DE is one of our core short positions in place, it's currently at a +6.6% profit as it was entered at $88.83 and it was intentionally left with room to add, currently it's about 2/3rds of a full size position, there's no leverage at all, just an equity short.
If you prefer, CAT is almost the exact same setup being they're both in the same Sub-Industry group, "Farm and Construction Machinery" in the "Manufacturing" Industry group.
Even though I think CAT and DE have excellent profit potential, I would not call either one a new short position right now, in fact i'm debating whether to cover DE temporarily for a better entry, but that's dependent on the stock, the group and most of all the market.
However, DE is another good example of why I thought and later as evidence came in, expected an upside market move.
I've found the market does very little without a reason, the reason I suspected a strong upside move was because of a majority of shorts on my watchlist being so close to ideal entries, I've used the NFLX example the last couple of days...
NFLX is so close to an area where retail longs, who are now at 52% bullishness according to Investor.com (which I'm told is one of the highest readings of the Summer)
will buy NFLX on a breakout move above the former high represented by a "Tweezer Top".
This post would be extremely long if I wrote the reasons why a breakout like this is an excellent short set up, however if you read these two articles I wrote, you'll understand all of the reasons why and they can be applied in reverse to bullish set ups and used in ANY timeframe in just about ANY market.
These are always linked for you at the top right of the site, but here they are again, I think if you read them a lot of things will start to make a lot more sense.
Understanding the Head-Fake Move Part 1 and
Part 2
DE is not at all the same as NFLX, but the concept is exactly the same...
Whether it's a new high, a breakout from a defined range like DE, a breakout above the resistance of a popular moving average like the 50 or 200 day or the breakout from a popular price pattern,
the concept is the same, retail traders like to buy price confirmation.
When they buy, they create higher prices and demand.
One of the most obvious yet most misunderstood differences between retail and institutional is trade size, most traders have many misconceptions about how institutional money buys and sells and what they need to do it. I think most traders never take the time to think about the challenges institutional traders face in moving positions.
Most of us can buy or sell, even what we'd consider a big position and barely move the stock and certainly not for long, that's not the same for institutional traders who may spend a year or more accumulating a position so when they want to sell or sell short (as far as the tape is concerned, selling and short selling are the same thing, both sales) they need 3 things:
1) Someone to take the position off their hands and what is the easiest way to do that? It's to make the position attractive such as a break out or a new high, to touch on that greed nerve where a trader feels like they've been left behind long enough and they aren't going to be left behind this time.
2) They need higher prices to sell in to. I was just listening to an interview with a hedge fund manager and rather than use a Market Maker (for NASDAQ stocks) or a Specialist (for NYSE stocks), they tried to fill in house and had moved price against their position by 5%! That's like trying to buy a stock with a bid of $9.98 and an ask of $10.02 with the last being $10, perhaps you expect a 10% profit on the position around $11 and when you go to buy you are filled at $10.50,
half of your anticipated profit already gone and that doesn't even consider the slippage when you go to exit. Then imagine the stock starts trading again around the $10 area.
To create higher prices to sell in to they need the same thing as #1, they need retail to want the stock, they need demand and to do that they have to catch their attention.
3) They need plenty of demand (to sell in to or supply to buy in to). Again, how do you create demand (i.e. volume)?
Typically when there's a very obvious area of resistance or a new high or any of the situations mentioned above, there will typically be a stack of limit orders just above the breakout level and perhaps a stack of BTC as well, whether one is buying long or buying to cover a short, it comes across the tape the same, a buy. That volume that is automatically built in (and anyone who has basic trading tools or just experience knows where the demand and supply are).
That's what institutional traders need to build or distribute positions.
Again, I can't stress enough how much clearer this will be if you read those two articles.
So lets take DE as our example because it's not only a good example in the past, it's a decent probability position.
This is a 5-day chart of DE (CAT looks almost identical). In the volume window I put plus and minus marks; a healthy move up should see rising volume with price, falling volume with rising price is not a healthy move and in fact is one of the most effective ways to confirm many top price patterns like a H&S top. The 1999 to 2006 move has rising price and volume. There's large volume at the end of the stage 4 decline which is capitulation and perfectly normal. However from 2009 to the 2011 top, volume is falling off which is not a healthy move.
In the price window we see a top-like area to the left in red and then a long trading range of nearly 4 years, this is where most traders have very little interest in an asset, but this is also where accumulation is most likely to occur and this concept is fractal like the markets so it can be applied to a range on a daily chart or even on a 1 minute chart.
Then we have a breakout from the range and volume rises noticeably and remember that 1 bar is a week, this isn't the kind of breakout we see distribution in to because we are moving from a stage 1 base to stage 2 mark up or the trending phase. Price finally tops out in an increasingly parabolic/volatile move (the same concept can be applied to any timeframe) and creates a Tweezer top.
