Editor’s Note: In the article below from Gabriel Andre–editor of the Swarm Trader and Slipstream Trader–you’ll learn how using technical analysis and chart analysis on ASX 200-listed stocks could add to your Australian stock returns. Read what “Operation Slipstream” is all about and how Gabriel plans to use it for the rest of 2009 to generate trading gains from blue chip stocks.
If you watched the coverage of the Tour de France in July, you would’ve seen how important tactics within a cycling race are to the overall result. What many casual observers of cycling may not realise is how important your actual physical place in the peloton (the large group of cyclists) can be to your overall performance. Where you locate yourself determines how much work you do and, more importantly, whether you are in the right place to make or follow a winning “move.”
Let me give you an example. Stage three of the Tour was a relatively flat 196 kilometre jaunt from Marseille to La Grand Motte. It’s not the sort of terrain in which you’d expect a strong cyclist to try and make a winning move. Normally, these flat stages are controlled by the teams of the sprinters and all the riders arrive at the finish with more or less the same time.
But just 34k from the finish of this stage something strange happened. The riders had been buffeted by winds all day coming off the Mediterranean coast of south east France. Riding in the wind is hard work. Studies show that if you merely ride behind the rider in front of you, you will end up doing around 30% less work! Why?
Strategy and Tactics Combined
When you ride in a “slipstream”, the rider in front of you encounters all the resistance and friction of the wind. If you get into his “slipstream” you avoid the wind. The less work you do riding in the “slipstream” the more energy you have later when you pick the right time to make an attacking move. Riding in the slipstream is a good strategy. Making the right “move” is the tactical aspect.
Near the end of stage three, the riders encountered a stiff cross wind. Since the wind was coming from the side and not directly head on, the riders formed an “echelon.” This meant that instead of riding directly behind one another, the riders rode slightly to the right of the rider ahead of them, with the lead rider on the far left-hand side of the road and the rest trailing off to the right hand side of the road.
This is when the team at the head of the pack played a surprising tactic. It found itself in a good position to make a “move.” It dove into the gutter!
That is, instead of riding on the left hand side of the road and allowing the rest of the field to ride in its slipstream, the lead team all moved to the right side of the road. This forced each of the trailing riders to move further in the right, which in this case turned out to be about four feet off the road in the dirt.
The result was that the echelon was broken and a small-group of 28 riders broke into the lead on their own. Once the “slipstream” was broken, it was impossible for the riders behind-slammed by the cross-wind-to catch up with riders in front. They worked just as hard. But by the end of the day, they had lost 41 valuable seconds-all from being in the wrong place!
Trading Profits Come From Being in the Right Place to Make a Move at the Right Time
What does all this have to do with trading the markets? Quite a bit, actually. To begin with, the goal is the same. To win! In cycling, it’s a race. In investing or trading, it’s to build a long-term portfolio of good stocks or profitable winners.
Whatever the climate on the financial markets, whatever the outlook and the current trends, there are stocks that you want to hold in your portfolio. You may want to own them because you think that over the long-term, they will be winning investments.
The question-especially in markets that lack a clear direction-is when should you make your move to enter a blue chip stock? Or, conversely, how do you know when it’s right time to exit a stock you like, but which has been disappointing you and about which you are not certain?
Timing Your Entry into Long-Term Blue Chip Holdings
Buying and holding a particular stock over years does not mean being passive on the markets. Many investors would love to be able to determine exit and entry points on stocks that they want to hold. It means that instead of buying and staring at your screen without any action, you take advantage of the trends that constitute a price development and offer you highly favourable entry and exit prices.
This means, for example, being able to exit the stock when an uptrend has completed, when the stock is clearly overbought or when a chartist pattern suggests a trend reversal. Why would you exit it? In order to buy it back lower and then lower your initial entry average price. It’s a stock you want to own. But if you can use a chart to help you but it cheaper with better timing, why wouldn’t you?
