The essential
guide to The Tactical Trading Outlook
There are four basic parts to Tactical Trading Outlook, The Daily
Outlook, The Breakout Trading System, Index Trading on the NDX and
SPX, and Hop&Pop stocks. Below I will briefly describe each section
and what it does for you. If you have an interest in the stock
market then there is a segment of Tactical Trading that will help
you with your daily decision making process. The more energy you put
towards the markets and your investments the more Tactical Trading
has to offer.
The
Daily Outlook
The Breakout Trading System
The NDX and SPX trading
systems
How we analyze the market (very
basic)
Common terms explained and Frequently Asked Questions
Our Daily Outlook is emailed in the evening, generally Sunday
through Thursday and it is sent by about 7:00 PM Eastern This is my
take on the market. There is a quick review of what happened, and
then I explain what I think was or was not important and what the
implications are going forward. Tactical Trading is a technical
based service. At times we will talk about economic events but our
focus is on what the market is doing and how it is doing it.
Economics are great to talk about, but when and how the market moves
tells us what folks are actually doing in reaction to all that other
stuff. I think what investors are doing is a lot more important than
all the other stuff, so that is what I focus on. From time to time
there will be a top section dedicated to something slightly askew of
our normal outlook, but it always relates to the market.
The heart of our approach is technical as opposed to fundamental.
Our primary technical methods are briefly explained at the end of
this guide in How we analyze
the market. Our focus is on price movement relative to previous
movements and we consider psychological indicators and conditions as
well. The primary tools are, the Directional Trends, Pattern
analysis, the short-term cycles, and keen awareness of the market
internals. The key is using the right supporting evidence at the
right time. How and why the market moves is sometimes more important
than the size and magnitude of the move. Sometimes it is the other
way around. We have many tools at our disposal, but depending on the
character of the market we won't hesitate to leave a tool in the
box. A good carpenter has a lot of different hammers and he uses the
right one for the job at hand. By remaining flexible with our
approach we do the same thing and I think this is one of my greatest
strengths. Great traders are flexible and they are always willing to
adjust to the market environment. I use technical methods but I
remain flexible and therefore mistakes are avoided by not trying
force something to work that not working.
The Daily Outlook has one featured element, the Directional Trend
and summary Table. The goal is to present, in a relatively small
space, a clear picture of what the market is and has been doing,
points (support and resistance) that if reached will indicate a
potential change in direction, and a breakdown of the day's activity
on an internal basis. The table may look confusing at first, and my
lengthy explanation may not help either. But, it only takes a minute
to understand what you are looking at and then it all makes sense.
Below is an example and it is divided into three sections.
![[Chart]](../../images/specialreport/003/essent1.gif)
The top section is the Directional Trend Summary. We
follow five indices, the Dow (DJI), the S&P 500 (SPX), the NYSE
Composite (NYA), the NASD Composite, (COMP), and the NASD 100 index,
(NDX). By keeping track of all five we are able to maintain a clear
picture of the market. We have narrow indices, the Dow and the NDX.
The S&P 500 and NASD Composite give us a view of the bulk of the
market capitalization, and the NYSE Composite is the broadest
measure of the market. This full spectrum helps us avoid being
swayed by a single index, which can be misleading at times. Every
day I look at the top section first. I look for changes in the
longer time frames first and then work down to the shorter time
periods. Changes on a longer time frame such as Monthly or quarterly
are very important. The shorter the time frame the more important
the change is likely to be to our current stock holdings or index
positions.
For each index there is a Trend and the Trends are shown in five
different time frames: daily, 3-day, weekly, monthly, and quarterly.
A trend points either up or down and they also give buy or sell
signals. If a trend is on a buy signal then by definition it must be
pointing up. A Trend must be pointing down to be on a sell signal.
