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Trading, Context, And Today's Market

08/16/12 08:29:40 AM
by Billy Williams

You can use a "one-size-fits-all" approach to trading today's market or you can tailor your approach based on the context of the market for greater success.

Security:   SPX, ALXN
Position:   Hold

For traders and technicians, it only takes a glance at the major market indexes to see that there is not a lot of commitment in the form of accumulation or distribution taking place in today's market. The lackluster price action reveals a less-than-robust stock market that is facing downward pressure.

While price has clawed its way out of the market's bottom and managed to make a steady series of higher highs and higher lows, there remain a number of factors -- both good and bad -- that keep both bulls and bears from taking control of the market and forcing a convincing trend to take place. See Figures 1 and 2.

FIGURE 1: SPX. The SPX has an upward bias but has still been somewhat range-bound since neither the bulls or bears have convincingly seized control of the trend.
Graphic provided by:
We are all aware of some of the market's challenges such as the European debt crisis, the upcoming US general election, questions on the quality of earnings being reported, seasonal patterns in play that are not conducive to trending markets, and more. However, as a trader, you have the responsibility to develop a strategy around these obstacles and, better yet, take advantage of them.

FIGURE 2: ALXN. Even with the upward bias in the current market, the lack of price action follow-through requires you to take profits at 10% to 12% from the higher levels of 20% to 25% while tightening up your stop-loss points as well.
Graphic provided by:
The market has an upward bias right now but is more or less in a range-bound market, so finding pullbacks and/or price support can offer solid trade setups. However, the lack of follow-through on the part of the market's price action needs to be factored into your trade management. Your typical profit taking needs to be adjusted, while your stop-loss point also needs to be more conservative.

For example, using the CANSLIM model developed by William O'Neil, where fundamental screening filters out companies that lack the accelerated earnings of strong growth companies along with other key criteria and combine that with strong technical price action, you have strong stock selection working alongside strong technicals for a sound trade setup. In addition, the overall market must be in a confirmed uptrend with both stock and the market under accumulation by major institutional traders.

Under those conditions, the criteria for this model when met has a statistical average of a 20% to 25% gain when price breaks out on higher volume to the upside using one of the four preferred chart patterns: cup & handle, double bottom, flat base, and base on base. But in a choppy uptrending market, you can see why profit taking needs to be adjusted to 10% to 12% due to lack of follow-through in price on the part of the bulls.

Likewise, this method also advocates an average 7% to 8% stop-loss point from entry, but that too could be adjusted to 4% to 5% due to the choppy price action.

You do that by customizing the parameters that you use to trade to take into account the market's changing nature by adjusting your targets. By doing so, you protect yourself from a black swan event and/or emotional trading on the part of the herd if something unexpected happens while still putting yourself in a position to keep profiting without overexposure.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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