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The Art of Trading – The story within the charts

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Mellanox ($MLNX) demonstrates the power of technical analysis

Intro – Technical or Fundamental analysis?

What is technical analysis? What does it give us as traders? Why are so many people around the world drawn into the “magic” of technical analysis?

The purpose of this article is to demonstrate the power of technical analysis by walking you through a technical trading scenario that I found, posted and monitored since since Aug 2013.

If you will ask most veteran traders and investors about technical analysis, they will laugh and say it is nonsense – Hocus Pocus stuff. But despite this old generation belief, the use of technical analysis is increasing among the younger generation of traders. Why is that? Hopefully, by the end of this article, you’ll learn the power of technical analysis and understand why it has become so appealing to so many traders these days…

There are two famous quotes about technical analysis and technical analysts:

“I haven’t met a rich technician” – Jim Rogers.

I always laugh at people who say “I’ve never met a rich technician” I love that! It is such an arrogant, nonsensical response. I used fundamentals for 9 years and got rich as a technician” -Marty Schwartz.

I guess that the endless battle between fundamental and technical analysis will always be there as long as ego is involved. For me? I say – who cares which tool you use? As long as it generates consistent profit.

Trading MLNX

MLNX is an Israeli Semiconductors company, that produces and supplies high-performance interconnection products that facilitate efficient data transmission between servers, storage systems, communications infrastructure equipment and other embedded systems.

For technical analysts, that information doesn’t mean a thing. Technical analysis does not require any understanding of the company’s business or any of its fundamental details.

The basic concept of technical analysis it that all the relevant fundamental facts and all the known (and unknown information) are priced and represented by the price action that you see in the charts.

MLNX was one of the staring companies of 2012 as this stock tripled its value and rose from 40$ to 120$ within 6 months!

The stock was screaming for a correction move and so after creating several technical reversal signals at the weekly chart (ending the rally with a bearish engulfing weekly candle), the stock’s price  started to fall and the anticipated correction move turned to a violent bearish wave that eventually erased all of 2012 gains (see chart below)

That was the time that I started to be interested in MLNX as a potential longer term bullish trading (investment) opportunity.

As a technical analyst, I needed technical reasons to take a trade and these were the technical reasons why MLNX became a stock that I’ve been watching since AUG 2013:

  1. The stock reached weekly structure support zone

  2. The Weekly chart showed two Fibonacci reversal levels that I constantly use as potential reversal levels – the 78.6 and 88.6 Fib levels. The two Fibs (taken from different price levels) created a Fib confluence zone that I assumed that would act as strong Fibonacci support Zone.

  3. Harmonic trading pattern – Harmonic trading patterns are my favorite tools in trading. I’ve been using those since 2010 and they are key part of my Price Zones trading strategy (as you can easily see in my blog posts and weekly newsletters). On August 2013 MLNX completed a weekly bullish harmonic trading pattern –Bullish AB=CD (see chart below)

  4. The RSI (weekly chart) was deep in the oversold territory

mlnx harmonics

MLNX weekly chart

 

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MLNX bullish AB=CD pattern

These four bullish technical reasons made me think that MLNX presented very good probability to see a bullish reversal that will lead at least to a significant bullish correction wave that I can profit from.

The fact that this stock just experienced a very strong sell-off with a steep decline meant that buyers won’t rush into this bullish opportunity and that it may take some time for the setup to mature – I wasn’t expecting a fast upward move but you can gain also from accumulation mode by trading in and out until more and more bullish signals will appear and suggest that the stock is ready to rally.

MLNX trading

First trade on MLNX

My first technical setup was based on a potential Wedge reversal pattern that I’ve spotted at the daily chart, right inside the support zone I’ve mentioned above. I decided to take the aggressive approach and bought the bottom side of the Wedge (following the appearance of a daily Pinbar candle that you can see above), assuming that MLNX will rally and break out of the Wedge to create a daily bullish reversal signal. As you can see, this aggressive entry didn’t work and the stock roll over, broke below the bottom of the Wedge and created a new low.

I was still bullish about MLNX but now I had to wait to find another technical reason to go long…

That reason didn’t take too long to appear:

MLNX trading

Bullish reversal and False Break scenario

My second attempt was based on another daily Pinbar pattern that appeared during a false break that the price was making below the weekly support zone that I was monitoring. The False Break was confirmed only few day later but I was already in the trade and with profit.

When the stock’s price rose back into the support zone (confirmed the false break scenario) it provided the bullish confirmation signal and potential entry signal that immediately after reached its target zones when the stock rallied sharply towards the daily downtrend line (was set as target zone for the bullish setup).

The daily downtrend line was a technical element that had to be respected and that is why I wanted to see how determined the bulls are and whether or not they will be able to gain enough momentum to break out and create the longer term reversal signal.

