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“This education material does not constitute financial product advice and has been prepared
without taking into account your personal objectives, financial situation or needs. You
should consider the information in light of your objectives, financial situation and needs
before making any decision about whether to acquire or dispose of any financial product.
Derivatives can be risky; losses can exceed your initial payment and you must be able to meet
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(OTC) products and are therefore not traded on an exchange. When trading CFDs you do not
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available from FP Markets can be obtained either from the website or on request from our
offices and should be considered before entering into transactions with us. First Prudential
Markets Pty Ltd trading as FP Markets (ABN 16 112 600 281, AFS Licence No. 286354).
This document has used the following sources for references:
http://www.zerohedge.com/ and http://www.dfat.gov.au. The charts used are proprietary,
and have been created based of the author’s discretion.
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Trading StrategiesA Retrospective Glance:
My recent “Inflection Point” report in March received great interest. It
proved to be rather timely given the recent sell off we have seen across
Global markets. Indeed, the XJO made a high of 5163 on 3/12/2013 and
has fallen -5.4% to a current low of 4883. However, it is the Resources
sector that has really suffered with BHP dropping from $39 to $30.50
in two months. That is almost a -25% decrease whilst RIO has slumped
almost -30% in the same space of time!
RIO Target – shown in the Inflection Point
RIO Target: Now
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It seems the Resources sector has come a long way from the bullish sentiment that was encapsulated so succinctly in this tweet from a market “professional”:
“Fear has lost!”20/02/2013 @cliffordbennett
The analysis presented at FP Markets has continuously been on the front
foot whilst this scenario has played out, providing clients with timely
and actionable trade ideas. The reality is that “shorting” stocks is a
very difficult strategy and requires a very different mindset to more
conventional buy techniques.
One question that I am continuously asked is; “What is your favorite
trading strategy?” and “how do you approach the markets?”. No doubt
these are key questions. In this whitepaper, I wanted to expand upon
Trading Strategies with a particular focus on shorting stocks.
Developing a Method:
If I could stress one point it would be that there is no correct or right
way to approach the markets. It took me countless hours of study,
application and real life trading hours before I came to a realization
of what works for me. They say that experience counts for everything
and I couldn’t agree more. I have almost 10 years of screen time and no
doubt have made many mistakes along the way, which have all served
as a learning lesson. The most important thing is to develop a trading
plan that fits your own personality and your own beliefs based on real
observation and study of the markets.
Books such as the “Market Wizards” series by Jack Schwager are
particularly enlightening in this regard. The traders interviewed in
these books show a diversity of styles and techniques whether it is
fundamental or technical, short or long term. However, common themes
always emerge such as the importance of having a trading plan and a
quantifiable edge, as well as the adherence to strict risk management
principles. Too often I see traders without a concrete trading plan and
strategy, and this is their undoing.
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Developing Strategies:
To me, stocks and the broader market really consists of a few states:
• A sideways consolidation pattern
• A major trend higher or lower, or
• A runaway/climatic price move to major tops and bottoms.
It really is that simple. Thus, I develop strategies around these scenarios,
of which shorting no doubt plays an integral part. Technical analysis
and studying price action are the tools I use to time such trades.
Here is a brief outline of the strategies I use and present in my analysis:
i) Breakouts: trading breakouts and breakdowns from consolidation
patterns. Using confirmation rules can enhance their effectiveness.
ii) Retracement Trades: buying pullbacks into a strong uptrend; or
shorting rallies into a confirmed strong downtrend.
iii) Climax Patterns: exploiting runaway and climatic trends through
patterns e.g. double tops/bottoms, ending wedges and candlestick
reversal patterns.
AND
iv) “Failed patterns”: these trades try to take advantage of the herd
and fade classic chart patterns once it is clear they have failed.
I wrote about these setups in a separate blog post here: http://
fpmarkets.blogspot.com.au/2012/08/the-most-important-rule-
in-chart.html These are often some of the most powerful technical
setups out there.
i
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Below are some real life examples that were all revealed in the FP
Markets Research section. It is all there in print. These examples clearly
illustrate the setup behind each trade and show you what we can offer at
FP markets to put you on the front foot to enable you to “move first”.
Guidelines For Shorting:
• Focus on shorting the weakest stocks AFTER they have reversed and
made their highs. These are the ideal candidates. A stock that cannot
hold up and breaks supports despite a broader strong market is a sign
of genuine weakness. Focus on weak stocks going lower NOT stocks that
are trending higher*.
• Analyze the broader market trend and individual sectors. The best short
candidates are in the underperforming and downtrending sectors.
