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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 what to expect and what it means
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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.
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
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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.
The NDX and SPX Trading Systems
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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
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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.
How we analyze the market
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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.
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.
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.
Common Terms Explained and Frequently Asked Questions
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- 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
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