Trend lines, especially in strong trends like we saw in MLNX during 2013, are very powerful technical elements that must be respected and as you can see below, this daily trend line played its role as resistance when MLNX tried to break out higher:

mlnx trading

MLNX rejected by the downtrend line

As you can see above, the bulls tried twice to break out of the daily downtrend line, but they failed. The stock fell like a rock. Bears could have easily used this downtrend line to catch some short term bearish move.. and they would have made nice profit as well.

If I wasn’t bullish biased, there was a great technical bearish opportunity to trend trade this stock on its second  breakout attempt that reached the 78.6 Fibonnaci reversal level (remember I love this level?) and formed a double top that generated a bearish engulfing pattern (or Outside Bar if you use Price Action) and very nice profit for the bears.

The price of MLNX created a new lower low and I was looking for another bullish reversal…

Near 35$, I’ve noticed that MLNX was forming a daily bullish harmonic trading pattern – Bullish Bat pattern. As you can see above, the price respected the PRZ of the bullish Bat pattern (read more about harmonics) slowed down from its decline and bounced to 36$ before it was pushed back down by the sellers to make another lower low.

MLNX harmonic trading

Failure of harmonic pattern – MLNX

But that little decline below the PRZ of the bullish Bat pattern didn’t take long and the short squeeze ended few days later.

The third bullish entry was similar to the second attempt. It was based on the assumption that the stock created another False break to the support zone (The price did return back into the zone).

I admit that this was a pretty risky trade but the price action (the way that the price moved) and the proximity to the trend line lead me to take another shot at this stock and at this stage, the trader’s hunch played a huge role. As you evolve as a trader and accumulate enough charting time, you start to notice market moves that are meant to confuse and misguide the common retail traders. Fake moves are probably the worst enemy of novice traders as quite often these moves keep the out of a good trade with a loss. Especially at the end of a major move, it is quite often that you’ll see a squeeze in order to throw away weak buyers (or sellers), using their stop losses to ignite the reversal move.

Thanks to my bullish bias, my experience and my longer term analysis I was able to hold on to the squeeze and took the long position.

Two days later – Boom!

mlnx trading

MLNX breaking out of its downtrend line

MLNX exploded and broke its daily downtrend line, providing the technical confirmation signal that confirmed my bullish bias.

Following the breakout, a pullback was expected. Pullbacks provide great opportunities to increase position size or enter a new position (if you work a short term trader and you take profits early). I was looking for the next Price Zone that can be used as potential Buy Zone and I’ve found it near 36$:

The opportunity came a couple of weeks later:

The reasons for the next bullish entry were:

  1. 61.8 Fibonccai retracement level after the major breakout.

  2. Bullish Flag I’ve noticed in the chart and the stock just touched its bottom.

  3. Minor daily support level.

Following my entry, the stock rallied again, broke out of the Bull Flag (white dashed lines) and generated another Bull Flag below the strong weekly resistance zone near 41-42$ that successfully managed to hold the price below it for the 3-4 previous breakout attempts.

The second Bull Flag was the final momentum gainer before the next breakout that happened on Jan 15th 2014:

mlnx trading

MLNX final bullish break out

Sharing some thoughts – Summary

Trading is all about fluidity. You have to flow with the market moves and to anticipate when to get up on your feet and start surfing the wave (know when to execute your trades).

You also have to know how to set your target levels objectively and on the other side know how to cut your losses and wait for the next opportunity to appear.

An investor would have bought MLNX under value and wait till it returns to its fair market value to take the profit.  Investor sometimes has to suffer the medium term losses as he focuses on the longer term goal. These losses period could be an unpleasant experience that may be tough to some people to go through.

 A trader, as opposed to the investor, trades in and out, taking multiple profits in the same trading range and more important cuts his losses quickly. In my opinion, it is easier to suffer twice a loss of 3% (for example) than to hold a loss of more than 6% for more than 5 months.

I do believe that my bullish bias worked against me in several cases where I could have taken some short position along the way which had very nice probability of success and created substantial profits, but overall I think you would agree that the bullish bias worked out perfectly.

The reason for my actions was that I saw better Risk/Reward to the upside based on my long term analysis.

Losses are part of the game, they are part of trading. If I would have decided to quit after the first entry setup I would have missed profits that came later on. Losses don’t mean you did something wrong – technical analysis is all about probabilities and when you lose a trade It just means that the market did what you analyzed as the less probable move.

Persistence – The markets will test you each time you will open a position. It is more common to open a trade and in the beginning, it will work against you than the cases that immediately the trade works for you.

presistance

Be persistent

trade your system

and manage your risks

That is the “holy grail” of trading





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