Short Scalps, Price Spikes and Financial Aerobatics

This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com

In looking over my charts from the last few days, I’ve come up with some more thoughts about StreetSmack-style short scalps.

What To Avoid

In my very limited experience, I typically watch a very short timeframe on these scalps, on the order of a few minutes. I’ve noticed that if there’s a lot of volume or choppiness at the (potential) top of a move, there’s no edge in entering there. Price could go either way. High volume means that sellers in size were met with buyers willing to take on positions in size. The bull / bear battle is not resolved at that point. This is different from the typical capitulation volume spike (like Jamie talks about) that indicates direction change. Here’s an example of why:

Notice that in the 15 minute chart, the volume spike does foreshadow a trend change, and it fully appears within the next 30 minutes. However, the 2 minute chart resolves the action of that 15 minutes into smaller pieces, and you can see what is happening with better resolution. The 2 minute chart shows that if you went short under the red candle after the volume spike, there was still another point to go before the ultimate top was reached. This was a time of high risk and uncertainty. The bull / bear battle was still being fought at the true time of the spike. The next few minutes resolved it, when price made a higher high on decreasing momentum and volume dried up. There were no more eager buyers at the new highs–upward momentum stopped. There were also no eager sellers in any size, so for a moment the stock is hanging in midair. This is the low risk, high reward spot! Shortly afterward, the stock went down, and selling pressure took over, and there were only red candles for the next 2.5 points, with at least a 5:1 reward-to-risk ratio.

(Here’s a larger version of the 2 minute to study if you’re interested)

Conversely, if there’s too much consolidation that occurs at or after the potential top, you also don’t have an edge scaling in here. The stock is either being accumulated or distributed by traders, and you can’t really tell which is happening until it breaks. Your odds are 50-50. This happened in the 2 min chart above from 10:30 to 10:50, and the stock broke out–it was accumulation, or at least a pause that was met with a new wave of buying interest that was unpredictable. You could try to short the breakdown, but narrow ranges mean less on shorter timeframes, and you’re better off being a 15 minute or longer “dummy” trader if you want to play that way.

What To Look For

A fitting analogy for what I’m looking for in a good parabolic top setup is a tailslide in an aircraft:

Zoomie can probably describe it less mathematically, but here goes: In a tailslide, momentum decreases until the aircraft reaches the apex, and for a moment the vertical speed is zero. The plane then reverses in it’s original attitude in a very gentle manner. Once speed picks up a bit, the aircraft tumbles back over and then begins to accelerate into a descent. You want your stock to do the very same thing! Upward momentum should slow, price should pause, and gently retreat. Next comes a tumble after the apex, and you want to enter here on a bit of strength, not short weakness or you could be walking into a bull / bear battle about to unfold. The stock will then start to accelerate into the downtrend, and you can ride it out.

Notice what the flight instructor says in this video:

“We don’t fight it, just let the airplane fly, power up, then we recover.” “If we try to force the airplane at slow speed it fights us.”

Don’t fight the stock! Don’t force the trade! Don’t try to short it when it’s still chopping around, and don’t chase a breakdown, either. It’s a graceful maneuver both in the air and in the markets. Just let the stock “fly” (stall out and gently reverse), power up (scale in) and ride the leg down. In my opinion, a choppy, violent, high volume peak should be avoided in the spirit of trading only the best setups. I want to pull off a tailslide.

What To Do and What Not To Do

Here’s a stock I traded poorly the other day–KMD. I identified a good entry (that I didn’t take) as well:

This is what I’m going to try to capture in my short scalps in the future. I’ll post the set of paintbars I come up with to help visualize this strategy better when I get them programmed. Comments and suggestions are welcome.

This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com