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TRADER'S NOTEBOOK


Channel Trade Win

02/24/10 03:39:28 PM PST
by Alexander Elder, MD

SpikeTrade.com is a group of 20 professional and semiprofessional traders involved in a weekly competition. Each member submits his or her pick along with the entry, target, and stop. The picks are submitted in private, and then all is revealed on Sunday afternoon. At the end of each week, the Spiker who wins that week’s competition writes up his or her analysis of the trade.

In this article, I will review the winning trade from the week ended December 18, 2009. The trader is Siddhartha S., a dedicated semiprofessional trader, who is one of the youngest members of the Spike group (you can see his profile and the description of his trading style on the website). Here is Sid’s analysis of his latest winning trade.—AE

WY LONG
When I sit down to do my weekend homework, I generally start with the broader market. I try to anticipate what the market may do over the next two to three days — and then try to find a pick in that direction. If the market gives me a mixed message, as it did last week, then I generally select a stock on its own merits.

Last week, I expected the market to test the upper band of its recent range. I went looking for a stock that showed some strength during the pullback of the preceding two weeks.



FIGURE 1: GRAB ME AND TAKE ME. WY broke out on big volume and was pulling back to its breakout line on low volume. It held above that line on closing basis. The 78-minute chart showed the stock digesting its gains after a runup. It was in a bottoming process with a squeeze forming.

When I saw Weyerhaeuser (WY) (Figure 1), it was a “Grab me and take me” moment, as Alex Elder likes to call it. It broke out on big volume and was pulling back to its breakout line on low volume. It held above that line on closing basis. The 78-minute chart showed the stock digesting its gains after a runup. It was in a bottoming process with a squeeze forming. My entry was above 42.2 (Figure 2), which was a resistance level on a 78-minute chart. My stop was below the consolidation level on a 15-minute chart and my target was the area of recent highs.



FIGURE 2: ENTRY POINT. The entry point was above 42.2, which was a resistance level on a 78-minute chart. The stop was below the consolidation level on a 15-minute chart and the target was the area of recent highs.

On Monday morning, WY gapped up, and so I waited for a pullback and some subsequent strength to enter it. That pullback turned to be sharp and scary, but it never violated my stop. In the afternoon it rallied, and I took the position home (Figure 3). On Tuesday, it was up 13% premarket on some news. I sold most of my position in premarket, leaving just a bit to ride it further. But after WY opened, it showed no strength, and so I sold the remaining shares. It turned out to be a good move because WY continued to sag and actually filled the entire gap in the next three days.



FIGURE 3: THE EXIT. The following day, WY was up 13% premarket on some news. The trader sold most of his position in premarket, leaving just a bit to ride it further. But after WY opened it showed no strength, and so he sold the remaining shares.

TRADE REVIEW
The trade that earned Sid his win was a channel trade. Channel trades work for stocks that move in slow and steady uptrends, bracketed by two channel lines. I prefer to draw channel lines parallel to a slow moving average. When a rising stock pulls back to its moving average or dips below it, I call that a pullback to value. When a stock rises above its upper channel line, I call that a rally into an overvalued zone. It makes sense to buy value and sell above value, just as Sid did in his winning trade.

Figure 4 shows several pullbacks to value, followed by rallies into the overvalued zone. If you look closer, you can find a few more that haven’t been marked. Try to find several stocks that move in this way, and you’ll have a pool of potential trading vehicles.



FIGURE 4: TRADE REVIEW. Here you can see that there were several pullbacks to value, followed by rallies into an overvalued zone. If you look closer, you can find a few more that haven't been marked. Try to find several stocks that move in this way, and you'll have a pool of potential trading vehicles.

Trading in a channel may appear as simple as going to a cash machine — buy at or below value, take profits in the overvalued zone. If you look closer, you recognize that the approach is not that easy. For one thing, you have to be very alert because both pullbacks and rallies can occur very quickly.

Sid bought and sold just in time. Had he waited just a day, his profit would have shrunk. If a channel trading reminds you of a cash machine, keep in mind that the machine in question has only short hours of operation. You have to be alert and near the screen to take full advantage of such trades, which is exactly what Sid did!

SUGGESTED READING
Elder, Alexander [2010]. “A Gem In The Junk Pile,”
 Technical Analysis of STOCKS & COMMODITIES, Volume 28: Bonus Issue.
_____ [2010]. “How I Won My Gold,”
 Technical Analysis of STOCKS & COMMODITIES, Volume 28: January.
_____ [2006]. Entries & Exits: Visits To 16 Trading Rooms,
 John Wiley & Sons.



Alexander Elder, MD

Alexander Elder is a professional trader based in New York City. He is the author of Come Into My Trading Room (Barron’s 2002 Book of the Year) and Trading For A Living, considered modern classics among traders. He also wrote Entries & Exits and Sell and Sell Short. He runs SpikeTrade.com with Kerry Lovvorn, a professional trader from Alabama. He may be reached at info@spiketrade.com.



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