Pimp My Trade

The China Trade

Posted on March 16, 2009 by Adam

Hello everyone, and welcome back from what I hope was an enjoyable weekend.

Part of what I try to do on this site is to provide some clarity and ideas for those of us who are trying to make sense of what the market is doing. I know it’s been a tough few weeks, but I have been noticing some bullish signs aside from the nice rally we’ve seen. That has me encouraged.

Lately I have been watching Chinese equities. During these tough times, they have showed remarkable relative strength. When you compare the FXI, an ETF that tracks Chinese equity prices, to the S&P 500, you will see that China has been holding up really well. For one thing, they are still above their November lows, whereas the US stock market is digging itself into a hole we haven’t been down in over 10 years.

But in spite of it all, I try and trade what the technicals are telling me. Right now what I see emerging is a low risk bearish setup. Now, I wouldn’t normally try and short anything that’s been displaying relative strength, but the setup is pretty hard to ignore.

This setup is based on a tried and true point and figure entry signal that tends to work out pretty nicely. If you haven’t ever used point and figure charts before, I would highly recommend it. You’ll see how they can be useful in a second. I also suggest you take some time and watch my point and figure tutorial video. I think these are an excellent tool that is used less widely than it should be among retail investors.

The setup works like this. When you see a stock that is on a point and figure sell signal, you want to enter a short trade at a low risk entry point. Based on a point and figure chart, that low risk entry point comes right before the stock would go on a buy signal. That way, if the stock goes on a buy signal, you can get out before much, if any, damage is done.

The problem with that signal is that it is sometimes a low probability strategy. This signal becomes much more actionable, however, when that low risk entry point coincides with a test of a bearish trendline. Testing a point and figure trendline results in a reversal more often than not. The two factors add up to make a high probability, low-risk trade.

I’m seeing that setup in FXI right now. Here’s a look at the chart:

FXI is one point away from super bearish entry signal.

If this stock prints 28, then it will be only one point away from going on a sell signal. That makes for an ultra-low-risk entry point. You can set your stop-loss at 29 exactly. At the same time, it would be bumping its head against a big bearish trendline, which increases the probability of success.

I’m not saying this trade will work every time, but if you can get this as a short between 28 and 29, I wouldn’t mind at all. In fact, I might do the same.

Happy Trading!