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Tape Reading 101
Like all trading techniques, tape reading is not 100% reliable, but I will trust my gut over a chart pattern any day. Nonetheless, tape reading failed me in a trade this morning - I have no regrets (kind of) because more times than not, I will use these subtle signs to exit a trade long before I am about to get roughed up. Let's get right to the trade.
As you know, I have been doing a lot of Rubber Band Trades recently as they have been very robust. This morning, with a weak overall S&P and Nasdaq market, I was looking to short the stocks that were up a lot and were exhibiting "overbought" characteristics. A handful of stocks at the time were filtered out by my software, stocks like (RIMM | Quote | Chart | News | PowerRating), (SNDK | Quote | Chart | News | PowerRating) & (ESRX | Quote | Chart | News | PowerRating). ESRX was the one that stood out the most, I though it was a perfect short set-up.
1. Overbought stochastic (>90) as well as a bearish stochastic divergence (chart above)
2. A break to new day lows with stochastic confirmation on the S&P's (chart below)
You cannot ask for much more in terms of a high-probability set-up.
I went short ESRX at 62.16, while it dropped initially to about 62.12, it quickly became obvious that there was a buyer as the 62.12-14 bid was being refreshed each time it was hit. This is the first sign that while you may have timed the market and even the stock properly in terms of the technicals, there was a buyer standing in your way regardless of the weakening market. Only this thought should occur in this situation:
"OK, I am short one of the strongest stocks on the board right now, the market is falling away, ESRX is not, and there is a persistent buyer at 62.12-14. When the market stops going down, I will likely be in big trouble."
If a stock is not going down when the market is making day lows, you have to assume it will jump higher (higher than most other stocks) when the market does turn back up or at least stops going down.
I had no choice, I waited as patiently as possible but once the downward momentum in the S&P's faded, I covered ESRX for a 1 penny loss. I felt pretty good about my decision.
What happened next was not only unforeseen, but a bit frustrating.
The lesson: it was the one time out of the previous nine times that logic and observation failed. Typically if you ignore the signs mentioned above in terms of tape reading, the trade would have gone against you 90 cents. You always have to trade your game plan.
As always, feel free to send me your comments and questions.
Dave Floyd is a professional FX and stock trader based in Bend, OR and the President of Aspen Trading Group. Dave's approach to FX combines technical and fundamental analysis that results in trades that fall into the swing trading time frame of several hours to several days.
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