A Two-Bar Pattern that Points to Trade Setups

Trader Education Week begins September 26

Some people like to get outside on the weekends, maybe playing tennis or working in the yard. Some people like to visit their friends or cook a big meal or go out to see a movie. And some people who are passionate about their work — such as Elliott Wave International’s (EWI) analyst Jeffrey Kennedy — like to stare at hundreds of price charts on their computer screen to find patterns that point to trade setups. We used to worry for his health but not anymore, because he’s been doing it for years and he comes up with some amazing trading lessons. Enjoy this lesson on bar patterns from EWI analyst Jeffrey Kennedy.

[Editor’s note: Elliott Wave International is hosting Trader Education Week, September 26 through October 3. During this event, analyst Jeffrey Kennedy will share video trading lessons that will empower you to improve the way you trade.]

The Popgun I’m no doubt dating myself, but when I was a kid, I had a popgun — the old-fashioned kind with a cork and string (no fake Star Wars light saber for me). You pulled the trigger, and the cork popped out of the barrel attached to a string. If you were like me, you immediately attached a longer string to improve the popgun’s reach. Why the reminiscing? Because “Popgun” is the name of a bar pattern I would like to share with you this month. And it’s the path of the cork (out and back) that made me think of the name for this pattern.

The Popgun is a two-bar pattern composed of an outside bar preceded by an inside bar. (Quick refresher course: An outside bar occurs when the range of a bar encompasses the previous bar and an inside bar is a price bar whose range is encompassed by the previous bar.) In Chart 1 (Coffee), I have circled two Popguns.

So what’s so special about the Popgun? It introduces swift, tradable moves in price. More importantly, once the moves end, they are significantly retraced, just like the popgun cork going out and back. As you can see in Chart 2 [not shown], prices advance sharply following the Popgun, and then the move is significantly retraced. In Chart 3 [not shown], we see the same thing again but to the downside: prices fall dramatically after the Popgun, and then a sizable correction develops.

How can we incorporate this bar pattern into our Elliott wave analysis? The best way is to understand where Popguns show up in the wave patterns. I have noticed that Popguns tend to occur prior to impulse waves — waves one, three and five. But, remember, waves A and C of corrective wave patterns are also technically impulse waves. So Popguns can occur prior to those moves as well.

As with all my work, I rely on a pattern only if it applies across all time frames and markets. To illustrate, I have included two charts of Sirius Satellite Radio (SIRI) that show this pattern works equally well on 60-minute and weekly charts. Notice that the Popgun on the 60-minute chart [not shown] preceded a small third wave advance. Now look at the weekly chart [not shown] to see what three Popguns introduced (from left to right), wave C of a flat correction, wave 5 of (3) and wave C of (4).

There’s only one more thing to know about using this Popgun trade setup: Just be careful and don’t shoot your eye out, as my mom would say.

A FREE trading event that will teach you how to spot trading opportunities in your chartsElliott Wave International is hosting a free Trader Education Week, Sept. 26 through Oct. 3. Register now and get instant access to 4 free trading resources from EWI analyst Jeffrey Kennedy — plus you’ll receive more lessons from Jeffrey as they’re unlocked each day of the event.Don’t miss this opportunity to learn how to spot trading opportunities in the markets you follow. Register Now >>

This article was syndicated by Elliott Wave International and was originally published under the headline A Two-Bar Pattern that Points to Trade Setups. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

Triple Witching In September

The Stock Trader’s Almanac notes that seasonally for the last few years, Dow has done well on the triple witching day in September. Dow Jones had been up 8 of the last 10 years on the third Friday of the last month of the third quarter.

We can develop a trading strategy based upon this seasonal trend. This seasonal tendency also impacts S&P 500, NASDAQ and Russell 2000.

The original Almanac strategy goes long on the Thursday close before the triple witching day in September and exits on the Friday close. Using ETFs – DIA for Dow, SPY for S&P, QQQ for NASDAQ and IWM for Russell 2K – we get following results:

ETF # of Trades Win % Avg. Ret Avg. Avg. Win Avg. Loss Avg W / Avg L Avg Days Held Annualized
QQQ 14 71% 0.3% 14 47 (67) 0.70 1 105%
DIA 15 67% 0.1% 6 28 (38) 0.75 1 46%
SPY 20 30% (0.3)% (14) 40 (37) 1.08 1 (102)%
IWM 13 69% 0.3% 15 44 (50) 0.87 1 108%

The annualized rate is computed based upon the average return for the average days held.

