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Thomas Bulkowski’s successful investment activities allowed him to retire at age 36. He is an internationally known author and trader with 30+ years of stock market experience and widely regarded as a leading expert on chart patterns. He may be reached at

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Busted
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Market
Industrials (^DJI):
Transports (^DJT):
Utilities (^DJU):
Nasdaq (^IXIC):
S&P500 (^GSPC):
As of 04/21/2017
20,548 -30.95 -0.2%
9,134 7.68 0.1%
706 4.81 0.7%
5,911 -6.26 -0.1%
2,349 -7.15 -0.3%
YTD
4.0%
1.0%
7.0%
9.8%
4.9%
Tom's Targets    Overview: 04/17/2017
20,100 or 21,150 by 05/01/2017
8,500 or 9,500 by 05/01/2017
725 or 685 by 05/01/2017
5,950 or 5,650 by 05/01/2017
2,275 or 2,425 by 05/01/2017
Mutt Winners: None YTD

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November 2009 Headlines


Archives


Monday 11/30/09. Market Monday: The Week Ahead

Last night I dreamed I was eating a huge marshmallow, and when I woke up, my pillow was gone!

A Brief Look Back

The following are economic news or events that moved the markets last week. The numbers refer to the close-to-close move in the Dow industrials.

Monday: Up 132 points on news of better than expected existing home sales perhaps due to the first-time home buyers tax credit and a weaker US dollar.
Tuesday: Down 17 points. Inflation came in lower than expected with consumer confidence rising.
Wednesday: Up 30 points. Traders may have left early for the holiday. Personal income and spending were up, and initial jobless claims were down.
Thursday: Holiday
Friday: Down 154 points despite a half-day of trading, on news Dubai World might default on billions in real estate loans.

Economic Reports

The following information is derived from yahoo!finance and times are local to the east coast. The "Dow Moved" column is the close-to-close price change of the Dow industrials on the release day from the prior trading day, the last time the report came out.

ReportTimeA-F
Rating
Dow
Moved
Description
Chicago purchasing managers index9:45 MB-250Monitors regional manufacturing activity.
Construction spending10:00 TD+77Covers residential/non-residential/public spending on new construction.
Auto & truck sales2:00 TC-+77Monthly sales of domestically produced vehicles.
Other reportsW??Challenger job cuts, ADP employment report, crude inventories, Fed beige book.
Initial jobless claims8:30 ThC++31Counts people filing for state unemployment benefits.
Productivity & costs8:30 ThD++114Cost of producing a unit of output.
4 Employment reports8:30 FA+17Nonfarm payrolls, unemployment rate, avg workweek, hourly earnings.
Factory orders10:00 FD++77Durable/non-durable goods orders w/factory inventories.

Options Expiration

No options expiration activity this week.

CPI: Chart Pattern Indicator

On Friday, 11/27/2009, the CPI had:

0 bearish patterns,
0 bullish patterns,
369 patterns waiting for breakout.
The CPI signal remains bearish since it flipped from bullish to bearish on November 19. I'm not sure why no bearish patterns appeared on Friday after such a large down move. There's an excellent explanation for this. I just don't remember what it is....

The chart pattern indicator is bearish with two of three solid triangles showing (). Additional triangles are a measure of strength with solid triangles meaning a more reliable signal. Bearish divergence appears between the market and the indicator, but it's been that way since September. Bearish divergence suggests the market will turn down.

Other

Earnings season is over.

The number of pipe tops last week were: 0 and bottoms: 1. Large numbers of pipes often signal the start of a short to intermediate-term trend change. Since only 1 bottom appeared last week, the reading is meaningless.

The following industries, of 52 that I follow, were the best performing.

  1. Internet (best again this week)
  2. Apparel (was 3 last week)
  3. Shoe (was 2)
  4. Medical Supplies (new to the list this week, replacing coal)
  5. Metals and Mining (Div.)(new to the list this week, replacing computers and peripherals)

Here are the worst performing.

