TSC Technical Forum: Supply and Demand Theory, Program Trading and Candlesticks

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A note of thanks to everyone who

signed on for my recent

Yahoo! Chat

. Chats are great fun for me, and, as I receive $10 per question, they give me a nice income stream! Okay, I'm kidding about the money, but not about the fun part. Thanks all!

And, until the next chat, you can always send your questions here. Just mail them, along with your full name to

technicalforum@thestreet.com, and I'll try to get an answer up by the following Saturday.

And now this week's questions...

Program Trading

Can you explain program trading -- what is it, when it is triggered, etc.? -- Jenny Plesums

Jenny,

Here's a great example of the strength of the

TSC

: I knew

Cramer

had written about this topic many moons ago, but I didn't know where. A five-second search of the archives found it for me, and details are in an excellent

column from March.

Try doing that with

The Wall Street Journal

!

Scanning the Archives

HELP! You had one column devoted to the subject of day trading -- can you point the way to that column? -- Larry Jones

Larry,

Boy, two search examples in a row! Try the following articles: The first is a brief

discussion of this topic back in March, while the second is one of

Tracy Byrnes'

excellent

Tax Forum columns.

Weekend Charts

In a recent article, you mentioned that you review approximately 500 charts over a weekend. How do you select these charts, and would you use a paper charting service that can FedEx these to you? -- William Beckham

William,

On the selection of the charts, I obviously look for at any charts that make my

GBS Classic

candidate list. In addition, though, I scroll through stocks in the news, high-profile stocks like

AOL

and

YHOO

, favorites of mine like

IBM

and

BA

, and any stocks with big volume surges. Most are not potential trades, but rather give me a feel for what the market is doing.

As for a paper-charting service, I suppose that's a possibility, but it's hard to believe that's cheaper or more efficient than a data service like

Worden Bros

. At less than $2 a day, my data expenses are a rounding error, particularly given the flexibility the service provides.

Atypical Charts

How would you analyze some charts of stocks that are not strictly meeting your parameters for your GBS system? Could you let your readers know how you would go about breaking down some charts that were just thrown at you, charts that had no qualities that pertained to the breakout with volume strategy that you primarily talk about? Maybe you could just randomly pick some charts and explain how you would interpret the current price action, what techniques you use (support, resistance, retracements, range days, etc.), why you would look at it that way, and what conclusions you would draw from your analysis. It would be a valuable learning experience for us to see how you look at charts that do not fit your typical strategy. -- Rob Cooper

Rob,

Excellent suggestion. In the new

Charted Territory

column, this is exactly what I'm trying to do. Hopefully, you and many of the readers will find it helpful!

Both Sides of the Fence

I read your response to playing a stock on both sides. I agree with your comments about this, but it is not always a mistake. First of all, if you short your long position, you can ensure your exit price as if you were buying a put to ensure your exit price. Also, if you like a stock long term but don't like it short term, you can make money on a temporary decline and still keep your position. Playing a stock on both sides has allowed me to provide some insurance for myself. The only negative I see with doing this is that, if the stock goes up, you have to make a decision to cover your short with your long position or cover it by buying the stock in the market. In my opinion, it is less riskier than buying a put because the worst thing that can happen is you will miss any gain above the price where you shorted the stock. Cramer talked about using puts as insurance recently, and shorting against your long position is also a way to provide insurance without paying for it. Of course, you can walk away from a put but not a short position. I have been trading for only six months, so if I'm missing some big negative that I didn't think of, please mention it. -- Abe Watson

Abe,

I'm not sure we have a disagreement on it being doable. No, my issue was on the complexity of the trade. It is difficult enough for me to work a trade one way. Having the same position long and short -- and looking at it in two timeframes -- makes the trade exponentially harder. Now, if you only had one position working, then yeah, I guess you could do it. However, multiply that by 10 or 20 trades, and you'd have a real mess. I'm not even sure my spreadsheet has that many columns!

A Few Good Sources

How do you use the candlesticks to assist in your decision? I've never learned the meaning of the symbols -- if you have a URL for going to school on them, that would be appreciated also. -- Gene Marr

*****

Please give a few good sources on candlestick charts. A good article on the Web and a good book would be helpful. -- Carl Lindros

Gene and Carl,

There are a number of books at

Amazon.com

and the other usual places on candlesticks. I'm pretty much self-taught, though, so I can't vouch for any of them.

However, those nice folks at

Equis

(they make

Metastock

) have a neat

Web area explaining such nuances as the difference between a doji and an evening star.

