How to Use "Crayon Drawings" to Make Money Trading (Part 3)

07/28/2010 12:01 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

(Continued from Part 2)

Let's take a look at how the market unfolds as price approaches the area of confluence.

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Sean's limit buy order at 16.58 was filled right at the confluence formed by the change in behavior line and the multi-pivot Line. As I mentioned earlier, these areas of confluence often act as energy points, and after working them now for many years, I feel their most important contribution is that they inject an element of time (or space, if you are using non time-based bars) to the right side, or unfolding side, of your charts.

Looking at this chart, I like that traders probed the area below the multi-pivot line. In essence, the market wants to know if the whales still have interest in buying more stock down at that area. Price closed well back above the multi-pivot line, so at least for this day, there appeared to be a good deal of limit buy orders at or near 16.58, including Sean's order, of course.

Let's quickly talk about attention to detail: Sean will be back in school in early August, so one of our first rules was that he was not allowed to daytrade, nor was he allowed to watch his positions during the day. (Yes, I'm sure he likely peeked now and then, since he interrupted one mid-day mentoring session to tell me his position was up more than 50 cents on the day near the close, which got quite a few “Go Sean!” or “Is Sean taking clients yet?” comments during the session.)

But the cardinal rule that cannot ever be broken under any circumstance is this: Initial stop loss orders are always put into the market at the same time that limit entry orders are placed. There’s no such thing as “soft” stop loss orders, though I have had many an argument with other professionals about the concept. Stop loss orders are your best friend; they protect you from losing all the capital in your account should something go wrong. Learn how to effectively use stop loss orders— it is the first thing I teach the crayon crowd.

Once the market closed, Sean checked to make sure his order was filled, and then he checked that his “good 'til canceled” stop loss order was in the market. At that point, he measured where price would intersect with the magenta-colored, down-sloping line and put in a limit order to sell one half of his position at 18.03 and a separate limit order to sell the second half of his position at 18.93. Let's see how the market traded in the few days that followed.

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Two days later, price opens near its high but then trades lower and closes in the lower third of its daily bar after making a new low for the move. I zoomed in on the price action so you can clearly see each bar. Price has closed lower six straight days in a row! Who would buy this stock with this sort of price action?

The whales would! They “need” this type of action at or near their price entry point to get smaller traders to dump their long positions. Looking at this chart after the close, I clearly remember my opinion: If Burger King (BKC) did not find significant buying orders at this level the following day, Sean would quickly be stopped out of his position. Conversely, if the whales did have orders at these levels and a rally began, no smaller traders were long and they'd be forced to chase this stock higher once they understood what was going on. At the close of this day, Sean's position in Burger King would either be a very-well-thought-out long, or he had held out his hand and tried to catch a falling knife. The next day's action should be interesting, indeed!

If you’re wondering, Sean did not ask my opinion after the close and I did not offer it. Part of finding out whether he liked trading and could be a good trader was watching him follow or not follow his trading plan.

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Price gapped higher the next morning and climbed higher all day, closing near its high. After the market closed, Sean pulled up his charts and then knocked on my trading room door. He asked a very insightful question: “What would price need to do tomorrow to make me feel there were whales or large limit buy orders at the recent area of congestion (right at the multi-pivot line)?” The obvious answer is price simply has to go higher, but the logic behind the answer is more important, and I think that’s what he was really asking about.

More tomorrow in Part 4…

By Tim Morge of MarketGeometry.com

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