• Execution and entry is very important. In downtrends, stocks undergo
very sharp bounces and short squeezes. The temptation is to short
when all hell has broken loose but the actual open risk on such
positions increases dramatically.
• Stocks often go down a lot quicker than they go up! Short traders need
to be opportunistic and prepared for quick sharp thrusts lower. Use the
panic to cover positions. You have to be willing to buy and cover short
positions when no one else wants it.
Shorting Examples:
i) Breakdown Trades
Ideal candidates are those stocks in established downtrends with
a series of lower highs in place on the Daily chart.
The key to this trade setup is waiting for a period of consolidation
and potential bounce attempts. It is only a series of failed bounces
that the market is tipping its hand that buyers are losing control.
This is the time to capitalise as a break of support often leads to
sell stops going off and a sharp move lower in the direction of the
bigger picture downtrend once more.
*The exception here are blow off type moves and climatic exhaustion trades. Please see “Climax Patterns” later on.
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Copper Daily:
This was the Copper setup shown on the March 1st ASX report. Copper
looked primed for a breakdown given the series of lower highs,
weakening overlapping bounces, and the fact that the commodity was
failing to push higher despite strong equity markets- a lead indicator
Copper Daily: Now
This is how it played out. Traders could have used a number of
breakdown candles as a signal to short. The focus here is shorting a
weak market in a downtrend after a confirmed breakdown.
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OZL Daily:
OZL is in a clear downtrend with a number of lower highs and all
moving averages pointing lower. Price was consolidating at the $6
support zone but note that each bounce attempt failed to produce a
meaningful reversal higher.
OZL Daily: Now
The breakdown through $6.00 led to a number of potential short
triggers into the 4.50 Weekly target zone. Once again, the focus is on
shorting weak stocks in downtrends as they lose support.
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ASL Daily:
ASL formed a multi month consolidation pattern from 2.80 to 3.20.
However, each bounce attempt slowly became weaker and weaker
forming this topping pattern. The breakdown through supports was the
trigger for a fresh downtrend once more.
ASL Daily: Now
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ERA Daily:
A series of lower highs on the Daily chart confirmed the broader
downtrend. A mutli month consolidation pattern failed to produce a
meaningful bounce and a move below supports was the trigger for a
resumption of the bigger picture downtrend.
ERA Daily: Now
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Note that in almost all of these examples, one is not picking tops but
focusing on the stocks that are already in downtrends with a number of
lower highs on the Daily chart. After a period of consolidation, traders
capitalise on the breakdown through supports and a resumption of the
downtrend once more.
ii) Retracement Trades
This setup looks to capitalise on bounces back into established
downtrends for low risk short entries. When prices are making new
lows, always look to short the first pullback. Once in the trade, look
for a continuation of the previous trend. One of two outcomes
typically follow – the retest will either fail at the previous low, in
which case a small profit can be made. In the second scenario, a
whole new continuation leg begins.
The key to this setup is obviously deciding when the “bounce”
has gone high enough to initiate the short.
I look for
• Retest of previous support
• Retest of moving averages
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NCM Daily:
NCM broke down sharply though key support at 21.00. The stock is in
a clear downtrend. Thus, the most probable trade is to short the first
retracement.
NCM Daily: Now
NCM retested 20.00 in a flag type pattern. There was then a very sharp
reversal as Gold collapsed. This opened up a target into the previous
low and beyond into the weekly target zone (16.50)
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RSG Daily:
Breakdown through 1.20 and thus looking to short the first pullback
into resistance.
RSG Daily: Now
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iii) Climax Patterns:
These trades look to take advantage of runaway price moves and
exhaustive trends. Note that these are opportunistic type trades
and counter the previous 2 strategies which look to exploit the
weakest stocks.
Key to these setups is waiting for a clear confirmation and a
rejection of higher prices. Examples would be candlestick reversals
out of overhead resistance zones. A tight stop loss point needs to be
identified based off the recent high AFTER the turn.
FMG Daily: 3 Peak Pattern
Back to back bearish reversal candles right into overhead resistance
after a major run up.
FMG Daily: Now
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FGE Daily: Ending Wedge Pattern
FGE formed a climatic wedge right into the top end of the range and
overhead resistance area. This offered a low risk short setup with
tight stops.
FGE Daily: Now
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iv) “Failed patterns”:
These trades try to take advantage of popular chart patterns and
fade the crowd once it is clear such patterns have failed. Technical
analysis has become very commonplace these days and as such
many traders are looking at the same patterns. If everyone is
positioned the same way and the stock fails to move in the
direction of setup, a swift unwind can ensue which exacerbates
the move in the opposite direction.
