SHADOWTRADERPRO SWING TRADER USERS GUIDE

How to get maximum value from your ShadowTraderPro Swing Trader subscription.

ShadowTraderPro Swing Trader delivers value to its subscribers on multiple levels. The
newsletter stands alone as either a purely informational vehicle for those who like to find
and trade their own ideas, or as a daily resource for high probability trade setups, both
listed in Bulls & Bears section in the morning and also via real-time emails. Following is
an explanation of each specific section of the report and how to utilize it. The newsletter
is sent out daily and each morning's edition arrives at midnight the evening before,
assuring that users have ample time in the morning (no matter HOW early they get up) to
digest the information.

THE BIG PICTURE:

Every Swing Trader starts with the Big Picture. The Big Picture takes a snapshot of one
particular technical event that is happening in the market at the time and gives a full
commentary on it including bias its implications in the "bigger picture". Commentary
often includes snapshots of daily broad market averages with fibonacci levels and other
support and resistance pivots marked off. A brief rundown of how the market acted in
the prior day is usually included for those individuals who need to get a brief rundown of
the prior day's action at days end.

UNDER THE HOOD:

A listing of the prior day's closing figures, including the major averages and the market
internals such as breadth and a/d lines. Closing prices on spot gold and crude are also
included as are the top 3 strongest and top 3 weakest sectors the day before. Readers are
encouraged to print out the Swing Trader daily to look for convergence and divergence in
the moves in the averages and the market internals to look for clues as to future direction.

A short explanation of some key numbers and how to interpret them in “Under the Hood”
follows:

NYSE AND NASDAQ OVERALL VOLUME – This is measured in actual shares traded on
both of these exchanges. The amount of volume is then compared in percentage terms to
the previous close. If the markets close above the prior day’s close (up) or have
advanced strongly off of lows creating a sizeable ‘body’ on their daily charts, and have a
percentage increase in volume, then this is called an “accumulation day” which is
indicative of institutional traders accumulating shares. The opposite is true for days that
are down on increases in volume and are called “distribution days”. If the market is to
maintain an uptrend then it needs accumulation days and to maintain a downtrend it
needs distribution days. Pay close attention to days where overall volume increases
greatly but the market either does not make a new high/low or fails its intraday high/low.
This is a sign of “churning” where institutional traders (think, smart money) are either
selling to retail traders at a high or buying from retail traders at a low in anticipation of a
reversal.

NYSE AND NASDAQ BREADTH – This is expressed as a ratio which is simply the
amount of up volume (volume that flowed into stocks advancing) compared to the
amount of down volume (volume that flowed into stocks declining). If the ratio reads 2:1
then the amount of up volume was simply 2x the amount of down volume. In periods of
lower volatility, look for breadth readings of better than 2:1 to be meaningful and
indicative of strong momentum. In periods of higher volatility its common to see
readings of 10:1 or greater on either side. A general rule of thumb is that anywhere
between 2:1 positive and 2:1 negative, the market will not be able to sustain moves.
There is simply too much push/pull going on between up and down stocks. Check out
these numbers daily and see how they closed on trending days of expansion of range and
congested or inside days where there was a contraction of range.

BREADTH RATIOS – This is a way to compare how much in percentage terms the up
volume was in relation to the rest of the market. The formula for the ratio is simple: ((up
volume) / (total volume)) * 100. This will give a number between 0 and 100. If the
number is 50, then obviously the up and down volume was at parity. You want to look
for readings above 80 to confirm strong bullish price action and readings below 20 to
confirm strong bearish price action. On strong trending days up this number can read
well over 90 into the close and on strong trending days down, this number can read less
than 10.

NYSE AND NASDAQ ADVANCERS/DECLINERS – The number of advancing stocks

minus the number of declining stocks on the NYSE and Nasdaq. Be aware that like all of
the market internals listed in the ‘Under the Hood’ section, these readings are taken at
4pm EST when the market closes however during the course of the day, the a/d line can
vary greatly from anywhere to minus 2500 to plus 2500. Your best bet is to always
compare an intraday chart of the S&P with an intraday chart of the a/d line to see if there
was convergence or divergence that either supports or denies the price action in the
markets. If you are bullish you want to see these a/d lines close well over +1000 on
strong days and well under -1000 on weak days if bearish.