  1. Cement and Aggregates (was 48)
  2. Petroleum (Integrated) (was 50)
  3. Trucking/Transp. Leasing (new to the list, replacing homebuilding)
  4. Alternate Energy (was 51)
  5. Short ETFs (worst) (was 52)

My Prediction

Picture of the S and P 500 (^GSPC) on the daily scale.

Retail sales numbers on Saturday show a 0.5% increase over the prior year and that should help boost the markets on Monday. However, the Dubai situation, if not resolved, could make foreign markets even more nervous than they are, thereby causing the US market to be volatile, too.

My guess is the Dubai crisis served as a reminder that the commercial real estate problem is one not yet addressed in the US. If the holiday shopping season is a flop, then mall operators and stores will have difficulty staying in business in the coming months. However, the good retail sales report on Saturday I believe will allow the Dow to close higher, especially since the index climbed off its lows on Friday. I expect that upward rebound to continue.

Beyond that, the employment reports that come out on Friday, if worse than expected, will send the market stumbling. Everyone knows that employment is going to get much worse before it gets better, but everyone hopes that's not the case. My guess is the market will move sideways until Friday. If events push the industrials to close above the top red line, then expect the up move to continue. If Friday is a diaster, then expect the down move to take hold.

Many are betting the move will be down because of the huge increase since the March lows. I'm not so sure even though I show the Dow moving lower on Friday and my targets for the other indexes are also below where they were trading on Friday. The market could confound us all and climb. That would be a nice holiday present.

Mutual funds may be dressing up their portfolios for the year end, if they haven't finished that already. They often do that at the end of November but their buying in December can push the market higher. This is especially true in January when new money tends to flow into the market causing the January effect. Of course year end tax selling can make December a volatile month, too.

-- Thomas Bulkowski

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Monday 11/23/09. Market Monday: The Week Ahead

Economic Reports

The following information is derived from yahoo!finance and times are local to the east coast.

ReportTimeA-F
Rating
Description
Existing home sales10:00 MoCCounts sales of used homes.
Gross domestic product8:30 TuBMeasures economic activity; GDP deflator measures inflation.
Consumer confidence9:00? TuB-Surveys 5,000 households for consumer trends.
Personal income and consumption8:30 WeC+Measures sources of income to predict future demand.
Personal consumption expenditures8:30 WeC+Covers durables, non-durables, and services.
Initial jobless claims8:30 WeC+Counts people filing for state unemployment benefits.
Durable goods orders8:30 WeBMeasures orders and shipments of goods with lifespans of 3+ years.
New home sales10:00 WeC+Shows sales of single-family homes.
Crude inventories10:30 We?My guess: Measures oil inventory.

Options Expiration

No options expire this week.

Other

Earnings season is winding down.

Market holiday on Thursday: Thanksgiving. Probably a low volatility day.

Based on my study of holidays, the market will close higher on Wednesday (happens 56.7% of the time, the best performance of all holidays), but lower on Friday (occurs 51.1% of the time). I consider both numbers to be about random.

The chart pattern indicator is bearish with three of three half triangles showing (). Additional triangles are a measure of strength with solid triangles meaning a more reliable signal. Bearish divergence appears between the market and the indicator, but it's been that way since September. Bearish divergence suggests the market will turn down.

On Friday, 11/20/2009, the CPI had:

51 bearish patterns,
7 bullish patterns,
430 patterns waiting for breakout.
The CPI signal is 12.1%, which is bearish (<= 35%).

The following industries, of 52 that I follow, were the best performing.

  1. Internet (best again this week)
  2. Shoe (was 3 last week)
  3. Apparel (was 2)
  4. Coal (replaces long ETFs)
  5. Computers and Peripherals (was 5)

Here are the worst performing.

  1. Cement and Aggregates (was 48)
  2. Homebuilding (replaces eastern electric utilities)
  3. Petroleum (Integrated) (was 49)
  4. Alternate Energy (was 51)
  5. Short ETFs (worst) (was 52)

Picture of the Nasdaq (^IXIC) on the daily scale.

The chart shows the Nasdaq composite on the daily scale.

Several people have asked if the pattern in the Nasdaq is a broadening top. Yes, it is. Price touches the top trendline three times and twice on the bottom, forming a megaphone-shaped pattern.

