Thursday, December 29, 2011

AB=CD measured move



When the first leg of a trend move is reasonably strong (denoted by strong bars with closes near their highs, steep trendline, shallow pullbacks, etc), there is a very good chance that the first trendline break will result in a second leg that should go the same number of points.

The first leg today started with b1 and ended at the double top on b18 denoted by the purple line AB. The size of the leg was 7.5 points. This means the trader can expect the second leg to go about 7.5 points as well. The second leg denoted by the purple line CD also was 7.5 points and exceeded the expected move by 1t.

Measured moves are not guaranteed moves and sometimes the price fails to reach the target or moves way beyond the target. But on a reasonable day when the price action is normal, its a reasonable expectation.

The key to trading is to only take a deep pullback and only a strong leg's first deep pullback (i.e. TL break) at b21.

Wednesday, December 21, 2011

The need to be right

When a trade fails and the market moves against the trader, she may continue to re-enter in the same direction over and over again. At the end of the day, the trader may realize she has been shorting all the way to the top, usually unsuccessfully on a strong bull day. Similarly, some traders will buy every drop on a bear day, assuming that "it should turn anytime now".

Being married to the bias is a common failing. The trader insists he knows better than the market and it should turn and go in his direction anytime soon. The failing to recognize that the market is always right and the trader is always wrong is a fundamental error that can be the difference between one bad trade and a series of bad trades. Such a mindset is also liable to encourage the trader to add-on to a losing position because every failed entry results in a much better price if the price is going to reverse anyway.

A simple but hard way to deal with this is to not have bias. This means ignoring news, TV, economic and political analysis such as why the market should go down because of the misdeeds of politicians, why Europe is doomed or pretty much anything else since news is sensation-driven and does not reflect immediate demand and supply.

Even if you do have bias, if the trade goes against you for a large number of points, you should not enter in the same direction until there was an obvious trendline break and test of extreme.

Most important, do not be shocked that your trade has failed. No one can be right all the time. Keep your loss small by taking an early loss and sit out for a couple of bars if you need to clear your mind. Taking a step back and looking at the overall chart or a higher timeframe will often reset your bias and allow you to recognize trendlines and enter with-trend or sit out of choppy moves.

Monday, December 19, 2011

Going on Tilt

Poker players understand that when a player gets an especially bad beat, he is likely to go "on tilt" and especially when its a large pot. This generally means the player is likely to play the next few hands aggressively on weaker cards and in general make poor judgements trying to win his money back. Whenever anyone at a table has a bad beat, the rest of the table will turn on the player like vultures hoping to take the rest of his chip stack.

This is relevant to traders because a lot of traders approach trading like they approach gambling. A strong belief in luck and other superstition, trading larger size after a beat, bragging about your huge wins but not mentioning your losses, etc. are signs that you may be approaching trading as an alternative gambling system.

And just like gambling, most players will end up losing most of the time with an occasional win that you brag about. If this is the case with you, you are better off going to the casino and playing blackjack -- at least you will get free drinks.

A significant cause of a bad beat is the unexpectedness of the result. The player was expecting a win -- possibly a large win -- but was shocked to end up a loser. This shakes the player's confidence in his ability to read the cards and analyze the players' moves and in general play the game successfully. At this point he needs to win just to restore his confidence and he needs to win quickly. This urgent need will impair his judgement and force a lot of errors. Going on tilt in trading is psychologically very similar.

The way to approach this is to avoid having a large beat. Always enter fixed risk and size. Over time as your consistency improves, you may choose to increase the size but you should never trade arbitrary size just because you are "feeling lucky". You should also never loosen your stops or add-on to a losing position, since large losses are what will impair you psychologically.

In addition, your daily loss limit needs to be fixed. Just as you would leave the table when you realize you are the worst player, you should stop trading for the day if you have been beat 2 or 3 times in the day. Over time, the knowledge that your downside is limited per trade and per day, while your upside is much larger will give you confidence and eliminate the gambler's mentality.