The terms buy and sell are used lightly here as we do not make
trades based on these signals. However, if you follow the signals
closely, they do produce gains over a prolonged period of time. For
now just remember a buy signal is more bullish than an up signal and
a sell is more bearish than Down. I have studied every trend change
on the Dow going back over 70 years. Each trend has its own
personality, and when something happens I will talk about it as
necessary. Please feel free to send me questions regarding the
trends. In general the trends are best utilized as a guide to
confirm or deny expectations going forward. If you are expecting
higher prices and the daily trends turn up then your expectations
are being confirmed. When a trend does change it is highlighted and
in bold print the next day. Green if for a positive change and red
is obviously a negative change. This adds a dynamic element to the
table, which makes it more useful.
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The middle section of the table shows us what the indices
did today and where they closed. Key turn and or signal prices for
the daily and weekly trend are also shown. Sometimes in the
commentary we list support and resistance levels, but if we don't
and you want a level to focus on, these turn and or signal points
are the place to focus. Notice the daily trend on the Dow is showing
buy. Now look at the daily turn and signal points. It shows "D @
9040 S @ 8871" That means the daily trend will turn down if the Dow
reaches 9040 and subsequently a daily sell signal will be given if
the Dow reaches 8871. When a trend turns it suggest the move will
continue. When a buy or sell signal is given it means an even stronger
move should be expected. If 9040 is broken then we should see
additional weakness as the daily turn point is the first support
level. If the second support level, 8871, is broken a more serious
negative signal is given. The weekly column works much the same way,
but the price points are more important because of the longer time
scale. You don't need to spend a lot of time considering the
implication of these price points. I usually spell that out for you.
But, understand these are important support and resistance
levels, which if broken will indicate a changing or strengthening
(buy or sell signal) trend.
The bottom section contains technical metrics. The market
internals shown for the New York Stock Exchange, the OTC market, and
we combine these readings into a Market Total column. By looking at
them in three ways we can quickly tell if a move was uniform or
lopsided. During the course of the bear market this has helped us
spot clear divergences as the market peaked and/or lopsided advances
that were prone to failure. For an explanation of the internal
metrics, see Common Terms Explained at the end of this guide.
Last we have the VIX and VXN buy and sell signals and the CQI
index. CQI stands for Confidence in Quality Index. When this
metric reaches one the market should be very close to a very
important low as a reading of one indicates folks have very little
confidence in what they have in their portfolios. The higher the
reading the greater the confidence folks have in their holding. If
there is a remarkable reading I will discuss it.
The VIX and VXN buy and sell signals are based on the action of the
VIX and VXN indices. 100% indicates a very strong signal while 0% is
a very weak signal. The ideal time to act on a signal is the first
day it is not at 100% after it has been at 100%. When a good signal
is given we will discuss the situation. These will also be
highlighted when they are close to 100% or 0%. This signal set is
just another tool. When it is working it is nice, but for the first
half of 2003 this tool has been in the tool box.
In addition to the indicators, metrics, and techniques mentioned
here, we have a lot more. These are the metrics we think are the
most important and should be observed at on a daily basis. From time
to time we will have additional charts or comments on other things
deemed important or relevant to the current market condition.
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At the end of the Daily Outlook we have a conclusion
paragraph that starts out "Here is the Deal." If you are
pressed for time just skip to this paragraph. I summarize the
situation as briefly as possible and offer a likely expectation.
When things are going well I will have a "Perfect world" scenario.
The "Perfect world" scenario is a combination of all our different
approaches and it is an expectation. If the market follows the
"Perfect World" scenario we know all of our methods are in sync and
confidence is high. The further the market strays from the "perfect
world" or sometimes I will say "Ideally" the more we will have to
adjust our expectations to fit with what is actually happening. I am
not here to tell you what happened. Anyone can do that. I am here to
tell you how and why what happened is or relates to what should or
should not happen going forward. The market can only go up or down,
but staying on track with the market and knowing when you are off
track are the keys to staying on track and that is my goal, to keep
you on track with the market.