Given all this, though, let me explain how I use candlesticks: I really don't. They're what I consider a fourth-tier indicator. Price and volume always go first, then support and resistance, then trendlines and moving averages, and THEN esoteric stuff like candlesticks. But, they're nice to look at sometimes!

A Question on a Question

My question concerns the following response you made to Rich Vendig's questions. In this case I understood neither the question nor the answer. Perhaps you could address this in a future issue... Your response was: "Regarding buying a T-bond, yes, you've hit on a route many day traders take. Others invest in SPY or Dogs of the Dow. Whatever. Think safety first, of course, and then returns. But as long as you return to flat each night, 'borrowing' that money is essentially free." -- Tom Winberry

Tom,

This was one of those dialogues I knew I mangled from the get-go. Let me reload: If you have $100,000 in your account, you have buying power of $200,000. Therefore, if you start on a Monday morning, you can take $100,000 and buy some T-Bonds. With the other $100,000, you can day trade your fanny off. Now, come 4:00, if you return the entire $100,000, you incur zero margin charges. In addition, though, you gain interest on the T-Bonds, or whatever you've sunk your equity into. All in all, pretty nifty.

Trend Line Troubles

Could you explain how to draw trend lines? Also, what is the difference between a trend line being violated and, say, a 50-day moving average in terms of predicting a serious reversal in a trend? -- William P. Kruger

William,

There are actually programs out there that automate the drawing process, but I'm glad you asked for the manual way. I really think that's the best way to do it.

The first step is to ensure that upward trend lines always go along the bottom of your bars. Downward trend lines go across the tops. After that, I then draw a trend line that runs across as many bottoms (or tops) as possible. It's certainly not a science, so sometimes I'll draw a few before I get it right. Of course, there is no "right" trend line, only the one the looks best.

Take a scan through some of my past

columns, and you'll see what I mean. By the way, this method is exactly the same for support and resistance lines.

As for the difference in violation, I'd give the nod to the 50-day average being more serious. Reason? That's something mathematically defined that is more or less a standard. And therefore, many people see the same exact line and are alarmed -- rightly or wrongly -- when it's violated. On the other hand, a trend line is usually just your opinion.

Online Savings

Seems like I remember in a recent column of yours a reference to a low-cost (possibly $7.95) online trader. This cost included limit orders and stop orders. However, for the life of me, I can't find that issuance. If it was one of your articles, would you please return to me the date, title, etc. of that article? -- Rosalie Anderson

Rosalie,

The broker I probably meant was

Ameritrade

, and they do have all you mentioned. However, rather than point you to a dated column, check out TSC's excellent

Online Brokers Survey. Mucho good reading.

Howdy Partner

I would love to have a partner but finding one does not seem to be an easy task. I have been reading all of your columns for a while and have just recently finished law school. While the majority of my time is consumed with studying for the Bar exam at the end of July, I am receiving IBD's two week trial and have been paper trading using your methods. I seem to succeeding more often than not but I need more practice. A partner would help someone like me a great deal, but people are not emailing me with suggestions. I am also leery of trusting an electronic partner at first, because who knows exactly who you are dealing with? Did you meet Wesson before you trusted him/her with your account information? Do you have any suggestions on how I can find a partner? -- Kevin Corcoran

Kevin,

I agree, it's not easy, and my "method" probably is not the way to go. As for suggestions, here's what I'd do: In Dallas, for example, there is a wonderful group called the

Association for Technical Analysis

. They were nice enough to have me speak, and, if I still lived in Big D, this is a group I'd hang out with. Talk about a bunch of geeks -- there were 350 folks there EXACTLY like me! Surely, there would have been one person who'd make a good partner. And I know there are similar groups across the country. It's a good place to start.

Regarding my trust in Wesson: He volunteered his account number first, and, since I knew his account was larger than mine, I figured I had the upper hand!

Finally, good luck with your Bar exam. It's always nice to have a "hobby" to fall back on if your trading doesn't work out!

Demanding Demand Info

Corn goes up in price if demand to buy goes up and vice versa. Stocks go up in price if demand goes up. We have no access to the demand of stocks. I need demand information -- nothing else. Why don't you provide the most important information? Demand to sell and demand to buy is the key information to the value. As the demand to sell goes up, the value of the stock goes down just like corn. This is so simple, but I have searched the Web and see hours of reading material -- in fact, years of reading material -- and I am the only person in the world that knows about the supply and demand theory. Does any one at

TheStreet.com

know how I can screen 10,000 stocks and find the top five stocks with the greatest sell volume and vice versa? -- Ken Entwistle

Ken,

You raise some interesting points. And your use of supply and demand theory would be dead-on except for one thing: In supply and demand theory, economists assume all the facts are known and everyone will be honest in revealing what price points they'll buy and sell.