Let’s take an example with the chart below from BHP Billiton (ASX:BHP). And let’s assume two different investors, happy owners of BHP stocks bought at $12 in 2004. The first one wants to remain “long” BHP over the long-term. He bought them and he wants to hold them without any action. The other one also wants hold BHP over the long-term, but is worried about corrections and interested in the idea of profitably trading any identifiable trends in the stock’s history.
Does the chart help the trader? From 2004 to 2007, it was an easy, quiet and profitable investment as the stock rose from $12 to $47 (October 2007). Buying and holding was sensible. However the last two years have been stressful and bearish.
However, there were clear signals that could have been very useful for this investor willing to take advantage of sharp moves. If he was willing to trade the stock rather than simply to buy and hold, profits were there for the taking (provided he timed his moves correctly).
In other words, a successful strategy could have been to sell BHP when the bullish trend was exhausting itself before buying in back it later, on lower levels. Not all investors may want to do this. But my aim today is merely to show you that it IS possible.
I’ll show your more in a moment how to use charts and technical analysis to time your moves. But let me be clear that market timing is not about doing short-term in-and-outs on stocks that you don’t care about. That’s fine. But that’s speculation. Market timing is about making additional gains from stocks that you want to keep in your portfolio for the long haul.
A timing service that combines chart patterns with basic technical analysis (and some discretionary judgment) may help you limit your downside risk in blue chip stocks while making gains from regular trading patterns possible. It also turns a problem into an opportunity.
This tactic of putting yourself in the right place to make a profitable move is not available to most institutional fund managers. A fund manager whose strategy is to be “long-only” knows that he will have to face negative monthly returns. He cannot sell.
Most of the time, his job is to deliver a better performance than the benchmark of reference, typically a stock index. Even though he can’t short-sell, he can add some value (returns) to his fund by using market timing to reduce the exposure of the fund during bear markets, while being fully invested during bull markets. Market timing is indeed essential to lower volatility and increase returns through risk exposure modification. It sounds complicated, but it really comes down to riding in the stock’s slipstream and timing your move, whether it is bullish or bearish.
Retail investors are less familiar with this as they don’t have time or the tools to manage their portfolio efficiently. They usually don’t manage their portfolio very actively. For instance, you may reckon that you want to hold BHP over the long-term as it should take advantage of the commodities boom. But with a little analysis from the charts and the technicals, you can ride in the stock’s slipstream and could have avoided a significant part of the plunge occurred last year when the stock fell from $50 to $20 in six months.
Blue Chip Trading
In a normal market, you would not think of trading the blue chips. But this is not a normal market. Some stocks are up. Some are down. But there is no real underlying trend that gives you confidence about the general direction of stocks.
That’s why using some tools to put you in the right place to profit from moves in blue chips can be surprisingly profitable (I hope). The idea is very simple: in a volatile market, buffeted by uncertainty, being in the right place to make your move can boost your investment returns AND save you from losses.
I believe “Slipstream” trading (as I call it), based on accurate trading patterns and technical indicators, can help you make surprising large profits in a short period of time off a blue chip. And this is on both the long and short side! Trading opportunities can be identified on stocks that you don’t consider as long-term investments.
To summarise: “Slipstream Trading” can give you portfolio optimisation and discrete trading opportunities. It’s based on medium and long-term technical indications and chartist patterns, it aims to detect, trend completions, overbought/oversold configurations, support and resistance levels on blue chip stocks. Its objective is simple: identify optimal entry and exit points on the most popular Australian stocks (among the S&P/ASX 200).
“Investing Collectively” for Large Cap Profits
Above, I’ve emphasised the importance of market timing to your investment portfolio. Yes, it’s not easy to do (some would say impossible!). But knowing when to enter and then exit stocks isn’t just for speculators.
It can benefit large cap investors too – spectacularly-if you get it right. I’m not talking about telling you what to buy or how to build your portfolio. Rather a sharp bunch of indicators that provide the right entry and exit points on ASX 200 stocks that YOU want to trade.
Take the BHP Billiton (ASX:BHP) example above. I showed that – even if you want to be a long-term holder of a stock – you can still profitably trade its ups and downs over months and years.
