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Trading Short with Technical Analysis

In this part I will show you a second example with a short trade, how to make buy and sell decisions based on technical analysis techniques. I will apply the basic knowledge presented in the previous videos.

We are looking at the chart of Allegheny Energy Inc November 9, 2007. The first thing we do is, look at the long term trend with this weekly chart. The long term impulse wave [5] may be close to completion. I used my Elliott wave count indicator to help find a count that complies with the Elliott wave rules.

Next I used the start and top of wave {1} to project long term Fibonacci price targets. This projection seems to fit quite nice the targets reached already.

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Hallo, Sylvain Vervoort with technical analysis part 33. In this part I will show you a second example with a short trade, how to make buy and sell decisions based on technical analysis techniques. I will apply the basic knowledge presented in the previous videos. Pay a visit to my website at stocata dot org and buy my new book “Capturing Profit with Technical Analysis”, a complete technical analysis reference and a winning trading system.

We are looking at the chart of Allegheny Energy Inc November 9, 2007. The first thing we do is, look at the long term trend with this weekly chart. The long term impulse wave [5] may be close to completion. I used my Elliott wave count indicator to help find a count that complies with the Elliott wave rules. Next I used the start and top of wave {1} to project long term Fibonacci price targets. This projection seems to fit quite nice the targets reached already. Look at the price action around the target levels and the relation with the price move in the previous long term downtrend. The next Fibonacci price target is around $63. If that is indeed a long term price top, we can make good profits with a short trade. A common 50% reaction would bring price down to about $33. Let's have a look at the daily chart now.

On the daily chart we can make a more detailed Elliott count. From the start of wave {4}, we can see an impulse wave up, now waiting for wave (5) to complete. There was an impulse wave extension in wave (3). Let's switch to a short term view.

Wave (5) has an extension and wave 3 of this extension has another extension of a lower degree. We are probably close to the end of wave 4 to start wave 5 up. If we make a short term Fibonacci projection from the start and finish of wave 1, we get a target price of $54.5. Together with a pitchfork in line with the price move, we estimate this target price to be reached second half of December. Let's follow-up the next price move.

Price moves up close to the target price and is now turning down. Should we open a short position here? In favor is that the wave count is possibly complete and we are close to the Fibonacci target. Against selling short now is the fact that price now touches exactly the last uptrend line and the lower side of the last possible pitchfork channel and the fast SVAPO(5) indicator used here to find an entry point is not showing a divergence with price and is close to an up turning point. In this kind of situation I would wait one more day to see if the turning point will be confirmed by a break of the uptrend line.

 

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The down move on December 17 was not confirmed and price made a new higher high, effectively reaching the Fibonacci price target. Now price is falling out of the pitchfork channel and we have a closing price below the last uptrend line. Furthermore there is a negative divergence between price with higher tops and the SVAPO indicator with lower tops. At the top there was a dark cloud cover candle pattern confirmed with a lower closing price. Buying now at $62.6, we can keep an initial stop at $65.5, the top of the dark cloud cover pattern, meaning less than 5% away. It looks like it is a good time to open a short position!

What are the long term price targets? Looking at the complete long term up move and drawing the Fibonacci retracement lines, we find targets at $42, $34 and $27. First target is probably the support and resistance between $50 and $55.

To estimate the shorter term price targets, we can draw a Fibonacci projection from the start of the down move and the first reaction point. This gives us targets at $60, $56.5 and $51. Close to that last low point there is also a longer term support level at $48.5. When can these levels be reached? We have no reference point for the median line of a pitchfork. So, we will try to estimate an acceptable angle. A last downtrend line and the angle of the downtrend start now seem to give acceptable downtrend acceleration. The median line is also at the support/resistance level of the last window gap. With this projection we expect the lower price targets to be reached in March. We buy now at $62.6, keep an initial closing price stop at $65.5 and we start an ATR trailing stop with a 3x multiplication factor, considering the volatility is rather low. We can eventually adapt that value later to be in line with price volatility that moment in time.

Price makes a fast move down close to the third Fibonacci target level, but bounces up the same day back to the second target level. Now price is turning back down again. We are clearly making an impulse wave down, forming the first correction wave. We adapted the trailing stop multiplication level  because it was moving too far away from price. Now it is set at only 1.8, bringing it close to the turning point of wave 4, more in line with the level of price move we have now.

Now it looks like we have completed the first correction wave (A). The last downtrend line is broken and we have a positive divergence with higher bottoms in the SVAPO indicator and lower bottoms in price. Expecting the (B) correction wave up, we are now closing our short position bought at $62.6 and now buying back at $48.8 giving a profit of more than 20%. We would basically now wait for the completion of correction wave (B) before entering a new short trade with correction wave (C) down.

April 29, 2008. We consider the (B) correction wave completed with a lower order zigzag correction wave and the closing price now falling through the uptrend line. There is also a negative divergence between the SVAPO indicator and price. Opening a short position now at $54.2 and an initial stop at $56, the previous high, gives a good risk-to-reward ratio, a possible loss of around 4% only. No doubt we want to open a new short trade here.

Our medium term price estimate is around $28, a historical Fibonacci projection between wave (A) and wave (B). This is in line with the long term retracement at 38.2% as we saw already in the beginning with the weekly chart. The target date is October 2008, as indicated by the pitchfork crossing the price target.

October 20, 2008 the closing price breaks through the downtrend line after an impulse wave down with an extension of a lower degree in wave 5 to complete the (C) correction wave. The position can be closed now with a very nice profit. In August we moved the pitchfork to bring price back within the pitchfork channel.  

Time to test your knowledge! In a long term downtrend of CI price has most probably finished correction wave (B) up and started correction wave (C) down, with finished impulse waves (1) and (2). The lower top of (2) confirms the trend reversal. Price is now falling through the last uptrend line. This may be a good moment to open a short trade to catch wave (3) down. Before opening this short trade, try to answer the following questions:

1. What is the value of your initial stop setting?
2. What is your target price?
3. When do you expect this target price to be reached?
4. Is the risk-to reward-ratio OK?
5. What will be your profit taking base?

You can find the solution at: stocata.org/youtube/solutions.html

This is the end of the part about a second example with a short trade, how to make buy and sell decisions based on technical analysis techniques. Next we will continue the learning proces by following-up a single stock to find buying and selling points in real time. Tell your friends about these videos and while visiting my website order my new book “Capturing Profit with Technical Analysis”, a complete technical analysis reference and a winning trading system. See you in the next video!

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