NYSE AND NASDAQ TRIN – Also called Trader’s Index or Arms Index (after inventor
Richard Arms). This is a complex fraction that takes the amounts of advancing stocks
and declining stocks and advancing and declining volume into account.

Advancing Issues / Declining Issues

----------------------------------------------------
Advancing Volume / Declining Volume

If the above fraction returns a value that is lower than 1.0, then it is an indication of
buying pressure across the market. If the value is above 1.0, then it would indicate
selling pressure. Readings that are above 2.0 (very bearish) and below 0.30 (very bullish)
should be paid attention to closely. Like all market internals, the trin can be charted and
it makes sense to chart it in the same timeframe that you do when you are charting your
broad market index such as S&P or Dow.

Note: We don’t use the TRIN as much as we used to here at ShadowTrader HQ. Certain
indicators seem to work well for a long time and give clear signals and then later on do
not. We think the recent deficiency may have something to do with a inordinate amount
of contra-etf’s coming to market which are bought by traders who are betting the market
will go down. Thus you have a lot of false buying pressure coming into the market even
when its going down sharply. We are currently using the $TICK as our “3rd internal”
(after the Breadth and A/D line). The $TICK which measures the difference between the
total number of stock trading on an uptick minus the total number trading on a downtick
at any given moment is not listed in Under the Hood because it must be watched
intraday in order to have any value and its closing number is meaningless.

$VIX – The VIX or CBOE Volatility Index measures the implied volatility of S&P 500
Index options. While that’s good to know, what is essential is what this number really
means when seen in the Under the Hood and how you should interpret it. The VIX is
quoted as a number but is actually a percentage reading. If, for instance, the $VIX says
42.7, then what this means is that there is an expected change of 42.7% (annualized) over
the next 30 days. The annualized part is important. How much the actual expected
change for just the next 30 days (which is what we care about) is taken by dividing the
vix percentage into the square root of 12 (for the 12 months of the year). In our example
above, we would divide .427 by 3.464, giving us .1233, or 12.3%. This means that S&P
500 Index options are priced with the assumption (read: implied) that the magnitude of
the S&P 500’s return over the next 30 days will be less than 12.3% in either direction.
For you math geeks out there, note that this assumption is only that there is a 68%
likelihood that this will happen because in a normal distribution each standard deviation
is roughly 34% from the mean. Think of all of the prices that the SPX could land on over
the course of a month as a big bell curve. Right in the middle is the peak area where we
calculate the mean. The prices then fan out in either direction both up and down. In such
a normal distribution, the first two bands or standard deviations represent roughly 34% of
all the values in either direction. So because the market goes both up and down, the VIX
is telling us that there is a roughly 68% chance that the market will move somewhere
between 0 and 12.3% over the next 30 days.
The CBOE uses current market prices for all out of the money calls and out of the
money puts for the front month and second month expirations. Knowing this in and of
itself is important because it helps us to understand what creates high or low VIX
readings. When the VIX value is high (let’s say over 30), then the prices of those way
out of the money calls and puts is high because those who are selling them are expecting
a high premium for the risk that the market could “go there”. Conversely, those that are
buying must pay a high premium because the market has a good chance that it could “go
there” and those options might actually be worth something. Many people think that it’s
only the expectation of a large move down that causes a high VIX, hence the name “fear
index”. This is sort of a misnomer because as we have pointed out above, the calculation
takes into account the current prices of both out of the money calls and puts. So, high
VIX readings mean that traders of options are pricing in significant risk or chance of a
sharp move in either direction. The VIX will be low when those same traders perceive
very little risk or chance of the market moving in either direction.

