Friday, July 25, 2008

Base & Break - Arch Coal, Inc. (Public, NYSE:ACI)

Yesterday we said that ACI looked like a C&H waiting to BO. The first chart highlights the C&H pattern and expected Fib. extension of 100% from the ideal BO point. The blue lines represent pivot points and basing areas. Whenever we execute a planned trade, we want to find a low risk entry point near a pivot point, targeting the next level pivot as a possible exit. On a measured move basis, chart patterns such as a C&H usually extend 100%. That's the norm, but sometimes they surprise us with bigger or smaller moves. It depends on the market and momentum. In our case the 100% extension of the pattern lined up almost perfectly with the next level PP, so this added an extra element of confidence in the setup.

Today ACI gapped open and retraced approx. 50% of the move from yesterday's closing lows to today's ORH. It breached the blue line in early trade, retraced sharply and began forming a base at the PP through a couple of higher lows. The best time to enter is after price settles into narrow range trade at the base to of the PP, or wait for the retest of the base after the BO. Don't buy if price runs up quite a distance to reach the PP, wait for price and volume to contract just prior to BO. I know that this is not as easy as it sounds, but it helps to put you in a winning trade much more quickly rather than sitting through all the backing and filling.

As you can see from the chart below, once price successfully retested the base, it took off nicely reaching the target in an orderly fashion.

We also mentioned that we would like to short LEH if it pulled back to the broken trend line or 50 SMA on the 15 minute time frame. Neither of those two things happened as LEH opened weak and spent most of the session chopping around. There was little opportunity for a decent size profit because price was so close to the $17.00 target anyway. Don't force a trade if the risk:reward ratio is less than 1:2 or ideally 1:3.

12 comments:

anarco said...

Hey Jamie~
I was inspired by your Thursday post on ACI, so I also took a C&H trade on HES. Although the principles I applied to my trade are similar to yours, I hesitated taking the ACI trade because of the gap up. That totally threw me off, so it is very useful for me to see how you handled the gap. In fact you did not use the base of the cup (52.06) as the entry line, you used a daily PP that somehow aligned with the 38% Fib Extension. That is a great idea and something I'll try to remember next time.
Thanks.

Rick said...

I've noticed that you have been trading a lot more 3 PP B&Bs this summer. Was this a conscious decision or do these patterns just show up more in choppy markets? I've noticed that there are a lot fewer flags and OR breakouts this summer compared to say the month of May.

Thanks,
Rick

OONR7 said...

anarco, jamie: I actually haven't changed a thing with my watchlist, which specifically looks for gappers, and I've found quite a bit of B&B candidates. Any reason you all believe that gappers are bad for B&B trades? I know HCPG says to ignore their entry prices if a stocks gaps way above or below it but I would imagine gap stocks that have a lot of volume would be natural candidates for B&B setups.

Jamie said...

Hey Anarco,

Great job on the HES C&H pattern. I agree that oil is due for a retracement. Hopefully, it will set up many trades for next week. :)

Jamie said...

Rick,

Over the years I've noticed that when the markets change direction, the old trading strategies don't work as well. As a rookie, I didn't know how to adjust my trading setups to match the new trend in the market and mostly just sat on the sidelines. Now, I can do much better because I feel I have a much better handle on the market.

The 3 PP base is a much safer way to trade under current market conditions. The ORBO has been working better for shorts than longs, as well as the C&H. Just not getting the extensions we were getting back in April & May on C&H longs. This one worked because coal was so oversold, it was ripe for a quick snap back.

The 3 PP base & break works well in conjucntion with gappers because the time to form the base allows the 5 period ema to catch up to price.

Jamie said...

OONR7,

I use the 3 PP B&B for gappers quite often. By PP I'm not referring to R2 and S2. For gappers I prefer if the PP base forms at or near the ORH(L). That gives me more confidence in the setup if I have nothing else to key off of. A good example is the MICC gappers short I took on Tuesday. The ACI trade above is very similar to your retracement setup. The key is to let price settle into a pattern of higher lows as it pivots in and out of the base. Then I look for a very narrow contraction before the actual BO.

