The Only Three Directions-Lesson Four

The Strategic Day Trader with Sami Abusaad

Welcome to lesson number four. We are still on the basics, which are the most important lessons to learn because that's the foundational stuff. Everything else builds upon them.

Lesson Three Recap

Lesson three covered reversals and pivots. Here’s a quick recap and we'll move on to lesson number four. When we're measuring the potency of a reversal, we look for mainly two things:

Number one is the size of the reversal. The bigger it is in relationship to the prior move that it's reversing, the more significant, or the more potent, it is. So the larger the reversal bar is in relationship to the prior bar, the more potent the reversal is. Number two is the depth.

The level or depth of retracement into the prior candle increases the potency.

In the third example in the top half of the graphic, we can say it was really potent. Not only did we reverse this bar, we actually went way below it. So we reversed the entire bar. It was a 200% reversal. It wasn't a 50% reversal or 25% reversal. It was a complete negation, plus more.

In the case of the fourth example, you’ll notice we started to reverse the green bar, but we only got so far. So, It’s not very potent. As the size and the number of candles that make up a reversal increase, so does the potency.. And that's why, from left to right becomes increasingly potent.

Check out the bottom section of the graphic. The first couple of candles, even though we reversed about 80% of the green bar, still were not significant because they were very small bars. It was a small battle. Now check out the fourth example in.

That is where the real war is.

It’s a big green bar, completely reversed by an even bigger red bar. In the example all the way to the right, it's even more bearish because the stock attempted to go higher and then gets rejected, resulting in a topping tail, which trap people. Topping tells form when the stock rallies, which is immediately rejected.

It gives them very little time to get out, which is the reason this is the most bearish. 

But, to tell you the truth, it depends on the timeframe. The last two in the example are pretty bearish. And the center one is really bearish, except that the green bar we were reversing wasn't so big. If the green bar was a little bit bigger, I would say that's pretty bearish, too.

REVERSALS AND PIVOTS: TRENDS

A reversal is how a pivot forms. A low pivot is an indication that buyers took back control. Sellers were in control, resulting in red bars, and the buyers got it back. A low pivot forms whenever you have a higher low on either side of a candle. If you have a bar with a higher low on either side, you get a pivot.

A high pivot is indicative of sellers taking back the control from the buyers, overwhelming them. And in order to get a high pivot, you have to have a lower high on either side of the candle.

Now, not all pivots are created equal. That's why we also can measure the potency of a pivot. The more higher lows on each side, the more potent. So the more higher highs and higher lows, the stronger the pivot. It’s more secure and consistent.

We also said that the right side of the pivot is actually more important than the left side of the pivot because the right side of the pivot is the group that's taking back the control, whether it's the buyers or the sellers. If it's a pivot high, then it's the sellers.

If it's a pivot low, it's the buyers. That's the more important side to examine and really pay attention to. It’s better to have higher highs and higher lows.. Larger candles usually mean larger volume. And in addition to all of that, the deeper the V in the pattern, the more powerful it is.

That is because a deeper V means a faster the retracement and reversal. The faster the reversal, the more people trapped, and the less time people have to get out of the stock before it actually reversed. So in this case, the short gets trapped.

So, the deeper the V, the more likely it is a bottoming tail on the larger time frame. That means it’s more likely that it actually forms a large bottoming tail. Large bottoming tails, a deep V, the pivots: these are all created by big money, not you and I.

Look at any sharp V pivot that you can find on a liquid stock. Look at the amount of shares that went into creating that reversal. You'll be astounded. It's in the millions.

If it's on a stock like Apple or Amazon, it'll take tens to hundreds of millions of dollars going into that stock at that moment in time within, let's say, five to 10 minutes, to formed that reversal. It'll be a staggering amount. It's the big institutions that can make this happen.

UP NEXT: TREND ACTIONS

In this lesson, we discussed how reversals form pivots and pivots form trends.

We only have three trend actions. The price of a stock can only go up, down, or sideways. 

THE UPTREND

The uptrend is defined by higher pivot highs and higher pivot lows, a rising 20-period moving average, a rising 40-period moving average, and relatively even space in between the two rising moving averages, which is what we call railroad tracks.

On smaller time frames, the 8 or the 10 period moving average can be used rather than the 40. For day trading, I use the 8 and the 20 for day trading. For swing trading,  I use the 20 and the 40. I wouldn't use the 8ma on daily, weekly, or monthly charts.

That’s for only the smaller time frames. I use the 8 and the 20 to create that railroad track, or the 10 and the 20. 

Once the above options criteria is met, your sole objective is to buy every single dip, or pull back and break out in the stage two uptrend. Your job becomes to buy every pullback to the rising 20MA, or a setup as a breakout. You can scan your trading universe to make a list of stocks currently trending in powerful stage two, meaning an uptrend.

So far, we haven't shown you any real charts. Above is a real chart. Note the smooth nature of the 20ma and the 40, which creates the "Railroad tracks." You don't want the 20MA that's going a little sideways or really sharp 20MA; you want the 45 degree.

You want the moving average that goes from the upper left corner of the chart to the upper right corner of the chart.

If your chart is square, that should give you exactly 45 degrees. So you want the 45 degree 20ma, because that's the trend that's sustainable. If it is a lot sharper, then it's not sustainable; it's really powerful, but those are the ones that go climactic and exhaust themselves, and then they tank.

If it's not trending enough, it means it's not in a strong uptrend. Again, you want the 45 degree.