But there’s another benefit: by taking advantage of information provided by both the price and the volume actions translated into a chart, you can also pick optimal entry points into stocks you’ve never owned but want to buy into.
Say you’re looking at Paladin Energy (ASX:PDN). You would be amazed how useless it can be to spend hours analysing the fundamentals (the financial ratios of the underlying company and the macroeconomic trends of the sector and of the global economy) when you can get all the synthetised information in a chart.
Not everyone agrees with this of course. But I do. And the chart confirms my analysis! In November last year, my scans indicated a “double bottom” in Paladin which was preceded by a decline that set in well before the October sell-off. Further analysis indicated that this was the optimal time to open a position in Paladin at $1.68. Eight months later, the stock trade above $4.73.
With Slipstream Trading, ‘Safe’ Stocks can be Profitable Too
If you’re a forward-looking investor, the current markets throw up multiple dilemmas – is it time to start buying back the stocks you sold? Are some stocks you own still vulnerable? Is this volatility throwing up profit opportunities that are passing you by? Should you get into banking stocks now… or never?
The speculators are going ballistic. Half of them are making a killing, the other half are losing their shirts. But what should the large cap investor do when there is so much “noise” in the markets? My best answer is – if you want your ASX 200 holdings to be winning investments over time – is to trade in the ‘Slipstream’ of big price moves.
This is easier said than done. That’s why erasing emotions during the investment/trading process is so important. It’s very difficult to accept being wrong (losing trade) when you feel that your thinking was right.
To avoid this, the best answer is to track the charts, and only that. It is assumed that the market players have all the information available. Therefore the price reflects everything: the data, the fundamentals, the expectations, the emotions, the risk appetite etc. And that’s why I like the ‘Slipstream’ metaphor.
Tracking efficiently both price and volume actions will give you the possibility to “launch” your market attacks at the propitious moment. Exactly like the cyclist I used to be in my early 20’s, when I was riding up and down the hills and valleys of the Pyrenees.
An Individual Sport, Practiced Collectively
One maxim says that “cycling is an individual sport practiced collectively”. It means that alone, you are nothing, whatever your skills. This is exactly the same in the financial world: you cannot possibly win if all the other competitors are against you.
And I believe this is especially the case when trading the biggest companies on the stock market – ones with market capitalisations over $800 million. Because here there are a heck of a lot of other investors trading the same stock, meaning more chances to ride in the ‘Slipstream’ of price moves.
See, in cycling, you have to take advantage of the peloton to be able to win a race. This means being able to identify and assess the strengths and the weaknesses of the peloton. You don’t need to analyse the weather conditions, the distance or the slopes (the fundamentals) because the other racers have analysed them too. You won’t make the difference here.
However, you will be able to win if you are able to analyse, understand and anticipate the behaviour (the price action) of the peloton. It is them you are racing against. If you are able to identify when you have to wait in the middle of the pack or when it’s time to attack, then it means you’re a potential winner.
A Question of Timing
This is exactly the same thing with stock markets. If you understand and anticipate the price action, if you know when you have to wait (hold) and you have to attack (place a trade), then you’re a potential winner. It’s a question of timing. Market timing. It doesn’t guarantee victory, of course. But it can put you in exactly the right position to profit, time after time.
I quickly found that technical analysis for market timing purpose would be my best friend when I started my career in the investment industry. I have been using technical analysis and chartist indicators for almost ten years now. I’m absolutely certain my gruelling cycling slogs through Pan, Jurancon, Gan and Coteaux de Lasseube gave me an edge in analysing the markets. In fact I’m surprised I’ve not heard the analogy before, as I know many traders who are avid cyclists.
I’ve profitably used my ‘Slipstream’ timing technique both as a trader for hedge funds and as an analyst for the Swarm Trader . The key is to detect what is the priority and what is of secondary importance when you trade.
The priority is to track what the crowd does. The rumours, the news, the statistics and all other pieces of data that constantly arrive on your screens are of secondary importance. These will be translated into price development regardless of what you make of them.
If you know how to “read” what the crowd does, then you can anticipate what the crowd will do. This relies only on the analysis of the price action. Indeed, you “read” the behaviour of the crowd through indicators and chart patterns.