Clearly, S&P 500 does not show a seasonal trend. NASDAAQ shows a stronger trend and Russell 2000 has higher volatility.

We can improve the performance of this strategy by applying some filters for entry and exit.

Entry Filter: Go long on the Thursday close before the third Friday of September only when the price is below the 5-Day SMA. This filter is applied on DIA, SPY and QQQ.

Exit Filter: Exit on the 3-Day high close. (For DIA, SPY and QQQ.)

For Russell 2k, IWM, a hybrid exit strategy is used.

Entry: Go long on the Thursday close before the triple witching day.

Exit: If IWM was above 5-Day SMA on entry then exit on the triple witching day close. If the price was below 5-day SMA then exit on the 3-Day high close.

The filters reduce the numer of trades but improve the overall result.

ETF # of Trades Win % Avg. Ret Avg. Avg. Win Avg. Loss Avg W / Avg L Avg Days Held Annualized
QQQ 7 100% 1.6% 78 78 3 209%
DIA 8 88% 0.8% 41 62 (102) 0.61 3 90%
SPY 8 75% 0.7% 36 63 (44) 1.42 3 84%
IWM 12 75% 0.5% 26 47 (36) 1.31 2 114%

Here is the list of trades using the modified strategy:

# ETF Entry Date Entry Exit Date Exit Return
1 SPY 16-Sep-93 46.03 22-Sep-93 45.41 (1.3)%
2 DIA 17-Sep-98 78.78 21-Sep-98 79.25 0.6%
3 SPY 17-Sep-98 101.46 22-Sep-98 102.33 0.9%
4 QQQ 16-Sep-99 61.47 17-Sep-99 63.31 3.0%
5 DIA 16-Sep-99 107.53 17-Sep-99 108.38 0.8%
6 SPY 16-Sep-99 131.75 17-Sep-99 133.04 1.0%
7 QQQ 14-Sep-00 93.00 19-Sep-00 93.19 0.2%
8 DIA 14-Sep-00 111.02 22-Sep-00 108.75 (2.0)%
9 IWM 14-Sep-00 53.91 15-Sep-00 52.91 (1.9)%
10 QQQ 20-Sep-01 28.97 24-Sep-01 29.61 2.2%
11 DIA 20-Sep-01 83.65 24-Sep-01 86.20 3.0%
12 SPY 20-Sep-01 98.18 24-Sep-01 100.16 2.0%
13 IWM 20-Sep-01 38.56 24-Sep-01 39.00 1.1%
14 QQQ 19-Sep-02 21.58 25-Sep-02 21.87 1.3%
15 DIA 19-Sep-02 79.64 26-Sep-02 79.81 0.2%
16 SPY 19-Sep-02 84.25 25-Sep-02 83.90 (0.4)%
17 IWM 19-Sep-02 36.40 25-Sep-02 36.45 0.1%
18 IWM 18-Sep-03 51.86 19-Sep-03 51.80 (0.1)%
19 QQQ 16-Sep-04 35.32 17-Sep-04 35.43 0.3%
20 DIA 16-Sep-04 102.75 17-Sep-04 103.01 0.3%
21 SPY 16-Sep-04 112.54 17-Sep-04 112.55 0.0%
22 IWM 16-Sep-04 57.32 17-Sep-04 57.22 (0.2)%
23 QQQ 15-Sep-05 39.16 16-Sep-05 39.40 0.6%
24 DIA 15-Sep-05 105.66 16-Sep-05 106.23 0.5%
25 SPY 15-Sep-05 122.49 16-Sep-05 122.84 0.3%
26 IWM 15-Sep-05 66.17 16-Sep-05 66.94 1.2%
27 IWM 14-Sep-06 72.49 15-Sep-06 72.66 0.2%
28 IWM 20-Sep-07 80.79 21-Sep-07 80.96 0.2%
29 QQQ 18-Sep-08 41.57 19-Sep-08 42.90 3.2%
30 DIA 18-Sep-08 109.97 19-Sep-08 113.57 3.3%
31 SPY 18-Sep-08 120.07 19-Sep-08 124.12 3.4%
32 IWM 18-Sep-08 71.80 19-Sep-08 75.00 4.5%
33 IWM 17-Sep-09 61.66 18-Sep-09 61.91 0.4%
34 IWM 16-Sep-10 64.94 17-Sep-10 65.21 0.4%
35 IWM 15-Sep-11 71.41 16-Sep-11 71.52 0.2%

