As part of my Total Alpha service, members are provided with morning and afternoon market updates to help keep them at the ready for any timely trade ideas.

This past Wednesday’s afternoon update was particularly timely since it came just as some of the heaviest selling of the year was getting started.


The day started out on a positive note, but as trading progressed the price action grew increasingly negative, adding to the top-heavy price action that had already been developing since the early part of November.

As part of this past Wednesday’s afternoon update, I highlighted this first chart to show the Nasdaq 100 ETF (QQQ) testing its 200 hourly moving average for the 3rd time after buyers failed to take the ETF above key resistance, also for the 3rd time.


As the price was being squeezed between these two key levels, I warned of my outlook of the QQQ to eventually break lower.

As I always do, I presented a plan of attack for members interested in placing trades to take advantage of this outlook.

This next image shows the actual working limit order for a bearish “credit call spread” that I set up for this trade as guidance for Total Alpha members. 

In the end, Wednesday’s trading session saw the QQQ weaken even more aggressively, eventually ending the day with a -1.7% decline.


As the week progressed, so did the bearish pattern that initially inspired me to want to bet on further weakness in QQQ.

Therefore, I continued to update the events as they unfolded with charts like this next one that highlights the “head and shoulders” topping pattern that inspired the trade.

You see, when a market develops a top, that top develops as part of a process, a process that includes a gradual deterioration in market sentiment and the transfer of ownership from those selling old shares to those buying new shares.

This process can cause a stock’s price to take the shape of many different types of technical patterns, with the “head and shoulders” top being among the more popular ones.

Other topping patterns you may be familiar with are “double tops” and “triple tops.”

Price tops rarely form because of one thing.

Instead, these complex periods of change in a stock’s long-term trend usually form with help from a combination of factors.

What were the ingredients that helped create this latest top?

Well, we can certainly blame the Federal Reserve Chairman, Jerome Powell, whose comments confirming that inflation is no longer transitory sparked fear that the market’s “punch bowl” may soon be taken away to help slow inflation.

Next, we can blame the newest fear campaign being propagated by the media about the newest Covid variant that many now believe to be no deadlier than the Delta variant. 

Finally, fundamental narratives like this often foster deeper selloffs when they occur at overbought points in the market, and as this next chart shows the left shoulder of this pattern started when QQQ was registering an extreme RSI reading of 79.

Now, according to the textbooks, the way we obtain a potential downside target as a result of this type of pattern is to take the height of the pattern’s “head” and project it lower from the point at which price broke below the pattern’s “neckline.”


This next chart illustrates this procedure.

As traders, we must recognize that while patterns like this are often very helpful at telling us that downside risks are dominating the market, these patterns do not always deliver on their potential targets.

For this reason, I decided to play the pattern in a manner that would allow me to benefit from the passage of time, rather than a trade that requires the price of QQQ to fall aggressively in a short period of time.

Specifically, I am referring to the fact that I placed a bearish “credit call spread” as opposed to just buying straight puts.


Bottom Line

When we’re talking about an ETF as large and as liquid as QQQ, the technical patterns that develop over time are a reflection of the gradual change in psychology that occurs across the huge shareholder base.

These patterns are great trading tools because they have set rules and price targets that help us know when we’re wrong (i.e., when the pattern is no longer working) and where to place price targets.

Since these patterns don’t always work, but this particular pattern was still showing good potential to do so, I decided to simply make the higher probability bet (i.e., placing a “call credit spread” that QQQ would remain below the “right shoulder” of this pattern for the remainder of the week, as opposed to taking the lower probability trade, which is to buy straight puts, and wait for a sharp downside move that may or may not occur.


To YOUR Success!

Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

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