Jim's Chart
of the Month



Book: Kane Trading on: A Totally New 5-Point Pattern
September 5, 2010 Commentary (monthly edition)-
Another wild and crazy month goes into the record books. After a vicious drop right back to the much watched 1040 area, and some severe gyrations there, the S&P wound up the month just about where it started. This is potentially more interesting than it at first sounds, because several different possible scenarios are at hand, each with very different implications. We will take a look at some of these in the latter part of the commentary. The one thing I will say is that the action, the manipulation, the currency moves (watch the Aussie/Yen most closely), the Treasury bubble, the potential commodity explosions, the whole thing is just insane, a real market gone wild, out of control, showing its truly broken condition. It really looks like it is in its last death throes before it completely stops functioning. That's just my opinion.
I really enjoyed not doing a long intro last month, and I am going to stick with that again this time around. I will comment briefly (and I mean it) on the ongoing situation, as a simple prelude to some of the discussion that will follow when we get to the current market position later. As I have stated many times, I think we are just doing more of the same, blowing one bubble after another. No news there. To keep the status quo going more and more liquidity just keeps getting pumped into the system. Eventually this must fail, I believe, but how long they can keep the game going as they fight for their lives and their way of bilking everyone, who knows, probably a lot longer than anyone can imagine. But that won't change the end result, in my opinion.
The main issue on everyone's mind is are we facing deflation or potential hyperinflation as our biggest threat. This topic is far too complex for a brief comment here, but I have some thoughts to ponder. Recall how I mentioned in the past that I feel we may have both. If we were struggling with true deflation as I define it, crude I think should be struggling with $30/bbl. Look at cotton, sugar, wheat, and so on. All the commodities look to me like they are waiting for a trigger to explode, not implode. This doesn't look like the stage for deflation. I think we have some select asset bubbles coming back in, and that's it. Houses and stocks are way, way, way overpriced, even at these levels, in my opinion. They are being held up here by extraordinary means of manipulation. Their 'fair value', without these means, is way lower.
I am of the opinion that these bubbles coming in are being viewed as deflation, all the while the insane measures of money printing/monetizing are setting the stage for an event triggered hyperinflation of commodities/staples, and a trashing of the purchasing power of the dollar, all in the blink of an eye. This likely will come about from a sudden loss of faith in the currency, i.e. a 'currency crisis'. I don't think it will be gradual, it will be event driven. Today we are fine, tomorrow we wake up and all our life savings, our 'store of wealth' held in paper dollars, will be gone. And commodities will be through the roof.
Now, if your salary was simply readjusted for this then day to day nothing would change for you, except your savings would be gone. If you owed money, you could pay it off with perhaps a day or a week's wages. This favors debtors, and who is the biggest debtor in the known universe? The United States. Since everyone knows there is no mathematical way to ever pay all that debt off, it only makes sense that they will monetize it away by inflation. This is a stealth default, since 'the U.S. will never, ever default'. This is all just my opinion, of course, but it is what I suspect is coming. In an attempt to inflate the stock market and the housing market, the only real way to make those numbers into higher numbers is to just devalue the dollar.
This is what I covered awhile back with my theory on valuation. In a deleveraging cycle there is no way to increase the inherent value, all they can do is change the price upwards (at the cost of stealing all our savings) to try to trick poor, dumb slobs (pardon my French) into thinking prices are rising and the value is increasing. And I'm thinking there are getting to be a lot, lot less 'poor, dumb slobs' in our country, as people are reading the better blogs and getting informed as to what is really going on. Well, enough said on this. I'm just saddened that I think we are not seeing technical signs that commodity prices are going to stay stable, and everyone should recall what happened to poor people around the world the last time they ran commodities up. The next time may be far, far worse.
For today I am going to cover last month's chart of the month on WFC, and then finish with a look at the current market position, and lay out some possible scenarios. I am going to dig into the WFC play and comment on some management aspects, some price action concepts, and so on. There is only so much I can do in this limited commentary, and given that it takes me eight hours plus to do it, I am surely not going to be able to even scratch the surface on what I could cover, or do anything like what I cover with a mentor student over a long period of time. But, we'll do the best with what we have here, and as I have said, I've been told many time that what I provide for free is far better than what other people charge for. I don't know if that's true, but it is the opinion of many.
I am going to try something new with this commentary, and see how it works. To save on chart space I am going to post a link here to see the previous Jim's Chart of the Month. Click on that and see what I posted last month, and then hit the back button on your browser to get back here and continue (or right click the link and open it in a new tab so you can keep referencing it). I may try to archive them somehow, but for now I'm not looking to create any additional work for myself, and I think the readers should have some responsibility themselves to make a copy for personal use and future reference. We'll see in the future about an archive.
So, now that you've looked at last month's chart of the month, let's move forward and see what happened off that spot.

