Option Investor
Educational Article

Entry Point, Entry Point, Entry Point

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By Jim Brown

I wrote this article as part of a ten part series late last year and due to the large number of new readers requesting them we are going to update and reprint them over the next ten weeks. The charts and analysis are just as valid today for learning how to pick stocks as they were when the article was first written. It is the principle I am trying to get across not a specific stock for trading on Monday.

Two different traders could buy options on the same five stocks in the newsletter this week and one trader could be profitable on all five and the other lose on all five. Why? Entry Point!

One of the biggest frustrations of the newsletter writers is the rush by readers to buy options the next day on recommended plays. This is not a good plan. NEVER BUY OPTIONS THE DAY AFTER A NEWSLETTER unless you have a good entry point.

The newsletter updates plays three times a week. Sunday, Tuesday and Thursday. The chances of a great entry point, on any stock in the newsletter, occurring on Monday, Wednesday or Friday would be purely coincidental.

The plays listed in the newsletter are based on fundamentals, technicals, news stories or special events like earnings and splits. If a positive news event just occurred on one of our picks then the stock probably ran up because of it. The stock is not a play until it cools and option premiums deflate.

Current readers have probably heard me say this many times but one of the keys to options trading is entry points. The next biggest problem is exit points. If you pick a good entry point then all you future decisions will be much easier. It is much easier deciding to sell if you are up +$4 than being down -$2. Many readers still make the greed mistake but that is another article.

You here us say, wait for all the conditions to line up before stepping into battle. The list of conditions is long and I doubt that anyone ALWAYS waits. Those that do reap the rewards and those that ignore them completely are doomed to big losses.

The conditions we want to see on our side are:

1. The Dow and Nasdaq in positive territory and climbing.
2. The advance/declines positive and climbing
3. The ticks positive
4. The sector positive
5. The stock positive and at an entry point
6. Wait one hour after the open
7. No major economic reports within the next 48 hours

And if we are really wishing for the moon we would like to have the market rebounding from a three day sell off.

Now, I can hear you now. If I wait for all these things to happen I will never get a trade executed. It may seem that way but in reality we can get most of them at least once a week. ONCE A WEEK! I will never make any money trading once a week! Yes, you will and if you trade without the majority of those conditions satisfied you are right, you never will make any money.

For this lesson, we are going to assume the market factors are in our favor. Now all we have to do is pick the right stock. Now, if the object of the game was to make money then why would you want to trade any other time? If all the market factors are in our favor does that mean that ALL stocks are going to go up? Of course not. The ones that deserve to go up will and those that have been out partying may not.

A recent example could be QCOM. Based on the chart below if all the market factors are in our favor on the next trading day do you think QCOM will continue to defy gravity. It may, and may continue for another day or two but eventually common sense will prevail and the profit taking will be fierce.

Check out these charts: Do they all look the same?

Yes, they all are showing the same characteristics. Rapid unsustainable growth out of a long period of consolidation. This event is called the climax event. Another name is the last fool theory. This means the last one in is the biggest fool. History has shown us many times over that this kind of explosive gains are not sustainable. Look again at AOL and SCH as the bloom came off. AOL lost over half it's gains.

Schwab dropped from a high of $78 to $28.

These examples are extreme but so are the gains made by QCOM and JDSU in the last three days. Using the many tools at our disposal we can prevent buying in at the highs and being the last fool.

One of my favorite analysis methods is the most simple. By simply drawing a line across the highs and the lows on the stock you are studying, you can get a fairly good idea where not to buy. Take our QCOM example:

This is crude but effective. If QCOM was near the top bar then it was probably not a good idea to buy. Historically, stocks tend to move between ranges. Another way to do this with more precision is called regression channel analysis. Basically the charting program calculates where the future highs and lows SHOULD be, based on historical highs and lows. Here is the regression analysis on QCOM. It looks like an exact copy of the simple trend line example.

It is very close because the recent history on QCOM has been fairly stable and within historical ranges. Notice how neat and orderly the upward movement has been. Looking at the past makes picking previous entry points look like child's play. Unfortunately the future is not quite as easy. Lets look at the recent QCOM move.

