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Author: Linda Raschke (MarketClub Trading Service)
Short Skirt trades are scalp trades made off small continuation patterns in swinging or trending markets. The phrase was originally coined to describe the trades taken off bull and bear flags on a 1 -minute S&P chart, but the concept works on any time frame, any market. Short Skirts are retracement patterns that follow a sharp impulse down. Remember that momentum precedes price. "Impulse" signals more "impulse", and this is what creates a trend. After an impulse move, there are very high odds of either a retest or another leg in the direction of the impulse. The average profit when trading "short skirts" off a 1-minute time frame tends to be between 1-3 S&P points. The best way to place the stop is to risk 3 points from the initial entry price. The market rarely retraces 3 more points beyond your entry level without first going back down for a retest. In extremely volatile markets, it is suggested that a 5-point initial stop be used. As the trade starts to work in your favor, pull the stop down. Active trade management is an important trading skill. By trading on a small time frame, much tighter risk parameters can be used, which allows one to trade with more leverage. The idea is to get into the market and grab as much spread as possible in the least amount of time. It is the ultimate game in scalping. There are several ways to enter these continuation patterns. One way is to look for a retracement back to the 20-period EMA. Another way is to watch the price action for when it starts to stall out on the reaction. The last way is to eyeball the retracement pattern that is forming and use discretion. Sometimes the best trades are those that make flat ledges and do not give much bounce at all. "Short Skirt" trading works best in heavy volume markets, broad swinging markets, and trend days. This style of trading does not work as well on the day following a large trend day or buying/selling climax. This is because consolidation days have little follow through, and the Short Skirt trades count on follow through to reach the profit objective. It also works best when there is good liquidity. Slippage in noisy markets can eat a trader alive! Trades are taken in the direction of the trend. Thus, most losing trades tend to come at the end of the trend! There are 2 distinct patterns that most often signal the end of the trend. By being aware of these two patterns, losses can be reduced.
Patterns By Which To Filter Losing Trades:
The first is the '72" setup. This is actually such a nice trade it can be taken in the opposite direction. It is in part a simple divergence between the price and a smooth moving average oscillator. The easiest oscillator to use is one derived from the difference between a 5 and 35-period exponential moving average. (The 3/10 oscillator is too sensitive to use on a 1-minute SP chart). Second, do not look to take a "short skirt" trade after a buying or selling climax. A selling climax can be recognized by an extreme tick and tiki reading .... such as -800 ticks and -24 tikis. The market can also make a sharp N" type reversal after a selling climax. The end of a trend can also be more readily identified when looking at a higher time frame. For example, if there is a corrective downtrend on a 5minute chart, but the 30-minute chart is still in an uptrend, the downtrend on the 5- minute chart is most likely to find support at the 30-period EMA. It helps to look at multiple time frames. If the market retraces deeper than the 30-minute EMA, the next level to look for support would be the hourly EMA. The "Short Skirt" trading works best when watching 2 time frames side by side. For scalping, use a 1 and a 3-minute chart. The same principles should be used when looking for flag formations on other markets. For example, when trading bonds, perhaps a trader would want to use a 15 and a 60-minute chart. This is the best way to eliminate false signals on the shorter time frame. Lastly, it is always important to examine the expected market volatility environment. The market tends to alternate between a trending and a non- trending environment. After a buying or selling climax, look for a trading range to begin. When the market is narrow or there is a large opening gap, expect a trend day. Short skirt trading cleans up in a good trend leg up or down.
Ticks indicate how much buying/selling power is stored up. If there is a large "uptick" reading, a majority of stocks are being bought on balance. Ticks must be watched with respect for the overall tone of the market. They are can be used in a countertrend manner by looking to fade the extreme readings when in a trading range. They can also be used in trending markets to enter on retracements in the direction of the trend. For example, if the market is in a steady uptrend and there has been a burst of buying activity which drives the plus ticks to +600, watch for the ticks to retrace back towards zero as a buying opportunity. In a normal sideways trading environment, +500 and -500 tend to be overbought/oversold levels. Ticks trade in an approximate 1200 tick range, so if the market has been in a down- trending environment, and the tick readings fluctuate around -1000, then +200 will be "overbought" or represent the upper end of the range. Ticks should be watched in conjunction with the "Tiki's", (or "Ticki's" on some data feeds). This reading is the net number of Dow stocks on an up-tick or downtick. In general, overbought/oversold range is +24 to -24. If the Tick reading is +500 but the Tiki's only register +12, there will probably be another surge up. The implication is that the trading programs have not fully kicked in yet. The programs almost always cause the Tiki's to reach +/ 22 to 26.
