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Two-day Rule

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The following is some great information sent in by Ron F.:

A quick overview of the Two-day Rule...

Before entering a position on a rolling stock which is establishing a bottom (or is entering its buy zone), look at a 2 day chart of the stock; also, use a 5 minute time frame here.

Find the high of the 1st day, and then use that as a reference point for the present-day's possible entry point. For example, if a stock made a high of $6.00 on Monday, you wouldn't consider entering a trade unless it broke past $6.00 on Tuesday. Some traders use a whole number round-off scheme.

For example, if a stock's high was $6.38, you might round that off to the nearest whole number ($6.00) and then add .30 or .50 points (whichever is higher) to establish your potential entry point. For this example, 6.50 could serve as the target price.

One word of caution here.

Just setting an entry point is not always enough---especially if a stock reaches that number by making a large upside move. For instance, if a stock were trending along and then suddenly went upside forming a sharp angle on your chart and touching your target entry price, I would wait until the stock showed some signs of pulling back, or at least moved sideways before considering entry.

Entering a trade on a spiking stock will often land you on the wrong side of the momentum. Unfortunately, the market makers----those slick fellows who buy and sell stock all day on the exchanges----will often artificially raise prices to create an appearance that stock is moving up fast to lure in buyers. This is probably more true on the NASDAQ than the NYSE.

One question is, "where should the stock pull back to after reaching the target high, before the trader should consider entry? " Answer: Wait for a pullback to the moving average line, or at least some point of consolidation. If you've got real time charting (which is highly recommended), you can set 2 moving average lines---the fast line for 10 minutes, and the slow line for 20 minutes.

Generally, stocks will pullback to the fast line before they're ready to resume an upeard trend, or will hover near that line as a sign that the stock is still testing its current support levels.

Getting back to our example, let's say your stock hit it's target of $6.50 by spiking up. You might then wait till the stock pulled back to its moving average line, made lower highs, and then continued its uptrend toward or past $6.50 before entering.

In some cases, a stock may not pull back but move sideways. Here, waiting for a pullback might cost profits, so you have to use your judgment to determine if the stock is consolidating and testing a new support level before executing your trade.

One method that can further help determine buying strength is the use of Time and Sales. Simply put, time and sales provides a real time printout of actual shares being bought and sold. Buy orders will be printed in green, and sell orders in red.

Usually, when you see lots of green, and current buy orders are being fired off at the ASK price (the highest price being asked for the stock), thats very bullish. On the other hand, when lots of red orders appear at the BID (the lowest price that market makers are willing to buy back stock from sellers), that's bearish.

Green and red orders rolling down the Time and Sales screen (some call this a "Christmas tree") are not conclusive. In any case, you might consider using the Time and Sales screen to confirm a breakout of your entry point using the 2 day chart method.

Getting back to our example one more time, if $6.50 were hit as your target price on a spike up, but then you saw a bunch of red orders being filled on your time and sales, that would mean that 6.50 is hitting a wall of resistance and sellers are coming into the picture.

But if the stock pulled back, and then started climbing with lots of green prints going off (or at least, few red prints), this would suggest continued or potential upside move of the stock. More buy orders + good volume = bullish.

Remember: the above example is only helpful after screening for stocks that are in their buy zone. Good luck traders.
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