Tuesday, December 1, 2009

Trader's Diary: A Dow Short Gone Bad, A Potential NZD/USD Long

Here's an analysis I wrote for a VIP client. It contains some lessons we all should review.

Hi Mr. X,

Here's the analysis as per our conversation.

A Dow Short Gone Bad

Here's the chart of the Dow that we discussed:

Dow 30 Daily Chart (image:11 dec 01)

You had the right idea getting on an established downtrend on November 2nd. You were very close to strong resistance at 9750, where there was a QUADRUPLE combination of

• Price support as shown by repeated closes/opens, ( I count about 14 since August)showing that this level was a price support level

• A 50 day moving average

• A 23.6% Fibonacci retracement

• The lower trend line of a long established rising channel

This was indeed a great "QUAD" combination of strong support indicators. A great place to go short because if this support at 9750 didn't hold, it was a strong signal that the uptrend was not yet dead.

Clearly we're not the only ones who thought so. When price broke through it decisively the next day on 11/5 ( the third candlestick to the right, the big blue one), the market decided there was more upside. The fact that 11/5 shattered it decisively (along with a series of further Fibonacci retracements and Bollinger Bands was your big warning that the lower line of the rising channel was holding nicely as support.

If you still had doubts, the next day showed broke through the next Fibonacci level, and on 11/9 the entire downtrend was retraced and a new high set. It's understandable to believe there might be a reversal/retest at the new high, but we never try to anticipate reversals, we wait for them, as you did when you got into this short.

My only criticism/reservation is that you were trying to trade against a long established channel, as shown in the chart below. That can be very dangerous because

• The DJIA needn't have even dropped, it could have just stayed flat for a while until the bottom trend line caught up to it. Even if YOU don't believe this channel has validity, many others do, and there are computerized systems that may choose this line as a buy point given the uptrend that was in place since March. Remember, trading isn't about understanding what's true, but understanding what most other traders are thinking.

• You needed to identify the channel (not too hard, though slight variations possible and legitimate) and THEN be careful to place a stop loss after you have some kind of confirmation that the support (in this case, lower) channel line is holding. You got that loud and clear on 11/5. The big blue candle on 11/5 was the third day that the lower channel line had held, AND that candle smashed through the combined 3 support types at 9750 and closed far above it, AND the move was confirmed the next day when price opened higher still and closed even higher.

Of course, at the start of ANY reversal of a long trend, you'd be doing something like this. Thus the need for the stop loss in case you're wrong.

In sum your key mistake was not to look for support points which, if violated, would be your signal that you were wrong. For reasons noted above, the big ones were:

around 9750, where there was a combination of

o Price support as shown by repeated closes/opens, ( I count about 14 since August)showing that this level was a price support level

o A 50 day moving average

o A 23.6% Fibonacci retracement

o The lower /support line of a rising channel

Consider exiting the position and wait for the next move down.

A Potential Long on the NZD/USD

IF markets continue up (watch for a rising S&P 500 and have criteria chosen to tell you there is more room for the uptrend, like a strong break about 1100, etc), the NZDUSD has room to run higher. Consider the following chart.

NZD/USD Daily Chart (12 Dec 01)

This is an intriguing long at current levels because it's at the lower end of its horizontal trading range, and has already broken through the following resistance:

• Downward trend line

• 23.6% Fibonacci retracement

• 0.7265 price level

Beware, however, that this pair has long broken below its rising channel, AND has broken below its 50 day moving average (red line)

FYI if the S&P 500 does pull back (my preferred indicator of overall risk sentiment) AND the NZDUSD breaks below the 0.7100 level (has both price support and the 38.2% Fibonacci retracement support, THEN the pair might make a worthwhile short once it looks like it will close under the 0.7100 level. Once it does, if you go short, consider placing a stop loss not too far ABOVE that 0.7100 level, perhaps near 0.7288, at which point there is both price and another Fibonacci level

Cheers & Good Luck, Cliff


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