Chart 1
Source: QCharts.com
The ABCD in WFC did play out as I anticipated, and the 'W3' type scenario off the key area where the A point is marked did not overwhelm the beautiful pattern setup. This is about as good of a setup and reaction as I could ask for. What I'd like to do first is look at what I was thinking is the most likely case scenario as far as the movement off the pattern. The really interesting part here is that even though this assessment is being shown after-the-fact, the process is the same, pretty much, for my basic setup as shown here. My mentor students should attest to anyone asking just how consistent the process I show really is, almost to the point of boring repetition. If they wouldn't attest to this, they not only would surprise me greatly, it would be an indication that they aren't comprehending the methodology.
Now, before we move on, I want to make one thing very clear here. I am a trend trader, and my methodology is a trend-following methodology. The phrase 'profit target' is nowhere in my written 'Trading Plan', and I can't recall using it with any mentor students outside of explaining why I don't use the phrase. Hence, although I am looking at areas where I think things may change, they are not 'profit targets'. To me, profit targets are areas where, once reached, profit is automatically taken, regardless of price action.
The market could be in the start of what looks like a 'flash crash' that might take the DOW down 1,000 points, or even 3,000 points, and if that profit target area is hit a few points down (on a short trade, in this example) you grab those profits while you have them. Nope, not for me. The market tells me when it's over, and by its very nature that's a 'give back' strategy. I want to give some back. I need to give some back to have a reasonable assurance that the trend segment I am working on has ended. That's the strategy.
I'll add on some key Fibs and we'll discuss what I am looking at.

Chart 2
Source: QCharts.com
When I showed the downward arrow on the chart last month, notice I showed it down to the lower parallel. I just wanted to indicate, as a starting point, about where it may go if it played out as I suspected. It was a rough approximation. I can hunt for additional timing factors and see where they hit with various key Fibs and such, but that is far too advanced for what I can show in this commentary. In this case WFC decided to play around a bit before the drop started (a bit more on this later).
But, notice the level of the arrow, and the lower parallel as an area where I would start to have concern, and be looking at perhaps adjusting my management plan (via tighter stops, as one example) as the area is approached. Notice, too, the upsloping dotted gray outer division line from the key set from the previous action. Look at the downsloping lower parallel, the upsloping dotted gray division line, and the Fibs, and see what area they define.
I'll add on an obvious natural median line set, and highlight the median line for that set with the bolder red.