Breakouts from broadening tops have a random direction, with 50.3% breaking out downward. My guess is an upward breakout will occur after showing a partial decline. That partial decline could bottom this week, supported by the continuation gap in the middle of the uptrend. That gap also happens to appear halfway up the move from A to B. Remember when I discussed gaps last Tuesday? Continuation gaps appear midway through the move and this is a perfect example.

I expect price to retrace half of the AB move.

I show my prediction for the price path this week with the Nasdaq rising the day before the holiday and dropping on Friday. I don't expect any wild swings due to the holiday and lack of important economic reports. Tuesday will probably be the more volatile day of the week because traders may quit trading early on Wednesday and extend the holiday through Friday.

-- Thomas Bulkowski

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Thursday 11/19/09. When Patterns Collide!

Picture of powershares dynamic leisure (PEJ) on the daily scale.

A question that comes across the ether every year or so is what happens when two chart patterns appear on the chart at the same time? Which do you believe? The chart of PEJ -- PowerShares Dynamic Leisure & Entertainment exchange traded fund -- shows such a situation.

Along the top of the chart are peaks 1, 2, and 3. Many of you will recognize that pattern as the start of a triple top. Connecting valleys 4, 5, and 6 form another pattern called a right-angled broadening formation, descending. I show the outline of what that pattern looks like in the inset.

In short, we have two chart patterns that appear on the same chart at the same time. Which is right?

Let's take each pattern separately. The triple top isn't really a triple top, is it? Do you know why? The answer is the same for many chart patterns. The triple top is just three peaks on a chart but it does not become a valid triple top until price confirms the pattern. That means price has to close below the lowest valley between the three tops -- valley 6. Clearly, that hasn't happened yet.

However, a triple top is bearish. When confirmed, it signals a downward move.

What about the broadening pattern? That pattern does not have to prove confirmation. As long as the pattern obeys the identification guidelines outlined in my Encyclopedia of Chart Patterns book (pictured), then everything is fine. In this example, the pattern does obey the guidelines, so it's a valid pattern.

What about the breakout direction? For this broadening pattern, the breakout direction is upward 51% of the time -- random, in other words.

When patterns collide and both are bearish, or both are bullish, then you don't have a problem. When one is bullish and the other is bearish, you still don't have a problem. Why? Because you should always trend in the direction of the breakout.

It's as simple as that.

-- Thomas Bulkowski

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Tuesday 11/17/09. Tutorial Tuesday: Gauging Gaps

In candle speak, a gap is called a rising window or falling window, depending on whether the trend is upward or downward. Thus, I had an opportunity to test gaps in my book, Encyclopedia of Candlestick Charts, pictured on the left.

I found that they don't work very well as support or resistance zones despite what candle lovers claim. Gaps in an uptrend (rising windows) show underlying support 20% of the time in a bull market and 16% of the time in a bear market. In other words, when price drops and stumbles upon a gap that happened in a prior up trend, price will reverse at or within the gap 20% of the time.

For downtrends (falling windows), price hits overhead resistance setup by a prior gap 25% of the time in a bull market and 33% of the time in a bear market. That means price gaps lower (a downtrend) then curls around and tries to move higher but runs into the gap and reverses.

Let's talk about the types of gaps. There are several. An ex-dividend gap occurs when a company such as an electric utility issues a dividend. Price gaps lower by the amount of the dividend and if price does not move back up to cover the gap, you will see it on the daily chart. It's rare that an ex-dividend gap appears without price closing the gap by day's end.

Chart of Boeing (BA) on the daily scale.

If you are a gap expert, then take this quiz. The chart of Boeing appears on the daily scale. Four gap types appear on the chart: area or common or pattern, breakaway, continuation or measuring or runaway, and exhaustion. Identify which names apply to which gap on the chart and include gaps 1, 2, and 3.

Area Gaps

Area gaps occur frequently, but price really doesn't move very far. On the chart, A and F are area gaps. F is the best example. Price gaps upward and the next day, price retraces and closes or fills the gap. Gap A could be a breakaway gap but price just doesn't move far. It doesn't trend like you see in breakaway gaps.