Qcom was trading in a very tame $20 point range for several weeks before the trigger earnings event. Note how the extreme moves have broadened the channel. Note also that QCOM is at the very extreme top of the band. Most, strike that, ANY analyst looking at this chart would predict a pullback to at least the $270 range before QCOM can move forward. We are not however dealing with a mathematical equation with a perfect answer. Emotion and market forces are at work and nobody knows the actual outcome. Six months from now you will be able to look back on a chart and see if it looks like AOL or SCH, or if it really did defy gravity. The point here, using this exaggerated example, would you want to bet your hard earned money on QCOM breaking $300 next week? Probably not. Here lies the problem. Every crap shooting day trader in the market is going to short QCOM Monday if they haven't already. If QCOM manages to hold on and gain even more ground then the short squeeze that caused this spike will get even worse. Needless to say, if you don't have the money to lose then don't play in this game.

** Now it is seven months later and we know that QCOM did pull back in mid-November but then rocketed to near $800 and a 4:1 split in January. The point of the exercise is to make you wait for that pull back after a great run before the next one starts. **

So lets use what we know about historical pricing to look at entry points we can all play. Using stocks in a Sunday newsletter lets see which are good plays for the following Monday and which are not.

** These were plays from Nov-99 but again, "It is the concept, not the specific stock" that I am trying to teach. **

Lets start with an easy one. Broadvision recently has been on fire. The stock rocketed into record territory on the heels of several upgrades and a 3:1 stock split announcement. The split was on Oct-26th. There was only one day of post split depression and then BVSN was caught up in the Nasdaq excitement for a $23 gain. With the Nasdaq still setting new highs the $23 gain ($69) pre-split was too much baggage and the real post split selling began. After dropping -$10 when the Nasdaq was soaring we see another tell tale sign of a breakout. It is called the "Higher Lows" formation. BVSN has resistance at $85 as you can see by the chart. But for the last four days the low for the day has been higher than the day before. This means the buyers are slowly overpowering the sellers. The resistance at $85 is under attack. As these intersecting lines come together the result is normally a breakout and more strong gains. Is BVSN at a good entry point right now? It depends on your risk profile. Aggressive traders are buying right now in hopes of a big pop when/if it breaks out. Cautious traders will want to see it trade and close over $85 before starting a new position. They are willing to give up the initial breakout in favor of a safer entry.

CMVT - Comverse Technology is showing the same type of pattern. Higher lows with resistance at $114. Cautious traders will want to see it close over $114 before starting a new position.

Another way to decide when a breakout may occur is to drill down into the chart with a higher magnification. Instead of a 30 min, switch to a 10 min. In the last three days note that the drops under $112 are becoming less dramatic. The selling spikes are having a harder time penetrating the bottom support. This would indicate selling volume is decreasing and limit buyers are moving up their orders.

Lattice Semiconductor is showing the same lower high formation with a couple more bullish twists. First notice that the intraday ranges on LSCC are narrowing. Where we had big intraday moves in October the last week or so has been compacting. This is a bullish sign and means the sellers are drying up.

The second thing you should look for is the plateaus. This shows in graphic detail that there is at least one big buyer and he is having to adjust his limit order upward each day because nobody is coming down to his level. Note the end of day dips are shrinking and on Friday there was no dip at all.

A classic entry formation is VSTR. Voicestream has broken out after a consolidation period and the sector is hot. We have been given several excellent entry points over the last three months on normal profit taking. The news is good and outlook is bright.

Here we have a picture perfect play. VSTR has performed the perfect bounce off both sides of its channel and looks to be on the verge of another bounce off the bottom. The upside potential if it does bounce is close to $110. Note where the top line would intersect the right side of the chart. The keyword here is IF. When things look too good, they usually are. Still, you can only go on what knowledge is available.

ADPT shows an almost perfect chart. No major drops, no major spikes. The three days of resistance occurred when it hit the previous resistance from early October. Other than that ADPT has been following the center line of a very tight channel. It really has not been bouncing off the bottom so any dip under the center line would be buyable.

Level Three is showing confirmation from both different chart styles. The higher low chart is showing resistance at $72 but the channel chart is showing a classic entry point off the bottom channel. Cautious traders would want to see a close over $72 and the next upper end of the channel could be around $76-77.

