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July Soybeans — A Chart Lesson

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The chart of July Soybeans is very instructive for traders using classical charting principles (Edwards and Magee or Schbacker).

As a starting point, no two classical chartists may label a chart in the same way. And even if some classical chartists agree as to pattern identification, it does not mean that:

  1. The pattern will be valid and not morph into something different, or,
  2. The traders will trade the pattern using the same entry and exit strategy, sizing and leverage, etc.

I had labeled the July Soybean chart as a 16-week symmetrical triangle. By the way, the morph rate on symmetrical triangles is quite high. Nevertheless, the pattern was mature enough that I bought the breakout on June 2 at 1402. My initial stop was based on my Last Day Rule principle (see Diary of a Professional Commodity Trader book for an explanation of this rule). The LDR price of 1383.6 was violated on June 7, stopping me out. I lost about 50 basis points on the trade.

I still have the chart labeled as the same symmetrical triangle, and view June 2nd and 3rd  as a premature breakout — although the breakout could prove to be a bull trap of significant magnitude. I will receive a secondary completion signal if the market can clear the June 3 high at 1419.4 or close above the upper boundary line of the triangle (about 1404). As of this writing, July Soybeans are trading at 1402, not high enough to trigger an entry signal. If an entry signal is generated at the close, the new Last Day Rule will be the low of today at 1385.

I will go long on a secondary completion of the pattern with a risk of 50 basis points (1/2 of 1% of capital). If I go long again and get stopped out, I will no longer follow this market. I give a pattern two chances for a clean breakout.

There is another lesson in this market. I have recently written about my dismay with high/low bar charts because of the noise factor. I have a strong bias in favor of closing price charts. On a closing price chart, August Soybeans completed the symmetrical triangle on June 2, but has not violated the pattern. A close below the May 31 close at 1372 would be required to violate the pattern.

Using closing price charts raises the subject of not using intraday stops, but rather using “stop-close-only” orders (real or mental). I discussed this idea in my blog posts titled “Lessons from a difficult year of trading” on May 24 and “Stops or no stops – a response to StockSage1” on May 25.

From a tactical point of view, using close-only stops (or much wider intraday stops) means that a trader must downsize his or her leverage or sizing in order to limit the risk of a trade to a certain basis point loss. Ideally, while the profit potential per winning trade would decrease with smaller sizing, the win/loss ratio would improve over an extended period of time in a manner to hopefully offset the lower leverage per trade.

Well, that’s my brain drain on this subject for now.

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Silver: Going According to the Script – DOWN!

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The markets  whip me around often enough that I will take credit when I make a correct call…and my next call for Silver is DOWN.

Every once in a while a trader gets “in-step” with a market. And when that happens, a trader needs to ride that horse until the first time the horse bucks the trader off. At that point the trader needs to dust him or herself off and find a new horse.

On April 24, I posted the blog, “How do you spell bubble?…SILVER!” A chart included in the posting is shown below. In the posting I stated that the market was within weeks or even days of a major top. In fact, the high had already been made on April 25. On April 28 the market tested the high and the subsequent decline was historic.

On May 1, I posted the blog, “8 years of global Silver supply changed hands last week.” My conclusion was that a major distribution of ownership had occurred from the strong hands to the week hands. The chart I included in the post is shown below. The next day, May 2, Silver droped $5.65 per ounce at its low.

On May 10, I posted the blog, “Silver – What’s next short-term?” The chart from the post is shown below. My conclusion was that Silver would drop to new lows for the decline, then rally into the low 40s, then drop sharply.

I was correct on projecting new lows for the decline, but I think I was wrong on forcasting the rally into the low 40s. Earlier this week I posed the possibility of a 4-week H&S bottom with an extended right shoulder. While this is still a possibility, my preferred interpretation is that a H&S failure will occur. Extended right shoulders should generally cast doubt upon a H&S interpretation.

A H&S bottom failure occurs when:

  1. The pattern is briefly completed, but the advance immediately terminates and the trend preceeding the H&S bottom returns, or,
  2. A right shoulder rally falters short of the neckline and prices fall below the existing right shoulder low, completing the H&S failure pattern. [Note: I consider the H&S failure to be a pattern unto itself.]

The current chart of July Silver is shown, highlighting an idealized H&S failure.

I want to conclude with  two points. First, neither the H&S bottom nor the H&S bottom failure have been completed. This market remains anyone’s guess. Charts are constantly evolving with one pattern morphing into the next, into the next, into the next, and on and on it goes. The real value (arguably, the only value) of charts is they provide traders with trigger points containing favorable risk/reward relationships.

Second, I am flat but would go long if the H&S bottom is completed or short if the H&S bottom failure is completed. Either event would be a tradeable signal for me. My bias is that the H&S failure will occur. The H&S failure formation would have a pattern target of 28.52 and a swing target of 21.58.

If the market continues to drift sideways in a choppy manner and then completes the H&S bottom, the chances are great that the H&S bottom completion will be a giant bull trap.

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Japanese Meltdown — Stock Indexes are Looking Radioactive

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Major Japanese stock indexes are on the edge of the cliff

The charts of the major stock indexes in Japan are on the edge of the cliff. The Topix, iShares MSCI Japan Index Fund and Nikkei Dow are at critical support levels. Traders with Japanese exposure should watch these support levels carefully. A penetration below these support lines would indicate that the “dead cat” bounce from the March lows is over.

 

Trading strategy

The trading strategy I like best is being short the Osaka Mini Nikkei or short EZJ, the Ultra Long ETF. The global stock indexes are famous for bull and and bear traps. The Japanese market, especially, often generates a false signal just prior to a big move in the the other direction. So, I will be very flexible with these markets. Should I short the Japanese market (the mini Osaka or the ultra long ETF), and should the market reverse back to the upside, I will double up going long.

