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Hello everybody,
There has been talk on how the Friday close in the upper part of Friday's
range may have signaled a reversal in equity indices and several popular
stocks like Intel, Tell Labs, and Peoplesoft.
Commentators on CNBC have also suggested that this is a classic pattern
reminiscent of Oct 27 - 28 1997 lows and that the correction may be over.
Since I am flat equity indices and short 2 of the above 3 stocks, I present
my analyses of Friday's price action. This is part of an email response to
G. John Boggio
who wrote:
>> One of my favorite techniques (for buying reversals) is to find stock
>that were down
>>>big during the day but rallied substantially off those lows by the close
>of
>>>trading.
>(he then gave a list of 15-20 stocks that had such intra-day reversals).
My response:
Your logic is conceptually correct. I have researched identifying and
trading off of such reversal bars with some guidance from Larry Connors's
published work.
We are essentially looking for a short term trend reversal bar, with a
low-risk entry method in the direction of the reversal. This should work for
both Long and Short entries.
Rules (for buys, sells reversed):
1. Today makes a 10 day intraday low.
2. Today's range is also the largest range in the past 10 days. This range
expansion usually makes it a 2 std deviation move, which is a rare event
statistically (1 in 20 chance of occurrence). Normally in the story so far,
any range expansion should expect a follow-through in the direction of that
expansion, especially if it comes from a low volatility environment.
3. Today's close is in the top 25% of today's range. This indicates that the
shorts have been flushed out and the market is set to reverse.
We'll call Today = Day 1.
4. On Day 2 or Day 3, buy 1/8th (one tick) above Day 1 High. This is
logically where all trend-following shorts will place their stop-loss
orders, and any break will cascade into a short term follow-through.
5. Once entered, place a stop one tick (1/8th) below Day 1 low and trail it.
This restricts risk to the 2 std-deviation Day 1 range. Statistically, 2
consecutive 2-sigma moves are very remote.
For Monday 8/24/98 I have the following Buys and Sells from a scan of 485
securities including indices:
Equity Buys:
CMB, KOF, DAI, FMY, GM, GPSI, HRL, PSS, PSFT, MDY, TLAB, TXN
Equity Sells:
HMC
Index Buys:
TYX(30 year yield), FVX (5 year yield), CMR (Morgan Stanley Consumer Goods)
Index Sells:
VIX - this is contrarian - lower VIX means falling fear means stability of
uptrend.
Futures Buys:
YX Continuous (NYSE Composite), RL Continuous (Russell 2000), SnP Sep, Dec
98 and Mar, Jun 99.
Futures Sells: None in my universe.
Using this stand-alone filter, I did not get confirmations for some of your
picks since one or the other rule eliminated the stock.
Example reject = Intel, in which case it has had a 2 deviation move already
in the last 10 days. On a weekly scan, Intel actually is a SELL using the
above rules with short entry triggered this week or next if price trades to
82.25.
In any case, long entry one tick above Friday high (85.75) and stop 1 tick
below Friday low (82.25) should help define your risk.
Charts of daily and weekly INTC attached for visual interpretation of above
rules, with history of long and short entries triggered by these rules.
Here is where I depart from Larry Connors' work.
Top plot on each chart is the ratio of short term versus long
term historical volatility, to show that a breakout from a low volatility
environment follows through in the direction of the breakout; and that
falling volatility implies continuation of trend. Low volatility is defined
by short term volatility being 50% or less than the longer term volatility.
It is expressed as a ratio on my charts, and has been discussed widely on
this forum before.
Conversely, if the volatility ratio is much over 1, volatility contraction
follows, implying a sideways market as volatility reverts to its longer term
mean.
What concerns me in Intel is the low volatility ratio on the weekly chart
coupled with a negative weekly 2 std deviation move - Friday's low is close
by, and
a break below Friday's low is likely to continue and accelerate as weekly
volatility reverts to mean.
On the daily volatility chart, the ratio is already trending above 1, which
means prices at a minimum will consolidate sideways as volatility reverts to
mean.
A triangle formation is also forming. Upper bound and nearest lower bound is
shown on the weekly. Upside penetration failed, likely to be initial
resistance on daily.
Next email contains PSFT and TLAB that confirm your long entries using the
above rules, but their overall picture isn't quite healthy.
Regards
Gitanshu
Statutory Disclosures:
At the time of this writing, I am short Intel. This is not a
recommendation to buy or sell any security, this email shares a method
available publicly as modified with my own analysis.
G. John Boggio has also indicated in his emails that he prefers to look at
the big picture before making investing decisions, and his opinions or
excitement at finding a recognizable pattern in no way influences his actual
trade implementation. At the time of this writing, he may or my not be long
or short any of these equities.
Credit for this particular entry method goes to Laurence Connors, as
acknowledged in the text of this message.
Rest of the modifications and the overall interpretations are mine.
None of the individuals concerned bear responsibility for your trading
decisions based on this email.
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