The Three 2Bs

04/04/07 08:36:09 AM

by David Penn

For picking tops and bottoms, always bet on 2B.

Security: ESM7
Position: N/A

A few days ago I started working on an article about a 2B bottom I spotted in the 15-minute chart of the June emini Standard & Poor's 500 futures contract (Figure 1). As I've written, in spite of suggesting that an important top would occur in the 1460 area of the index ("Fifth Of A Fifth," Working Money, February 28, 2007), I've been a doubter of the correction virtually since the beginning. This has made me particularly aggressive in looking for patterns indicative of a bottom to the general correction. But it has also made me more than a little impatient with the shorter, smaller correction that has occurred since the market bounced. With regard to the 2B bottom in the 15-minute June emini, I wrote:

... [T]he initial low took place during the 15-minute session that began at about 9:45 am EST. The high of that session was at 1430.25. When the bounce from the lower low a day later comes, 1430.25 is the buy stop, which was filled shortly after 2:00 pm EST.

FIGURE 1: EMINI STANDARD & POOR'S 500, JUNE FUTURES, 15-MINUTE. The highlighted area shows the initial 2B bottom. The rally from that 2B bottom rallied as high as the peak between the two lows on Wednesday and Thursday but failed to make a higher high on a closing basis. That failure set up a tradable 2B top that sent the ESM7 back to the bottom of the range by mid-session on Friday.

Graphic provided by: Prophet Financial, Inc.

But a funny thing happened on the way to the breakout. While the June emini (ESM7) moved back to the top of its range and briefly exceeded it, the contract was unable to follow through on the second, higher high. In fact, the ESM7 actually ended up lower on a closing, 15-minute basis, in spite of the brief higher high.

I had speculated that, given my time-stop method with the 2B bottom, profits from any trade on this play would need to be taken — or protected — by late morning on Friday (see my "Breakouts, Pullbacks, And Gaming The 2B," Working Money, January 24, 2007)(Figure 2). Unfortunately, the market didn't make it that far. By 9:00 am the June emini was struggling to close above the Thursday high, and shortly after 10:00 am, the ESM7 was actually confirming a 2B top, threatening to send the market back from whence it came.

FIGURE 2: EMINI STANDARD & POOR'S 500, JUNE FUTURES, 15-MINUTE. Somewhat irregular, the lower low on Friday morning nevertheless shows the sort of characteristic lack of follow-through to the downside after making a lower low that marks a 2B bottom. Note also the surge in volume on Friday's low, suggesting a selling climax and the opportunity for a bounce.

Graphic provided by: Prophet Financial, Inc.

The June emini S&P 500 might have been headed lower, but it certainly wasn't staying there. Peaking Friday morning and plunging toward midday, the ESM7 actually formed a third 2B, this time another 2B bottom, which suggested that still yet another reversal was in the cards. Key also to the reversal was the exceptionally long lower shadow as the June emini was making its low on Friday. This shows an exhaustive and ultimately failed attempt on the part of the sellers to close the market near the low of the range. The overwhelming volume underscores the exhaustive nature of the effort — and the likelihood that buyers would be able to step in and push the market higher.

This move higher began immediately. Even though the market appeared to merely meander on Monday, a higher low and a subsequent higher high were both established during that session.

Victor Sperandeo, from whom I learned the 2B reversal method, wrote: "Even if you get whipped out two, three, or even four consecutive times, the one you catch will end up making you a bundle." In fact, in a section on chart analysis in his book Principles Of Professional Speculation, Sperandeo goes so far as to say: "I recommend you double your position on the second 2B buy after a whip. Make it pay double!" Whether or not you share Sperandeo's confidence in trading 2B tops and bottoms, it is worth taking away that not only do 2B tops often follow 2B bottoms — marking excellent entry and exit points — but also that trades should be ready to give 2B bottoms a second (or even third, apparently) chance. As long as risk can be defined by the second higher high or lower low, the 2B remains among the best ways to trade tops and bottoms in markets on a variety of time frames.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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The Three 2Bs

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