While the second top in 2011 does not look like a textbook double top with a wider rounding area between the two tops, it is.
This is where Technical Analysis is used against traders as most expect resistance from the first top to hold price just under as the second top is formed, however Wall St. knows exactly what traders expect as they've been doing the same thing for a century.
If you look close, the second top breaks out above the first and we have a higher high, this would seem bullish, but it does the 3 things I listed above in "What Institutional Money Needs".
The difference here is distribution started long before the top was reached, small chunks of the position were sold in to higher prices, making sure not to disrupt the supply/demand balance so they can keep selling this large position at consecutively higher prices as demand starts to fall off as prices move higher.
That last breakout above the former high in the new Double Top allows them to sell any remaining shares or to put on a short position.
From there a symmetrical triangle develops, this is not a consolidation triangle, but traders treat it that way, these are almost always a top when in this position or a base when following a downtrend. The breakout out of the triangle and above it is an excellent area to go short so long as you have confirmed distribution. Traders are buying a breakout from a triangle and allowing sellers a door out.
Lets look at Money Stream (accumulation/Distribution Indicator by Don Worden).
MS is in line with price on the first top, but falls short showing distribution on the second top even though prices were actually higher. As the triangle develops and the breakout poccurs, there's even deeper distribution so this tells you the probabilities of the breakout from the triangle seeing distribution are very high. Since then, MS has moved to a lower level.
A closer look...
If you look at the breakout and look at Money Stream you can see MS is lower at the breakout level, already there's distribution to eager longs.
Again, even though this pattern is way too large to be a bull flag, traders don't care and misidentify patterns all the time, Technical traders expect an upside breakout from a bull flag so where do you think they place their limit orders or alerts to buy? Right above resistance of the flag and I believe that's the area we entered DE short, that'a false breakout and when they fail, they usually fail pretty fast and hard, my articles explain why, but this is another reason why institutional money creates these head fake moves, what appears to be bullish usually takes a lot of people's money and leaves them holding the bag.
Finally we have a range right now. Demand is above the range and supply is below the range, if you are an institution or someone like me who wants to add to a short position, where would you rather do it? At levels below the range where your stop and risk are much wider or above where your stop, entry and risk are much better?
The hourly 3C chart shows there was distribution at the flag breakout, that's what I'd want to see to confirm it's a head fake move and that's where I'd enter a short position and I believe that is where we entered DE or CAT, I know we had both ideas out there for a bit.
The current range has a positive divegrence in it, it's not going to move on it's own by retail who have no technical reason to buy it, but if smart money sucks up the supply, they create a tight situation in which some market upside that gets retail bullish will send DE through the top of the range, if you know that's likely to happen, wouldn't you buy in the range and sell above it? Not only are you creating a situation in which you get the move you want, you're making some extra money in doing it, WIN/WIN.
Now, if the daily divergence were not negative, I'd be concerned, but since the larger divergence is negative, I see this as a cycle to effect a means to an end. The reason I'm considering covering DE is to preserve the profits already there and if I think I can re-enter the position at a better cost basis considering the profitable sale, why not? Unless there's a good reason to sit through the draw down and add when everything lines up, it may be better just to cover.
However a reason I can think of to sit through the draw down would be the state of the market, the "Black Swan " effect that SKEW has been showing. I'd rather take the chance of sitting through some drawdown that will not eat up all the profits if it looks highly probable the market could fail at any moment. This is why I haven't made a decision yet about covering DE or not, but I would like to add to DE above the range and for those who don't have a position in DE or CAT and may be interested, that's the area to keep in mind.
However, this again is the reason I initially thought the market would make an upside move, whether NFLX or DE, there were simply too many shorts that were too close to excellent entries that Wall St. could not only use, but may need. It just didn't make sense not to take the market that little way to hit those areas, soon after the thoughts we started getting positive divergences confirming that line of thinking.
This is the 10 min DE 3C chart,
to me it looks like DE will break above the range, the daily chart's stronger negative suggests once above the range, it will be distributed like it was at the second top of the Double top, as it was at the breakout from the triangle and as it was at the breakout from the flag.
Essentially it looks like this, demand sitting just above the resistance zone and if you look close there's a small bear flag in place, for a technical trader a breakout from a bear flag is a strong long indication, a breakout above the range following that will keep them interested.
We don't enter any short even above the range unless and until we have strong 3C confirmation that what we expect (distribution above the range) is clear.
There are a lot of stocks that are different variations of this same theme, again the two articles will make a lot more much clearer than I can in this post alone.
I'm going to have dinner with my family so I'll be checking in a bit later, probably a futures post. Don't forget tomorrow in op-ex Friday, typically the max-pain range is near Thursday's close and around 2-3 p.m. most contracts are closed out and the market starts coming unhinged from the oin and acting as it likes.
