alan farley - the master swing trader

ALAN S. FARLEY THE MASTER SWING TRADER Tools and Techniques to Profit from Outstanding Short-Term Trading Opportunities To John Yurko Market Wizard, Selfless Teacher, and Ancient Soul Acknowledgments xix Introduction xxi PART ONE THE GATEWAY TO SHORT-TERM TRADING Chapter 1 Trading the Pattern Cycle 3 The Path to Trading Power 3 The Hidden Market 6 Pattern Cycles 7 Trend-Range Axis 9 Swing vs. Momentum 12 Time 14 Trend Relativity 16 Volume 18 Cross-Market Analysis 20 Reward:Risk 21 Mastering the Trade 21 Chapter 2 Preparing for the Market Day 25 The Closing Bell 25 Support-Resistance 26 Types of S/R 27 Cross-Verification 35 3D Charting 35 The Charting Landscape 38 Building the Road Map 39 Moving Average Ribbons 40 Candlesticks 43 Bollinger Bands 45 Chart Polarity 50 Bull-Bear 51 Trend-Range 51 Expansion-Contraction 53 Leading-Lagging 54 Convergence-Divergence 56 Reading Market Sentiment 58 Avoiding the Momentum Trap 59 The Big Picture 60 Dow Theory Y2K 62 Finding Winners 63 Needle in the Haystack 63 Opportunity Costs 64 Building Watch Lists 66 Writing Scans 67 Chapter 3 Analyzing the Market 69 Pattern Cycles 69 Bottoms 70 Breakouts 73 Rallies 76 Highs 79 Tops 81 Reversals 84 Declines 86 Market Mechanics 90 Pattern Characteristics 91 Understanding Price Breaks 92 Recognizing Trends 95 Trend Mirrors 97 Clear Air 99 Signposts 102 Volume and the Pattern Cycle 104 Accumulation-Distribution 105 Trends and Volume 107 Congestion and Volume 109 Intraday Trading Volume 110 Silent Alarm 111 Reading The Crowd 112 Bear Markets 112 Chapter 4 Building a Swing Trading Strategy 117 Systems and Methods 117 Momentum Trading 118 Countertrend Trading 120 Trading Tactics 124 More on Cross-Verification 126 Trader vs. the Crowd 131 Short Sales 132 Time Frame 137 Loading the Gun 139 Day Trading 142 Risk Management 143 Winning and Losing 145 Stop Losses 147 Capitalization 149 Records and Results 150 Inner Trader 151 Avoiding Self-Destruction 152 Chapter 5 Mastering the Tools 155 Patterns vs. Indicators 155 Managing Technical Tools 156 Price, Time, and Volume 160 Building Custom Indicators 162 Pattern Tools 163 Trendlines 164 Psychotic Trendlines 168 Parallel Price Channels 168 Gaps 170 Triangles 180 Flags 183 Candlestick Patterns 184 Pattern Failure 189 Indicator Tools 192 Bollinger Band Tactics 193 MACD Histogram 195 RSI and Stochastics 197 Volume Tools 199 OBV 200 Farley’s ADA (Accumulation-Distribution Accelerator) 202 Special Tools 204 Fibonacci 204 Market Numbers 212 TICK 213 Chapter 6 Understanding Time 219 The Time Element 219 The Market Clock 221 Position Timing 223 First Hour 225 Opening Imbalance 225 The Gauntlet 226 Midday Markets 229 Time for the Pros 229 Finding Midday Winners 231 Last Hour 232 Change of Character 234 Quitting Time 235 Time of Week and Month 235 Seasons and Seasonality 237 PART TWO THE 7-BELLS: TOOLS TO LOCATE OUTSTANDING OPPORTUNITIES Chapter 7 Mastering the Setup 243 Classic vs. Original Patterns 243 Pattern Recognition 244 Managing Opportunity 246 Two Classic Applications 248 2B Top 248 Description 249 Setup Tactics 250 Execution and Position Management 251 Reward:Risk 253 Channel Break 253 Description 253 Setup Tactics 254 Execution and Position Management 255 Reward:Risk 256 Introducing the 7-Bells 257 Original Setups and Execution 257 7-Bells Characteristics 258 Dip Trip—Price That Moves Against a Strong Trend Will Rebound Sharply 258 Coiled Spring—Constricted Price Gives Way to Directional Movement 258 Finger Finder—Candles Flag Reversals in the Next-Smaller Time Frame 258 Hole-in-the-Wall—Gap Downs after Strong Rallies Signal a Trend Change 259 Power Spike—High-Volume Events Print the Future Direction of Price 259 Bear Hug—Weak Markets Drop Quickly after Rallying into Resistance 259 3rd Watch—Breakouts through Triple Tops Signal Major Uptrends 259 Trading Strategies 260 Chapter 8 Dip Trip 261 Characteristics 261 Trade Mechanics 262 Dip Strategies 265 Applications 268 The 38-62 268 Description 268 Setup Tactics 269 Execution and Position Management 269 Reward:Risk 270 Continuation Dip 271 Description 272 Setup Tactics 272 Execution and Position Management 273 Reward:Risk 275 First Pullback 275 Description 275 Setup Tactics 276 Execution and Position Management 277 Reward:Risk 278 Chapter 9 Coiled Spring 279 Characteristics 279 Trade Mechanics 279 Spring Strategies 281 More on Range Bar Analysis 283 Applications 285 Triangle Coil 285 Description 285 Setup Tactics 286 Execution and Position Management 286 Reward:Risk 287 Failure Coil I 288 Description 288 Setup Tactics 289 Execution and Position Management 289 Reward:Risk 290 Failure Coil II 291 Description 292 Setup Tactics 292 Execution and Position Management 292 Reward:Risk 294 Chapter 10 Finger Finder 295 Characteristics 295 Trade Mechanics 297 Finger Strategies 299 Other Considerations 300 Applications 302 Hidden 100 302 Description 302 