1/12/2012 SPY

SPY

Unlike the previous 2 posts, I keep track of the SPY chart on a daily basis therefore I use the hourly and 15-minutes charts more often. Since this is the first post on the SPY I will use a longer time frame to show the underlying trend and I will do my analysis on a short time frame after this.

In the weekly charts, I found 2 patterns, a continuation diamond and a head & shoulders. First, let’s look at the continuation diamond in the chart. A diamond pattern usually happens after a quick rise or drop and serves as a reversal pattern in most cases. However, what we see here is a continuation rather than a reversal. If this is the case, just remember price exits the diamond in the same direction as it entered, which means if price rises into the diamond, it should exit the pattern on the upside, vice versa. Regardless whether it’s a reversal or continuation pattern, the move that exits the pattern should have similar magnitude as it enters. If you look at the weekly chart, price started to rise in early July, 2009 around the $90 area and entering the pattern around $115 in early 2010, which was about a $25 move. At the end of the diamond, price exited the pattern around the $110 level in early September, 2010 and continued rising until it hit the resistance @ $135, which was also a $25 move. When you are trading the diamond pattern, make sure you make good use of the second characteristic to determine target and risk of the trade.

The second pattern on the weekly is a Head & Shoulders. I personally don’t trade this pattern a lot simply because my mentor is not a big fan of it. Nonetheless, Head & Shoulders is easy to identify. Just like its’ name, the 2^nd peak (the Head) should be higher than the 1^st and 3^rd peaks (the Shoulders) and the shoulders should peak around the same level. Although I don’t trade this pattern much, I do use the shoulders’ peak @ $134.69 as a resistance level. Some people use the 2 valleys (the Neckline) @ $126.2 in the pattern as a resistance/support level as well; however, I don’t find it provides much insight to my trade so I usually ignore it. To what I know, Head & Shoulders is a reversal pattern. In this chart, an ideal trade was to take a short position as price was forming the 3^rd peak (2^nd Shoulder)@ $134.69 and use the top of the 2^nd peak (the Head) @ $137.18 as the risk. Target wise, I aim for the neckline @ $126.2. If you wish to take a larger gain, you can set your target at any underlying support level below the neckline. The next support level I have is @ $111.92. 

The reason I pull the weekly chart up is to give you a brief overview of the Diamond and Head & Shoulders pattern, now let’s move onto the daily chart and hourly.

In the daily chart, you can still clearly see the Head & Shoulders pattern in the early half of 2010. I keep the shoulders’ top @ $134.69 as a resistance since it bounced off that level for several times. You can also see the neckline (in red) @ $126.2 I have from the weekly chart is 1 point off from my main support/resistance level @ $127.38. If I used the Neckline as my resistance, the price would have broken that level for several times already, which is not a good. Comparatively, the $127.38 level is more solid and formed an ascending triangle with the uptrend line, so I see it as a better support/resistance level.

Now that I see price broke out of the ascending triangle on the upside in the first couple days of 2012, how do I trade this? I’m quite confident that this is a breakout rather than a bull trap (happened once in late October, 2011) because price movement was well above the resistance level for the last 6 - 7 trading days and the moving averages indicate that price movement is still going to be on the upside (I will explain more about this later). According to the book “Getting Started with Chart Pattern” by Thomas Bulkowsk, an up break from the ascending triangle usually results in an average of 30% post-breakout rise. However, that would mean to set the target @ $165.59, which is impossible because this price target is a whole 8 points higher than the 10 years high @ $157.52. Therefore, I switch my target to the shoulders’ top @ $134.69 instead. On the other hand, I use a very tight risk level to minimize my loss if I'm wrong on this breakout. My risk is set at the main support/resistance level @ $127.38 because a good resistance level often becomes a support level when price goes through it and vice versa. If you wish to take more risk, you can move your risk down to either the neckline or the uptrend line.

For the hourly chart, it shows a better picture of intra-day price movement and helps me to adjust the entry price. Right now the 5 period simple moving average (the light blue line running along with the price bar trend, aka 5 SMA) is crossing up against all the other periods’ moving averages and the 10 period SMA (in purple color) is making a valley turn as well, indicating the general direction is on the upside. I also throw in a Fib retracement level just to see how far did price give back since it hit the top @ $130.18. Price recently bounced off the 23.6% level @ $127.8, this is also the level where it congested for 3 trading days from last Thursday to Monday; it should serve a fine short term support level. At the end, I lined up a few peaks and valleys showing an up sloping channel, I'm expecting the price to keep trading up within the channel, just be careful when it breaks the bottom of the channel you have your risk level determined and get out of the position decisively.

I hope I gave you some insight in this post, thank you for reading and please feel free to give me some feedback.