Jim's Chart
of the Month

Book: Kane Trading on: A Totally New 5-Point Pattern
September 6, 2009 Commentary (monthly edition)-
Well, another interesting month goes into the record books in the trading world. I've seen and heard things among the pundits and others on the idiot box that I never thought I'd hear. I guess human nature really never does change. Crowd and herd behavior dominates, and many, if not most, people you see have a hidden agenda. Most are shills for 'the system', in my opinion. I guess when the very station you are watching is owned by a multi-national corporation that is a big part of the problem you'd be quite a fool to think you'd get an objective viewpoint on that program. This is a lesson I am just coming to grips with myself, after all these years.
I guess I've always been somewhat of a 'sucker' in the sense that I believed in these icons, these pillars of the community, both the financial community and the community at large. As time has marched on, and I saw what was unfolding before the crisis and since then, I started to realize we are being snowed. Since then I have followed places like Zero Hedge and Mauldin's blogs (which I recently linked for your convenience on the links page), and now I feel I'm all too painfully aware of what is really going on. And even with such sources as these, I wonder how much is still hidden from view. All I can say is it's a disgusting mess, it isn't likely to end well (I think we are maybe in the third inning right now, not the bottom of the ninth as the rah-rah I have an agenda cheerleader pundits say), and is a sad reflection on human nature and corruption. But, alas, it serves little purpose in here to go on about this. Read the material out there and you'll be on the same page as I am.
Let's change the topic and get more cheerful here. Despite all the lunacy that is happening in the financial world (and the world at large), I see very little difference in the trading setups. As markets evolve one always has to adjust in subtle ways to 'tweak' the 'Trading Plan' to stay in tune with the changes, almost like a doctor continues to go to conferences to learn about the ever-changing treatment methods as they develop, or an airline pilot has to adjust to new developments in instrumentation. Overall, though, I think the market is still trading fantastically. The ES is still making a lot of moves in the overnight GLOBEX and in the morning session (and sometimes in the engineered afternoon ramps), and going dead for long periods, and CL is still just a monster for trading. Let's see if that changes at all as fall gets into full swing.
Before we move on to the chartwork, I'll cover multiple items of business, and then some market discussion. Then we'll take a look at what we have on deck for today. To start, did you see the new title on the top of this page? I finally did the new title image, changing it from the long outdated 'Daily Commentary' to the more appropriate 'Monthly Commentary'. Not a big deal, but if you saw what I have to go through to do it, you'd understand why I play it up like it's something. So, just humor me on this one.
Next, I wanted to mention that the 'trader tax' is coming back into the limelight, this time with the backing of the AFL/CIO (what would the AFL/CIO have to do with taxing traders???). I won't rant and rave about this here, as I've mentioned it in the past already. If they keep trying and trying on this one I worry that one of these times it is going to pass. And you all know how it will happen. At the last minute the powerful lobbies will convince them to allow exemptions for the very places that caused all this trouble, and it will basically apply only to small traders. Understand, they are talking about a tax of say $400 round turn on 1,000 shares of a $100 stock. This is win or lose, every trade, assessed at the brokerage when the trade is made, like commissions are. So maybe you pay $10 commission total for a buy and sell, and $400 tax, and by the way, if you make a profit, you have to pay tax on that, too.
If you don't think this can happen, you are risking your career on that opinion. Please get active, do a search, and sign all the petitions and write all the letters you can. On top of all this, if they ever did pass this in the current form, liquidity would dry up so bad that the markets would be destroyed, in my opinion. I have seen comments by exchange officials who feel the same way. All in all this has to be one of the worst ideas I have ever seen. In all forms I have seen it would also be applied to futures contracts, based on the full value of the instrument, not your margin amount, so it could be equally devastating there, too. Seriously, get on this.
Moving on, it looks like I will be implementing the new data feed by the November commentary, if all goes as planned. If so, I will be able to finally start to mix it up more like the old days. I can get back to showing the mini's, futures of all sorts, so we can look at treasuries, gold, currencies, grains, crude, and all that type of stuff, as well as some other things I haven't been able to get lately because of all of the interface issues. Hopefully this will all transition without a hitch. If so, it should make for a lot more variety in the upcoming commentary.
Now on to something positive for Jim. I am going to paraphrase from my July commentary, with a little adjustment for the current situation:
