Trading is one of the most interesting, challenging and rewarding
businesses. Simply, we are tying to find price patterns that have high
probabilities of follow through, then we look to the market internals to check
if it makes sense to hold a bullish or bearish trade and, if possible, we
compute share size per our Trading Play, enter the trade and then enter
“management mode.” As a trader looks for stocks to trade in a certain area, it
is best to trade the cleanest patterns which show relative strength for longs
and relative weakness for shorts.
You can determine strength through
various ways. Some include comparing the stock to the sector, market internals,
or itself. For instance, if the SMH has a bullish daily, gapped up, and has a
gap to fill on the 5-Min. chart, but AMAT also has a bullish daily, also gapped
up, but is standing at the high into the first reversal and did not pull back.
It is showing relative strength to the market. Now suppose the S&P Futures
pulled into the gap fill on the 5-Min. chart (and TICK fell and TRIN rose), but
both SMH and AMAT also have a bullish daily, also gapped up, but are standing at
the high into the first reversal and did not pull back, they are showing
relative strength to the market internals. Finally, many novice traders believe
that a stock’s Relative Strength Indicator (RSI) measures relative strength to
the market. Remember, the RSI, like any oscillator, is a derivative of price and
volume; therefore, all compare stock action to itself, not to a broader market
index. So RSI measures the momentum of a stock’s price action compared to its
price “x” periods ago (default is 14 days), but to me, presents no advantage
that is otherwise not readily determinable from price action.
“winnowed” long and short trades for feasible entry at market open, I observe
two market minders looking for relative strength or weakness. I have sorted, in
order of most up on the day, both the Dow-30 and a separate Trading universe of
about 125 stocks. If the market gaps down and I am considering fading the open
and looking a long, I will focus on those showing relative strength compared to
the broader market. Similarly, if the market gaps up and I am looking for a
short, I will focus on the weak stocks, which are those down at the open that
did not contribute in the market’s gap power.