Breakaway Gaps

Speaking of breakaway gaps, what are they? These are key players on the gap scene. They appear when price breaks away from a congestion area. On the chart, B and E are breakaway gaps. Look at B. Price leaves an area where there was lots of price overlap. In that congestion region, price moved sideways without really establishing a trend. The B gaps changed that. It began a straight-line move higher.

Exhaustion Gap

Exhaustion gaps frequently occur after a breakaway gap has begun a trend. Exhaustion gaps signal an end of the trend. After one appears, price tends to fill the gap within a few days, forming a congestion region. Examples of this are gaps C, D, and G.

G is a good example of an exhaustion gap. Price gaps higher then curls around, forming a breakaway gap (J) and price moves lower, filling the gap at G.

Why is gap D an exhaustion gap? Often very tall gaps will be exhaustion gaps. That makes sense because traders want to take profits after a large gap, which causes price to reverse and fill the gap or attempt to do so. Large gaps may not fill due to their size. D is an exhaustion gap because of its size and because it runs into a congestion area in a few days.

Continuation Gaps

You could argue that D is a continuation gap (because price continues lower for two more days). Continuation gaps occur when price breaks out of a congestion zone, often in a 3 gap sequence: breakaway, continuation, exhaustion. If D is a continuation gap, the downtrend should have begun with a breakaway gap (but not always, so allow flexibility here) and the gap should be located about midway along the trend. A good location for a continuation gap would be at H. The trend begins with a breakaway gap and ends with an exhaustion gap. Unfortunately, no continuation gap appears on the price chart. They are rare.

I show a continuation gap at 2. Price breaks out of congestion at 1 in a breakaway gap, then a continuation gap appears about midway along the trend, followed by an exhaustion gap at 3. If you see a breakaway gap followed by another gap that does not close in a day or two, then it's probably a continuation gap. Measure the move from the breakaway gap to the continuation gap and project it in the trend direction to get an estimate of where price will likely stall. A third gap along the chain often means the trend is ending.

If you want more details about gaps, such as how soon they close, then consult pages 362 to 373 in my book, Encyclopedia of Chart Patterns, second edition, pictured on the right.

For traders, gaps are handy. When price gaps out of a congestion area, that often means price will continue higher in a breakaway gap especially if accompanied by high volume.

Continuation gaps occur in the middle of trends and help you predict how long the trend will last.

Exhaustion gaps occur after a trend is in progress. They end the trend.

Area gaps are just a pain in the ass because they look like breakaway gaps and fool you into thinking a trend has started. Be cautious.

-- Thomas Bulkowski

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Monday 11/16/09. Market Monday: The Week Ahead

Last week, I guessed that the S&P 500 index would climb for two days and then trend lower. I got four out of five days right but thought it would peak lower than it did. The S&P looks to be forming a double top now instead of a head-and-shoulders top.

This week, I'll look at the Dow industrials since they are more interesting. Before I get to that, let's look at everything else, starting with economic reports coming out.

Economic Reports

The following information is derived from yahoo!finance and times are local to the east coast.

ReportTimeA-F
Rating
Description
Retail sales8:30 MoA-Reports total retail sales (not services). Says if people are spending their money.
Inventories10:30 MoC-Reports manufacturing, wholesale, and retail inventories. Only retail number is new.
Producer price index8:30 TuB-Measures cost of wholesale goods. An indication of future inflation.
Capacity utilization9:15 TuB-Gauges economic activity. Readings >85% (often unreliable) suggests rising inflation.
Industrial production9:15 TuB-Measures production of utilities, mines, and manufacturers.
Housing starts8:30 WeB-Counts number of homes beginning construction.
Building permits8:30 WeB-Measures building permits for new construction.
Consumer price index8:30 WeB+An inflation report. Measures cost of select goods and services.
Initial jobless claims8:30 ThC+Counts people filing for state unemployment benefits.
Leading indicators10:00 ThD-Summary of already known reports.

Since the report on retail sales is the most important of the bunch and arrives on Monday morning, it could set the stage for the entire week.