Commodity prices are topping now!

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Germany (via the Euro) has the World’s Cheapest Currency

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Major chart top in Copper — target is 350

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Bear flag retest of diamond top is turning down

Two chart observations are worthy of note on the nearby daily futures graph. First, the decline in early May completed a 4+ month diamond top. This is a major reversal pattern. Second, the rally from the May 12 low is tracing out a bear flag. The decline today may indicate that the May 31 high will be the high of the flag.

The weekly chart of JJC, the Copper ETF, shows that the dominant trendline from the late 2008 bottom has been violated. Keep in mind, the violation of a bull trendline is not, in and of itself, a bearish signal. It does recognize that a trend change is in the process of developing.

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Euro heading for par against Swiss Franc

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Another strike against intraday stops

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It’s the line that counts.

Every thing else is noise and clatter intended to confuse and separate traders from their money. Where a market closes is all that matters.

My final thought for the weekend.

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Latest member of the Hall of Shame

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I plead with all you newcomers to trading, please don’t get caught in this trap.

Trading is hard work. There are no short cuts. Tuition is required, and the markets decide the amount of the tuition.

Yet, every year thousands of newcomers to trading get trapped by con artists such as the people behind this email ad. There is no such thing as a trading system that is accurate 88% of the time.

Enter scams such as this at your own risk.

P.S. The bottom of the ad, in tiny print, contains the sentence, “These trades were not actually executed.” That tells it all.

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Stops or no stops – a response to StockSage1

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Yesterday morning I posted “Lessons from a difficult year of trading.” The post detailed three major factors contributing to my current 13 percent drawdown and nine modifications I am making to my trading plan in response to the situation. All successful traders – discretionary and systematic – are constantly on the alert for ways to improve their trading operations.

One of the nine modifications was the following:

Modify my protective stop protocol to reflect increased intraday noise

I have always believed in having protective stop orders in place at all times. I am no longer a strong advocate for this practice. I have been stopped out of too many positions only to see better exit spots within hours or days. Rather, I am now an advocate of the following protective stop protocol.

  1. No stops in overnight markets, including forex
  2. Mental stops based on closing price charts – the use of mental stops requires disciple to follow through with intentions
  3. Very wide actual stops (daytime session) to protect against a “worst case scenario

My friend and peer, Robert Sinn at The Stock Sage responded to my post almost immediately with an excellent piece titled, “The Evolution of a Professional Trader – Stop Loss or No Stop Loss?” Read Robert’s post here.

Robert Sinn, The Stock Sage

Robert is one smart trader and seldom misses a beat. Robert, very wisely, makes the following point:

 “I believe that the use of stops is absolutely essential in short term trading. A trade should have a defined target objective which in turn requires a defined risk. It is too easy to talk oneself into moving a mental stop in the middle of a trade, therefore, using a hard stop (placed shortly after the trade is entered) is optimal over the long run.”

In a subsequent back-and-forth email exchange, Robert suggested that I more fully explain the thinking behind this modification. Great suggestion! So, here it goes.

Stops are essential in trading. Novice and emerging traders should NEVER trade without a protective stop. NEVER! I agree with Robert that using a hard stop is optimal over the long run.

The modification I am making is a rather nuanced one, as I will explain with three points and a chart example.

First, it is important for you to know that I seldom trade a leveraged futures or forex position (although the total value of all my positions combined at any given time will exceed my account value). For example, for each $1,000,000 of account value I am likely to limit a trade to four contracts of Comex Gold, 300,000 to 400,000 EURUSD or ten contracts of Corn, just to provide a few examples.

Second, I traded for decades when overnight markets were not even available – and my performance during those years was actually superior to my performance since 24-hour markets began. I can remember being awakened in northern Minnesota in the middle of a summer night by a thunder bolt, and wondering, “Is it raining in central Illinois…how will Beans open tomorrow?” I begin trading spot forex in the early 1980s, but did not pay any attention to overnight cross rates (except for the Yen) until 2007. I was in the Crude Oil market at the start of the Gulf War. I was in a Gold position on 9/11 when the Towers were hit. I survived these events just fine without 24-hour markets.

Sure, not having an order in the overnight markets will result in an occasional hit. But, I am convinced that the risk is worth it – especially considering the fact I am not leveraged in any given market.

Third, my focus on closing prices is very consistent with orders that were once common place in the good-old days of the exchange trading floor. The electronic exchange has taken flexibility away from traders. How unfortunate! For example, one order I used extensively was an “OCO,” or “one cancels the other” stop, with one component being a hard stop and other component being a “close-only” stop. Here is a real example of how this would have worked in a recent trade.

I shorted the June S&Ps at 1323 on May 17. I always place protective stops a few points above the high of the bar I use to protect a trade. The bar I used for the stop was the May 16 bar, which had a high of 1341.25. My stop was placed at 1343.25. I was stopped out on May 19.

However, my preferred order would have been to place a “close-only” stop against the May 16 bar and a hard stop against the May 13 bar. In the good-old days my stop-loss order would have read…

  • “Buy 10 June S&Ps at 1353.50 stop OCO buying 10 June S&Ps at 1343.25 stop-close only, one cancels the other.”

This order strategy would have kept me in the trade. In a very real sense, this modification of my protective stop strategy is a roll-back to earlier days intended to nullify intraday noise. I will lose more money in those trades in which I am dead wrong on direction, but I will keep from getting chopped up in many more trades.

Yet, I completely agree with StockSage1 in principle that the use of stop-loss orders, all other things being equal, is a must in trading.

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