The reason HCPG tells readers to ignore gaps, is because many of their subscribers are new traders and they don't want them to chase the gap if it opens above the daily spot.

I usually take the HCPG picks that I like and map out my support/resistance and PP lines. If the stock sets up at a different spot, I target trade. For example, on Friday I traded PRGO. It formed a 3 PP base with NRIB at $35.80. Took half off at the next resistance level $36.20 and held on for a target trade back up to the daily spot, which was not met but still a good ride given the choppy mess we had on Friday.

Jamie said...

OONR7,

As I mentioned in comment to Rick, 3 PP B&B is an excellent way to trade gaps, especially wide gaps, because the basing period allows the 5 period EMA time to catch up to price on the 15 min. time frame.

OONR7 said...

thanks for all your info jamie... it really makes a lot of sense. Funny how that happens when we're on the same page.

Another question: I've been setting my first baseline of the day (3-min chart) off of a stock's first pivot. Using a gap up as an example, I keep that baseline until it's proven to act as support. I then move my baseline up to the next pivot area and wait for it to act as resistance. If it does act as resistance, I then look for a breakout bar. Do you think this is a good way to approach setting my baselines or do you have a better, more effective way?

As you noted, more often than not with gappers, the :15 OR often proves to be a good pivot area.

Jamie said...

OONR7,

That's certainly a neat way to do it. If I try to relate that back to ACI 3 minute timeframe, the way I understand it is that after the 10:00 pivot high was confirmed as support on 10:42 bar, you would be looking to enter long on break of 10:30 bar which would give ample room for a sizable profit.

Your methodology ensures that the trade is orderly prior to committing money which is entirely logical. If prior resistance doesn't hold as support, then the setup is disorderly and not worth the risk.

OONR7 said...

jamie: Right now I'm looking to enter on breakout bars at the pivot high (for gap ups). Now, if that pivot high has been tested and rejected a couple times or more and THEN the breakout bar forms... even better. ACI is a good pretty good example. I would have my first baseline (with a trendline alert) at the pivot high of the 9:36 bar. I would wait for consolidation below that area and a breakout bar at the high with increased volume. Since that baseline was not broken till the 10:24 bar, I wouldn't have seen the inside pivot high at the 10am bar. If you were stalking this stock, then the breakout bar would've been on the 10:21 bar. However, the spread in that bar was still a bit wide but it would proven to be the ideal entry.
So, I would've taken an entry off a break of the 10:24 high and ended up with a loss the first time around. Another pivot area formed from the 10:30 bar high and that was confirmed as support but I don't seen any good, narrow range bars with volume to enter. Another pivot area forms at the 11:06 pivot high with nice consolidation afterwards. A good-looking breakout bar forms at the 11:18 bar high and that where I would've entered. I probably would've been able to take a point out of that entry.

It's a complicated answer to your question but I wanted to walk you through my current method. While I prefer the pivot area to be tested at least once or twice before a breakout bar forms I still think they are good areas to watch for.

Jamie said...

OONR7,

I see how you're playing these. It is slightly different from the way I trade them. Sometimes the 3 PP base forms inside the the early swing high/low. Easier to see on the 1 minute timeframe, but I am having a high success rate with the 3 PP base. In your example of BMC Friday, the 3 PP base formed inside the early swing low with three clean pivots. I would have placed a sell stop order two pennies below the lowest inside pivot at $33.16. The trade would have been stopped out on the strong reversal bar at 1:00, but still a very decent risk:reward.

OONR7 said...

yeah, I really messed up BMC's entry but since I had my baseline still at the 9:33 low with an alert I was able to stalk the action later on. Unfortunately, I didn't 'put together' the mini-base that was happening at 33.18.