Scanning for Opportunity, the Old-Fashioned Way

I have been in the trading and trading education world for many years. My path began on the floor of the Chicago Mercantile Exchange and included writing a daily trading advisory letter for three firms, managing funds for clients and myself, lecturing to thousands of traders and investors around the world, and more. I remember the very early days when I became interested in charts. There was no manual or book to teach you how to build a chart or anything like that. Often, the one machine on the trading floor that provided charts didn't work so I would build my own charts using graph paper and colored pencils. I really enjoyed that and believe me, when you're building your chart with colored pencils, you really get to know where the significant buyers and sellers are in the market you are charting.

Old-Fashioned Reality Based Analysis

As I began writing trading advisory letters, I would go through the same "top down" scanning process each afternoon after the market closed to find trading opportunities in the stock (and Futures, Forex, and Options) market for the following day. For stocks, I would first identify the support (demand) and resistance (supply) levels in the S&P and NASDAQ. If these two markets closed near demand, I would know to look for opportunities to buy the next day as price was likely to rally from that demand level. The next step was to look at charts of a few of the large sectors to find some that are also trading near demand as those sectors would likely rally from that demand level with the broad (S&P and NASDAQ) market the following day. Out of the few sectors, I would always find one or two that were setting up very well with the broad market. The final step was to look at a handful of high volume stocks within that sector and that is always where I would find a VERY quality trading opportunity. There would always be a few stocks that were also trading right near demand just like the sector and broad market, ready to move higher the next day from that demand level. If I found more than three or four of these quality opportunities to put in the letter, I would choose the stocks that had the largest profit margins. When I say "profit margin," I mean the stocks trading at or near demand that are farthest from supply (resistance). This was a VERY profitable three-step scanning process that I repeated day after day, month after month, year after year. For years, I produced these letters daily for some of the largest firms in the industry who would distribute the letter to clients worldwide.

The Technology Boom

As the years went by, the technology boom really took off. This led to faster and faster trading platforms and super, high-powered scanning software. I began to use all the latest scanning software to find low risk and high reward trading opportunities for readers. I tried everything that was out there in the industry. If it scanned for stocks, trust me, I have tried it. I would put in the filter parameters I was looking for, hit "enter," and watch all the stock symbols that met my criteria populate a quote box. Next, I would scroll through each of these hundreds of stocks looking for the setup I was in search of, either a decline to demand for a buying opportunity, or a rally to resistance for a shorting opportunity. I would scan and scan and scan, often for hours with these automated machines. I remember many nights where I would fall asleep at the key board in the middle of this scanning process. I kept at this for some time as I figured technology would certainly speed up the process and let's face it, I was on the high-tech bandwagon like everyone else. After trying every scanning software product you can think of, I realized that I was not only wasting time, I had also made what was such an easy and profitable process VERY difficult. One day years ago, I got rid of every automated scanning tool I had and have never used one since. I went back to doing my market analysis the old-fashioned way and it was one of the most profitable and time-saving choices in my trading career. What triggered this realization that day was a visit to a quiet little library I would go to when I had to write an article for a magazine. I was walking to my favorite corner spot in the library and I walked by a table where two children were coloring some pictures. They were using colored pencils and as soon as I saw those colored pencils, it hit me: The power of my profitable trading letters was easily attained from doing my market analysis the old-fashioned way. Quality charts replaced colored pencils but the analysis was still my basic three step, top down approach to stock market analysis.

The "Top Down" Approach

These days, instead of producing a daily advisory letter, I spend my days trading and providing live market trading, analysis, and education in one of two graduate programs at Online Trading Academy, the Extended Learning Track (XLT) - Momentum Intraday Trading Extended program and the Futures Trading program. During a live session with XLT members on Monday April 20th, we focused on finding potential low risk, high reward, and high probability trading opportunities for the following day. We first analyzed the S&P to determine where prices were likely to go the next day.

S&P 500

When we quantified supply and demand in the S&P (chart above), we noticed that there was a quality demand level, the unfilled gap from days before. We determined that if the market were to trade lower the next day, it would likely turn higher at the origin of that gap as that is where the buyers were, demand exceeded supply. Sure enough, that is exactly what happened. The market gapped down right into that price level where demand exceeded supply and rallied strong for most of the day.

Financial Service Sector (XLF)

After quantifying demand and supply in the broad market, I then looked at three or four sectors and found that the XLT (financial service sector ETF) also had a quality demand level that lined up with the demand area in the S&P. In the XLF chart above, notice the gap, area "A." Price gapped higher because there was so much more demand than supply at the origin of that gap. Therefore, if that sector was to return to that price level, price was very likely to rally which would carry the stocks within that sector higher as well. The next day, just like the S&P, the XLT (financial service sector) opened right into that demand level "B" and rallied strong all day.

Bank of America (BAC)

After determining that the financial service sector had a demand level that lined up well with the S&P 500 demand level, we then looked at three major bank stocks and found Bank of America (BAC). We found the demand level marked on the chart, area "A." This was considered a very quality demand area because of the strong gap away from area "A." You need to understand that the stronger the move away from a price level, the greater the demand and supply imbalance at the origin of that gap. All this analysis was done on April 20th. The next day, price gapped down right into our pre-determined demand level offering us a very low risk and high reward entry.
The trading idea was also high odds because at "B," a group of novice sellers were selling BAC. How do we know this? The sellers at "B" were committing the same two mistakes that every novice trader makes. First, they were selling after a decline in price which is not a smart action to take. Second, they were selling right into a price level where demand exceeded supply. As an astute market speculator, you have to recognize this novice action and be the buyer to that novice seller. Had we been wrong and lost on the trade, the risk was only $0.15. We followed our profit-taking strategy and the trade worked out well. Congrats to XLT members who took this trade and the others from that day.

Finding this trading idea the day before only took a few minutes as I used the old-fashioned "top down approach." Had I used one of the many automated scanning tools, I would have spent much more time and likely never found BAC anyway. As strange as it sounds, for me, scanning for opportunities in markets the old-fashioned way saves me plenty of time as my objective rule based analysis leads me right to the gems quickly. Will computers someday be able to do this faster than me? Maybe, but I don't really care. If I had a little more time in my life these days, I'd love to dig up my old colored pencils and some graph paper and get to work. Keep in mind that this simple top down analysis was all done the day before prices revisited the demand areas noted on the charts. Planning your trades in advance and timing your trades with the broad market as we did with BAC is important whether you are an active trader, swing trader, or longer-term position trader.