The Breakout Trading System is a professional style trading
strategy designed to capitalize on strong price moves which occur as
stocks make short to intermediate term trend changes or accelerate
higher from short consolidation patterns. In short, we employ a
trend reversal or breakout system. A key component to a successful
breakout move is volume, the more the better.
What to expect
Our goal is for a huge winner every time, but don't expect every
single trade to be a huge winner. That would be unrealistic. This is
the stock market and anything can happen. While we do have a high
success rate it is important to understand that the key starting
elements of any successful trading approach are risk control and
risk management. Even if you have a terrible system if you use
proper risk control and risk management you can make money. These
elements are designed into the Breakout Trading system and I know
the system is a great one, so we are starting with a successful
formula. Common sense risk disclosure: don't put too much of your
money into any signal trade, this is risk control. Exit any position
that is not working before it moves significantly against you, this
is risk management. We use specific stop prices for risk management.
I suggest you follow them.
Each night we show our Current Portfolio. The positions are listed
in the order they were added with the most recent first. The Longs
on top and the Shorts come at the bottom. These are trades we have
already made. If you can't get into the trade near the entry price
then wait for the next trade. While we don't have a specific time
table, we are flexible and if a stock starts acting funny we won't
hesitate to exit. I don't want to see you buy into a current
position today and then we sell it the next day. We take a big gain,
but because you got in at a different price your result is
different. Wait for new trading ideas. Our goal is 8 to 12 trades
per month. That is a target and general market action will impact
the trade count to a certain degree. There are times when it is
better to do nothing than to try and force something to happen. My
years of experience have taught me that trying to force a trade is
rarely profitable.
A Breakout System top
On a daily bases we scan over 450 stocks looking for specific
formations. Our scanning software, which I call Reggie, does a lot
of work for us. But that is just the beginning. Typically Reggie
will find between 75 and 150 stocks that should be monitored for a
breakout move the following day. Yes, I usually watch over 100
stocks a day looking for the ones that are breaking out and have the
greatest potential to move a lot higher.
When a stock is on the move and we are going to add it to the
Current Portfolio we send an e-mail alert. If you get an alert to go
long or go short, unless specifically stated that we are waiting for
a price to be reached, we are making the trade and the stock will be
added to the Current Portfolio.
The e-mail Alerts have a lot of specific information in them. Now it
is important to interpret this information the right way. If the
alert says we are going long at $15.25, and you look at the stock
and it is $15.35, then go ahead and make the trade. Our entry price
will be what is listed in the alert, but a few pennies here or there
won't make much difference in the long run. But, don't chase a stock
too far. In the example, I might go as high as $15.40 or $15.50
depending on the price action that day, but I don't recommend going
much further than that. If it is a higher priced stock maybe you
give it more latitude. With a lower priced stock you will want to be
more precise as 10 cents is a greater percentage of a lower priced
stock than a higher priced stock. There will also be times when you
can get a better price. When that happens you will be able to make
up for other times. Be flexible but keep you emotions under control.
The Stops and Targets
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Once you are in a position the focus becomes on getting out right.
Don't expect to sell at the very high. While that might happen from
time to time making that a goal will drive you insane. Trust me,
when I first started trading I got a huge winner exactly right. That
success screwed me up for a year because I kept trying to repeat the
perfect trade. Let me save you the trouble. There is no perfect
trade. If we get out with a one cent gain then it is a good trade
because you avoided a loss. If we get out with a 7% loss it stinks
but our risk management will keep us from taking a really big loss.
If we end up with a 30% gain...well that is pretty good too.
Our stop and target prices are subject to change daily. What a
stock does today impacts the expectations for tomorrow and the next
day. If a current position gets close to its stop price we will send
an automatically generated stop alert. Stops are done automatically
to make sure the information is sent out in as timely fashion as
possible. However, just because we send a stop does not mean to exit
the trade. The stops are sent before the stop price is reached. It
is an early warning system. I think that is a lot better than
telling you we sold a stock at our stop price long after it went
through it.
