Saturday, October 14, 2006

Short Setup #1 and 2: Falling Off the Mountain and Falling Off the Hill

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Over the next few weeks I'm going to present a few of my favorite setups, which I've labeled in my trading journal as "money setups". The first two short setups are, what I call "Falling off the Mountain" and "Falling off the Hill". What's so great about them? In my opinion, they do a good job of combining key elements of technical analysis: candlesticks, support and resistance levels, stochastics, RSI and chart patterns. Used seperately, each element is rather weak. However, combining them can give you a powerful edge.

Short Setup #1: Falling Off the Mountain Top:
1. Look for a bearish engulfing candlestick pattern in an uptrend. If you are not familiar with this pattern, here is information on engulfing patterns.

2. Check both RSI and Stochastics. Both must be in extremely overbought territory (above 70 or 80, depending on your preference).

3. Look for confirmation that the uptrend is over.

A. Both RSI and stochastics should break below your chosen overbought level. I focus on the stochastic more than RSI, and will sometimes make an entry when RSI has not reached overbought status but stochastics have.

B. Fast and slow stochastic lines should cross.

C. Price has moved below the bearish engulfing candle formation.

4. Enter and place stop just above the bearish engulfing candle formation.

This setup identifies stocks that are extended and may be topping. While it's always risky calling a top, the beauty of this setup is that it waits for confirmation of a fall, rather than trying to predict it. Also, it is low risk in the sense that the stop is so close to the entry point. Five losing trades can be all but forgotten with one big win, and the wins can be huge with this setup. If you used this setup over the past few months, you would have caught many of the energy and metal freefalls. Take a look at this chart of Goldcrop, Inc. (GG):

Notice that this setup caught the top of a head and shoulders pattern. This happens frequently. Here is information on other bearish patterns.

Short Setup #2: Falling Off the Hill
A second way to use this setup is on low volume pullbacks moving back up to the resistance level of a head and shoulders pattern, or any pullback to resistance in a bearish pattern. We're now talking about falling off a hill instead of a mountain, but it's still very profitable, and a little more safe since this pattern is now being used in the midst of a downtrend.

This second method is the way I'm currently using this setup in the energy and metal sectors. The big top has been made, and now stocks in these sectors are moving back up to the first major resistance point. I'll be looking for bearish engulfing candle patterns as these stocks become overbought near resistance. Valero Energy Corp (VLO) is setting up as a possible "falling off the hill" short candidate in the near future:


walter said...

nice idea for a post!

Masterjaz Out said...

The falling off the mountain trade is perfect. I trade the exact opposite in my IRA. I wait for doji or bullish engulfings at the bottome of a trend coupled with a slow stochastics (5,5 lookback) below 25 and a uphooking CCI (basically RSI). Trade works well. Check out . Again, great post and good luck.

Masterjaz out

The Market Speculator said...

Thanks Walter!

Funny you mention having the "exact opposite trade". I too have a couple of long setups that mirror these short setups, which I'll post next week.