I really need to take an 'end of summer break' while our weather is still so nice, and I'm going to do it this upcoming week of September 7th-14th. I plan to do the same thing I did last time, just take a week off and play around the house. Work in the yard, go golfing, actually watch some non-financial television maybe, just take a break from computers. I will still be around, but if I check e-mails, watch the market (yeah, I will probably still monitor the swing plays...), and so on, I'll just never take a break. I only mention this here because for that week or so I won't be shipping any book orders out, or even checking for orders. If you want to make an order please do so this weekend (September 5th or 6th), or wait until after I return on the 14th. I posted a note on the top of the books page, too, as to when I will be 'out of the office', so you can use that in your timing decision.
And finally on to my last order of business. I've given a lot of thought to a new idea, and spent more than a few hours putting together a page on this so that I don't have to clog up the commentary with details. If you've bought the book set and might be interested in attending a Kane Trading webinar, please check out the page I've created by clicking on the link here. It's all explained there, but before you get your hopes up, right now I'm just tossing an idea out there and looking for some feedback, and then we'll go from there. I hope everyone checks this page out, as I need all the input I can get at this stage.
Now, with all those items of business out of the way, I want to discuss a few market items before we get to our chartwork. I haven't went back to that UNG chart that I showed awhile back. This was the 'long-term play' based on some of the fundamental aspects of natural gas, and the extreme ratio of crude to nat gas, among other things. Well, as you all know, nat gas has broke hard to the downside, and UNG seems to be having issues of its own. I have heard talk of the fund having to close out some of the position (after having reached their speculative position limit), and even of the fund closing entirely and reopening with a different structure.
This is all far more than I can fully cover here right now, and it has made for some interesting speculative discussions with my trader buddies. The bottom line, though, is that even if any trading position was initiated in the basing area shown on that chart, it would have been stopped out by my plan when that low was breached. If this was taken as a 'long-term investment play', and that 1.272 I mentioned it seemed destined to test was used as a line in the sand for some 'dollar cost averaging' (as a trader that term makes me wince), that play would have been stopped out when that 1.272 area gave way, by any plan I would construct.
Notice, too, there was no decent entry trigger at that 1.272 area, so I don't think any additions would have been warranted regardless. So, is nat gas done going down in here? Is this the basing area? Is it going to rocket up from here, or do that much talked about one handle? All I can say is nat gas at this price, with respect to the energy complex and all other factors, is perhaps the oddest anomaly I have ever seen as a trader, despite all the fundamental reasons they give to justify it.
Let's look at some sentiment, and then it's chart time. The insiders just keep on selling, exploding the record insider sales ratio to 61.8 to 1 sells to buys. They have sold at a furious pace for the entire run up, starting right off the low. It is amazing how little press this gets on the rah-rah stations. So, I thought insiders accumulate as the bottom is forming, and distribute into the formation of a top. Now, in this 'bull' market they distributed starting at the bottom, and all the way up. From what I've read this has never, ever happened in a bull market in history.
Hey, maybe that stat is incorrect. Maybe some bull markets are the exact opposite of that. Maybe the buying demand is so great that the insiders can sell at unprecedented rates, and the buyers can absorb all that and want more, such that prices just keep rising the demand is so strong. But wait, if the demand is that strong why would so many insiders want to sell so much so soon, instead of waiting for the top to form, which we have been told is way, way, way up from here, and then sell for a lot more? Hmmm, seems like the insiders don't have a clue. They are the 'dumb money'?
So, let me give one other stat. Keep in mind the accuracy of this is only as good as the accuracy of what I read when I first saw it, so take it with a grain of salt, and do your own research to confirm any facts you get. I heard the entire market cap since the March low has increased $2.7 trillion. Of that $400 billion has 'come off the sidelines' from sources like the money market. But here's the curious thing. In that same period of time the FED balance sheet has increased $2.3 trillion. Hmmm, very curious, when you add those up, you see an interesting thing, don't you? Nah, must be some kind of coincidence. And this, while bull sentiment has now reached a level greater than in October 2007. It just gets 'curiouser' and 'curiouser', now doesn't it?
Okay, let's move on to the chartwork. Today we will look at some overhead areas based on line work. As you all know I never try to pick tops or bottoms, as it is completely unnecessary for trading, in my opinion. I chose to look at this today for two reasons. First, it seems to be all that anyone talks about nowadays on television and even in forums and blogs. And second, I want to review my general approach to 'context' and staying with the trend. I thought this would be a good chance to look at both of those and study some interesting areas and line work.
Before we move on to the current market position, let's do a quick review of last month's chart of the month in rates.