ES PIVOT POINTS – These are the pivot points for the current day that the Focus Report
is dated. The calculations are based off of prior days data. We get tons of questions on
how we calculate these and why they ours are different from the TOS platform or other
data sources. The formula we use follows:

PIVOT = (High + Close + Low)/3

R3 = High + 2(Pivot - Low)
R2 = Pivot + (R1 - S1)
R1 = (2*Pivot) - Low
S1 = (2*Pivot) - High
S2 = Pivot - (R1 - S1)
S3 = Low - 2(Hi - Pivot)

The “big secret” to why the values are sometimes different is that although futures trade
24 hours per day, ShadowTrader uses only the high and low from the prior days’ trading
hours only (9:30 – 4pm EST). The “close” value used to calculate the PIVOT is the
CME Settlement Value which comes from the CMEgroup website. The link to this is in
the glossary section of our website at www.shadowtrader.net. Just click on the “about
us” tab and choose “glossary”. Once there, scroll down to Pivot Points.

STRONGEST AND WEAKEST GROUPS – These are the 3 strongest sectors (most up in
terms of percentage from their open) and 3 weakest sectors (most down in terms of
percentage from their open). Although these figures are for the prior day’s action, do a
cursory check every day of which groups were strong and weak. Sectors that seem to
pop up in the top three very often are probably trending and should never be traded in the
opposing direction. Sectors that have not appeared in the Focus Report in quite some
time and suddenly show up in the pole position of strongest groups may indicate a sudden
reversal of a long-term trend.

HEADS UP:
Your one-stop-shop to know what is happening regarding economic data in the days to
come. The Swing Trader lists all important economic data for the next 3 trading days,
highlighting items which we feel will have the greatest propensity to move markets in
bold.

BULLS AND BEARS:

This is where readers go for long and short trade ideas every day. Bulls and Bears
generally lists 2-5 trade setups per day with defined entry and stop, along with a very
brief description of what we feel is putting the stock in play. Stocks listed in this section
may or may not end up as official ShadowTraderPro plays that are part of the
ShadowTraderPro Model Portfolio. If we know that an entry for the Model Portfolio is
possibly setting up the next day we will more than likely make every effort to list the
stock as a trade in this section but its not required or guaranteed. The section would also
include stock ideas that might not fit the price and volume requirements of official
ShadowTraderPro Model Portfolio plays.

THE SHADOWTRADER PRO MODEL PORTFOLIO

In addition to plays listed in the Bulls and Bears section, ShadowTraderPro Focus Report
includes a daily updated Model Portfolio which traders can easily simulate themselves by
entering and exiting positions in sync with ShadowTraderPro's real-time emails. Entries,
exits, stops and changes to stops and targets are emailed out constantly to current
subscribers. Once a stock is in play either to the long or short side, it is entered here into
the Model Portfolio. Any and all changes to the portfolio, be it a closing of a position or
adjustment to a stop that happened since the last report came out are updated here.

“TARGETS” IN THE MODEL PORTFOLIO TRADE ALERTS

When a model portfolio trade alert to initiate a trade gets sent out through RedOption it
will always include an entry price, a stop price, and a target price. The entry and the stop
are self explanatory, however, we seem to get lots of emails on the targets. Firstly, the
target does NOT in any way shape or form mean that we are exiting the position at that
level. ShadowTraderPro prides itself on being a true, live, dynamic full service trading
service which will always send you an alert if we are doing some action. We are only in
if we send an email, and we are only out if we also send an email.

The price listed as a “target” is nothing more than a guideline for ‘do it yourself’ traders
to use. Sometimes we pick an area of obvious resistance or support as this target and
sometimes we simply calculate what would be 1.5-2 times the amount of our stop and set
the target there. Either way, the market changes daily and rapidly. Once you follow
ShadowTraderPro for awhile you will see that we are very often out of trades for a nice
profit well before the target and on other occasions the trades sail right through the
targets and we are then looking for better exit areas. Again, just to be clear, the targets
are nothing more than arbitrary numbers posted in the trade alerts in the interest of giving
a more comprehensive trade alert.

ORDER TYPES USED IN THE EMAIL TRADE ALERTS:

There are essentially seven different types of orders that are sent when our portfolio
managers are trading stocks in the Model Portfolio. These are found in the “Action:” line
of your REDOption trade emails as in the sample below:
Buy the stock – This means that you should buy the stock asap as soon as you receive the
email. In our case we have already bought the stock and are telling you what price we
got filled at. As the market is moving, your own entry may be better or worse than ours
depending on how the stock acts. We do make every effort to list plays we like in the
Bulls & Bears section of the report just to give subscribers a courtesy “heads up” but its
not a rule. Be prepared!