Setup Tactics 303 Execution and Position Management 303 Reward:Risk 303 2B Finger 303 Description 304 Setup Tactics 305 Execution and Position Management 307 Reward:Risk 308 Death Star 308 Description 308 Setup Tactics 309 Execution and Position Management 311 Reward:Risk 311 Chapter 11 Hole-in-the-Wall 313 Characteristics 313 Trade Mechanics 313 Hole Strategies 316 Applications 319 1-2 Decline 319 Description 319 Setup Tactics 319 Execution and Position Management 320 Reward:Risk 322 Support Hole 322 Description 322 Setup Tactics 323 Execution and Position Management 324 Reward:Risk 324 Island Reversal 324 Description 325 Setup Tactics 326 Execution and Position Management 327 Reward:Risk 328 Chapter 12 Power Spike 329 Characteristics 329 Trade Mechanics 329 Spike Strategies 332 Applications 333 Breakdown Spike 335 Description 335 Setup Tactics 335 Execution and Position Management 335 Reward:Risk 336 Pullback Spike 337 Description 338 Setup Tactics 338 Execution and Position Management 338 Reward:Risk 339 Climax Spike 340 Description 341 Setup Tactics 341 Execution and Position Management 341 Reward:Risk 343 Chapter 13 Bear Hug 345 Characteristics 345 Trade Mechanics 345 Bear Strategies 349 Applications 351 50-200 Pinball 351 Description 351 Setup Tactics 352 Execution and Position Management 352 Reward:Risk 352 Channel Short 353 Description 354 Setup Tactics 355 Execution and Position Management 355 Reward:Risk 355 Intraday Short 356 Description 357 Setup Tactics 358 Execution and Position Management 358 Reward:Risk 360 Chapter 14 3rd Watch 361 Characteristics 361 Trade Mechanics 361 Watch Strategies 365 Applications 368 Watch Echo 368 Description 368 Setup Tactics 368 Execution and Position Management 369 Reward:Risk 371 3rd Watch Classic 371 Description 371 Setup Tactics 371 Execution and Position Management 372 Reward:Risk 374 Swing Watch 374 Description 374 Setup Tactics 374 Execution and Position Management 376 Reward:Risk 377 PART THREE MAKING THE TRADE Chapter 15 Precise Trade Execution 381 Timing and Methods 381 Execution Target 381 The Trading Day 383 Building Execution Skills 386 Pullback Execution 393 Trade Management 397 Perfect Entry 397 The Fill Machine 398 Watching Active Positions 400 Exit 404 Beating the Game 406 Mastering the Tape 409 ECNs and Direct Access 409 The Tape 412 Level II 415 Market Lies 417 Fakeouts 417 Whipsaws 419 Noise 421 Conclusion Thirty Rules for the Master Swing Trader 423 Trade Craft 423 Rules for the Trading Game 424 Market Wisdom 424 The Swing 425 Time 425 Execution 426 Opportunity and Risk 426 Secrets of the Price Chart 427 The Master Swing Trader 428 Appendix A: Suppliers 429 Appendix B: Glossary 431 Bibliography 439 Index 441 FOREWORD With explosive growth of the Internet and major changes in the financial markets, a new breed of speculators has evolved. Armed with high-tech tools, these new traders access Wall Street via their home computers in a search for the Promised Land. Although the art of speculation in all of its forms has existed for centuries, the financial media label these online traders as common gamblers who missed the bus to Atlantic City. The use of skill rather than luck separates profitable speculation from gambling. Now that the gates to Wall Street are open to all who wish to compete, smart speculators will hone their trading skills and apply the right tools as they attempt to become masters of their profession. Education is the essential element in building success in any discipline, and trading is no exception. Fortunately, you are already on the right path if you are reading these words. You are seeking your trading education from one of the best instructors in the industry today. My dear friend Alan Farley teaches traders across the globe how to master the art of high- probability short-term trading. He founded Hard Right Edge (http://www.hardrightedge.com), an excellent website for short-term traders and a comprehensive online resource that provides thousands of traders with educational materials on a daily basis. Alan is also an active message board participant, generously answering challenging questions from both new traders and market professionals. He has a true passion for teaching the beginner how to avoid the mistakes and pitfalls associated with short-term trading. When I asked Alan how he finds the time to answer all of those questions, he told me that he makes the time because new traders depend on veteran traders to give them good advice. ‘‘If I manage to save only one new trader from making a costly mistake, then it is well worth my time,” Alan said. Alan is determined to provide high-end education and has joined me on several occasions as we took center stage to teach at national online trading events. Although our compensation is small, I always look forward to spending time with him because he has true character and a great sense of humor. The greatest thing