Ticks also function as a confirmation/non-confirmation indicator. If the market makes a new high, the ticks should make a new high. When this occurs, retracements can be traded in the direction of the trend. However, if the price makes a new high and the ticks do not, a reversal is likely. Always remember, in a strongly trending environment, ticks and momentum based indicators or oscillators, will have a tendency to give premature false readings, so be sure and assess the degree of trend in the market before using these indicators. Since the market alternates between a trending and a consolidation mode, the day following a trend day or wide range day tends to be a particularly good one for using the ticks in a countertrend mode. Ticks can also be used to confirm the opening in the S&Ps. If the S&Ps have a large opening gap up, and the ticks have a high reading, thus confirming the move, there should be continuation in the direction of the gap. If Ticks reach an extreme reading one day, it indicates a trend day. There are good odds for a bit more follow-through the next morning on a day where the ticks hit +/- 1000 in the afternoon. Once again, the following day should see a lesser reading in the tick extremes before the trend turns.
DOG DIDN'T BARK
Ticks can be used to confirm the price action. A strong up move should be accompanied by healthy uptick readings. At market tops, there is a tendency for the market to get dull and complacent. The market rallies but the tick readings are barely positive. This pattern is called "The Dog Didn't Bark". It is a sign of weakness and means the market is ready to rollover. The same principle can be used on opening gaps. For example, if the market has a large opening gap up, but the ticks only register between 100 and 300, this represents "non-confirmation" and is another case of "The Dog Didn't Bark". The market should sell off.
THE SHIP AIN'T SINKING
Just as there are distinct patterns such as a lack of tick reading at tops when the price action starts to roll over, there are also patterns that show support coming in at bottoms. When there is a series of heavy downtick readings, but the price starts to hold, it is called "the ship isn't sinking". The market is throwing a barrage of oversold tick readings at the market but it refuses to fall apart. Tick readings worse than -500 must be seen over an hour long period while price holds. A rally of a couple hours duration should then materialize.
"Z" days are consolidation days that can be aggressively scalped off intraday swing highs and lows. The market starts to form a trading range and key pivot points should start to contain the price movement. These are also days where overbought and oversold tick and tiki readings can be aggressively scalped. The market makes many intraday tests, as it begins to consolidate. On consolidation days, a penetration of the first hour's high or low will be a false breakout and a trader should look for signs to fade the breakout. Keep in mind, the penetration of the first hour's high or low can still run a few points over a half hour time period, so wait for a sign of small buying or selling excess, or an exhaustion point. If the market is consolidating following a strong up-thrust, the first deep pullback in the ticks sets up a good buying opportunity. As long as there are strong uptick readings, it indicates a strong trend. Wait for the period when the "Dog Doesn't Bark" or the ticks show a lack of up readings, before looking to go short. It will be a better short trade if the high is exceeded on a lack of plus tick readings and the market then rolls over, rather than trying to short a buying climax.
Tiki's are the number of net Dow Jones Industrial stocks that are on an uptick or downtick. In a sideways (trading range) or light to moderate volume day, look to enter a short or exit a long when the Reading is greater than 24. Look to buy or exit a short when the reading is greater than -24.
S&P - PREVIOUS DAY'S HIGH AND LOW
The previous day's high and low are two of the most important pivots to watch. The market tests these levels many times and often they become key support and resistance levels. If a trader used no other indicators, he would still be able to make a living just by watching the play around these points. The first "play" of the morning should be to move towards one of these levels. If the market close in the lower end of its range, expect it to test the low and vice versa. If the market penetrates one of these levels and does so on good volume, it will often retrace back to this level before starting another leg down. Old support becomes resistance and so forth. Key swing highs and lows are the most visible chart points and serve as magnets for the price action.
The Globex high and low can be watched as key support or resistance in the same manner as the previous day's high and low. It is very rare that the Globex range is not traded into during the next day's session. In other words, if the next day's open gaps outside the Globex range, it is likely that a move will be made to test back into this range. The first thing to note is whether there is buying or selling pressure on Globex early in the morning. More often than not, this pressure will assert itself after the day session's open. If Globex is trading 3 points higher than the previous day's close and then the day session opens 5 points higher, this tends to be a sign of strength. Conversely, if Globex is trading 3 points higher than the previous day's close but the SPs open flat, this tends to be a sign of weakness. Usually, there will still be a small move to test where the Globex session closed.
Proceed to part II of this trading guide, click here.
About the author:
Linda Raschke, President of LBRGroup, Inc., has been a full time professional trader for nineteen years. She began her trading career on the Pacific Coast Stock Exchange and later moved to the Philadelphia Stock Exchange. In the early 1990s, she became a professional money manager and started LBR Group, Inc. Linda was written up in Jack Schwager's book, The New Marketclub Wizards, and also in Women of the Street by Sue Herera. In 1995 she co-authored the best selling book, Street Smarts-High Probability Short Term Trading Strategies. Linda continues to trade every day and posts her trading activity to the Internet (mrci.com/lbr). Linda also continues to be actively involved in presenting trading workshops and online seminar for companies such as the MarketClub Trading Service. To find out more about MarketClub, see what others are saying about this tool: MarketClub review.