Unfortunately, with stocks, a lot of players, don't tip their hands up front. Instead, they try to wait until the other guy shows his cards before they commit.

Let me give you an example. I own 1,000 shares of XYZ, and it currently trades for $50 per share. On the other side, Joe owns no shares of XYZ, but heard they're coming out with a cure for cancer. Therefore Joe is looking to buy 1,000 shares.

Unfortunately for Joe, I've heard the same news. Now, Joe's order is on the books to buy at the market. And let's say XYZ is thinly traded, so your 1,000 shares represents a big order.

Okay, Ken, here's the information, as requested. What do you do with it? Do you try to also buy some XYZ because it has big demand? Let's assume you do.

Great, now I have two buyers looking to buy my 1,000 shares. I start raising my price. In fact, even before I sell any shares, I raise my price to $200 per share. Are you still in? Or out? Are you happy you bought at $200 and hope it goes to $300? I hope so.

Now, that's the easy one. Let's throw in the hidden seller. Al, who also owns 10,000 shares, knows for a fact that XYZ is a phony company. So, he waits on the sidelines patiently and sees how high the price will go. Al finally sees that $200 price and he unloads all his stock. Oh sure, he doesn't get $200 for each share, but he keeps hitting every bid until the stock you bought at $200 is now worth $49! Uh oh. What you thought was big demand, turned out to be a trap. You had the right data, but it wasn't worth diddly.

Now, it doesn't always work out this terribly, of course. My only point is that even if we know where a lot of demand is -- and many times we don't -- that's not a sure sign that buying that stock is a good deal. I certainly don't mean to be condescending, but there are people in the trading game 100 times smarter than you or me looking for clues, indicators, signs, entrails, simple solutions, and whatever, to "solve" the trading algorithm. Maybe like

Fermat's Last Theorem

, it will eventually be solved. But, I don't think so.

Now, given all that, there are multiple ways to view high-volume stocks, and, based on their respective price directions, ascertain if the push is coming from the buy or sell side. One way is to double-click on the scrolling

Nasdaq

,

AMEX

or

NYSE

data on the left side of the

TSC

home page. That will pull up "most active" issues and may address some of the information you need. And, of course, your local newspaper will always list these same issues if you want to focus on end-of-day data. The thing I'd focus on, though, is not so much total volume, but total volume traded versus the average daily volume for that stock. A most-actives list will always pull up

INTC

or something large. What you really want, though, is something with big volume that normally doesn't have big volume.

IBD

is helpful in that regard.

Lag Time

When I started reading your columns back in March, I thought, "Why would you need to know how to go short?" After last month's market, it's obvious that you couldn't be a successful short-term trader without that ability. My question is: When the market does break out (to the upside I'm confident), is there lag time before the GBS system clicks in? Logically (not from experience), it would seem that it would take a bit of time for a "good selection" of stocks to start appearing due to the 52-week high criterion. On the opposite side of things, it would seem that good selection of short stocks would start to appear rather quickly in a down market due to the parameters in selecting them. What does your experience tell you? Also, having a trading partner would be a valuable asset. If anyone is interested, email me at pmailey@silk.net and I'll send you information about myself. Preferably someone in the Pacific Standard time zone. -- Paul Mailey

Paul,

Good questions and observations. In direct answer to your question, I find my long candidates are always a bit ahead of the market breaking out. That is, the strongest stocks are always the first ones to pop back up.

However, if your point is that my long candidates lag when the market first starts to move back up, then we are in agreement. I am always a bit late on the rebound; however, I am generally safer.

As for shorts, you are dead-on. Short candidates do seem to appear quickly, and, in fact, I had a number of successful short trades when the market was still heading up. I'm always hurt, however, if the market undergoes a V-turn and there's a buying frenzy. However, by that time, I've usually nailed enough short trades to mitigate most of the damage a sharp updraft causes.

Gary B. Smith is a freelance writer who trades for his own account from his Connecticut home using technical analysis. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. His column, Technician's Take, appears every Monday. His Q&A column, TSC

Technical Forum, appears every Saturday.