Veritas Software has a great chart on the surface. As we dig deeper there are some problems. The channel chart shows the stock with strong resistance at $110 and the price is drifting towards the bottom of the channel.

The biggest problem I see is the Gap and Crap trend. Now you can make money on this trend but it is strictly a day trade proposition. There is some optimism about the stock which creates the gap open in the mornings. However you can tell there is some heavy selling with the daily sell off. After gaining almost $20 intraday during the week, the sellers pushed it back down every day to about the same price it started the week. I would not be a buyer of VRTS until the end of day selling quit. I think an entry point here would be in the $105 range or the bottom of the channel. Day traders would target shoot the end of day dip and then sell on the morning gap open. When you find a stock that has this trend it can be very profitable even though the stock is not going anywhere.

SYMC - No magic here. It just bounced off the bottom of it's channel and still moving up. Entry point would be anything under the center line. Resistance at $50 but closing. Cautious traders would wait for a close over $50.

MXIM - just like SYMC, good chart, maintaining the center of the channel. Looks like two days up, three days flat for the last couple of cycles. The last day was up, wait one day then look for an entry point with the market.

IMNX - Immunex would not be my favorite. Trending to the bottom of the channel but bouncing off the bottom just the same. I would want to enter IMNX around $63.

Intel - INTC - is making a steady move upward. The wide channel is a result of the big drop on Oct-27 and the rebound the next day. If you ignore those two days and draw a line from the low on Oct-25 to the low on Nov-5th you will see an almost perfect upward progression. Because of the possibility of a Nasdaq pull back I would look to enter Intel closer to the bottom of the channel, around $80.

Apple Computer has been tracking through a strong upward channel since it's breakout. The angle is getting stronger but as you can see on both the 30 min and the 15 min it is exactly at the top of the range. I would not be a buyer of AAPL on Monday morning. If I wanted to play AAPL I would try and target shoot the next intersect point somewhere in the $86 range. If we get a Nasdaq pull back then $84-85 would be ideal but tougher to get. The difference in angles is due to the different chart times.

EMLX - Outstanding play - on Nov 3rd! Not a good play now. As you can see it is out of range and needs to correct before you open a new position. Should we drop it as a pick - NO! The outlook is great, just the timing is wrong. EMLX has been tracking in a $20 range and we got lucky the last three days. A wise trader would wait for the dip back to the bottom of the channel and then buy calls again. An aggressive trader would be buying puts and looking for at least a $10 drop. Every pick is a good play if you wait for the right entry point.

Sun Micro is showing the strong pattern of higher lows and closed right at it's resistance of $110. This puppy is going to blow! The only question is when. If the Nasdaq pulls back so will SUNW and then we will need to see what formation we get after the drop. Look for these formations, they are normally free money.

Sony Corp has a great chart with a couple different patterns. We have the two levels of consolidation and then breakout in the last four months. It just broke out over the previous high of $160 and could be ready to run.

Using the long term channel we see it just broke the centerline and has a ways to go before touching the top again. This along with the breakout over $160 is positive.

Using the short term channel you can see that we are due a slight pull back before it moves up again. The difference between the time frames gives us a microscopic look at the different forces at work. If you just look at the big picture then the small potholes can trip you. Practice drilling down to the shorter time frames.

This is a graphic example of the many entry points SNE has given us in the last eleven days. If you waited for the dips you would have been profitable almost immediately. If you blindly bought on the up moves then you could have been stopped out on the dips. Would this have been a good play 11 days ago. Could you have made money with the right plan? Sure. Could you have lost money with the wrong plan? Sure. Knowing the difference is worth it's weight in gold.

AOL - The best for last. After a long slide AOL has caught fire again and with a split coming we all know it is not going to drop any time soon. At least until you open a position then it will correct for sure. Using the long term, daily, chart you can see it is at the top of it's trading range. This is where knowledge of outside events is key as well as a closer view. Based on this chart you should not buy AOL.

