Trading with Stage Analysis

 

What if you could just glance at a price chart and find good trades immediately? It's not as hard as you think. Start by looking for recurring patterns and trends, and then see where price is trading on this "pattern tree." It should tell you right away if there's money to be made.
	What if you could just glance at a price chart and find good trades immediately? It's not as hard as you think. Start by looking for recurring patterns and trends, and then see where price is trading on this "pattern tree." It should tell you right away if there's money to be made.  Stage analysis defines your location within the market universe. Stan Weinstein documented this powerful technique in his classic Secrets of Profiting in Bull and Bear Markets. He described how market action can be broken into specific stages of development.
Each stage has its own characteristics and favors certain strategies over others. For example, uptrends are better for buying stocks, while downtrends are better for selling short. It may sound simple, but many of us do exactly the opposite.

 

I've reconfigured these mechanics into a concept called pattern cycles. These focus on the cyclical aspect of stage analysis, and how traders use them to capitalize on a wide variety of market flavors. Pattern cycles track markets through repeating crowd behavior. They are evolutionary -- i.e., one phase naturally progresses into the next. They signal the strategy that works best in the current phase, and what to expect from the next one.

What are these repeating cycles? They follow the common TA language we've learned over the years -- bottoms, breakouts, uptrends, new highs, tops, breakdowns and downtrends. Each phase also defines a trend-range axis that carries price sideways, upward or downward in a predictable manner.

 

One overriding factor complicates market-stage analysis: It exists in more than one time frame. In other words, markets will be at one stage on a weekly chart, a different one on the daily chart and yet a third on the intraday chart. Traders must deconstruct this trend relativity to achieve accurate price prediction, and take advantage of a specific stage.

Trend relativity errors wash many traders out of the markets. We recognize a stage and throw money at it. But we might forget a longer time frame that's moving against our position. You can overcome these errors by defining holding periods that align to the stages being traded. In a broad sense, this is the same process that divides market players into scalpers, daytraders, position traders and investors.

 

Opportunity peaks at the interface between different stages. Here are three examples. Breakout trades appear where bottoms gives way to uptrends. Pullback trades develop where price retraces to the edge of the last phase. Bursts into new highs awaken an assortment of momentum trades.

Pick your strategies wisely. There's a time to buy breakouts and a time to sell short. There's a time to press your positions and a time to take whatever the markets give you. And there's definitely a time to chase momentum and a time to trade pure price sensitivity.

Stage recognition errors hurt the investing public as well. Look at the multitude that got crushed buying the dips when the markets descended from the bubble top in 2000. And in these bear market days, investors forget that bottoms take time to develop, and returns need to be measured in years, not days.

Value investors enter the markets when bottoms are forming. Momentum traders come in during strong uptrends and downtrends. But sadly, the public enters during tops and climaxes. So whether you trade or invest, take the time to identify current stages in your individual stocks and in the broader market. This ultimately defines the best way to play your hand.

Remember that standing aside is a proactive strategy through certain stages. You won't make money when market conditions don't match your holding period or trading skills. Instead, sit on your hands and let the market come to you when the cycles makes no sense. This requires discipline, but it will keep you in the game for the long run.

Swing traders can take the next step and master a variety of stages. This lets us capitalize on a broad range of market environments. We become breakout traders when markets are on the move, but play the swing game when they're just chopping around. Diverse skills enable us to sell short when markets decline, or work the edges during extended ranges.

For restless souls like you and me, this opportunistic style offers a great way to make our favorite hobby a full-time job.