Options Expiration

The following is courtesy of yahoo!finance and they stole it from The Options Industry Council.

OptionDate
2010 Equity LEAPS conversionMonday
2012 Equity LEAPS addedMonday
VIX, VXN, RVX expireWednesday
A.M. settled index options cease trading.Thursday
Expiring equity, P.M. settled index options and treasury/interest rate options classes cease trading. Expiring cash-settled currency options cease trading at 12:00 P.M. EST.Friday
Equity, index, cash-settled currency and treasury/interest rate options expireSaturday

Many options expire this week, so traders will be looking to close out their positions ahead of that, and that suggests increased volatility (large daily price swings).

Other

The chart pattern indicator is bullish with two of three solid triangles showing (). Additional triangles are a measure of strength with solid triangles meaning a more reliable signal. Bearish divergence appears between the market and the indicator, but it's been that way since September. One of these times it will be right.

The following industries, of 52 that I follow, were the best performing.

  1. Internet (best)
  2. Apparel
  3. Shoe
  4. Long ETFs
  5. Computers and Peripherals

Here are the worst performing.

  1. Cement and Aggregates
  2. Petroleum (Integrated)
  3. Electric Utility (East)
  4. Alternate Energy
  5. Short ETFs (worst)

Picture of the Dow industrials on the daily scale.

The chart shows the Dow industrials on the daily scale. The average has been moving up following two nearly parallel lines, forming an up-sloping channel.

Since the average touched the top of the channel, it's natural to believe that the Dow will drop to the other side of the channel. That seems almost too easy, too predictable. I don't think it will happen because everyone expects it.

This week, I show the average trending lower, but it could make an upward turn next week or sometime thereafter. Since the move up during the past two weeks has been vertical, I expect a partial retrace of it this week. The rapidity of the decline will be determined by the economic reports and options expiration activity. Mutual funds may begin rebalancing their positions in preparation for closing out the fiscal year, too.

The horizontal green line is where I predict the Dow will turn, but it's just a guess. That line rests on a "shelf" (two bars near topping out near the same price) and at a 62% retrace of the AB move.

-- Thomas Bulkowski

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Thursday 11/12/09. The Tesoro Exit

Chart of Tesoro (TSO) on the daily scale.

I show the chart of Tesoro (TSO), which is a west coast oil refiner, on the daily scale.

I took interest in the stock in mid August and added it to my watch list. Three days after adding it to the list, I pounced and bought, receiving a fill at 13.30. The buy reason was a head-and-shoulders bottom with a breakout from a small congestion region. I show that chart pattern as LS (left shoulder), Head, and RS (right shoulder). A blue neckline connects the armpits.

If the armpit were to slope downward from left to right, a buy signal triggers when price closes above it. For up-sloping necklines, I use a line horizontal to the right armpit. I show that as a horizontal red line in the picture. The reason for the two methods is that with up-sloping necklines, if they are steep enough, price will not close above it. You can see the price difference between the two entry points (the intersection of price and the red and blue lines).

In the picture, I show the location of the buy and the congestion area is the prior week's horizontal price movement. Yes, it's hard to see in the chart, so do not adjust your reading glasses.

Price moved up and I wasn't concerned with the stock forming peaks because I wanted to hold this until it reached my target of 20, then 30, then 50. That's not a pipe dream, because it represents overhead resistance areas and is still possible for a long term holding (like 2-3 years).

Unfortunately, the fundamentals changed and the stock is no longer a good investment. What happened? The company reported on November 9 that they were cutting the 10 cent dividend in half and that due to weak demand and maintenance, they could drop capacity to 77% in Q4 (fourth quarter). That told me that business is weak and will remain weak.

If the fundamentals are weak, then the stock will likely tumble, perhaps to 10. Since I had a small profit, it was time to exit.

I sold the stock at the open and received a fill at 13.86 for a 3.8% gain. Had I waited until the end of the day, I would not have had a profit at all (the stock dropped over 4% the day I sold).

The moral of the story is this: When the technical or fundamental picture changes, sell. And sell immediately.