The overall win percentage of the strategy is 83%.
The average return in 0.8%.
The average win to average loss ratio is 1.23.
The average hold period is 3 days.
The annualized return in 118.3%.

The strategy had only three losing years – 1993, a loss of (1.3)%; 2000, a loss of (1.2)%; 2003, a loss of (0.1)%.

Instead of 1X ETFs, one can also use ultra ETFs (2X or 3X). Using 2X ETFs, DDM for Dow, SSO for S&P, QLD for NASDAQ and UWM for Russell 2k, will double the return but will also increase the risk.


The Fine Print: Before employing this strategy in your live account please understand the rationale behind this seasonality pattern. Then run some back tests for the trade start-date and holding periods. Make sure that the risk level, max draw down, win ratio and average loss falls within your comfort zone and that you can withstand the draw down and the associated risk. Also read our disclaimer.


Inflation or Deflation

The ninth month of the year 2012 has seen a series of quantitative easing and stimulus announcement from a sundry of major government and central banks. First off the block was the ECB, which announced a commitment to buy unlimited amount of sovereign debt of up to three years in maturity. Then China’s central government announced a $150bn infrastructure spending package. In the middle of the month, Federal Reserve embarked on QE3 with a plan to buy $40bn worth of mortgage-backed securities each moth without an announced end date. During the same period, Bank of Japan, concerned due to rising yen, launched $26bn quantitative easing, it’s eighth so far.

With so much stimulus and quantitative easing, the talks about inflation were bound to become headline. But, is that the case?

Reuters/Jefferies CRB Index had been declining ever since it retraced to the 61.8% Fibonacci level of the 2008-financial crisis induced fall in May 2011. After reaching to the highest level in May 2011 since March 2009, it turned down and retraced 61.8% of the advance from the lows of March 2009. The index then bounced off the lows of June 2012 and by September, it had retraced 50% of the decline from May 2011. This Fibonacci level also coincided with couple of other resistance highs made in October 2011 and February. The resulting down-drift from this resistance ceiling is increasing a chance of an inverse-head-&-shoulder pattern provided the index arrests its decline at around 290 levels. In 2011, CRB index declined first from early September to early October and then from Late October to mid-December. Both times it found support at around 290 levels.

The broader Goldman Sachs Commodity Index has slight different chart action. From the bottom of March 2009, it retraced to 78.6% Fibonacci level by April 2011. Before that it had made a horizontal trading channel for a year – from October 2009 to October 2012. Since April 2011, it has been forming a descending triangle pattern. The lower bound of the triangle overlaps with the upper bound of the 2010 horizontal channel.

These two commodities indices show that though they have risen from the lows they are still stuck in a trading range without a strong upward bias. Their current action after the series of QE and stimulus announcement by the major global policy makers is also muddled with somewhat downside bias. The inflationary pressures do not seem to be too obvious at the moment.

On the other hand, the 30-Year US Treasury bond is perhaps making a topping pattern but it has not yet toppled over decisively, though, the recent action is down. Bonds move in reverse direction than the interest rates. Bonds also do not indicate any dangers of runaway inflation.

US dollar index has broken below an uptrend line that it had been tracing since August 2011. At the end of that uptrend it made an uneven double top formation in July 2012. Since then, by September, it has completed the downside measured move off that pattern. The dollar index is also within a long term trading range – bounded by high 80’s and low 70’s. This chart also corroborates the commodities and bonds that though deflationary pressures are vanishing the inflationary pressures are nowhere to be seen.

How to Find Correct Elliott Wave Patterns in Market Charts

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