As we manage the current positions try to keep the positions in
perspective. Trading can be emotional, but we really want to keep
emotion out of the decision making process. It's the stock doing what
we want it to do, is it acting normal, or do we need to sell it?
These are the factors to consider. Having a gain or a loss is not
important. If the stock is acting poorly when it should be strong
then it is time to move on.
We also use Targets. Targets lock in gains where as stops protect
gains. Some folks don't like targets because they think it puts a
limit on the upside. Well, it does. It also can make a big
difference in a gain though. A target may be 10% above a stop price.
If the target is reaches and the stock later falls to the stop price
you were better off exiting at the target. In short, using targets
improves overall returns.
After the daily outlook we have two index trading systems which
employ the same methodology; however, when we have a higher degree
of confidence in our market call we will use an appropriate
strategy. The NDX trading system is based on the NASD 100
index. The symbol on my quote service is NDX, so I call it the NDX
system. The other is the S&P 500 system whose symbol is SPX. These
are both cash indices and it is not possible to actually trade the
NDX and the SPX unless you have a whole lot of money. The easiest
way to take advantage of these trading recommendations is to trade
the ETF equivalents, which are the QQQ and the SPY. The SPY normally
trades at a premium to the cash index while the QQQ normally trades
at a discount. The formula for each is:
SPY = [ SPX + 3 to 5 points of premium ] divided by 10
QQQ = [ NDX -- 3 to 5 points of discount ] divided by 40
In our comments we often list the QQQ and SPY equivalent prices,
but I can not express how important it is to focus on the action of
the SPX and NDX. In a fast market the premiums and discounts on the
ETF's will expand or contract and that will affect your entry price,
but this is give and take. Sometimes your price will be better
sometimes worse. Over a period of time the differences should
equalize.
Each day buy and sell points are displayed on the charts, but in
our comments we don't always discuss them. Follow the instructions
in the comments.
Hop&Pop Stocks are additional trading ideas for those of you that
want more stocks to look at on your own. I look at the current list
of stocks on a daily basis, but additions and deletions are not made
daily. Specifically deletions are not likely to be timely so if you
are trading these stocks you need to set your own risk parameters
for a timely exit.
A Hop&Pop Stock is a stock that traded a lot of volume recently,
volume was hopping, and the price is popping higher. First I screen
for stocks that are up on volume. Then I run that list through an
algorithm that looks for a Cup with Handle formation. Ideally we
want a stock that is popping higher from a handle on strong volume,
hence Hop&Pop.
Just keep in mind that these trading recommendations are outside
our Breakout Trading Portfolio and they "don't count" in our
official record.
That covers the Essential Guide to Tactical Trading. The comments
below briefly explain several concepts we use in our basic approach
to analyzing the market on a daily basis. If you are new to the
service I recommend you read the Daily Outlook for a few days. Once
you are familiar with our comments you can return to this section to
answer questions that may arise. Though brief, I could write a book
on this stuff, it should answer the basic questions. In addition, at
the end is FAQ that should answer the most common questions and some
terminology is explained.
The Trends
Pattern Analysis
The Short-term cycles
The Technicals
First off I want to talk about how we go about analyzing the
market. We have four conceptual components, the trends, the pattern,
Cycles, and the technicals. In the part called the technicals I
include all technical oscillators, the internals, sentiment, and
just about everything else.
The Directional Trends are one of
our primary tools and the Directional Trend Table is updated every
day. In short, the trend is your friend. While we follow the trends
in five different time frames the concept is generally the same for
each period. If a periods high is higher than the previous periods
high the trend is up and vise versa. The picture below presents the
basic concept. The bars can represent daily, weekly, monthly or even
quarterly time periods. The basic concept is the same.
![[Chart]](../../images/specialreport/003/essent2.gif)
Daily trends change often and signals only last several days.