Chart 1
Here's that rate chart as it was posted last month. I was watching to see of an ABCD pattern might form, perhaps as a 'wave 4', to send this for another leg up. I put one arrow on the chart at that red sliding parallel, because that was a key spot where it may start up instead of making a move for point D. I also highlighted a key trendline, which is also an important line to watch. There is no way I can highlight everything that I am watching on a single, small chart like this, so I try to pick the most obvious areas. Once price action forms additional structures then I have to update the potential premises. I do the best I can to show areas that I want to keep an eye on, though, with the hopes that the logic and reasoning for how I came to watch those areas will become more and more obvious.
Let's see what happened. I'll move some of the labeling, and add a few things onto the chart.

Chart 2
Rates did 'see' that red sliding parallel at the leftmost arrow, and they snapped up nicely off that area. They formed a nice corrective structure up to a higher potential C point, the labeling for which I adjusted on this chart. I didn't show it here, but draw a trendline/sliding parallel over those swing high points between the B and C price action. Just look at where the C point finally petered out. There were other things at that spot, too. Do some work and you should find them.
And where did it go after the C point? Right down to that trendline, where it started to react. Notice, too, the two key time factors coming in on the 4th, just two days after the reversal at the trendline. This is very close, and the up day when it started to move was right on the 4th. Remember, just like with Fib groupings and lines, I am looking for areas, not exact points, and this is well within the time area.
So, will this head up here, or will this just be a minor reaction at this trendline, and the ABCD completes lower? Or will this be a 'wave 3' and it drops even lower? Think about this. If the market is to go down here money will likely flee to 'safety', and treasuries will go up, and hence rates down. If rates go up here, treasuries are going down, and likely the market is going up as money flows out of treasuries into the market. Hence, when I try to assess the market, or rates, or currencies (as similar relationships exist), I look to see how the setups from each area complement each other (or don't). So, rates have some interesting things coming together, as does the market, as we will see.
Let's go way back to a chart I showed in the April commentary. All I will do here is add on the current data. The reader is encouraged to go back to the April commentary to look at the chart at that time.

Chart 3
The S&P has just headed straight for that area posted some five months ago. This area is based not only on a key trendline and sliding parallel, but also a 'minimum' .382 time retracement. There is nothing magic about any of these factors, they are just some of many that I am watching. It does show, though, the 'magnet effect' that some of this stuff appears to have. So, this is a 'starting point' for me to do some more analysis.
Let me add a big, key weekly set onto the chart. This is 'way cool'.

Chart 4
Here's a big, weekly set that was on my chart in October of 2007! Now, a few observations come to mind. First, there was a lot of interaction along that upper division line (the upper dotted line coming into the key area). Price 'tested' that line three times before breaking down, and once it did break down, it came back through that price action many times, above and below, before it finally gave way. That gives me additional confidence in that line. It seems not a coincidence that the line comes right into the key area, right at the key time.
On the other hand, the next observation that comes into mind is that overall, the other lines from this set haven't done a great job creating price reactions. That detracts from my overall confidence in the set. Remember nothing is 'cut and dried' in price reading and trading, if it were, we'd all be billionaires (actually, if it were all the money would be sucked out of the market immediately and there wouldn't be a market anymore). At this point, let's leave this set and look at another viewpoint. I will tie the above in with what I am about to show next, for the chart of the month. I suggest that after you review the remaining charts you hit the popup for the chart of the month, and then you can look at that in the 'context' of what I am showing here step by step.
Let's look at another big, key set from the weekly timeframe, show closer up on the daily chart here.

