Scott Pluschau is a Contributing Editor to the ETF Digest.
Scott was a financial advisor with Citi. His technical analysis report on the Nasdaq Composite Index was featured by Dr. Marc Faber in his June 1, 2011 Gloom, Boom & Doom report. Scott earned his degree in Accounting and Taxation from Pace University. He lives on Long Island with his wife Ilona, daughter Olivia and son Henry.
20 year+ U.S. Treasury Bond exchange traded fund, symbol TLT, is skating on thin ice. A “head and shoulders” pricing pattern developed on the Daily chart recently. A head and shoulders pattern shows a gradual overcoming of supply vs. demand and it can have serious implications when it appears at the end of an uptrend. Back in late 2011, you can see the beginning of this formation that I noted with blue letters as the price of TLT attempted to move higher. When a neckline is broken off the lows between the two shoulders, it is a signal that a change in trend may be taking place.
The “measured rule” for a profit taking target on a H&S pattern is the distance between the top of the head to the neckline and then adding that onto the breakdown point. The risk or stop loss is above the right shoulder. The probabilities are good from a reward to risk perspective.
The problem for the bulls is that should this H&S pattern get fulfilled, it will also be breaking a prior “support” level.Support is where market participants previously thought price was too low. Will there be demand for TLT this time again?
There are two “gaps” on the chart that I noted with blue ovals as well. Gaps happen when a market opens a following morning at a higher price level than where it closed the previous trading day and fails to return there. Gaps have a tendency to fill and are targets for traders. Once the support level I noted fails to hold, these gaps will be in play. The smart money bulls will typically step aside once support is broken, and admit defeat in the short term.
Looking out on the horizon, should TLT keeps heading south, there is what I call an “Air Pocket” below. An air pocket develops when price spends a relatively small amount of time trading in a particularly large range. This could lead to very sharp and explosive moves downward much like what happened on the way up. The next logical stopping price would likely be the major support level I noted on the chart.
Other technical signals that are flashing a warning the selloff may pick up some momentum are the MACD oscillator and the RSI indicator. Besides the bearish negative divergence when the head formed, the MACD also recently completed a crossover to the downside and is on the verge of crossing over the centerline resistance level. The RSI Indicator is confirming the move down by making new lows from within the H&S pattern. The RSI will often find support and turnaround at the 40 area in a bull market. Bulls want to see the MACD also bounce off the centerline and turn upward.
What is worth pointing out on the chart is the last time TLT was at this major support level back in August of 2011. Major support levels are prior major resistance levels. Resistance levels form a ceiling when price struggles to trade higher in repeated attempts. Notice the explosive volume when it finally broke out from that level. There was little chance of TLT looking back on a breakout with that much volume. It will be difficult in the future for TLT to “buzz saw” right through there to the downside, and that will be a great place to lock in profits for short traders.
In full disclosure I went short TLT a small trade off the break in the neckline of the H&S. I am looking to add to the trade on each successive failure of the horizontal minor support levels I noted, with the ultimate target being the major support level. With this type of trade plan, should the initial H&S pattern not work out, I will be stopped out with a small loss on my smallest size position, making the risk quite comfortable compared to the reward of going for the jugular once my initial judgment has been proven correct.
Let me finish with these thoughts on trade management. When you add to losing trades and they continue to move against you, it can lead to large and destructive losses. If we add to a winning trade, and it reverses, we will only be giving back some gains.
I believe traders should embrace the risk of losing profits, when they have a trade idea that is being validated by the market. That gives you the potential to score big. It becomes very difficult to get back in a market that has left you behind when your exit was not based on reason but the P&L.
I also believe traders should avoid taking risk when their trade idea has been invalidated by the market. This keeps losses small and manageable if using the correct position sizing in relation to account size.
What traders want to avoid doing is taking the sure profit for the sole reason of fear of losing it. That is not the time to avoid risk. Unfortunately for many traders, they embrace risk when they have a trade gone bad, by either adding to it or holding on.
If you would like to see future commentary of mine expanding on risk management, trade management, trading psychology, position sizing and/or money management, please leave a comment or send me an email:
This e-mail address is being protected from spambots. You need JavaScript enabled to view it
Subscribers to ETFDigest get email alerts for trades being placed in the model portfolios.
