Path to the Abyss

Last week was a very difficult trading week for most.  We’ve been quietly working with a small group of traders using an experimental new system.  I’ve enclosed the commentary of the reports sent to the participants in this exclusive club along with the applicable output of our pattern recognition algorithm for the day.  Please keep in mind that the quoted comments and statistical outputs you’re reading now were published the evening before the events in question.

I’m trying not to get too ahead of myself but if the feedback from our users is any indication we’ve potentially got something big on our hands. Amidst all the noise of the charts we were able to do two things.  1. Correctly identify the possibility that Tuesday on the close (or potentially Wednesday morning in the case of a gap up) was a high for the week.  2. Identify that if the jobs report was bad and the market gapped down on the news the market would sell off all day.  Maybe these things seemed obvious to you in hindsight, but it was tough to know what was going down last week and I’m sure glad I had a road map.

Think of the blue lines as theoretical price curves based on historical patterns.  The key insight gained by the beta group is to look at the strength of the patterns over the three curves.  In particular when the top two curves in each report have matching patterns or components of the curve that line up you’ve got a fairly high probability play.  As an example, look at the late rallies in both May 29th bull curve 1 and 2.  As long as the market doesn’t invalidate the curves entirely this is usually a strong indication of short term direction.  Another insight is that you can’t predict or account for every wiggle in the chart but when the curves all line up in one direction you better be paying close attention.

Is pattern recognition a crystal ball?  Absolutely not.  Is the data super easy to interpret.  Not really, there’s a learning curve.  The system takes the market one day at at time and most importantly it allows the market make the first move.  Everything in the market is path dependent.

Here was last week through the lens of our pattern recognition algorithm.

May 29, 2012

The patterns are inconsistent today.  I will be paying special attention to bull curve 1 and pig curve 2.  Bull curve 1 can setup a very bullish remainder of week.  Pig curve 2 can setup a very bearish remainder of week.

Gap up: Bullish patterns with different paths to higher prices.
Flat: Immediate and aggressive selling is a big caution flag.
Gap down: If we somehow gap down (which is looking doubtful as of this report) be careful if we break the noon swing lows.

Here are the primary curves for the trading session.

Here’s the actual trading session:

The market did not pullback off the open.  Strength off the open was the path of curve 2 and this early strength was the tip-off that it was likely playing out even though it was a lower probability play before the open.  Both patterns had indications of very strong closes and the market rallied hard into the close.

Had the market opened flat (pig) we would have been looking at this.

Had the market gapped down we would have been looking at this.

May 30, 2012

Another day with very mixed signals.  Very binary.

Just like yesterday, I’m keeping one eye on the longer term, both bull curve 1 and bear curve 1 are healthy for higher prices into the NFP report Friday.  Seasonality is working for us here, but there is a probability that the highs this afternoon and/or tomorrow morning will be highs for the week.  Something to keep in mind.

Gap up: Polarity pattern.  Be ready for anything.
Flat: Bearish patterns.  This is the most bearish scenario for the week.
Gap down: Bounce early or drop.

Here’s the actual trading session:

Keep in mind the collective thinking of the market up until this point.  We had just had a great rally off oversold conditions.  Traders were looking for follow-thru.  Not only did the market gap down, but it couldn’t muster any bounce off the open.  The lack bounce early meant the optimal strategy was to either get short or hold off on your buys (curve 2).  There was a very low probability of a squeeze-type move at 1:30 (curve 3) but that would have been a true gamblers play.

Had the market opened flat (pig) we would have been looking at this.

Had the market opened up we would have been looking at this.

May 31, 2012

No report.

June 1, 2012

Happy NFP day.  Depending on the situation there are some good trades in here.

Gap up: Even on a good report this will have a tough time making any serious upside progress.  The report will have to be a smash to have a runaway upside day.
Flat: Look for a sharp reaction off the open and then chop for the remainder of the session.
Gap down: Not good.  Even if we get a bounce, the lows of the day all match on the close.

Here’s the actual trading session:

All three patterns had the low of the day on or near the close of the session.  That in and of itself should have told you to stand back from buying until very late in the day or not at all.  Did your system tell you that the lows would come on the closing print of the day or were you looking for support on the $SPX along the way?  Before my partner and I developed this system I would have definitely been among those looking for a bounce on a day like this where everyone is seemingly throwing in the towel.

The real bounce came on the short squeeze on Monday.  Bull curve 1, I kid you not.  I’ll leave that one for another post.

Had the market opened flat we would have been looking at this.

Had the market opened higher we would have been looking at this.

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