Sell the stock – This means you should sell a long position as soon as you receive the
email. In our case we have already sold the stock and are telling you what price we got
filled at. Like “buy the stock”, you must use your own judgement as to whether to use a
limit or market order depending on how the market/stock is currently acting. Generally
faster moving stocks that are “thick” with good volume should be entered at market when
time is of the essence. ShadowTraderPro only trades stocks in the Model Portfolio that
are over $20 and trade at least 500,000 shares daily on average.

Short the stock – This alert means to initiate a short position as soon as receiving the
email in the stock. Again, the price listed in the email is the price we received.

Cover short position – This means you should buy to cover a short position as soon as
you receive the email. The price listed in the email is the price that we covered at.
Setting buy stop – When you see this alert, it means that we are looking to enter a stock
long that is currently below and has not yet traded up to the price listed in the email. In
your thinkorswim platform, you should select “stop” as your order type and enter the
price that is in the email alert into the price column. A correctly filled out order is below:

This will set a live “buy stop” at the price you selected. In the above example if IBM
traded up to $104.75, then as soon as that price printed the first time, your order would
turn into a market order to buy 100 shares of IBM and you would be filled immediately.
We use these orders to get us long at “trigger points” that are either over daily or intraday
highs or at some other technical pivot that we want to see crossed before we take action.
The buy stop order is a nice way to have your platform “do the work for you”.

Setting sell stop – Same exact order as the one above but in reverse. In this case we are
setting a “sell stop” order which will turn into a market order to short a stock that is
currently trading above the price listed in the alert email. So, the stock will then have to
trade down to the price you entered whereupon it will execute a short at market.

Moving stop – Every trade alert issued to enter a new position always includes a stop
where we will get out of the position automatically if it goes against us. During the
course of the trade we often move the stops once the stock starts moving in our favor.
Note: on long positions we never move a stop down and on short positions we never
move a stop up. Moving stop is always for decreasing risk or to protect profits. When
you receive the email alert, you can set a physical stop at the price listed which will be
the same type of order as above, the only difference being that it is always set for a price
that is below the current price for longs and above the current price for shorts which is
the opposite of “setting a buy stop or setting a sell stop”. One is for getting you out of a
current position and the other is for getting you into a new position.

HOW TO STRUCTURE YOUR PORTFOLIO TO HAVE THE SAME RISK

REWARD AS THE SHADOWTRADERPRO MODEL PORTFOLIO:
The ShadowTraderPro model portfolio is based on a hypothetical starting balance of
$100,000. Each position taken, either long or short, strives to utilize approximately 10%
of unmargined capital, or $10,000. Although, the model assumes that standard 2:1
portfolio margining is allowed, our goal is to basically not use margin unless necessary.
Total capital committed should usually be somewhere between $50,000 and $100,000.
So, firstly figure out what percentage of 100,000 dollars your portfolio or total buying
power will be and adjust your share size proportionally. If a play calls for 300 shares and
you are trading a $200,000 account, then 600 shares would be your size. For a $50,000
account, 150 shares would be more appropriate.
RISK:
ShadowTrader firmly believes in a swing trading model that has a defined dollar risk per
trade, rather than a fixed percentage of the share price of the stock that is in play.
Keeping this risk amount as a constant, allows us to dynamically adjust position size on
every trade to allow us to play the big movers with the same risk as stocks that move
slower. This means that an entry into a $100 stock may require a smaller position than a
trade on a $50 stock. Simply dividing 1/10th of the portfolio by the share price is not
however prudent because it does not take into consideration how far away your stop may
be. More expensive stocks that have bigger beta (volatility as measured against the broad
market) often require wider stops than slower moving issues. So, what we do when
calculating share size is to use technical analysis to determine a "line in the sand" where
we feel that the play will no longer work if price goes to that level. That distance from
the entry is then divided into $500 which represents our maximum risk per trade. This
$500 represents one half of one percent of the starting value of the portfolio, and is the
maximum allowed loss per trade. Size is then rounded up or down to the nearest 100 lot
at our discretion paying close attention to how much capital is being used up at all times.
Although clients are of course free to adjust position size to their own particular comfort
levels, we feel strongly that risk per trade should be kept to a minimum.