Scott Pluschau is a Contributing Editor to the ETF Digest.
20 year+ U.S. Treasury Bond exchange traded fund, symbol TLT, is skating on thin ice. A “head and shoulders” pricing pattern developed on the Daily chart recently. A head and shoulders pattern shows a gradual overcoming of supply vs. demand and it can have serious implications when it appears at the end of an uptrend. Back in late 2011, you can see the beginning of this formation that I noted with blue letters as the price of TLT attempted to move higher. When a neckline is broken off the lows between the two shoulders, it is a signal that a change in trend may be taking place.
The “measured rule” for a profit taking target on a H&S pattern is the distance between the top of the head to the neckline and then adding that onto the breakdown point. The risk or stop loss is above the right shoulder. The probabilities are good from a reward to risk perspective.
The problem for the bulls is that should this H&S pattern get fulfilled, it will also be breaking a prior “support” level. Support is where market participants previously thought price was too low. Will there be demand for TLT this time again?
There are two “gaps” on the chart that I noted with blue ovals as well. Gaps happen when a market opens a following morning at a higher price level than where it closed the previous trading day and fails to return there. Gaps have a tendency to fill and are targets for traders. Once the support level I noted fails to hold, these gaps will be in play. The smart money bulls will typically step aside once support is broken, and admit defeat in the short term.
Looking out on the horizon, should TLT keeps heading south, there is what I call an “Air Pocket” below. An air pocket develops when price spends a relatively small amount of time trading in a particularly large range. This could lead to very sharp and explosive moves downward much like what happened on the way up. The next logical stopping price would likely be the major support level I noted on the chart.
Other technical signals that are flashing a warning the selloff may pick up some momentum are the MACD oscillator and the RSI indicator. Besides the bearish negative divergence when the head formed, the MACD also recently completed a crossover to the downside and is on the verge of crossing over the centerline resistance level. The RSI Indicator is confirming the move down by making new lows from within the H&S pattern. The RSI will often find support and turnaround at the 40 area in a bull market. Bulls want to see the MACD also bounce off the centerline and turn upward.
What is worth pointing out on the chart is the last time TLT was at this major support level back in August of 2011. Major support levels are prior major resistance levels. Resistance levels form a ceiling when price struggles to trade higher in repeated attempts. Notice the explosive volume when it finally broke out from that level. There was little chance of TLT looking back on a breakout with that much volume. It will be difficult in the future for TLT to “buzz saw” right through there to the downside, and that will be a great place to lock in profits for short traders.
In full disclosure I went short TLT a small trade off the break in the neckline of the H&S. I am looking to add to the trade on each successive failure of the horizontal minor support levels I noted, with the ultimate target being the major support level. With this type of trade plan, should the initial H&S pattern not work out, I will be stopped out with a small loss on my smallest size position, making the risk quite comfortable compared to the reward of going for the jugular once my initial judgment has been proven correct.
Let me finish with these thoughts on trade management. When you add to losing trades and they continue to move against you, it can lead to large and destructive losses. If we add to a winning trade, and it reverses, we will only be giving back some gains.
I believe traders should embrace the risk of losing profits, when they have a trade idea that is being validated by the market. That gives you the potential to score big. It becomes very difficult to get back in a market that has left you behind when your exit was not based on reason but the P&L.
I also believe traders should avoid taking risk when their trade idea has been invalidated by the market. This keeps losses small and manageable if using the correct position sizing in relation to account size.
What traders want to avoid doing is taking the sure profit for the sole reason of fear of losing it. That is not the time to avoid risk. Unfortunately for many traders, they embrace risk when they have a trade gone bad, by either adding to it or holding on.
If you would like to see future commentary of mine expanding on risk management, trade management, trading psychology, position sizing and/or money management, please leave a comment or send me an email: This e-mail address is being protected from spambots. You need JavaScript enabled to view it
Subscribers to ETFDigest get email alerts for trades being placed in the model portfolios.
Follow this writer on Twitter/ScottPluschau