Page 343 - THE MARKET WHISPERER

THE MARKET WHISPERER 33 9

The Little Red Riding Hood
Trap

The term is clearly borrowed from the world of criminal behavior. Red
Riding Hood is a trap in which a candidate for elimination is invited to a
seemingly innocent event, only to discover that it was the biggest and last
mistake of his or her life. In short: seduction, deception, destruction.

In the world of trading, we apply the term “red riding hood” to an
enticing formation that rouses our inherent greed, draws us into entering
a stock full speed ahead, and usually leads to scathing losses.

What identifies a red riding hood formation? It’s usually one that looks
too good to be true: for example, when a stock consolidates at a distance
of just a few cents from the breakout line for several long minutes, or even
a few hours, it may look as though it is consolidating nicely in the short
term, readying for the perfect, full breakout. But in many cases it is a trap.
When you see a really good-looking formation, try to ask yourself what
is making it so attractive. A stock stuck in the narrow range beneath the
line of resistance is a very clear sign of one thing: a large seller. The stock
wants to rise, but the seller is not done just yet. Even if the stock breaks
resistance, there is a good chance that the seller will renew quantities,
buyers will panic, unload their merchandise, and the stock will fall enough
to shake you into a loss.

What should you do in this case? First, thoroughly examine the
resistance point. Take a careful look at the Level II window, check the
quantity of shares being offered for sale, and try to identify the seller. Is
this a market maker attempting to refresh stock all the time? Since it is
often difficult to access clear data through the Level II window because
sellers can hide their sell orders, carefully check the T&S (time and sales)
window where you will find the flow of trades actually being executed. No
one can hide the amount of shares being sold at the resistance point! If you
see a large quantity changing hands without being able to identify a seller
renewing stocks, you will understand that this is a smart seller concealing
sale instructions.