-- Thomas Bulkowski

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Tuesday 11/10/09. Tutorial Tuesday: Candlestick and Chart Pattern Location

I am happy to report that my prediction of the bearish doji star breaking out upward in GLD came true. That "guess" was based on an analysis of the candlestick discussed in my Encyclopedia of Candlestick Charts book, pictured on the left.

Here is another revelation from page 11 of that book, but it covers my Encyclopedia of Chart Patterns, 2nd Edition book as well.

In each chapter of every candlestick, I sorted the location of the breakout from the candle by its position in the yearly high-low price range.

For example, if a stock traded from 10 to 19 during the past 12 months, a breakout below 13 was in the lower third. A breakout above 16 was in the upper third and you can guess where the middle third resides.

I found that the best performing candlestick patterns occurred 84% of the time within a third of the yearly low. The middle third came in second with 11% and the highest third came in last at 5%. These numbers are regardless of the breakout direction and bull or bear market.

I did the same analysis with chart patterns. Those chart patterns with upward breakouts did best when the breakout price was within a third of the yearly low (41%), middle third was second (at 32%) and highest third was last (27%).

Downward breakouts performed better with 55% doing best near the yearly low, 25% for the middle third and 20% for the highest third.

What do the numbers mean? A downward breakout from a stock making a near yearly low suggest it's a short candidate but you'll want to do your research to confirm that. Those near the yearly low that breakout upward suggest things have been oversold. Buying then gives you a good opportunity to ride the stock upward.

With the stock market making a new yearly high in the Dow, I hope you brought your oxygen bottles with you because the air is thin up here.

-- Thomas Bulkowski

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Monday 11/9/09. Market Monday: The Week Ahead

Picture of the S and P 500 index on the daily scale.

I am substituting Mental Monday for Market Monday will look at the week ahead to make a prediction on how the overall market will behave.

It should be a calm week since options are set to expire next week and the economic reports coming this week are insignificant. Earnings season is winding down, but with the market as nervous as it's been, any rogue earnings could cause the market to make large moves.

The chart shows the S&P 500 index on the daily scale. I show the expected price trend for the next five days in red. The only reason I show this configuration is that price could form the right shoulder of an unconfirmed head-and-shoulders top. That is a bearish pattern, of course.

An alternative view is that price will continue rising along a channel, forming an ascending broadening wedge, beginning in early August, which I show by two green trend lines. With the large price swings last week, the index dropped below the bottom of the pattern but has recovered. This may only be a pullback, so that could be bearish as well. With the index's last peak on October 21 (shown as the Head on the chart), it failed to touch the top of the wedge, which is also bearish. All of this points to a higher likelihood of a head-and-shoulders pattern forming as it approaches overhead resistance setup by the left shoulder.

Economic and Other Reports

The following information is derived from yahoo!finance.

ReportReleaseA-F
Rating
Description
Initial jobless claims8:30 ThursdayC+Measures the number of unemployed filing for state unemployment benefits during the week ending the prior Saturday.
Monthly treasury budget2:00 ThursdayDTracks the budget deficit trend. Is important in April during tax filing.
International trade8:30 FridayC+3 reports covering export prices, import prices, and trade balance. Helps indicate how the US economy is doing compared to other world economies.

Options Expiration

OptionDate
NoneNone

Next week options expire so volatility may increase then.

Other

Wednesday is a bank holiday, and earnings season is winding down.

-- Thomas Bulkowski

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Thursday 11/5/09. Where is Gold Going?

Picture of a gold etf GLD on the daily scale.

The chart shows the gold exchange traded fund GLD on the daily scale. According to yahoo!finance, the ETF "seeks to replicate the performance, net of expenses, of the price of gold bullion. The trust holds gold..."

Recently, a right-angled and descending broadening chart pattern appeared. According to my Encyclopedia of Chart Patterns, 2nd edition book, the pattern breaks out upward 51% of the time. In other words, the breakout direction is random. This one punched through with gusto, forming a tall white candle followed by a doji.

What does it mean?

According to my book, Encyclopedia of Candlestick Charts, pictured on the left, you're looking at a bearish doji star. I show that two-candlestick pattern in the inset on the chart.