Chart 5
Before that area above in the 1,100's is reached, the S&P has reacted right off another key area right in here, at a division line from another weekly set I have had on my charts for some time. Notice how that last ABCD on the way up oscillated around that median line (in red). I will get to this a bit more later on, but note that the price action looks bullish as all get out here, ready to launch right up and over that line.
I'll add another line onto the chart.

Chart 6
The solid blue line that I added is a very obvious trendline from the weekly chart. We will examine that shortly. Notice how it comes right into this area, and how the S&P just hung around that confluence for days before dropping strongly. It surely 'saw' the area. The question is, will there be any downside follow through, or was the drop another one-day wonder, and up it goes? It is very tough to call the end to a trend, especially if you don't have a clear pattern. Here we have nothing but strong, strong impulsive action.
I'll zoom out a bit, and move up to a weekly chart, so we can see how all this looks from that perspective and 'context'.

Chart 7
This key weekly set clearly shows the upper division line in this area. Notice, though, the very interesting trendline in blue that also hits right here, time and price-wise. Yes, for those that are astute with 'crazy' trendlines, this one is pretty obvious, but nonetheless, it bears watching, in my opinion. Although I haven't shown it today, I have many other things in this current area. I did do a post on that in the public KT forum over at MyPivots, so you can check that over there for a bit more detail. The point is, although there isn't a clear ABCD pattern structure, there is a very noteworthy area right in here, as well as the one above it in the 1,100's area (I actually have two very tight Fib groupings in the 1,100's to complement the line confluence up there).
Now, what is the practical use for me in all of what I have shown? It's simply this. My plan is to go with the trend. I am looking for corrections in trends that I feel have more potential room to run. But a trend is a relative thing, as all of you that struggle to learn that most difficult of skills, 'context', can firmly attest to. The trend is manifestly up right now. But on what timeframe? On a daily chart it is clearly bottom left to upper right price action on the chart. On the weekly, though, it is clearly down. This move up appears to be just another correction is a strong downtrend. Look at the chart, the price action is upper left to bottom right all the way. Alas, though, what does a monthly chart look like? Bottom left to upper right, an uptrend all the way.
This is the skill part of 'context' analysis. There are setups galore all the time, but which ones have an edge when taken in the 'context' of the odds of that given trend persisting? That's the higher-level skill, in my opinion, determining that. So, at what points may the downtrend start to reassert itself? I watch the areas that stand out, like the two above, and I see how the price acts there. If I see something that would allow me to get on the short side, say in this case with some puts, I may look to do that. Many times I notice a reaction in the areas, but then it starts acting in such a manner that it is clear it has no desire to follow through.
I'm not trying to call the end to the trend, but rather attempting to take advantage of a reaction off a key area and some favorable price action that is giving me a chance at a decent reward/risk setup. If it stops acting as I would expect after the initial reaction, I can look to scratch the trade, and right back onto the long side I can go if that sets up. The last thing I want to see if I'm on the short side is the initial move down showing a corrective structure right into a key area, and then a reaction off that. I can give it time and see if it then rolls off the expected area, and if it doesn't call it quits at that point, or I can look to get off the short side and back onto the long side off the long setup. I am finding that this is what the market has been doing at every potential shorting area since the low.
So, to sum it up, as I've said in the forum many times, my bias is long, long, and more long, and when a very key area is hit and I see a reaction I look at the short side, and if it behaves poorly after the initial reaction, or sets up the long side, I get off that and right back to the long side. In between those key areas it is just long, long, long. That's the plan until it's time for the short side again. Maybe that's already started now, maybe it's not for years to come. It doesn't matter. I just look for setups with the trend. I don't care when this 'bull' market ends, or if it ever ends. It's all about the setups. The above is my very oversimplified overview of how I try to stay with the trend.
Let's look at a recent setup. I only have one chart space, so I can't show a before and after. We'll just look at the setup and what happened off of that.

