I continued to be inspired by the March Madness formed by the start of the NCAA
basketball tournament and its applications to trading. There isn't a better event in
all of sports, due to the passion of the players and unpredictability of the games.
One common theme I have noticed throughout the years is that teams that survive a
critical test or make a dramatic buzzer-beater in the early rounds often tend to go
deeper into the tournament than many expect. This is partly due to the
self-fulfilling buildup of confidence I discussed in Monday's TrendWatch. When a
team perseveres through adversity, what doesn't kill them makes them stronger. I
call these moments "inflection points", as the team could either fight or die at that
critical juncture.
The same inflection point concept applies to traders as well as to trends. As a
trader, have you ever felt like you were at a moment of critical decision, either on
the way in or the way out of a trade? Oftentimes under such increased pressure
(usually the pressure is self-applied), the trader will freeze and not take action,
which usually leads to missed opportunities by not entering properly or diminished
profits from not exiting in a timely manner.
For trends, in this more volatile market I notice that the big moves these days seem
to happen after the market hits key inflection points in my primary indicators. For
example, look at the daily chart of the Nasdaq 100 Index Trust (QQQ) below. I have
plotted the Stochastics Confirmation indicator discussed a couple of weeks back,
using the 21-day setting for %K (in red) and the 10-day average for %D (in blue).
When the %K crossed under %D back on March 11, most traders would say that the
stochastics is now headed lower so a bearish trade would be in order. But my tweak
of this traditional indicator requires that after the crossover, you must then see
price confirmation with a close under the low at 23.78 on the 11th (what I call the
"inflection bar"). While the following day the Q's did trade as low as 23.54, the
market reversed to the upside to close at 24.23, back above the key 23.78
confirmation level. And this led to the upside move that followed in the past week.
I have written a great deal about "breakout" versus "fakeout" markets, and this is
another case where the bearish crossover in the stochastic was a fakeout. The
confirmation method prevented you from going short at the exact wrong time. Longs
could have been placed once we saw a close over the March 11th inflection-bar high at
24.24, which occurred two days later at 25.62.
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