Based on this chart you should. The difference again is focus. Short term trends, especially news driven cycles, take precedence over longer term trends. We can see here that the channel for the short term trend is stable and we have progressive daily gains since the split announcement. It dipped some at the close on Friday and we may be ready to drop into the lower half of the channel. That would be a buy signal for me. Using the previous days range of $142-144 I think we could see it trade right to the bottom of the channel. $142 I think would be a good entry point. $140 of course would be better but I do not expect it to drop out of the channel. I really do not expect it to even touch the bottom. The market movement on Mon/Tue will determine how good an entry point we get.

Analyze the markets before planning any trade.

Here is a chart on the Nasdaq. As you can see we broke out of our recent trading range. That is the good news. The bad news is the strength of the breakout. From the recent bottom at 2650 three weeks ago the Nasdaq has been on fire. Too far, too fast. Just like the QCOM, JDSU, EMLX stock charts above, there is no support at this extended altitude. Sure the Fed is on back burner, yes the economic reports have been benign, but reality still exists. As you can see on the second chart the channel does not look good. Every time we have touched the top of the channel in the last year there was disastrous results. Several times a -10% correction was the result. As an investor in Nasdaq stocks this should concern you. All the positive stock charts above are worthless if the Nasdaq turns over. Where do you think the Nasdaq is going?

The Dow at this point is showing no support. For the last few weeks we have been range bound. On the bright side we did see the recent drop stop dead at 10,000. Since then it has been one strong day up, rest a week or so. We just finished dead in the center of our current range after the Nasdaq was setting back to back records for six days. Had the Nasdaq been dropping I am afraid the Dow would have been also. As you can see by the second chart the bottom of the recent channel just happens to meet the bottom of the recent range at 10,600. This is our inflection point. If we get a drop on Monday, and we should with MSFT in the Dow, then 10,600 is the number to watch. If we fall out of our current range then we will also fall out of the current channel and we could see several century marks lower real quick. The bright side is still the economic news. A benign PPI on Wednesday could ease the pressure and help keep us in our range until the Fed meeting. If we can hold the line until then we could be out of trouble.

I hope by explaining the different chart patterns you can see that nothing really goes up in a straight line. The stock that ran away from you yesterday will come back. It may not be back at the same number but when it does retrace that is the time to buy.

Retracement is a wonderful thing. Every strong move upward by a stock is met with a stronger move upward in the option premiums. If you doubt me, check out the calls on any stock that was up huge in the past week.

Retracement, even a little bit, will deflate the premiums significantly. It is the expectation that pumps them up and reality that brings them back to us. Never chase a stock. The inflated option premiums you pay will disappear instantly when it stops or turns back down. Wait for the opportunity to come to you. You will make fewer trades but you will be more profitable, and I think that is the object of the game.

There are dozens of other indicators you can use to chart stocks and many are as good or better than the ones I used here. These are the simplest and unless you are looking for a degree in charting these will do fine. If you like MACD or RSI or Momentum then use them. Just don't get caught up in the paralysis of analysis and fail to execute the play. If you execute and the play goes against you then get out.

If you were playing chess or checkers and your opponent made a move that exposed one of your pieces, you would not just leave it there. You would move it somewhere else or protect it. The same is true with options. Make the moves, some will work, some won't. Keep the good ones and close the bad ones.

Good Luck

Jim Brown

If you learned anything from this article then congratulations. However I hope you realize that this article only scratched the surface on this topic and option trading in general. This is the type of material we teach in our seminar series which is coming soon to a city near you. If this helped you understand trading better then how much could you learn in a two or three day seminar taught by our staff?

Most bad option trades cost several thousand dollars of your investment capital. 5-10 bad trades a year can cost tens of thousands of dollars. Why not invest $1995 in your permanent education and learn how to maximize your returns while minimizing your losses?

Experience is a great teacher but your best lessons are learned normally over big losses. Trading is a skill best learned on the losses and experience of others. Learn from their mistakes and become a wise investor not a poor investor.

The next seminar is a three day event in Los Angeles on June 22-24th. We guarantee you will not be disappointed. The class size is only 20 so you will get plenty of individual attention from Chris Verhaegh and the staff. At less than the cost of a bad trade you can learn how to analyze stocks and trade options like the pros. Don't wait, do it now.

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