In this issue:
The Essence of High Probability Trading
Contributed by Jeff Kilian
It would seem with the plethora of available stock trading software platforms and accompanying rocket science technical analysis techniques it should be a non-complex subject matter to once and for all define the essence of High Probability trade. However most of the inefficiencies associated with substandard trading results are to this day directly related to Backward Technical Analysis vs. Forward Technical Analysis. The before mentioned produces analytical findings and although factual are loosely based on independent indicator findings in isolation and therefore cannot produce the high probability trades we all seek to profit from. The after mentioned produces an entirely different outcome based on the desired result. The desired result now becomes our focus and the end goal is to trade only those stocks that have the highest probability of making an accelerated highly profitable move and do it in a short period of time. Before we proceed with making the case for superior single stock selection using this methodology we must first consider the definition of “essence” and its core value directly related to a trading methodology.
Essence is the permanent as contrasted with the accidental element of being; and moreover the real and ultimate nature of a thing as opposed to its existence. Most Technical Analysts are searchers of the truth and in this case that truth becomes the objective findings that create actionable intelligence for real life profitable stock trading opportunities. A truly committed technician exists in the trading world where his/ her findings are either black or white as the grey area is for the participants we require in the marketplace to realize our profits from. Unfortunately most traders and investors drawn to the marketplace employ Backward Technical Analysis due to a lack of experience or simply have not yet discovered the essence of high probability trading. So now let’s present a closer look at a Methodology using a step by step approach that has stood the test of time in producing the type of trades we all want to make.
Since the beginning recorded history in the US Stock Market; volume has been responsible for some of the most profitable moves in stock prices. By nature an unusually large or historical amount of positive volume at a certain price level clearly indicates accumulation. This accumulated buying as seen through the eyes of a seasoned investor or trader has great significance as this is a clear signal that a combination of insiders, pension fund managers, and financial institutions have made a decision to trade the security with a vested interest in selling it off at a forward date.
An example of how to determine that accumulation is in fact positive is evidenced by a volume spike of two maybe three or four or more times greater than the 21 period average daily volume or an accumulated high level of volume over a specified number of days that co insides with a newly formed Pivot Point low. Now in the case of an oversold or beaten down security, that pivot point low with the volume spike located directly underneath it could then be located at a previous price level established 6 months ago being the same level where another pivot point or base level formation had previously been established as well. The simple double bottom pattern now takes on a new significance as the smart money players have decided that this price level has now become the new intrinsic base value of the stock. The smart money or shall we say the people whom actually control stock prices have now taken a position with an intended intermediate to longer term hold time to surely sell it off with a huge profit. We know this because a vested interest in the accumulation of a stock by these people is one where there is an expected payback and is carefully orchestrated and is always realized. History has shown us time and time again that when the deal is sealed between the powers that be; the stock gets its big upward price move as surely as the sun rises and sets. So now that we have qualified the first step in indentifying a real high probability trade lets proceed with the integration of technical Indicators being graphical representations of mathematical formulas based on price and time as applied to Forward Technical Analysis.
The MACD Indicator as applied to single stock trading using this methodology serves as a trend following indicator showing us where the trend is likely to change direction by the crossing of the MACD line from below to above the signal line, with being situated below the zero level. Dependent upon the current chart pattern formation it as well may be on a short or long term positive divergence additionally signaling pent up buying pressure within the security that has not yet been realized in the form of the stocks upward price movement. The ideal indicator formation is it being on a short to longer term positive divergence relative to the chart pattern formation and now having the MACD cross above the signal line but still below the zero level; but now with continued upward momentum signaling in isolation the stock has “alta probabilidades” or (high probabilities) for a substantial upside move.
Chart 2The Stochastics Fast indicator as applied to single stock trading serves as a first responder providing us with advanced notice of the directional change in prices. Again let me say in another way, an advanced notification of future directional price movement before the stock price has made its reversal in direction. The 21 day Fast Stochastics has direct application to this methodology as when we have a security in an oversold environment it objectively provides us with a relative comparison in the form of its graphical representation of where today’s closing price is as compared to where it was 21 bars ago. Remember we are using objective analysis here and not subjective analysis where as objective analysis by nature is something that can be analyzed and the results are verified as being the truth.
The Money Flow indicator as applied to single stock trading now becomes the critical link between all of the indicators previously discussed. It is the ultimate indicator that confirms the tide of funds that have come into a security “desde principio” or (from the very beginning) was in fact the insiders, pension fund traders, the financial institutions that make the market all in unison initiating their positions for a forward dated highly orchestrated sell off for a substantial profit.
Now let’s integrate the 3 and 7 period pair of exponentially smoothed averages as the last confirmation that price movement and the momentum behind it are more than a mere aberration or anomaly and the train is now leaving the track being the first and official confirmed move of the intermediate or longer term stock price move that will play itself out over time. Exponentially weighted averages as in the preferred 3 and 7 day will guarantee us that we initiate our trades at the most opportune time and not come late to the party as SMA’s that the lesser experienced traders and investors would like to believe still have some validity.
Chart 5Now that we have the set up and have successfully constructed a valid and powerful core Trading Methodology for single stock selection, we have to decide when to execute the trade. Basing our entry on only a specific predetermined day can lead us to miss the correct entry and get shaken out of the trade only to see the stock catapult upwards. So how do we deal with the time element as it relates to the move? The answer is to expand the window of opportunity by widening the time period we allow ourselves to actually take the trade and by allowing all conditions to be met in any order that they may appear within it! Again we do not need a specific order for all the conditions to be met before we trade. All conditions met within per say a 10 bar period parameter now allows the trader the flexibility where not previously possible, for the trigger day to be located anywhere between day 1 and all the way up through day 10.
Whether you are a beginning trader or a seasoned professional. Following and staying true to this methodology will allow you to consistently maximize your profit potential and minimize your downside risk other methodologies only aspire to. Now this my fellow traders and investors we can all agree is ”the essence of high probability trading”.About Jeff Kilian:Jeff Kilian is a 13 year veteran trader, technical analyst, and educator. He is the founder of www.theinsidetechnician.com specializing in “one on one’ developmental training for those whom aspire to become real life profitable traders.
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About Kevin Nelson
Kevin Nelson is the founder of Breakaway Training Solutions, Inc. He has spent the last 17 years becoming an expert on MetaStock software and a serious student of technical analysis while working for MetaStock. Prior to joining MetaStock in 1993, Kevin was a stockbroker for a well-known NYSE firm. In his role as Sales Manager at MetaStock, Kevin interacted extensively with MetaStock customers via phone, webinars, and public appearances. His experiences while working at MetaStock have enabled him to gain a keen understanding of the needs of technical analysts worldwide. While with MetaStock, Mr. Nelson was a featured presenter for four years. During this time, he traveled the U.S. introducing the MetaStock program to thousands of people and teaching them how to use its many features. His easy-to-understand approach is considered by many to be the best in the industry. ©Breakaway Training Solutions, Inc. 2011
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