Weekly trends turn on average about once per month. The monthly
trends are very important and when turns or signals are given we
have to respect the message. Generally speaking, the longer the
trend the more important the message. However, all of the time
frames have their own unique behavioral characteristics. We
constantly comment on them as changes occur. The quarterly trends
don't change very often, only once or twice per year. They are best
used as a general guideline reference. For more detail about the
trends and their construction see the section on "How We Analyze the
Market at the end of this guide."
I will need to mention the 3-day trend separately because they are
a little different than the others. The principals are the same but
the 3 day time span is unique. The 3-day trend is one of the most
reliable indicators I have encountered. It consistently provides
reliable forward looking information about 70% of the time and
that is an uncommon level of accuracy in this business. Note, it is
important to understand that if it is right 70% of the time we know
it will be wrong 30% of the time too. Nothing in the market is 100%
and good traders know this. Successful traders tailor their approach
and risk management techniques with the knowledge and expectation
that they will be wrong and they will take losses. It is the nature
of this business, but the key to success is a flexible approach that
maximizes gains when the market is generous and curtails losses
during the less prosperous periods.
Next we have the pattern. For this we
use a rather complicated approach called Elliot Wave Analysis. Some
folks think this is the Holy Grail but we all know there is no Holy
Grail when it comes to technical analysis. Elliot Waves are somewhat
complex, but the basic idea is simple There are two kinds of moves,
impulsive and corrective. Each one has its own
characteristics, and once a move of either type is complete it is
generally followed by a move of the other type. Impulsive moves
are supposed to go somewhere, while corrective moves correct the
excesses built up during an impulsive move. A strong advance is
impulsive. The pullback or consolidation before the next wave higher
is the corrective move. There are a lot of rules and guidelines that
govern the details over what comes next and how far a move should go
and so on. Just remember when we say a move has an impulsive nature
or corrective nature this is what we are referring to. Impulsive
moves are also in the direction of the longer-term trend. The
picture below presents the basic concept in its simplest form.
![[Chart]](../../images/specialreport/003/essent3.gif)
While the blue lines are impulsive moves, the entire advance from
the low to the high is an impulsive move with two corrective moves
along the way. This fractal nature of Elliott Wave makes it a very
useful tool across a broad spectrum of time periods. However, I
think it is best to look for the best near-term interpretation and
to keep that separate from larger structures. This is another way of
saying I think the fractal nature has a limit and pushing beyond
this limit can lead to very erroneous conclusions. When the pattern
correlates with our other techniques it is very effective. When I
start on a perfect world expectation on a daily basis it is most
likely being drawn from this approach.
Cycles are cyclical. We use a variety
of techniques for cycle forecasting. Some are fixed, some are
variable, and some are irregular. Cycles are great but there are a
few major drawbacks. One is that a cycle can appear and be rock
steady for a long time and then just disappear with no warning. The
other problem is that sometimes cycles invert. By this I mean when
you are expecting a cycle high but you get a low instead. This is
more common for some series than others.
The most important concept of cycle analysis is not which cycle you
use, but to simply understand that cycles exist and they exist
within one another. From 1982 to 2000 we were in a bull cycle. Since
2000 we have been in a bear cycle. But during each of those cycles
we have seen smaller bull cycles and smaller bear cycles. In
addition, by having a cyclical component you will always be
estimating when or where the next turning point will be. Cyclical
expectations force you to realize that despite hopes or desires each
up leg will be followed by a down leg. Because we track larger and
smaller cycles we can assign more or less importance to an expected
cycle turning point. When a big cycle is due to turn at the same
time as a small cycle then the market is probably going to change
direction. Then we add in expectations from the pattern and the
trends and when it all comes together you can make an extremely
accurate forecast. In late November 2002 everything lined up
perfectly. I correctly called for a market high at the end of
November 2002 and expected a weak December. For the record the S&P
500 reached its closing high on November 27, 2002 and fell over 5%
during the month of December.
Fourth is the technical component.