From its name, you might think the candle pattern is bearish. It shows upward momentum pushing price up during the tall white candle and then pausing in the doji. It seems to indicate that price will collapse as soon as tomorrow (Thursday, since I am writing this on Wednesday evening). That could be the case.

However, testing I conducted when researching my book reveals that the candlestick pattern breaks out upward 69% of the time. It's one of the better candlesticks in terms of reversal/continuation performance (ranking 8th, where 1 is best out of 103 patterns), not by how much price moves after the breakout. The overall price performance is mid list, ranking 51.

Of course, all of that information and more is revealed in my book and that's why serious traders find it valuable. The probabilities do not guarantee success, but they do give you the edge over other candle traders that don't have that type of information. Traders recognize that they can recoup the cost of all of my books with just one trade.

An upward breakout from the candlestick will occur when price closes above the top of the candlestick. A downward breakout requires a close below the bottom of the candle. Since the candle pattern is a tall one, the probabilities suggest an upward breakout. My view is that gold and GLD have more upside ahead, but it wouldn't surprise me if the surge took a break for a few days.

-- Thomas Bulkowski

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Tuesday 11/3/09. Tutorial Tuesday: 10 Traits of Successful Investors

The following is taken from my review of Gabriel Wisdom's book titled, "Wisdom on value investing: How to profit on fallen angels", pictured on the right. If you are into value investing, I recommend it.

According to Gabe, successful investors share these traits.

  1. Think like a contrarian. Buy when others are selling or excessively pessimistic, and sell when they are buying/overly optimistic. This reminds me of the magazine cover theory. When the stock market makes it on the cover of Forbes or Time magazine, you know the market has peaked.
  2. Use a method to find value. Don't just pick any stock that touches your fancy. Use free cash flow, earnings momentum, price to sales, price to earnings, and so on to find value in a company.
  3. Don't change methods. A trader emailed me saying that he found a winning strategy of trading ascending triangles. Out of ten trades, nine made money. So what did he do? He threw away his winning strategy and bought a stock called Bre-X. That company turned into a gold mining fraud and the stock went to zero. He lost all of his money. The moral of this story is, don't throw away a winning strategy just to experience the adrenaline rush of a new trade. Give your investments time to prove themselves.
  4. Know when to sell. Have a target price or know what the financial ratios have to reach before you sell. Sometimes the financial situation will change within a company and that becomes the clue to sell. Whatever the mechanism, know when it's time to find another investment.
  5. Diversify. You can make a lot of money by putting all of your cash into one stock but if that stock tumbles, you're cooked. A portfolio of stocks, properly diversified in the number of stocks held and the number of industries, will help protect you for any one position causing severe damage. Wisdom writes, "With a properly diversified portfolio, a savvy investor can expect a 70 percent chance, or better, of making a profit." Avoid over-diversification. He recommends holding between 20 and 30 stocks with not more than 20% coming from any one industry/sector.
  6. Markets Change. Volatility in the stock market changes over time so get accustomed to changing market conditions. Do not sell a holding simply because volatility increases.
  7. Beware risk. Recognize that volatility and risk are different. Keeping a stock whose fundamentals have changed and price is dropping is relying on hope and miracles to stop the bleeding. A fallen angel is a stock that runs into trouble but can recover. A risky investment is a company that runs into trouble, serious trouble, trouble that increases the likelihood of bankruptcy or a stock price that remains flat lined for years like a dead animal.
  8. Learn from mistakes. Learn not only from the mistakes you make, but from those of others.
  9. Understand risk. You have to understand risk and know when an investment is a bad idea. Gabe is not fond of momentum trading, that of buying high and selling higher. He'd rather wait for a stock to sink low enough to be a bargain before he'll buy.
  10. Be ready. I have a watch list that I review daily with price targets listed. When a stock drops into the buy zone, I pounce. Investing and trading over the decades has taught me patience to wait for the right conditions before buying. Chasing a rising stock often leads to a loss.

How many of those traits do you share?