Chart 8
The S&P came off a key area for a potential resumption of the downtrend. This triggered a put play as it rolled off the A point on the chart. After the expected potential 'wave 2' heat, it started to roll nicely into what I was hoping was a 'wave 3'. Here's where setting up areas, watching developing patterns, and assessing other possible premises is crucial. If all I could think about was the short side play, I'd be blind to what might be developing. Even if I didn't want to look at the long side (in this case I was, as I described above, heavily biased to the long side), I still want to create and monitor the long side setups and areas, if for nothing more than management reasons.
I noticed that an ABCD pattern was forming. There is no way to know if this was a CD leg (wave c for you Elliotters), or a 'wave 3'. It's not necessary to know to trade. I showed a few of the basic, critical Fibs on this chart, but I had others. I had a key set on there, and I noticed a very obvious sliding parallel, shown in red, came right into an important area for the ABCD. (Please note that I do most of my work on the ES contract, and I do versions with and without overnight data, so the above is just a small representation of my actual working charts.) I also had a trendline, shown too in red (the more gently sloping red line), based on a concept somewhat like the 'crazy' trendline in the weekly S&P chart. The most interesting line was the blue one, which is an old median line from a set that goes way back to the crash time and the March bottom.
All these lines came together in one spot (I had other lines in there, too, not shown for clarity), with a time factor that some of you that study time cycles will see right off. It all came together in this one area. Not only that, it finished with a signature move I teach my mentor students, and after starting up, 'tested' the area with an .886 with some other factors that form a special .886 setup unto itself (at the arrow). This is all very clear on a lower timeframe ES chart, which I suggest you study. So, if I'm holding puts at this point, do the odds favor my being stubborn and giving them time as this begins to rise, or do the odds favor taking whatever I might have at that point and looking at some calls? (Understand, these very same areas give me the bias for intraday ES plays, as well as being useful for swing trading plays from area to area.)
If you look at what just happened after the possible 'one-day wonder' and reversal as this commentary 'goes to press' you can see that perhaps the same thing has happened once again as the S&P rolled off that key line area. On the lower timeframe it has formed an incredible pattern at a key Fib and line confluence. I have at least six lines hitting the same general spot, and then a few additional minor lines, too. I almost chose that one as the example here, but it would have taken too long to recreate all those lines. So, will this one follow through and up we go to that 1,100's area? I have no idea. Will this be a 'wave 2' bounce here, and down we go, an intermediate top in place, perhaps even a long-term top? I don't know. I don't need to know, though, to trade.
Look, when I'm short side and it forms a near perfect setup against me, and my initial trade is counter-trend for the current action, I am not going to want to sit around and 'give it time'. Giving a move time has its place, especially if one is a trend trader. Patience is truly a virtue for a trend trader. But I don't see the sense, either, of overstaying one's welcome and fighting the trend when a monster setup forms in the direction of the current trend, and it produces a strong reaction dead off of it. If the downtrend is to resume there should be plenty of time in that direction to look for setups.
Sure, under limited circumstances I can take shots at potential countertrend moves if I have a clear area, but I am ready to get off that and respect price action as it unfolds. I don't ignore clues and I don't marry one side or the other if the price action says otherwise. Make sense, I hope? 'Context' is perhaps the most difficult and most advanced skill to master. Human nature to fight the trend is strong. Just keep studying and working on this, as it is a critical skill to learn.
Well, I hope you found this commentary useful and informative. I find that as soon as my students get the basic rudimentary skills down they next start to struggle with two issues. One is the various psychological aspects of trading (I think because those didn't play much of a role when they were struggling so hard with basic skills at first), and 'context' issues. I have come to expect this, and I see the progression over and over in those that I work with.
Try not to get too discouraged if you, too, find 'context' and staying with the trend difficult skills to master. It takes time and practice, lots of it. No one gets to be a doctor in a few months or a few years, or an architect. This is no different. It's time to pay your dues. Happy charting, and I'll see you all next time, refreshed from a week long break tilling the soil, splitting firewood, golfing, swinging on the porch swing with my better half listening to the loons on the lake at sunset, and just generally wringing all that stress out of my system.
The next commentary will be next month's edition, posted by Sunday evening, October 4, 2009.
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