolio. Investors who want to trade the VIX should keep in mind that VIX-linked products are short-term trading instruments, only for traders who know the risks.

How to play the VIX

First of all, is important to tell that isn't easy to trade the VIX: it's like an art. Experienced traders know that. It special behavior forces you to take jealous control of your trade. That's why is best make VIX trades only in the short-term. And, after trying in different timeframes, I get better and more clear results in the daily chart.

There is a chart that I always have visible on my Thinkorswim platform: the daily of the VIX with just two studies: the Bohlinger Bands and its moving average SMA200. As we know, the Bollinger Bands is a popular technical indicator to determine overbought and oversold conditions. In a range-bound market (as VIX accustoms) the BB works even better as prices travel between its two "rubber bands". On the other hand, the Simple Moving Average 200 is probably the most used and reliable average used by traders and investors, including smart investors. An example of its power and influence in the markets could be observed recently last year in December when a falling SPX index touches its SMA200 and originated an amazing rebound that lasts until today.

The candles represent the VIX daily price action, the grey line is the SP500, always in opposition. In purple, the upper and lower bands of the BB. The blue-sky dashed line is the SMA200. The VIX behavior with these two indicators is typical, so is a good idea take advantage of it in our trades.


Look at the chart above, taken from the past year 2018. First, verify the inverse correlation between the VIX and the SP500 index SPX. It happens all the time, like a 
mirror image. Second: as the VIX trades, its value raises or falls, as it bounces off the upper or lower band of the Bohlinger Bands. So:
- Go long in VXX when the VIX falls to the lower band of the BB. At that moment the market is at a peak and began a pullback, as you see in the chart. 
- The same idea, but contrary, is used for the upper band of the BB: go short in VXX, and verify the SP500 began to rebound. 
There are many more complex option strategies (spreads) to take advantage of this situation, that I will analyze in a future post.

Now, check the SMA200.  Last year was a very difficult resistance (then support) for the VIX to overcome. Review other years and verify that its a typical behavior of the VIX with its SMA200. Since August it rebound many times in that level (in the yellow circles). Finally, after three attempts, in early October the VIX breached its SMA200, and the SP500 now reversed dramatically. These breakouts are very attractive entry points for a disciplined trader. Notice that in early November and December, with the SMA200, now as support, had two new failed attempts to crossover it. And today, with the VIX in 16.14, is in its third attempt, so pay attention with the volatility behavior this week.

Strategy using the VIX spikes

This simple strategy is focused on the VIX daily chart. I suggest in this case, when trading, forget the SPX chart because, although they are inverse, this moves in a tendential way, different from the VIX that does it in very marked ranges, and can create confusion and anxiety for the novice trader. Even sometimes there are divergences between the two that can complicate more the analysis.

More than a strategy, its a tip when trading the VIX. In its daily chart notice the clear difference between its relative tops and bottoms: tops are spikes, like an inverted V, while bottoms are more rounded
- In the tops, this is because fear is the predominant feeling, that very fast becomes in panic. This rapid rise is usually followed by a bearish candle when the smart investors decide to start trading.
- On the other hand, in the bottoms of the VIX chart, the market is more complacent, greed is in charge of the traders' feelings and so the SPX costs more to fall, that's why bottoms are slower and full of false signals. 

The diligent trader has already grasped the idea of this strategy: trade in the spikes of the VIX daily chart, operating shorts or puts. To find an acceptable entry point, the Bohlinger Bands are useful: waiting for the moment when the bullish candle leaves the upper band with some slack. Then expect a next bearish candle that wraps it completely (or almost) the previous bullish. This candlestick is known as engulfing. The open of the next candle is my entry point. Everything very simple. However, there are a couple of undefined points in this strategy. One of them is not being clear about the exit. Perhaps the best idea is to set in advance a risk-reward, like the popular 1: 3 used by many traders, to determine the exit.

The other complicated point of this strategy is the location of the stop loss. The usual is that the VIX continues its fall the following days and is difficult it returns above the engulfing candle, however, it can happen. A double top would be formed, the most reliable figure in the technical analysis according to Alexander Elder, where we could confidently sell the VIX. The best plan is to trial daily the stop loss to a safe level.

The "VIX spike strategy" works best in its daily chart. Every year happens, few but powerful. In this chart, taken from 2015, we noticed two big spikes overcoming the upper band of the Bohlinger Bands (mid-October and mid-December, in the yellow circle), both followed by an engulfing candle that generates the quick and important reverse. Two more spikes happen in January and February 2016 (also in a yellow circle) but in both cases, its price didn't overcome the BB, so its reverse isn't as powerful as the 2015 spikes. Finally, in the pink circles, we had two spikes that haven't an engulfing candle enveloping them, so the reverse seems very unclear.

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Friday, February 1, 2019

My Stock Watchlist for February 2019

On my Thinkorswim trading platform, I manage several watchlists, differentiating them according to the instruments it contains. There are stocks, futures, ETFs, sectors, and indices.

My ETFs watchlists (not shown) usually keep the same symbols in time, diversified by sectors, industries, countries, commodities, both at 1X normal speed and 3X triple speed, combining long and shorts positions. My Indicessectors, and futures watchlists (not shown) are also fixed, covering the main index and commodities in Wall Street and major foreign exchanges, the usual managed by all traders. 

Those that do change permanently (usually weekly) are the symbols of my stock watchlists, shown below. I divided them into two groups for follow-up: Main15, which I follow on a daily basis, and Active, important stocks to follow due to news topics, popularity, unusual volume in shares or options, or huge changes in price or volatility. Over time, appears there a new stock, disappear other, some ascend to Main, or vice versa, according to the importance they are acquiring, in my opinion. Keep in mind, there are watchlists (longs and shorts), not "Buy" Lists.

View the Disclaimer: that a certain stock is in these lists does NOT mean any BUY or SELL recommendation. My suggestions and ideas regarding these stocks, in which I'm longshort or neutral, I do in this blog through the "Watchlist Update" or "Stocks to Watch" posts. And mainly through Twitter or StockTwits, which are much more friendly and dynamic platforms for a chat and get feedback from traders. 

So, these are my Stock Watchlists for February 2019. Follow them in real-time through the stock ticker above, powered by Macroaxis, clicking in each symbol for more information.

Images were taken on January 30th. 18:15EST
Correction: ILMN instead of CERN in the "Active" watchlist.

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