about his success is the fact that he has done very well just being himself. He is an asset to the trading community, and I am proud to be his friend. Trade Smart! Tony Oz President, Stockjunkie.com Author of Stock Trading Wizard: Advanced Short-Term Trading Strategies and The Stock Trader: How I Make a Living Trading Stocks June 2000 ACKNOWLEDGMENTS Many friends and associates helped in the creation of The Master Swing Trader. I will fondly recall their invaluable assistance for many years to come. Writing any book is a hard task even for an accomplished writer. Writing a good book that may help thousands of swing traders beat the game is far more difficult. The following individuals should take pride in knowing that they played an important role in raising the bar of swing trading knowledge. Special thanks to Tony Oz for many hours of late-night discussion about the modern trading press and its many complications. His mentoring and friendship are greatly appreciated. Also, warm, personal thanks to Tim Bourquin, Jim Sugarman, Joe Bettencourt, and Hillary Marks for allowing a new voice to speak at national trading Expos. These dedicated individuals represent the bright future of trading education, and their influence on the financial world should persist for decades to come. A very grateful acknowledgement to Ross Ditlove and the MB Trading team in El Segundo, California, for a Townsend Real Tick account that allowed me to produce high-quality illustrations for the book. MB Trading presents a professional direct-access broker choice. They also offer readers $5.00 trades for the first 60 days after a new account opens. Call them at 1-888-790-4800 for details. I must acknowledge David Singerman, a graduate of my online trading course and very nice guy, for his endless hours reading and commenting on the book manuscript. His eye for small details goes well beyond my capabilities, and his efforts are greatly appreciated. Thanks for the special guidance of other professional traders and their ability to teach me new things each day. Perish the thought that all there is to know about the financial markets has already been written. It certainly has not, and these are the brilliant individuals who will continue to offer inspiration in the coming years: Mark Seleznov, Eric Patterson, Joe DiNapoli, Michael Turner, Teresa Lo, Rogan LaBier, Oswald Castillo, Linda Bradford Raschke, Michael Williams, Chris Wheeler, Geoff Mott, Steve Bell, Brandon Frederickson, Toni Hansen, and Vadym Graifer. A special thank you to members of the media and website community for making online trading one of the most powerful financial forces of the new century and allowing Hard Right Edge to be part of that juggernaut: Mark Etzkorn, Frank Kollar, Michelle Riley, Todd Switzer, Noble Ershad, Dave Huff, Tom Nelson, Teresa Carey, Gary Smith, Tom Perry, Angela Alaimo, Dennis Shepherd, Chuck Thompson, and Josh Friedman. Finally, warm acknowledgement to two Californians who talk me down whenever the trip gets really strange: Steve Moebius and Steve Sando. RealTick is a trademark of Townsend Analytics, Ltd. ©1986–2000. Used with permission. Any unauthorized reproduction, alteration, or use of RealTick is strictly prohibited. Authorized use of RealTick does not constitute an endorsement by Townsend Analytics of this book. Townsend Analytics does not guarantee the accuracy of or warrant any representations made in this book. INTRODUCTION Market knowledge comes from the most unlikely places. In March 1983 I spent a week learning Native American survival and tracking techniques at a very cold farm in western New Jersey. Our class spent restless nights on a freezing barn floor and days investigating scat, nests, sounds, and a thousand little secrets that changed our way of viewing nature. We mastered some practical skills by the end of that grueling week. We could read the outcome of a sudden battle through a chaotic set of footprints. Owl vision focused our sight to the animal’s point of view instead of our own. And we could sneak up on prey with a quiet fox walk without alerting them to our hungry intentions. As my interest in the financial markets grew, I quickly realized that successful trading requires these same natural talents. The price chart takes the place of animal tracks but still demands our inner knowledge to interpret the endless conflict. We sense opportunity when we see through the eyes of the emotional crowd and measure its members’ greed or fear. And we build consistent profits when we quietly sneak up behind them and empty their well-filled pockets. Many traders never fully understand the nature of competition in the markets. We are taught in Sunday school or by well-meaning spouses to be nice to others in all of our daily activities. This makes its difficult to build the predatory instinct that leads to successful trading. Recognize our single purpose when the market opens each morning. We are there to take other people’s money before they take ours. The only way to accomplish this task is to exercise a market point of view or trading edge that defeats this competition. [...]