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Trade Like an O’Neil Disciple -Book Review

The CANSLIM enthusiasts, and they seem to be legion if the reviews on Amazon are any indication, have nothing but praise for Trade Like an O’Neil Disciple by Gil Morales and Chris Kacher (Wiley, 2010). I decided to be a little more focused and less ebullient in this post and write about a trade setup not found in the standard O’Neil repertoire. Consider this a follow-up to yesterday’s discussion about the eye of ambiguity.

The setup is alternatively described as a pocket pivot or buying in the pocket. It is “an early base breakout indicator, which is designed to find buyable pivot points within a stock’s base shortly before the stock actually breaks out of its chart base or consolidation and emerges into new high price ground.” (p. 128) The pocket pivot indicator provides direction in what might be seen as an ambiguous situation. It is, the authors claim, particularly valuable in sideways moving markets.

A major virtue of a pocket pivot buy point is that it is a low-risk entry point—relatively close to support and far enough from resistance to be profitable even if the stock can’t break through to higher highs. Or, as the more optimistic authors claim, “the pocket pivot buy point technique can get an investor into a stock at a lower-risk price point and thereby make it more possible for the investor to sit through a pullback if the all-too-obvious new-high breakout buy point fails initially and the stock retrenches, corrects, or sells off.” (p. 129)

What are the characteristics of a pocket pivot buy point? “[A] stock should be showing constructive price/volume action preceding the pocket pivot. … [T]ighter price formations, that is, less volatility should be evident in the stock’s price/volume action as viewed on its chart. The stock should have been ‘respecting’ or ‘obeying’ the 50-day moving average during the price run that occurred prior to the time the stock began building its current base. … Except in very rare cases, … pocket pivots should only be bought when they occur above the 50-day moving average. Ideally, the stock’s price/volume action should become ‘quiet’ over the previous several days, which contrasts with the much larger and stronger volume move that comes on the pocket pivot itself. On the pocket pivot you want to see up-volume equal to or greater than the largest down-volume day over the prior 10 days.” (pp. 132-33)

The authors offer a series of variations on this generic trade setup. For instance, there’s the continuation trade: buying on volume after a pullback to the 10-day moving average. Or the bottom-fishing trade where a stock, after carving out a bottom, pushes through its 50-day moving average. They urge caution if a pocket pivot is too extended from its 10- or 50-day moving average when it begins its move or if a stock has been “wedging” upward instead of drifting downward before a pocket pivot. As they write, “context is everything.” (p. 162)

This setup is certainly not a revolutionary breakthrough in the world of technical analysis. In fact, anyone familiar with the literature might recognize several patterns rolled into one here. In the context of yesterday’s post, it is a “fast-follower” strategy because it requires a volume spike, created by the “first movers.”

THE BED OF PROCRUSTES

Nassim Nicholas Taleb, the former trader and well known author of The Black Swan and Fooled By Randomness, has put together a new book of aphorisms, entitled The Bed of Procrustes.  The Procrustes of Greek mythology was a cruel fellow who stretched or shortened people to make them fit his inflexible bed. Mr. Taleb’s new book addresses the modern day ways in which “we humans, facing limits of knowledge, and things we do not observe, the unseen and the unknown, resolve the tension by squeezing life and the world into crisp commoditized ideas, reductive categories, specific vocabularies, and prepackaged narratives, which, on the occasion, has explosive consequences.”  In other words, we live under self-imposed delusions.  Here are a few of the aphorisms that expose our delusionary thinking, many of which can be applied to trading.  But, in order to understand their application, we must first step out of our delusional state.

The stock market, in brief: participants are calmly waiting in line to be slaughtered while thinking it is for a Broadway show.

You are rich if and only if money you refuse tastes better than money you accept.

The best test of whether someone is extremely stupid (or extremely wise) is whether financial and political news makes sense to him.

You can be certain that the head of a corporation has a lot to worry about when he announces publicly that “there is nothing to worry about.”

The main difference between government bailouts and smoking is that in some rare cases the statement “this is my last cigarette” holds true.

The difference between banks and the Mafia: banks have better legal-regulatory expertise, but the Mafia understands public opinion.

They would take forecasting more seriously if it were pointed out to them that in Semitic languages the words for forecast and “prophecy” are the same.

The three most harmful addictions are heroin, carbohydrates, and a monthly salary.

I wonder is anyone ever measured the time it takes, at a party, before a mildly successful stranger who went to Harvard makes others aware of it.

It takes a lot of intellect and confidence to accept that what makes sense doesn’t really make sense.

Education makes the wise slightly wiser, but makes the fool vastly more dangerous.

The best revenge on a liar is to convince him that you believe what he said.

How often have you arrived one, three, or six hours late on a transatlantic flight as opposed to one, three, or six hours early?  This explains why deficits tend to be larger, rarely smaller, than planned.

The most painful moments are not those we spend with uninteresting people; rather, they are those spent with uninteresting people trying hard to be interesting.

The characteristic feature of the loser is to bemoan, in general terms, mankind’s flaws, biases, contradictions, and irrationality-without exploiting them for fun and profit.

You don’t become completely free by just avoiding to be a slave; you also need to avoid becoming a master.

The fastest way to become rich is to socialize with the poor; the fastest way to become poor is to socialize with the rich.

Some, like most bankers, are so unfit for success that they look like dwarves in giants’ clothes.

Over the long term, you are more likely to fool yourself than others.

It is those who use others who are the most upset when someone uses them.

A genius is someone with flaws harder to imitate than his qualities.

It is much less dangerous to think like a man of action than to act like a man of thought.

What I learned on my own I still remember.

Regular minds find similarities in stories (and situations); finer minds detect differences.

The tragedy is that much of what you think is random is in your control and, what’s worse, the opposite.

You can only convince people who think they can benefit from being convinced.

Trust people who make a living lying down or standing up more than those who do so sitting down.

Even the cheapest misers can be generous with advice.

The difference between magnificence and arrogance is in what one does when nobody is looking.

When conflicted between two choices, take neither.

A prophet is not someone with special visions, just someone blind to most of what others see.

You know you have influence when people start noticing your absence more than the presence of others.

There is much more where the above came from but you will have to get up out of bed, head to the bookstore, and find out for yourself.  May be worth the trip.