With this strategy, one is trying to think about how traders are
positioned and the psychology of the market. What would I be
feeling if I was long the S&P500, thinking I had this great trade,
and seeing the market go against me?
Furthermore, a market that is poised to go higher but fails to do
so is a sign of inherent weakness.
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XJO 60mins
The market looks poised for a breakout given the back to back
consolidation and triangle patterns.
XJO 60mins: Now
However, the breakout was sold into and a sharp sell off ensued.
Traders who had bought the breakout were forced to sell out and take
stops, and this further intensified the move lower. The trade to get short
is taken when price moves back below the previous breakout zone.
A market that is poised to go higher but fails to do so is a sign of
inherent weakness.
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Trades that didn’t work:
No doubt there are many setups that have not been so successful. That
is the reality of trading and successful traders have to be prepared to
take stops and move on. The key to longevity in this game really is about
cutting the underperforming trades and riding the winners. Sounds so
simple but often hard to do.
STO Daily:
STO broke down sharply through the key 12.00 support zone after a
failed rallied attempt which formed a lower high. This breakdown candle
implied a potential move all the way back down to the lows once more.
STO Daily:
However, there was no follow through and the stock regained the
previous breakdown zone stopping out the trade.
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Regular readers of my Research also note that I was looking for
potential topping patterns at times in the Banks. For instance when
CBA was retesting its 2007 GFC highs I was looking for a potential
double top trade out of $62 in January. The stock went as high as $63.70
before reversing lower and the sell off only lasted a whole 3 days before
rebounding strongly in an uptrend!
The WBC double top trade in March out of the $31.50/32.00 level did
work better for short term traders but even this was short lived. The
stock fell to a low of $29.50 from where it rebounded strongly and
subsequently broke out higher.
All one can do is take the stop and look for the next trade. The simple
fact that both these setups failed to follow through to the downside
implied genuine strength and offered subsequent breakout trades
higher in time. This is a complete reversal of the initial short idea! You
just have to be flexible as a trader and heed the price action. It is not
about making predictions, but about being flexible and making money.
Planning Trades:
Most of what I have presented here are just discretionary setups. A
trading plan needs a number of inputs such as the setup, an entry
trigger, stop loss management, and some guidelines on how to manage
the trade. There is not enough space in this document to expand upon
these points in full. I will say that risk and position management is
almost as important as the trade setup itself!
Savvy readers will note that most of the short setups I have shown here have hit their target zones. One will also note that the majority are in the Resources sector and Mining Services sectors as this is the segment in the market that is clearly downtrending. The fact target zones have been hit may imply that a bounce or turnaround in the market is due. Ironically, the simple fact that I am writing this
whitepaper AFTER the event implies the correction may well be done.
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Risk Management:
I could write a book about trade management and the importance of
using stops. A stop should reflect where a trade idea is clearly wrong. It
could be manual or automated. The reason for stopping out of a trade
should be when price action is doing something completely counter to
your trade idea. Traders need to understand that they are going to be
wrong a lot of the times. That is the nature of the game in a risk taking
business. However, knowing you are wrong and remaining wrong is the
true mistake.
The trading strategies shown here are designed around low risk/high
reward opportunities. Indentifying such scenarios for traders is key
rather than trying to make long-term forecasts. It is clear in these
examples where the trade idea has been invalidated and that is exactly
the place where stops need to be placed.
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ConclusionThe strategies presented here are a brief outline of the short setups
used in my analysis. They are discretionary in nature and are not
an automated system. This is just what works for me through my
experience in the market. I do believe having an approach on the
short side is a valuable tool in a trader’s arsenal. This enables one
to capitalise on both sides of the market. As can be seen in these
examples, it can be very rewarding indeed!
It is also important to stress that shorting requires quite a different
mindset. Downtrends are characterised by sharp rallies and vicious
short squeezes. Identify low risk opportunities and be willing to cover
open positions on extreme panic.
The higher probability trades are focusing on the weakest stocks in
the market in clear downtrends. Waiting for failed rally attempts and
the subsequent breakdown through supports are the ideal pattern.
The higher risk trades are exploiting blow off moves through climatic
patterns but these are for shorter term traders and need very strict
risk management.
Trading is all about trying to identify low risk high reward
opportunities. That is exactly what these patterns and setups attempt
to do. The best we can do as traders is draw upon demonstrable edges,
wait for price action to confirm, and pull the trigger. The trade then all
becomes about position management and knowing when you are right,
and when you are wrong.
I hope this has been enlightening. For those wanting to expand upon
my ides and analysis, follow me at the FP Markets Research section:
https://fpmarkets.com.au/research/register
Thanks,
Austin
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