All pullbacks are buy-able in this case, or breakouts. Notice if you keep your stop on the other side of the 20, you almost never stop out. When you do, the trend is over anyway, you want to be done with it.

Above is another example of an uptrend, showing the letters, indicate the higher highs. Notice how they're consecutively higher, so E is higher than D, D is higher than C, C is higher than B.

The same goes for the numbers; they are all consecutively higher than the prior pivot low.

THE DOWNTREND​

The downtrend is exactly the same, but to the downside. Instead of higher pivot highs and higher pivot lows, you see lower pivot highs and lower pivot lows. Notice how each circle is  lower than the prior one.

And then, notice the dotted lines; they are the pivot lows. You have here  lower pivot highs, lower pivot lows, a declining 20, a declining 40, and railroad tracks between the two. Downtrends are also known as stage four.

Why?

This is because we have that basic unit, which has four stages, so the downtrend side of that basic unit is called "stage four."

On smaller time frames, as we said, the 8 and the 20 can be used to see the railroad tracks. Once the downtrend criteria is met, your sole objective is to sell short every single rally and breakdown, depending on what the stock is giving you.

If it's giving you a sell setup, then do the sell setup. A sell setup is when you have three or more higher highs, in this case bars, at or near the declining 20. If the stock was to go sideways, that would be a breakdown. When you get a rally into the declining 20, you can actually short just under the last bar’s low, with a stop above.

The moment the prior bar's low is broken is your entry. The most important thing when it comes to a downtrend is the location. Even if you don't have three green bars in a row, as long as the entry is forming at or near the declining 20 you are in a good spot. Why? It's because you know the trend is not going to fail.

If you can put your trust in the trend, then you'll make a lot of money, because you just put your stop on the other side of the moving average, and it never gets taken out. It just continues and continues. If you put your trust that it's going to hold, then you can actually capture the majority of a trend.

Question: Do you enter the pullback at the 20 or at the break of the bar that touched it? Answer: At the break of the prior bar's low, so as soon as soon as there’s a break of the bar, not at the 20.

However, I often say, "If you don't have a sell setup, you're not sure where to get in, fall in." 

Like tripping, you just fall into the stock. As long as you put your stop on the other side of the 20, you should be fine. Sometimes, you may get stopped out, and that is alright.

If the last bar’s low is not very close to the 20ma, go ahead and pass on it, and catch the next one. And if you're still not sure, just fall in, and put your stop on the other side of the 20ma, and you should be fine. It takes a little bit of conviction and trust.

Once you do it successfully, with ease, you start to build some confidence. So you do it today, you make a little bit of money on it, and tomorrow you have a little more confidence. And then, you do it again, and again you have a little more confidence. Sure enough, after a while, it becomes second nature to you.

I do a lot of things that I don't even think about; I only verbalize them, because I'm describing them to you. Otherwise, I don't often think about it, I just do it. I know what I'm supposed to do.

The Sideways Trend

The sideways trend is defined as a series of relatively equal highs and lows. Sideways trends are also known as stages one and three. We’ll cover that in the next lesson.

Note that your objective is to buy the lows and sell short at the top. Never forget the four-stage cycle. Stage one is the initial low and stage three is the top. What comes after stage three is always a downtrend, which is stage four. But for a while, it's sideways.

What comes after stage one, at the bottom, is always a stage two, an uptrend. Because of that, we say in a stage one, you’re more prone to buying the dips than sell short the rallies.

In a stage three, you’re more prone to selling the short rallies, rather than buying the dips, because, eventually, it will break to the downside.

This is a picture of a sideways trend. It takes two pivots in the same general area before you can call something is a sideways trend. Following that, you can now continuously go long and short until it fails. Eventually notice that it broke out, meaning it must have been a stage one, not a stage three, because a stage three would have rolled over.

The fact that it eventually broke out signals a stage one, or it was already in an up trend and just went sideways for a while. One thing to note: the oscillator is of no use to us on this chart.

Even though I'm teaching you how to do so, I personally don't trade sideways trends. That’s because I don't want to be the jack of all trades but a master of none. I want to focus on what really makes good money.

For me, sideways trends, for the most part, are not very lucrative, and good ones are tough to find. Therefore, I stay away from them.

The good thing about sideways trends is that they signal that the stock is either ready to reverse or explode higher again, allowing you to figure out your staging. When it's in an up trend, you know it's in a stage two.

You must then figure out if this is a stage three or a continuation.

Here, you would not act until the third time pivot and every other time after that.

At the final bar, we can see that it broke out, and probably continued higher. The market always gives you clues. Every time it went back to the prior high, it used multiple bars up, which means it exhausted itself and then it came back down. In one bar it retraced about 80% of the prior move; that should have been your tip that it might be going higher.

Look at the size of the final igniting wide range bar.. It had a low higher than the prior lows, but also a wide range bar that reversed 80% of the initial move. This was indicative that it was going to go higher.

This is an uptrend. Notice how the pivot highs and the pivot lows signified through the numbers one through six are all consecutive.

Consecutive higher highs, consecutive higher lows. The rising 20, the rising 40, and the railroad tracks between the two moving averages; when you have that, every single pull back and every single break out becomes playable.

This is a down trend. It has lower highs, lower lows, declining 20, declining 40, and even space between the moving averages. When you have that every single counter rally is playable short.

Every single base break down is playable as long as it's as close to the 20ma as possible. When pivots are not consecutively higher or lower it forms what is known as a sideways trend.

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