Basically I call everything not discussed above a technical
component. Technicals include the market internals and all the
oscillators related to them. I also include any standard technical
indicator. The ones that are standard in shrink-wrapped charting
applications. Examples include things like Relative Strength, Moving
Average Convergence/Divergence (MACD), and Stochastic. Other
things like the sentiment indicators, the put/call ratio, and the
VIX index also come in this group.
I even put fundamental news events and economic releases in this
category. While they are not technical in any way I am much more
interested in the technical dynamics of the response to the news
than to the news itself. Who cares if the news is good or bad. We
have all seen the market go up on bad news. We have also seen it go
down on good news. Well, what if the market rises with poor
technicals on good news? Who cares what the news is, if the rally
sports poor technicals then it is likely to fail and that is what I
think is important from a technical standpoint.
In a perfect world all disciplines will converge and convey the
same message but this is the stock market and things are rarely a
perfect fit. However, when several approaches align with the same
message we have confidence in the signals. Most of the time we will
have a strong signal from one component and the others will provide
the supporting evidence, which allows us to make some really great
market calls. When everything lines up I will let you know and you
will be able to act with confidence.
- Directional Trend Summary Table
- Key Trend Turn and Signal Points
- U @ = The price where the trend will turn Up
- B @ = The price where a buy signal will be given
- D @ = The price where the trend will turn Down
- S @ = The price where a Sell signal will be given
- Net breadth is advancing issues minus declining issues.
- Net Directional volume is up volume minus down volume.
- Total volume is self explanatory.
- The Arrows pointing up and down indicate today's value
relative to the previous value. Pointing up indicates a larger
value while down is means a smaller value.
- Buying Pressure and Selling Pressure
- Daily Buy Pressure is a relative measure of daily up
volume to the recent average of daily up volume. This tells us
how strong up volume or buying is relative to what it has been
like. On a normal "flat" day we would expect a reading of 50%.
Anything higher than 50% indicates buying pressure is healthy.
80% or higher is very strong and the unique aspect of this
proprietary indicator is that it can go above 100%. When buying
is above 100% it is a really strong day. We contrast these daily
readings with other metrics and when something remarkable
happens we will explain all the details and the potential
meaning.
- Daily Sell Pressure is a relative measure of daily
down volume to the recent average of down volume. When high,
near or above 100%, it tells us that selling was much stronger
than average.
- 8-Day Buy and Sell Pressure These are 8-day weighted
averages of the daily readings. If the 8-day numbers are 55%-57%
then the market internals are suggesting the trend is
sustainable.
- The 5-day RSI's shown are based on the Wilder RSI
Formula. In short the further these metrics move above 70 the more
overbought the market is. Below 30 indicates oversold. 80 and 20
are very overbought and though very rare, numbers above 90 or
below 10 indicate an extreme situation that will likely mark an
important turn. If we have an expectation for the market to
reverse lower and the RSI readings are overbought we can have
greater confidence in the expectations.
- What do the ** mean in front of some of
the stock symbols?
- If you see ** in front of a stock
symbol it means the stock is a new position. This makes it easy to
distinguish which stocks are new to the list.
- The Target or Stop price changed, why?
- Every day we look at where a stock is and where it has the
potential to go. The stops and targets are adjusted accordingly,
and they change often.
- You rarely talk about the Names of the Companies, why?
- I am a technical analyst. For short-term trading I have found
it can be advantageous not to know much about the company you are
trading. There is always a risk of some fundamental development,
but in the day and age of fair disclosure no one should know when
or if a significant development is coming. However, knowing when
earnings reports are due out is not a bad idea. Basically I find
it is easier to sell a stock when I don't know anything about it.
If I learn what the company does or if I read a bullish report I
might like it. Then it may become difficult to part with it and
that can become expensive.
- Under Days Held, why do some say HOLD while others just list
a number?
- If you see exit, that means we will exit the stock at the end
of trading the following day.
- If you see hold it means we are happy with the stock after
holding it for a week and we will give the trade more time to
develop.
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Jim Patterson
Copyright ©2007 Tactical Trading Outlook, LLC. All rights reserved.
Risk Disclosure
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