To summarize: If you read this information correctly, you can position yourself in a slipstream – or ‘profit pocket’ – of an imminent price move. Professional cyclists call it “cheating the wind”. Here you could call it “cheating the market. Find the “bubble” in the price action and let the investors in front of you do all the work.
This is a remarkable way to detect perfect buying points in Australia’s top 200 stocks. It can help you make great profits in a short period of time off a blue chip stock. In some cases, the kind of gains many small cap gamblers would be envious of.
Of course, we’ve yet to cover the most important part: how do you know when a slipstream move is forming? Below, I’ll ‘lift the bonnet’ on my system, and give you a step-by-step look at how I integrate technical indications and chartist patterns to pick optimal trading points for ASX 200 stocks.
How Charts Can Position You in the Leading Pack
It looked like Mark Cavendish was simply going through the motions when he won Stage 10 of the Tour de France in July. He got a perfect lead-out from his Columbia-HTC squad. It propelled with great force the 24-year-old through two tight right-hand turns in the closing kilometre and safely on to the ramp of the 250m finishing straight.
Then, he exited the ‘Slipstream’ and his power took him away from his pursuers. Cavendish paid tribute to the way his team-mates had nursed him through three days in the Pyrenees: “I had eight guys trying to help me conserve my energy,” he said. This is the whole idea behind Slipstream trading, which we’ve covered above.
Let the rider – or stock buyer – in front of you cope with the headwinds. If you get into his “slipstream” you do less work. The less work you do riding in the “slipstream” the more energy you have later when you pick the right time to make an attacking move. Riding in the slipstream is a good strategy. Making the right “move” is the tactical aspect.
Taking this approach can help you, as an investor in large cap Australian stocks, answer many questions you may well have found yourself asking this year: When should you buy when a stock is riding a bull trend and is constantly rising? Should you at all? How do you avoid buying on tops? When should you take profits when a stock has had a surge? How do you avoid selling on lows?
All of these questions rely on making your move at the right time.
‘WHEN’ Not ‘WHAT’
When it comes to the ASX 200, my goal is to reveal not WHAT to buy, but WHEN to buy it. My assumption here is that you already know what stock you want to own, for whatever reason. The main issue now is to identify the best entry point.
Similarly, if you hold a stock and you have already decided to sell it (whatever the reasons that convinced you to sell), then your problem is to determine the best exit point.
Here’s an important point: just as in cycling, you don’t need to be in pole position in a trade to be an ultimate winner.
I love using this form of technical analysis to find entry and exit points for large cap stocks. It is unlike pure science: because you’re actively PARTICIPATING in the outcome. You’re not a dispassionate observer. When you take a position, you’re influencing and building on a pattern so the one you pick almost becomes a self-fulfilling prophecy.
This is like cycling in a race. While riding in a pack you’re participating in a co-operative effort; one that, all going to plan, leaves the next bunch of cyclists further and further behind you. Of course, you can only win by knowing when the next ‘move’ is about to take place.
So the big question is: How Do You Know a Move Is On?
So how do you know when to move with a price break-out, or hold back? On which elements do you base your decision?
I’m not going to attempt to turn you into a professional technical trader. For one, it would take a lot more than a long introduction like this. I’m not much of a teacher anyway. But what I do have is experience. In sharing some of this with you, I hope to at least help you make more enlightened investment decisions.
I believe that identifying and making ‘Slipstream’ movements is relevant to determining two important things:
- What forces are working inside the ASX 200 at any given time
- Where those forces might send a specific stock next
Knowing those two things can be very profitable in the long, medium – and in a small number of cases – the short term. How do you know a slipstream move is forming?
Inflection Points: Your Invitation into the Slipstream
Depending on the trading style and time frame, the tools or indicators that you use will differ, and the way you will weight them also varies. But the goal is always the same: identify the slipstream and position yourself in the right place to profit.
It’s a case of putting your capital in the right place at the right time. And, if you wish, getting it out at the right time.