Let's look at an example to illustrate how this works.

We identify a bull flag pennant in XYZ that is in the middle of a gentle pullback at a
moving average support. We decide that an entry should be made long over the
downtrendline that defines the pullback at $42.40. The chart tells us the recent swing
lows of the pullback were at $40.10, and we decided to therefore set a stop at $39.90. So
knowing that our risk per trade is $500, we take $500 / $2.50 (the difference between
entry price of $42.40 and stop of $39.90), which equals 200 shares. 200 shares @ $42.40
per share is a capital commitment (unmargined) of $8480. The second we know the
stock is crossing the pivot at $42.40 we send an email out immediately with the time and
price of entry, where our stop is and a brief description of our reasons for entering the
trade.

STOCKS THAT GAP UP OR DOWN THROUGH OR VERY CLOSE TO STOPS:

When stocks gap up or down through or very close to stops, ShadowTraderPro uses what
we call the “gap rule” to exit the position. In the same vein as the way that we often use
price clearing first 5 minute or first 15 minute bars to determine “real” strength or
weakness, we are not exiting positions on mechanical stops at the open because we know
from experience that stocks often gap and reverse immediately and we don’t want a GTC
stop to be unnecessarily triggered. The rule of thumb is this: If a stock gaps down below
the stop that has been established, wait for the first 15 minutes (up to 9:45am EST) to
trade before doing anything. Then place a new protective stop just under (adjust this
amount for the volatility of the issue) the low of that first 15 minutes of trade. Reverse
this entire scenario for shorts.
If a stock opens close to the stop but not below it and trades down through the stop within
the first 5 minutes of trade, then we use the “5 minute rule”. Again, we are not out of the
position on the original stop, but rather will let the stock trade for a full 5 minutes (until
9:35am EST) before taking any action. Once 9:35 has elapsed, we place our new
protective stop just under (adjusting the amount for the volatility of the issue) the low
made in that first 5 minutes of trade. Reverse this entire scenario for shorts.

STOCKS THAT GAP UP OR DOWN THROUGH ENTRY TRIGGERS

If a stock is listed in Bulls & Bears with a specific trigger point and it gaps up or down
either over or under that trigger point, then some amount of discretion needs to be
applied. Our basic rule of thumb is that we do not want to chase any stock more than 1%
from its entry. This 1% is the absolute furthest point away from the entry that we would
accept if it was a play that we had a high level of confidence in. The preference would be
a gap well below the 1% limit. So, if XYZ is listed with a trigger point of $43.40 in the
Bulls & Bears, we would deem it ok to take the play as long as the opening price was not
above $43.83 (1% of $43.40 is roughly $0.43).
Now, here is the tricky part that a lot of traders miss. If you are going to buy above
the trigger point then you MUST adjust your share size lower to increase for the greater
distance to the stop. Regardless of where you enter, the stop is in the same place, because
a stop should never be an arbitrary dollar amount, but rather must be some specific
technical pivot. So in our previous example, if the stop was at $41.00 with $43.40 as the
trigger, and our listed size was 200 shares, the new size would be only 175 shares.

Original setup
$500 risk / ($43.40-$41.00) = 200 shares

New setup, buying stock at $43.85

$500 risk / ($43.85-$41.00) = 175 shares

A good technique to use for swing play entries is the 5 minute high. Calculate the
difference between a few cents over or under the high/low made between 9:30 and
9:35am EST and the original listed trigger entry. If this difference is less than 1% of the
trigger price, then adjust the share size for the new entry point and set your buy and sell
stop accordingly.

Be aware that in stock trading there is only so much that can be reduced to simple rules of
“if this, then that.” We would be greatly amiss if we tried to convey that this was all
there was to it. There is definitely some intuitive feel that a good trader develops after
many years of studying and actively trading the markets. While these entry rules can be
applied “hard and fast”, always remember that there are always a nearly infinite number
of market factors that are coming into play during any given trigger point that will have
impact on your decision. Use your head. Keep the big picture in mind at all times. If
everything about trading were completely black and white, then it would only be a
question of discipline and nothing else.
Good Trading to you all…………..
-Peter Reznicek
ShadowTrader.net