Chart 3
Source: QCharts.com
The starting point for the set, in the upper left hand corner, is the high for the move. I'll leave it to the readers to confirm that for themselves. Now, how's that for an additional timing factor to help point to the spot I am focusing on. The area where I would want to adjust my management plan surely is right here. I would not be looking to 'grab profit' in here at all. I want to see how it acts, and give it a chance to show me the move I am looking for has finished itself off. Perhaps it flushes right out here. If so, I want to be in a position to stay with the trade on at least some of it. I show mentor students a variety of techniques that I may use to split up a potential trade based on various price action clues, as the issue goes against me to varying degrees.
Keep in mind, I am not pushing my mentoring program here (far from it, for as everyone should know by now, I am in no need of 'advertising' for more people). What I am trying to make clear is that management, as I see it, is a big, key component to the process. For my most serious students we work for perhaps two or three months just on how to manage a play, what I am looking at, and why, as the trade unfolds and various things happen. Sometimes I see forum posts that put down a methodology because the person can't say up front what they plan to do, like what their 'profit target' is. That would be a tough post for me, since I'd spend all my time doing endless searches on my 'Trading Plan' looking for a phrase that just isn't there. That doesn't mean I don't have a plan, it just means I don't grab profits at predefined areas.
In my books I describe this little game someone could play where they could come up behind me, put their hands over my eyes at some point during a trade (let's say a hypothetical trade, because if someone did this to me during a live trade I'd likely go ballistic), and then have me answer what I would do if the trade did this, that, and the other thing, covering every possible scenario of price action unfolding. I said that I felt that if you couldn't answer those questions right off the top of your head, you have no business being in that trade. Period. That's a key tenet of my methodology. And how finely divided up are my scenarios?
Well, I could see the human brain, once trained and skilled, at easily being able to see a hundred scenarios unfolding. I'm saying, if price drops $2.80 and then jumps up $0.40, what do you do? How about if it drops $2.80, and jumps up $0.60? $0.80? Drops $3.20, and then up $x.yz? And so on. Using my techniques, at any given time, I can say what that would cause me to do. Now, how many various scenarios are there? Perhaps thousands. And someone asks in a forum how I would handle it? Give me a break. Here's how I would handle it. I'd use all the skills I've developed over approximately 37,000 hours of hard work and follow my 'Trading Plan' using a dynamic process that is extremely skill-based and labor intensive every micro-step of the way.
You think I can show you that with a few charts? Explain it in a forum post? Gain the skill even with a few months of dedicated one-on-one work with me focusing solely on management, while I watch you work and continuous attempt to refine and adjust your skills? Man, you are dreaming. This is a skill based, labor intensive, really try to develop a deeply-rooted understanding of price action approach. Sorry, but that's what I've attempted to do with this methodology. I see very few others with this approach, if any. If that's what you want, then look my work over. If you want something else, congratulations, there are several million candidates out there willing to show you what they have. I'm not trying to be a big, old grouch here, just straightforward and clear.
Let's see what happened from here, current as of this writing. I'll switch to candles to better show the last day's data, and add on a downsloping line that I find potentially significant.

Chart 4
Source: QCharts.com
So, WFC went right into the area, put in a nominal higher low, and just started to smoke up, along with the rest of the market. Take a look, just for fun, at the triple line intersection (one of the lines, the downsloping blue line, is the one I added) and the candle that formed. It's also a potential island reversal in the making, if the area really turned it down. The point is, this is the area where I thought something may happen, and where I wanted to begin altering my management plan. We'll look at this in more detail shortly.
Let's switch gears for a moment, and drop down to the 130-minute chart.

Chart 5
Source: QCharts.com
If you didn't see this on the daily chart (although very compressed, it still did jump out at me), here's what WFC did with the set lines I had on there. Keep in mind, I had this work on here even before the chart was posted, but the readers got to see it at the end of the day's data where the arrow starts from. WFC drops down and goes to the downsloping dotted gray division line, and 'tests' it three times (poking a bit below on try number two), and then right back to the upper parallel, and back down to the division line, then almost back to the parallel, and then finally it gives way. (See the green hash marks.)
My students surely see something going on here that could potential be very useful if one wasn't already triggered into a trade right off the area. Notice, too, once the price action got flowing, it just moved very smoothly right into the area I was most interested in. Quite amazing action. It even 'congested' around that red median line on the way down, and sat on the lower dotted gray division line. Quite a useful set for me.
Let me drop down to a 60-minute chart, and I'll add on quite a few things, as we get back to our management discussion.