To be able to detect optimal entry and exit points you have to identify potential chartist inflection points. These appear through technical recognitions such as trend completions, overbought/oversold configurations, and support and resistance levels. And thanks to price indicators and volume indicators, those technical recognitions can be detected and then offer opportunities for getting in or out of the trade.
I realise I’m getting a little technical here. And, bear with me, because I’m going to get a little more technical – but I think it will be worthwhile. The point I’m making is quite simple.
Fundamental analysis might tell you WHAT stock you want to own or not own. But, in my view, only tracking and interpreting technical variables will tell you when a price ‘move’ is about to take place.
I use three tools to identify slipstream moves: technical variables, chart patterns and discretionary analysis.
You might have heard most of the technical variables. I liken these to the equipment pro cyclists use to win races. Where the casual observer sees a bicycle, pro cyclists see a Monocoque carbon aerodynamic design, carbon Vibe handlebar, PLT stem, carbon seatpost and 5mm gel armrest pads.
It all may seem a little trivial to us. It’s anything but for those who find themselves on the winner’s podium. Cavendish, for instance, went wild one day during the Tour when he suddenly decided he didn’t like something about his front wheel. He reached down to snatch at the quick-release, pulled the wheel off, and looked as though he might have hurled it at a mechanic if there hadn’t been a few spectators around the team bus. He got the wheel he wanted, and won the stage.
Similarly, when your average chart observer simply sees a bunch of lines and bars, the professional technical analyst sees oscillators and momentum indicators such as MACD, Commodity Channel Index, Momentum Indicator, Money Flow Index, Volume Oscillators and the like.
These are the most popular indicators used on the global trading floors. Read these variables correctly, and you’re in the ‘Slipstream’.
Of course, simply gaining a place in the peloton (the group of cyclists) doesn’t guarantee you’ll win, or even be able to stay with the group. Which is where we get to…
Remember, we’re talking about timing the markets here. Therefore both daily and weekly data are used. So in addition to indicators, I focus on chart patterns and line studies that regularly form. This is a mathematical way of tracking mass psychological and cycles, and the patterns they form to suggest impending price moves.
Think of these, once you’re riding in the pack, as really good signs – taken from the actions of the other pack members, as well as observations of the terrain – that a ‘move’ is on the cards.
The patterns I look for are head and shoulders; double tops/bottoms; indecision triangles; price channels; wedge patterns; Fibonacci lines and more. Finally, and most importantly…
Use Discretionary Analysis to Make Your Move
On top of indicators and patterns, it’s essential to add discretionary analysis to eliminate risky configurations that technical or model-driven systems can’t detect. You can have all the tools and training in place to position you with the lead pack, but it’s your ‘top two inches’ (your brain) that will determine whether you win or lose.
This analysis relies on one thing: experience. It’s not just a question of “how” but rather a question of “know how”.
In trading, it’s not complicated to understand how the indicators and the mathematical stuff behind each tool. However, the main issue is to know how and when to use them and in which context. Think of this as the thought process that goes through your head before the “bunched sprint” to the finish line begins.
One indicator by itself is not sufficient to provide a solid signal. Indicators must be combined to get confirmations and to have then a high degree of accuracy. They are more or less sensitive to price action, or to volume action. Some of them perform when combined, while others are redundant and not complementary. You don’t learn that in books or seminars. You learn that when you trade.
I know I haven’t turned you into a ‘pro-technical analyst’. But hopefully I’ve given you a little insight into how chart-watchers such as myself view and profit from underlying price actions. Below, I’ll give you some specific examples of how I’ve used this ‘Slipstream’ timing technique to profit from large-cap ASX stocks in recent months.
How to Boost Your ‘Boring’ Buy and Hold Returns by 105%
“Legacy stocks” are ones you believe in – income generators and slow-growers you’d like to think you’ll pass on to your kids one day. There’s no harm in owning a collection of legacy stocks on the ASX. But there’s no harm in maximising the returns they give you, either.
Take the BHP Billiton example I showed you earlier in the week. Remember I gave you the example of two types of traders: one who will steadfastly remain “long” on BHP. He loves the stock and will never let go. The other also likes BHP long-term, but is keen on limiting losses on corrections and profiting from rallies.
