Flashback Friday: Pattern Recognition 101

Includes: SPY, TNA
by: Philip Davis

We often talk about how the markets are controlled by machines.

Josh Brown has a post on our site this morning noting the 3pm activity in the markets is for non-human trading only. At PSW, we love the TradeBot, who we affectionately call "Mr. Stick" as he shows up a lot more often than Santa Claus to shower us with presents in the form of last minute market moves that are an option trader’s dream.

Even non-option players can make out great following the late-day action. 'JRW' leads our day traders with plays on TNA, which is a 3x Ultra-Long on the Russell and we often catch 2 and 3% moves on that ETF in the afternoons. Just yesterday, JRW was out and I had to fill in but, since we know the game is rigged and we know how to play along, I was able to call the trade for Members at 2:13 saying:

Day Traders: I would say possible entry point for TNA is going to be $40.30. Like a futures contract, you can play TNA over the $40.70 line with a nickel stop and then reload at $40.30 with a dime stop so risking .15 in catching one of the two moves up. Of course, I’d rather man up and sell the $38 puts for $1.80 agains the the $38/40 bull call spread for $2.20 and be in the $2 spread for net .40 but that’s just me…

I had a couple of followup comments but most of us were happy to take $1 on at least 1/2 and run as we were rejected at $42 just 40 minutes later. The second half ran all the way up to a $1.90 gain into the close. That’s how you use the stick to make a nice, quick 2.5%+ on a stock trade in a day. Of course the option play did a little better with the $38 puts dropping to $1.60 and the $38/40 bull call spread still at $2.20 for a net .60 off the net .40 entry, so a nice, quick 50% there but we have no reason to quit that trade as it returns the full $2 (400% profit) if TNA simply finishes above $40 next Friday. Unlike the stock trade, we don’t really fear the quick reversal as much as we can roll out of the position or just exit with a small loss.

At 3:53 we took our upside money and ran, as I said to Members: "Looks like we’ll be close enough to sell into the excitement on this move. There’s a reason Rule #2 is "When in doubt, sell half." Even if you are dying to be long tomorrow, so much better to take a little off the table into the close - just in case!" Remember, we are not so much bullish as we are bottomish! Nonetheless, I did put up a post for Members this morning called "Turning $10,000 into $50,000 by January 21st" in which we select a series of trades that should make 500-1,000% each if the market recovers off this week’s lows. The idea is to take a chance with a small portion of a larger portfolio - not to go all in with $10,000.

Of course, we are following much more interesting patterns than a simple intra-day stick trade. Take a look at the current 1-month chart of the S&P 500:

Now compare it to our last big sell-off in February:

And look what happens next: A sharp spike down to retest the lows that is reversed intra-day, leading to a strong move up the following week over the 1,100 line and then some consolidation on the way back over 1,130:

Is it possible that when computers do almost all of the trading, the market begins to fall into highly repetitive patterns, or is it just some huge coincidence? As you may know, I’m not a big fan of TA but it is fun to watch the patterns and see what shapes up. Today we have poor retail sales numbers but we expected that, especially with falling fuel prices knocking down gas station sales 3.3%, and it will be kind of funny if we get that big gap down at the open and then recover to even to end the week right back in the middle of the low end of our range. I think I would have to go a bit bullish into the weekend if that’s the case!

February 6th happened to be the day I put out our Q1 Buy List, which made stunning returns before we finally retired it in late April. Members should review that list, both for trade ideas as well as our logic at the time of buying at what we thought was a bottom with well-hedged entries that could either ride out a larger drop or make a very nice return if the market went higher. We got the latter, of course and there’s no reason not to go for it again in the last month of Q2!

Asia had a nice morning, and Europe was having one too until they saw our Retail Data, now they have turned red, led by the DAX, who are off 1% on auto sales fears. Our futures are down about 0.7% and we’ll be looking to do a little buying on the dips but nothing too crazy into the weekend - just some more of those fun day-trades if we see some nice patterns forming up.

Have a great weekend,

- Phil