Chart 6
Source: QCharts.com
To guide the eye as to the price flow, I added on a simple regression channel, and highlighted the upper line in thicker blue. I also added on a 34-period simple moving average (34 is, of course, a Fib number, but don't draw too much from that choice). I also added on a sliding parallel for the channel in red. Lastly, I spotted that the nominal higher low was an ABCD, and could also be viewed as a 5-Point pattern (although none of the ones that are popularized). Now, here's the point of all this. At what point was it clear that the move down into the area was over?
Each trader can formulate his or her own plan for this, but as the trend channel is taken out, the moving average, a higher low is put in, an ABCD is forms and is reacted to (as well as a 5-Point pattern), swing points are taken out, no matter the predecided plan, you can clearly see it happens somewhere in the same general area. Seriously, how clear is this? To me, it is like crystal.
This is not a 'well-chosen' example (although it is a very clear one, and not all are this clear, by any stretch), it is the chart of the month from last month, posted well before this downward price action had gotten fairly started. Look back at previous examples in gold and the Euro. Many times the price action speaks loud and clear. If I were looking to enter a trade in here, doesn't this seem quite similar to those other examples? Entry, exit, management, price action is price action. The market tells me things by the way it acts. That's my belief, anyway, and I'm not about to ignore the clues.
Let's move on to some discussion about the current market. I'll update a chart from last month's commentary. Everyone should go back and review the last commentary before proceeding. I'll start with the weekly chart for the ES continuous contract.

Chart 7
Source: QCharts.com
I've been looking at various scenarios for the market position in here. Understand, my main concern is in recognizing setups/patterns, and building a premise around those. I can use various potential scenarios for management purposes, and to make yes or no decisions on a given setup I may find. I am not trying to predict the market when I look at scenarios, I'm just trying to get a handle on what may unfold, and how it may unfold, and then I can watch for price action clues and try to use the information as one additional part of my overall process. As long as the 'context' of my approach is understood, then I think the overview can be of some value.
So, one obvious scenario is that we are now in a CD leg here that may carry the ES up around the 1160+ area. This would have to be some type of 'Wave 2' off a 'bull' market top from back in April. Many lines and things come together in that general area. The important thing is to understand that no matter how many Fibs, lines, etc. I have in this area, they won't make it go down. They point out an area I may be able to trade against if the market's intent is to go down off some kind of a 'Wave 2' scenario. Only 'context' can assist me in the decision of whether I think a 'Wave 2' is likely. Remember, every 'Wave 3' was first a failed ABCD.
That leads into the next scenario. Could this be a 'Wave 3' headed to take out the April high and really get moving, taking aim at the all-time highs? Sure, that's another possible scenario. If so, it may check back into a 'Wave 4' type of a pullback as another 'test' from below of thicker gray line. Now, how about that old sliding parallel in thicker red there, where the B point struggled last time? It closed for the week at the high, right on this line. This is also an area that has many other technical factors pointing to it. Recall back to the WFC chart and that last daily candle. My students should see some things in here, too, to add a bit more to the mix. Could that insane rush up be it? Do lasting ramps usually start with that kind of an explosion? In my experience, no. So, it is possible that it rolls right over from here. From a sentiment perspective, there are some things that can be thrown into the mix here.
Recall what I was saying about sentiment and what everyone was saying. The big talk on every forum, blog, newsletter, and television show was how the market will top in August, likely at a higher high than April, and then go down for September and October (to then likely rally to huge new highs). There were two key dates in August that were widely discussed. I felt the likelihood of an August top was slim and none. It was the only talk anywhere, from what I could see. I thought it either did set new highs (above the April top) but then just kept going after that, or it didn't set a new top, and perhaps went up through September and October, the opposite of what was so talked about. One thing so far has clearly played out, there was no top of any kind in August, as far as what they said.
Yes, the high on August 5th, if the market drops down from here and takes out the July low, could, in retrospect, look like 'they' were right (even though most said the high would be well above the April high, and it wasn't even close). That's what has me even more suspicious about a drop off the area we are at right now. If it sustained itself downward, 'they' could claim they were exactly correct all along, even with the big bounce here. So, I suspect up is the more likely scenario here. Next, this bounce came from the infamous 1040 area, which everyone was watching and discussing, when bullish sentiment had dropped to quite an extreme low. It was a golden opportunity for the 'manipulation rampers' to gun it up hard and force some short covering (not to mention some 'quote stuffing', which, according to what I have heard, can actually run the price of an issue up without any trades taking place).
Although this tension may have now been relived to some extent, I would think it still has some more to go to get the sentiment more balanced. That may lead to the ABCD I highlighted. And the way things swing so fast, especially with elections coming up soon, would have everyone extremely bullish very rapidly, in my opinion. But, look at what just happened on the charts (this is very clear on the upcoming chart). The S&P just formed a beautiful inverted 'head and shoulders' bottom. I would think it would at least want to get to the upper bounds of that pattern, in the area of 1120-1130. That's the area of the 'neckline' and the official breakout point. Now, do you think everyone sees this? And that the games are going to be outrageous? And that this is soon to be the only topic for discussion on all the forums, blogs, newsletters, television programs, etc.? For me, it's yes to all of them.
Let's drop down to a daily chart, and we'll continue our discussion.

