BigTrends

Do you ever miss a trade, and then mentally beat yourself up for not jumping in when you saw an obvious pattern emerging? Sure, we all do. In fact, I was doing that on Zion Bank (ticker: ZION) from its beautiful pattern on the Acceleration Bands breakout in January, complemented perfectly by both the Percent R and the Efficiency Ratio - see the left side of the chart below:

ZION Daily Chart with Acceleration Bands, Percent R & Efficiency Ratio



So when I saw this same pattern emerging with the 2 days in a row above the upper Acceleration Band on March 11, I was stalking this trade for a low-risk entry point. I saw Percent R give me the ideal "retest" point the morning of March 15, as the stock pulled back briefly intraday under the 21 support area. I pounced, buying the April 18 call at 3.20.  Within 2 days the stock snapped up from 20.75 to over 23, and on that 10% gain in the stock so quickly, I told my Options Shark subscribers to lock down their profits at 4.90 for a 53% gain on St. Patrick's Day March 17 - a nice green day for subscribers for sure!

By the way, this entry on March 15 qualified as a "bend but don't break" retest, a pattern I highlight in my Percent R DVD course. The basic theme is that the markets are constantly testing the strength of a trend, and the battle between the bulls & bears is very telling as to this key question: who is in control? When you use simple indicators like Acceleration bands, Percent R and the Efficiency Ratio to tell you who's winning the war, then all that needs to be done from there is to find a low-risk entry point, where you can stop out your trade quickly if it's not working while being able to let the trend ride to more dramatic gains in comparison to the small risk taken.

The Banking sector, which has been lagging for months now (I've previously commented on its underperforming range) has shown some interesting signs of strength thus far in 2010.  Take a look at the chart of the PHLX Bank Index (BKX) below:

BKX Daily Chart


You can see that the recent move higher has sprung Percent R and Efficiency Ratio to levels not seen in some time.  Additionally, the slope of their upward spikes is impressive.

Bank sector should be considered for a momentum upside play ... longer-term fundamentals remain iffy, in my view.  Additionally, keep in mind that Percent R has not yet broken 80 on the BKX Daily Chart, which is a key bullish threshhold in our analysis.  Also, we are right at the Top Acceleration Band (purple lines), which is also a key technical area.

I am always studying my trades to learn what separates my best trades from the rest of the pack.  In addition to techniques like Acceleration Bands and Momentum Divergence, I have noticed that the biggest trends I rode were also confirmed by an indicator called the Efficiency Ratio.  I refined the Efficiency Ratio as an actionable indicator based on the work of Perry Kaufman, a highly-respected systems developer. 

In Kaufman's book Smarter Trading (click here for a summary I created on this book's key points), he notes that the efficiency of a trend is calculated by dividing the net movement over a certain time period (I use 20 trading days), divided by the summation of the absolute value of the day-to-day price changes over the same time period.  So if a stock's trend is at perfect efficiency, as an example it could move up say 20 points over 20 days, and each of those days it moved up by exactly 1 point. This would mean that the ratio of net movement over combined movement was 20/20, or 1.00 (I plot it as +100 for positive efficiency).  If the stock downtrends by 20 points with the same perfect efficiency, its maximum downtrend reading would be -100.

Obviously it is virtually impossible for a stock to have a perfect efficiency reading, as any adverse movement against the trend during the time period examined will lower the efficiency reading. What I've found from my testing is that Efficiency Ratio readings above +30 are very favorable to define persistent uptrends while readings under -30 often denote steady downtrends. 

For example, one of my best-trending winners in the past month occurred when I bought May 25 calls on Phillips-Van Heusen (PVH) when the stock came back to retest its +30 key level on the Efficiency Ratio on April 15 at the key low of 24.11. If the stock closed under that level, I would have to exit the bullish trade. The stock quickly rallied up to 30.50 over the next 6 trading days, allowing me to execute the "free trade" rule of selling half of my position at a +100% gain in my Options Shark recommendation service. Once the next test of the Efficiency Ratio failed in early May, I exited the rest for a still healthy gain over +50% and managed to avoid the noise and drawdown that ensued back down to the 25 area.

Phillips-Van Heusen (PVH) Daily Chart with 20-Day Efficiency Ratio



The Efficiency Ratio is a useful filter to screen out many choppy stocks where breakouts may prove to be fakeouts, and allow you to only focus on the best of the best trends. One of the few places you can find it is right here in our Tools & Resources section - drop us a comment to let us know how you like the new charting tools!

A common mistake that beginning traders make is assuming a stock has moved too far, and if they don't make the additional error of betting against the trend, they at least continue to miss out by leaving too much money and opportunity on the table.

In addition to the chart I shared with you last week on American Express (AXP) which went on to even higher heights thanks to big earnings and the current prop-up in the financials, one stock my scans picked up early last week was jeans and apparel maker Phillips-Van Heusen (PVH).  Usually you'd think that anything having to do with retail in a rough economy would be the LAST place you'd want to look, but the scans said here's a leading stock with more potential.

In my Options Shark service, we managed to enter the May 25 calls a week ago at 2.75 when the stock was trading around 26.50, as the indicators said all systems were GO for more upside. Per my rules on taking half at a +100% gain, we sold half of the position at 5.50 last Thursday morning, leaving us with another "Free Trade" from here.

Phillips-Van Heusen (PVH) Daily Chart with 20-day Acceleration Bands & Bollinger Bands, plus Percent R and Efficiency Ratio

It's so much easier not to second-guess yourself once you're in a free trade position. You can simply let the rules of your system or method either carry the trend further, or lock in the remainder if the trailing stop gets hit.