Fundamental analysis may help the first investor in picking BHP outright. But it will be much less useful to the second investor – the one who wants to track and profit from movements in the underlying price.
To do this effectively, you need to look to the charts. Interpreting technical variables and indicators will tell you where a price is trending. That’s how you get into the ‘Slipstream’ of a price movement. One such indicator is bearish (or bullish) divergence.
Bearish and bullish divergence between price and the relative strength index (RSI) can forecast possible trend changes in a stock’s movement. If you can learn how to identify these turning points, you can extrapolate where a price might be heading. A bullish divergence often foreshadows an upward movement in price. A bearish divergence indicates a downward correction. Take BHP Billiton (ASX:BHP).
Avoid the Correction, Buy Back for the Rally
In May 2008, the charts showed me a clear bearish divergence was forming. As you can see in the chart above, the price action was posting a new high (point B) at $50. The RSI was oppositely posting a lower high (point D). This breach meant that the oscillator was not backing up the rally of this stock. Therefore a trend reversal was imminent.
As soon as the RSI peaked and curved downward, it was indeed the perfect time to sell the stock. This signal was triggered the week when the stock traded between $46 and $49. Had you received this signal, you could have sold out and taken profits before the stock plunged under $25.
Following this, in October ’08, a strong signal to buy back BHP occurred. This is indicated by the circle, when this same RSI posted an historical low in its oversold area (it had not happened once since 2003). Remember that this is the weekly RSI: it meant then that the stock was oversold on a weekly basis, which strengthens the reliability of the indication.
As soon as the RSI curved upward AND left the oversold area. This is a bullish signal signifying that a group of buyers was forming to push the price higher. In the last week of October 2008 a signal was triggered that it was time to join the ‘Slipstream’, when the stock traded around $25.
A Story of Two BHP Investors
So let’s recap where our two BHP investors stood in June this year. Remember, we’re assuming both investors got into BHP in 2004 at $12 when the resource boom began. One investor is using technical analysis and charts to time his exit (and later entry). The other is not. How do the two compare?
The first investor who simply buys and holds hasn’t done poorly. A recent close at $34.91 means he’s sitting on an unrealised gain of 191%. There was a big up and then a big down. But over the journey, he’s respectably up-although he hasn’t realised any profits yet. Still, not bad at all.
What about the second investor? He’s the one who makes his “move” in BHP based on the language of the market and not because of a fundamental fidelity to the position. The second investor would have sold when the stock price peaked at point B in the chart, but the RSI made a higher low (point D). This was the “sell signal” that I saw flashing but would not have been on the radar of the first investor.
If the second investor sold at $47 (not the high, but after the signal was triggered) he would have realised a gross profit of 291% on the long-term trade. That’s a full 100% better than the buy-and-hold investor number one. But there is more.
The second investor is not entirely neutral on BHP. He wants to own it. But his aim is minimise his exposure to price volatility while maximising the generally positive upward trend. In October of 2008, he notices the historically low RSI corresponds with a low in the share price. A buy signal is triggered at around $26.
He enters a new position in BHP at that point and using yesterday’s close-in addition to his gross profit of 291% which he’s already booked-he’s sitting on a second but unrealised gain of 34%. He’s long the stock again but he’s already made money.
Both these investors are “long” BHP, a decision they made in 2004. Both still own the stock. But compared to investor one, investor number two – if you combine his realised and unrealised gains – has doubled his profits and is sitting on a new gain, while investor number one is sitting on a respectable but unrealised gain.
To be sure, I am making some assumptions with this example. I’m assuming both investors entered BHP at a low. I’m also assuming investor number two got his exit and entry signals correct. It is always easier to do this in retrospect. Doing it in real time is the test of a true trader and a good system.
I hope to bring you more examples in the future. In the meantime, the BHP trading pattern of the last year is an excellent example of how you can use technical analysis to maximise returns on your long term holdings. It’s a tool you should consider adding to your investment playbook for your sprint to glory!