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Snapping Rubberbands
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Snapping Rubberbands

Snapping Rubberbands

by The MoleJanuary 31, 2011

While Scott is all about price patterns I’m more of an indicator guy. It’s just the way my brain is wired and instead of counting candles I prefer to sit down and simply write an indicator that actually takes candle patterns into consideration and produces trading signals (and stops) automatically. Yes, I’m lazy – I rather spend a weekend coding but then crack open a cold one and get an automated alert when a pattern I am interested in pops up. The other advantage of doing this is that I can also back test and optimize various settings in NinjaTrader, which often reveals rather surprising results.

Obviously I wouldn’t be the first to try something like this – a good example, and one I follow myself, are Net-Lines which designate reversals. What I like most about Net-Lines is that they help me with one of my favorite trading paradigms – which is that of snapping rubber bands.

The trick of course is to know when the tape is in the process of snapping back, and Net-Lines are a simple way to get positioned quite optimally – not too early and not too late. I have to be honest here and point out that I stole this concept from Chris Carolan who uses them heavily. Doesn’t mean he owns them though, so let’s dive in:

I would have loved to present you a coded TOS or NinjaTrader indicator and started putting one together this afternoon. However, I have been slammed this weekend and  simply didn’t have the time to finish it sorry – so the manually drawn example of Net-Lines on the spoos will have to do for now.

As I pointed out Net-Lines are reversal patterns and they are a whole lot easier to use than all that convoluted DeMark stuff – which again I’m too lazy (and probably too stupid) to even ever attempt. In essence Net Lines are being produced when there are three consecutive bars either up or down. Once you got three consecutive bars up you set the line at the low of the first bar, which when closed below results in a sell signal. Inversely three consecutive bars down produces a Net-Line buy at the high of the first bar, and again a close above the first bar down results in a buy signal.

Now, a buy signal indicates that the rubber band has been stretched to its current limit and may now be in the process of snapping back to the downside – a sell signal means the very same just that odds support a snap back of momentum to the upside. Another underlying idea here is that the longer the rubber band has been stretched the more violent the snap back or counter move.

Well, and snap it did last Friday! Unfortunately without us – just as Scott suspected a week ago. As you can see we sliced right through the last sell signal at 1277.75, which is the low of the 1/24 candle. That was officially our sell signal – per the Net-Lines sell rule. Unfortunately we however kept moving a lot further down the very same day, and in terms of a good setup that is suboptimal. We prefer to see a close near our current Net-Line sell level as that is where we want to get positioned. Or in other words – this move down is done and chasing it is very bad medicine. And that’s another very important piece of information Net-Lines can tell us.

I am also not sure that it’s straight down from here – yes, we may get some follow through for another day or so but before you get heavily positioned to the downside I have some exhibits you may want to see:
[amprotect=nonmember] Charts and commentary below for anyone donning a secret decoder ring. If you are interested in becoming a Gold member then don’t waste time and sign up here. And if you are a Zero subscriber it includes access to all Gold posts, so you actually get double the bang for your buck.
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I love my long term RSI_EMA chart – it’s rarely wrong and divergences usually play out within a matter of days. The recent top was no exception and we did slice through that support line I drew. However, look at the RSI_EMA line – note how far it has dropped already – and then look at prior occasions in comparison. Shouldn’t we have covered a lot more turf to the downside by now? We are rapidly approaching bounce territory – at least given recent history. Which to me indicates that this first move down may be limited.

Bollinger bands are prime examples of my rubber band paradigm – the really good setups happen when you push outside them. The further out the better the play for a contrarian trade. In any way if we breach through my 25-day SMA at the center of my BB then we may drop further to the 100-day SMA at the center of my blue BB. I would be very surprised to see a drop beyond that right now – maybe in a week or two from now but not just yet.

Let’s also not forget Mr. VIX, who ramped up a whopping 24% in one day and closed outside our 2.0 BB – and you know what that means – one step into a VIX buy signal. Even if we close higher (lower in equities) tomorrow – that close inside the BB will happen this week.

Yes, the daily Zero did drop a bit on Friday but by no means are we seeing a blatant divergence yet. Maybe we’ll never get one and we drop straight from here – that’s possible. But in that case we need to see a breach of the green support line first – followed by a continued negative signal paired with higher prices. Once we get that I am getting noticeably positioned to the short side. Until then I will do like the voyeur that I am and continue to just watch. That’s right, baby – take it off!!

Also take a look at my D/A (Declining:Advancing) ratio on the bottom pane of this chart. We jumped quite a bit in one day and in the past year a reading of 5.0+ usually was followed by sideways or upside action. Or in other words, the bears shot their load all in one day.

Finally a took at Gold and Silver futures – both of course having a fun time on Friday. A bit late – I expected that push back a week ago – so I was giving the PM bears too little credence. However, I don’t think this push higher will last though and painting new highs for the year as I hoped is off the table for now. I have marked resistance clusters for both precious metals. Once we get there I will be taking short positions with a healthy stop to account for sharp fake outs higher. My exit will be the recent daily highs.

Bottom Line:

I don’t have a crystal ball but I expect a lot more volatility this year than in 2010 – the smooth ride is over. But it’s not yet time to pick sides, in particular when trading equities. My rough outline for the year is a short term snap back, followed by a medium term drop, another ramp higher to new highs for the year going into late spring. That is where I would want to be positioned for a summer ride to the downside. Of course a lot can happen in between, and it’s best to stay nimble and let the tape tell us what it wants to do.

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Public Service Announcement

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Cheers,

Mole

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About The Author
The Mole
Mole created Evil Speculator amidst the chaos of the financial crisis in early August of 2008. His vision for Evil Speculator is a refuge of reason, hands-on trading knowledge, and inspiration for traders of all ages and stripes. You can follow him and his nefarious schemes at the usual social media waterholes.
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