by Pinchas Cohen
Tensions Mount
Combative rhetoric between the US and North Korea is escalating. While we’re used to that sort of thing from Pyongyang, it's unusual coming from Washington DC. Yesterday's comments by North Korea's foreign minister Ri Yong-ho, made in New York, would be considered an act of war by most countries under more traditional circumstances.
Though North Korea has accused the US in the past of declaring war against it, the Pentagon sending war planes on Saturday which flew near North Korea's coast, along with South Korea stepping-up of its live-fire tests does appear to ratchet up the possibility of a serious conflagration on any missteps or misunderstood bellicosity.
Why Tech Leads Rallies
Large cap technology stocks have been the leaders of market rallies, especially since the US election. That's because they're growth stocks, sometimes called discretionaries, which do well during expanding economies and rising markets, as opposed to defensive stocks, sometimes referred to as staples, which see improved performance when economies slow and markets fall since they sell products consumers can’t do without.
Therefore, during times of uncertainty when investors want to protect their money, they rotate out of discretionary growth stocks and into defensive staple stocks and other safe havens. Given the current, highly risky geopolitical climate, it makes complete sense that yesterday’s declines were led by large caps, which lead the tech industry.
This presents investors with trading opportunities. Large tech stocks can be traded via a variety of ETFs such as the Technology Select Sector SPDR (NYSE:XLK) and iShares US Technology Fund (NYSE:IYW) but in this post we'll discuss the Dow Jones Large-Cap Technology Index.
The index has been falling since Tuesday and crossed below its uptrend line since the beginning of July on Friday. This may signal a return to the less-steep, longer uptrend line since June 24, 2016, when global stocks began to rally after investors realized the world hadn't ended with the Brexit vote. The uptrend is currently above 1350 and rising.
There is support at the 1370 area since July 27. Note that it was a resistance in July, and before that in May.
Violated Resistance Turns to Support
Short-Traders Buy: whoever shorted gold at $1,300 saw it gain 6.3 percent April-May, and higher, to 7.1 percent, during June-July. Those traders were wrong when they tried the same thing in August. They are expected to join the new, uptrend - and place buy orders at the same $1,300 level.
Long-Traders Buy: whoever bought on August 20, made up to 1.55 percent in one day and up to 5 percent if they held on till September 8. They are likely to remember that big win - and are expected to place more buy orders at the same $1,300 level.
Closed Traders Buy: whoever closed a position before the September move – if via shorting counting their lucky stars since, while hoping for a chance to join the uptrend; if they went long, kicking themselves since and would be all too happy to jump right in with a second chance – and add to the buying at the $1,300 level.
On-the-Fence Traders, because couldn’t decide on a direction, after the 5-percent move in September, are likely to have recognized the uptrend - and buy at $1,300 level.
Since technical analysis is a study of market structure, often the “middle ground” between buyers and sellers ends up between different “pressure points.” In this case, the uptrend line since the Brexit vote meets the 1370 support on October 20. That may mean that the price will find significant support at that confluence of price and time.
Trading Strategies
Risk-Reward: Get the Good Side of Statistics
A common trader mistake is to cut wins (on fear of exiting on a loss) and run with the losses, thereby deluding onesself into believing that the price will turn around, and thus digging an ever-deeper hole. Traders must do the opposite: cut losses (to avoid losses...duh) and run with their wins to milk the trend, cover losses and cost of trading and allow themselves the chance to make a profit.
A classic risk-reward ratio is 1:3. In this way, a loss won’t take your account to the point of no return and a win will make up for several small losses. That means when traders select a stop-loss, they should factor in the target profit, consider its viability, then stick to it. Otherwise, they fall back into a negative risk:reward ratio, by increasing risk and limiting reward probabilities. These catch up with you.
Short Position
Conservative Traders trade with the trend and will therefore skip this trade.
Moderate Traders may wait on a short with a correction to retest the broken uptrend line since July 6, at 1,415—the resistance of the August peak—with a stop-loss above the 1,430 September peak, potentially forming a Double-Top pattern, exposing a +$15 risk, and ride it down to 1,370, for a $45 gain, satisfying the 1:3 risk-reward ratio.
- Entry : 1,415
- Stop-Loss: 1,430
- Take-Profit: 1,370
- Risk-Reward: $15:$45 = 1:3
Aggressive Traders may wait on a short for a return move to the round, psychological, 1400 level, with a stop-loss above the 1,410 resistance from July 20-August 16, exposing themselves to a $10 risk, which means they shouldn’t close the position before it reaches 1,370, making a $30 profit, to satisfy the minimum 1:3 risk-reward ratio.
- Entry: 1,400
- Stop-Loss: 1,410
- Take-Profit: 1,370
- Risk-Reward: $10:$30 = 1:3
Very Aggressive Traders may enter a contrarian-long trade, counting on the connection, with a very small risk relative to the potential reward. A stop-loss beneath yesterday’s 1,380 low, puts themselves at a $2.22 risk, which means they can satisfy the 1:3 risk-reward ratio when the price rises to 1,394, with a higher potential till the key 1,400 level.
Long Position
Conservative traders would wait for the price to retest the 1,370 support, with a second day advance that covers the previous day’s decline. An entry at 1,380 provides a $10 risk. The 1:3 risk-reward ratio would be satisfied with a take-profit at 1,410, with potential for another $20 on top of that, till the 1,430, September peak.
- Entry: 1,380
- Stop-Loss: 1,370
- Take-Profit: 1,410 – 1,430
Moderate traders would wait for the price to fall below 1,380 to enter a long position, with a stop-loss beneath the $1,370 July-August trough. Assuming a $5 risk, the 1:3 risk-reward ratio would be satisfied with a $15 profit, when the price reaches 1,390, with another $40 potential, till it reaches the 1,430 September peak.
- Entry: 1,375
- Stop-Loss 1,370
- Take-Profit 1,390 – 1,430
Aggressive traders would go long with a close beneath 1,380, exposing themselves for up to a $10 risk till the 1,370 support. The 1:3 risk-reward ratio would be satisfied when the price reaches 1,410, providing a $30 profit, with potential for an additional $20, till $1,430.
- Entry: 1,380
- Stop-Loss 1,370
- Take-Profit 1,410 – 1,430