... on the current trading environment Pattern Cycles also present a dynamic system that digests price change and updates the charting landscape in real-time This allows the swing trader to master a powerful execution strategy that few others will ever see PART ONE THE GATEWAY TO SHORT-TERM TRADING 1 CHAPTER TRADING THE PATTERN CYCLE THE PATH TO TRADING POWER Swing traders must compete against the best-informed... excellent opportunities on both 5-minute and weekly charts The swing trader should read this book But so should the day trader And let’s not leave out the position trader or technically-oriented investor Day traders can discover short-term tactics that don’t rely on scalping or frantic news releases Mutual fund holders can improve their timing with these classic principles and swing their investments into a... setup appears on a 5-minute chart, the swing trader checks the 60-minute chart for support-resistance but uses the 1-minute chart to time execution to the short-term flow of the market This multidimensional approach works through all time levels Even mutual fund holders can benefit when they locate a potential investment on a weekly chart but use the daily and monthly to time entry to the highest probability... strategy flaw They see their trades in one time frame but execute them in another This trend relativity error often forces a new position just as the short-term swing turns sharply against the entry Neophytes fall into this trap with great frequency They feel pride when they see an impending move on their favorite chart and recklessly jump on board The action-reaction cycle then kicks in and shakes them out... interacts with all other groups through the universal mechanics of greed and fear This dynamic 3D process results in trend convergence-divergence through different time lengths Swing traders improve performance when they adjust their chart view to match the chosen holding period As Table 1–2 illustrates, modern swing tactics encompass both the world of the day trader and the position trader Successful... patterns and indicators, the best volume analysis arises from the simple histograms offered through most charting packages These spikes and valleys in the lower pane of the price chart often tell swing traders all they need to know about the current crowd Common histograms display volume through a single hue or color-code the action based on the price bar’s closing direction The two-color (red for down... from the eye to the brain The rational mind sees large trends but may conveniently filter out the many obstacles along the way Or the marginal participant manipulates the chosen holding period and curve fits the opportunity to match the current plan Most players should never change their holding period without detailed preplanning Specific time frames require unique skills that each swing trader must master. .. candles Find these patterns in the intraday markets to pin-point turning points and profitable opportunities Add three original candle setups to the swing trader s toolbox CHAPTER 11: HOLE-IN -THE- WALL Study a new gap that generates promising setups and dependable profits See why other authors and traders missed it for decades Build diverse strategies to take advantage of price action after the gap occurs... time to read the first section before studying these examples and case studies The text introduces many original terms, concepts and strategies into the trading workflow The book organizes information so that the swing trader first masters Pattern Cycles, advanced technical tools, and time management It then demonstrates how to use these powerful forces to locate and execute outstanding short-term profit... opportunities The final section studies execution techniques and system choices that each reader must manage to access the modern market environment Pay close attention throughout the text to the attitude of the successful swing trader and how the crowd becomes the source of profit at each turn CHAPTER 1: TRADING THE PATTERN CYCLE Learn why the markets print repeating patterns over and over again Discover the . both 5-minute and weekly charts. The swing trader should read this book. But so should the day trader. And let’s not leave out the position trader or technically-oriented investor. Day traders. Find these patterns in the intraday markets to pin-point turning points and profitable opportunities. Add three original candle setups to the swing trader s toolbox. CHAPTER 11: HOLE-IN -THE- WALL. Swing traders capitalize on the emotions of others after they control their own. Pattern Cycles caution them to stand apart from the crowd at all times. In the simplest terms it represents the