Tuesday, September 01, 2009

Tools for Intermediate Time Frames

By D.R. Barton, Jr. of Van Tharp Institute

Click here for Dr. Van Tharp 2009 Live Trading Workshop Schedule

“Give us the tools and we will finish the job.” ~ Winston Churchill

The Right Tools for the Market

These days, I’m often questioned about the market direction. People ask "Will this market keep going up?" I do have an opinion on that based on ways—“tools”—to look at market action. Out of all the fundamental, technical, wave counting, and other tools that are out there, I only want to use the best ones—those that help me develop an opinion quickly and with the most conviction. As with the sandal, the right tool makes the job a lot easier.

I like to look at the market from an intermediate term perspective. I believe that the best tools to help me evaluate intermediate term moves for the market are analyzing retracements versus recent market moves, comparing our market to other world markets, and comparing price and momentum.

Retracement Levels

The traditional way to look at Fibonacci retracement lines is to use them as a trend continuation tool. In this case, we’d look at the big bearish move down and try to gauge the strength of the move based on the intensity of the retracements that follow the move. A retracement of 0.382 (38.2% of the original down move) that then continued down would signal a very strong down market. A retracement of 0.5 would be a “normal” move and indicate a moderately weak market. And a retracement of 0.618 that continued down would indicate that the down move is not very strong. A significant violation of the 0.618 line would indicate that the trend is over and would be classified as an uptrend.

Interestingly, the chart above shows that on the August 7th high, the market peaked just above the 0.382 line at 1014 and was rejected. We’re still not far from that line. If the market works down from this level, it would be a very bearish technical indication. If price does make it through the 1014 level, the expectation then would be for a test of the 50% level at 1121.

In Other Areas of the Globe

China’s markets made a bigger recovery from last fall than most of the world’s regional economies. Now, analysts are looking at that huge and growing economy as something of a bellwether.

This chart of the Dow Jones Shanghai index shows a 20% decline, throwing the Chinese market firmly into “bear mode” classification.

The middle of August swoon in China started earlier and has gone deeper than the minor pullback we’ve seen here in the S&P 500.

Traders and investors will add a useful tool to their swing trading toolbox by keeping an eye on the movements of the indexes in China.

Market Momentum

The last tool we’ll use focuses on the little double top that the S&P 500 made recently. First, look at the double top price action, then look at what the MACD and stochastic indicators did during that same period. Mabel, that’s called divergence.

Divergence is a great guide for evaluating tests of highs and lows. Since this test of the highs was so close together, perhaps the third test of 1013-1018 will be more important. But if momentum continues to be weak, the next test is likely to fail again.

(Side Note: Christopher Castroviejo has made a very lucrative career in the markets trading divergences. He is so well-recognized for his specialty that Market Wizard Ed Seykota nicknamed Christopher “Doctor Divergence”.)

Tools and Trading

The perspectives above give you a quick example of how a few simple tools can help you form an opinion about market action. Could you trade that? Well, maybe not just yet, but if you were equipped with the right tools, a set of tested rules and proper risk management, you probably could. At next month's swing trading workshop, we are going to provide you a full toolbox and sets of rules to help you go home and trade swing systems well.

Christopher and I will teach Tactical Pro Swing Trading in September. We’ll show the tactics that he and I have developed and used in a combined 60+ years in the markets. We’ll be digging into mechanical strategies while adding some street smart savoir faire to the mix. We also have a great section on using options in the swing timeframe that can add a “power” tool to your systems toolbox.

Viewed as a broad “style” of trading, the swing systems we teach can be rewarding from several perspectives. For a lot of traders, swing trading fits into even the busiest schedule. Swing trading offers numerous opportunities to catch lots of moves that the longer-term players miss. It also helps you get out of the way of some of the more dangerous market moves.

In addition, we’re teaching a fourth day completely dedicated to band trading. In the current market conditions, bands seem to be working well. Given how we see the markets for the foreseeable future, we expect bands to be a trading method that will work very well for some time to come.

Great trading, D. R

About D.R. Barton, Jr.: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at the Van Tharp Institute