-- Thomas Bulkowski

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Monday 11/2/09. Mental Monday: How Great Traders Go Bad.

I released a new version of Patternz on Friday and then another on Sunday to make Friday's improvement work properly. Oops.

The following is based on an article titled, "How great traders go bad," by John Sarkett from the July 1999 issue of Technical Analysis of Stocks & Commodities.

Since March, the markets have been trending higher. Everyone thinks their system is a winning one because the profits have been so large and so numerous. In the last few days, the market has starting the process of weeding out the weaker players. But even great traders can get caught up in the momentum of an easy market. Sarkett says to monitor four areas: self-knowledge, market knowledge, trading strategy, and risk management. This post covers the first two of those with next week's episode completing the article.

Self-Knowledge

If you are a great trader or one that believes they are a great trader, humility is a word you should remember. Check your ego at the door of your trading room.

How many of you have experienced the feeling of making a large win and feeling invincible? How many of you have made winning trade after winning trade and said, "Trading is an easy game." And that's when the market decides to drain your wallet or purse with a large loss. So what do you do? If you are an amateur, you double up -- make an outsized bet to make up for the loss. A pro cuts his market size because he knows better. "Risk not thy whole wad," is a commandment every trader should obey.

Don't let your ego control your destiny. Recognize that every trade you make could turn into a loss. The article talks about a system employed by Chesapeake Capital that generates 200 trades a year. Of those 200, just six will be profitable enough to cover all of the losses. Wow. "At best," Sarkett writes, "professional traders are right 50% of the time or less, so they must take only small losses."

That is especially true for trend followers. Every breakout looks like the start of a new trend but only a few actually make a meaningful and profitable move.

Having a series of winning trades inflates the ego, setting you up for a large loss. You fail to keep stops in place because you know it's not necessary. Perhaps you increase the bet size and why not? You're making big bucks. Then the market comes along with a 250 point down day and inserts a dose of humility into your trading room.

Sarkett asks the following questions to see if you have a problem with your trading personality/self-knowledge.

  1. Do others comment negatively about my personality traits?
  2. Do I suffer emotional extremes?
  3. Is my body sending me messages?
  4. Do I take responsibility for my actions?

Market Knowledge

When I trade options, I have to keep reminding myself that each option is worth 100 shares. If you own 1,000 shares of stock and want to write a covered call, you don't place an order for 1,000 contracts.

I remember one time that I placed a limit order instead of a stop order and wondered why it went through so fast. Perhaps you have added to a position by mistake instead of selling it (or the reverse, selling a position instead of buying more). Those are just examples of trading mistakes. But lack of knowledge can be dangerous, too.

Let me give you an example. I've been watching Conseco (CNO) and the stock has retraced most of the move up in the last two weeks. I am tempted to buy because I believe the stock will recover, perhaps quickly. What's stopping me? The company will issue $200 million worth of new shares and that will take the stock down. How much it will fall remains to be seen, but price will drop. After the drop ends, then that will be the time to buy and not before.

Such market knowledge keeps you from taking unnecessary losses. How did I find out about this? From a news item on yahoo!finance. It's public knowledge.

I have researched the markets and found that Friday's are the best day of the week to buy, so I often find myself placing buy orders then. Thursday's are the best day to sell, and I have been dumping stocks then, too. Do you know the markets well enough to make those kinds of choices? My results may not be right for you and the numbers change over time anyway. I posted research about trading around holidays, for example. Did you read it? Have you done similar research for your markets?

Here are four questions he poses to determine your market knowledge.

  1. What affects your market?
  2. How are things changing in your market?
  3. When will you know you're wrong?
  4. How much profit is enough?

To the last question, Sarkett writes, "If you're a typical newcomer, you may be looking to double your money. For a pro like Jerry Parker, the answer is much more modest. His goal: 2% a month."

If you know yourself well enough, you'll understand that it's not a good idea to day trade when you're in a pissy mood, nor when you feel as if you can conquer the world. If you understand the markets, you will adjust your position size to match market conditions. During 2008, for example, I dropped my position size to one-fourth what is used to be, and then only traded the sure things.

-- Thomas Bulkowski

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