Chart 8
Source: QCharts.com
So, the inverted 'head and shoulders' jumps right off the chart at me. Notice how key, and obvious, the downsloping red trendline is. Notice, too, how the 1120-1130 area has two lines coming together right in that general area. I can see some major game playing, and a lot of mouth running, around all this. Now, look at the ABCD as laid out on this chart. Keep in mind the lines and layout from the weekly chart.
Using some offset lines you can see how the price action so far fell a little short of the lower parallel at the A point, and then on the way to the B point was offset by a similar amount around the dotted gray lower division line and the red median line, and then once again at the B point with the dotted gray upper division line. The move to the C point had a checkback centered around the median line, and then another shortfall at the C point by that same amount. This has me looking at that amount as a tolerance level around the key line areas on this chart.
So, I think, I've laid out quite a solid framework that I will be attempting to operate within as things unfold. I think they plan to run the market not only for election purposes, but in general to 'fight deflation'. I feel they equate the stock index values with prosperity, public mood (via their 401k's), lack of deflation, the economy in general, and so on. I think they couldn't be further off from the truth, but all that matters from a trading standpoint is what they are trying to do. How much they can manipulate it up is to be seen, but I am always aware that they are trying to keep it rising, and only big shock events can drive it lower, in my opinion. And even too much bad news causes them to get blasé about bad news, and up it goes.
This all has me thinking one very possible scenario is up through September and October, perhaps even to new highs over the April high, and then down into November and December, when, after a huge run up through the seasonally terrible period, the greed mongers then start talking about the Santa Claus rally, and the new January money getting put to work, and as January goes, so goes... and on and on. And then they get crushed. I'm just looking for ways for the masses to get sucked in and fooled. No matter how it goes, I think there is going to be some wild, wild action coming. It's only a matter of time until these various shoes drop, and one of them I think we be a monster, and the battle to save the world will be on again.
Who knows, maybe all that fairy dust really worked, and solving overleverage and huge debt with higher leverage and 'huge-er' debt really is the answer. Maybe those latest stats I heard that said the total debt, including unfunded liabilities isn't really $115 trillion, it's more like $200 trillion, and the underfunded pensions that are laughed at by some (because is surely can't be) when they say $10 trillion, may be more like $100 trillion, maybe all those stats don't matter. Maybe we are going to be just fine. Yep, and maybe I'm going to flap my wings and fly to the moon tonight. Yeah, maybe...
As I wrap up, I wanted to mention that I had one more chart I wanted to show, but I opted to go with the daily chart there and the detailed explanation that went with it. I have noticed this really cool price action that the market has been doing lately, and I was going to show that. Perhaps I'll be able to fit it in next month. So many things are happening, I can't say what I'll be showing. With gold looking ready hit new all-time highs, that yen is just, well, look at. Holy smokes. The Swissie, especially with respect to the Euro, that Aussie (Aussie/Yen, and its correlation with the market and 'Risk on/Risk off', is just nuts, as I alluded to earlier), the ready to explode grains, and on and on, it promises to be nothing short of hair-raising, as far as I can tell. Strap yourself in and get ready.
The next commentary will be next month's edition, posted by Sunday evening, October 3, 2010.
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