Monday, December 5, 2011

Overconfidence

Consistency requires practice and you just need experience with all sorts of price action. When the price action changes by either slowing down to tiny bars or being volatile with huge bars, your consistency will suffer some impairment. This will continue until your trading experience builds sufficient recall that you will be able to react effortlessly.

For many traders, the start of consistency brings a new enemy: Overconfidence. This will trick the trader into trying new setups, increasing size aggressively, taking larger risk and in general work hard on self-sabotaging and loss of their hard earned consistency.

For example, a trader making 2 points consistently by trading the first two-legged pullback of the day may become successful enough that he thinks he can add a new setup or perhaps incorporate a new trading style such as trading mid-bar or on limit. Chances are that the new addition negatively impacts his trading results and may flip him back to being a losing trader.

The devastation and loss of confidence that can follow is possibly severe. A trader may find himself between periods of consistency and inconsistency and lose hope of ever being able to trade consistently for a living.

Overconfidence is hard to treat because its hard to distinguish it from plain confidence when you have to judge yourself. The way to deal with this is to attempt only one new setup at a time and only try it once or twice a day. New styles such as limit trading and mid-bar entry should never be attempted since they are micro-optimizations. If most of your setups are expected to go 4 points, an additional one point by entering on limit is usually not worth the additional risk. Prove all new setups by trying them on disciplined SIM trading first and tabulate results. Many of them are probably not even worth trying.

Remember that success lies in taking a few profitable trades and working on increasing the volume. A trader with only one winning setup that is 70% successful is better off than one with a 100 setups that are overall 50% successful.

You need only one or two good setups. Even a single setup could take years to master so don't try to cram new techniques until you have mastered your current setup.

Saturday, December 3, 2011

Trading Discipline

When trading BPA, I try to follow the following rules:

  1. Clarity: I will not trade unless I read one of my proven setups. I want the setup to be as clear as possible. Any ambiguity probably means the move wont go too far. I want pullbacks to be deep and signal bars to be strong without a lot of overlap. If these characteristics are missing, I will usually wait for a second entry. If the setup is poor, I will often pass it up. I'm OK with not taking any trades on any given trading day. 
  2. Swingable entries: In general, I only prefer to enter setups that will go four points or more. I also want to only enter where I believe the price will not pullback to my entry price after moving away from the signal bar. Often these are second attempts.
  3. Firm stopsStops can only be tightened. Once the price moves a certain distance away from the entry price (say 2 points), I will move the stop to breakeven and lock in gains beyond every new swing point.
  4. A few good trades: In general, I prefer to take a few good trades rather than many mediocre ones. This is because I can be a winning trader with a modest percentage of successful trades as long as at least some of my winners go 2x to 4x the risk.
  5. Daily loss limit: Daily stops losses are crucial. Some days, my game is just off possibly due to lack of rest or unexpected price action. I prefer sitting out and keeping my winnings from my prior days over trading every day and losing everything I've made over the last few days.

Note that the above rules are applicable to any trading system and the important point is to stick to these simple rules since they will help you measure your success and isolate winning setups.

Rule 1 and 3 helps you measure your success and helps you to isolate winning entries.
Rule 2 and 3 improve your win/loss ratio.
Rule 2 and 4 helps you focus on larger moves and not be mesmerized by the current bar or two.
Rule 5 helps to protect you against outlier days when price action is not favorable to trading.

You can measure your progress by keeping a score card of each trade to see if you followed the rules you laid down. Soon you will be able to detect what areas you need to work on.

Thursday, December 1, 2011

Discipline

Discipline is the ability to stick to your long term goals by successfully ignoring short term temptations. You probably already know if you have a modicum of self-discipline. Are you successfully able to stick to a diet or exercise regime? Are you a person who can stick to a decision to make a permanent change to your life such as waking up at 5:00 AM every weekday or to quit smoking cold turkey?

Most people would stop and wonder here and that means no. Discipline, like muscle strength needs to be trained and built upon and will atrophy when you stop working on it.

For a trader, discipline is the ability to stick to a plan and execute only that plan. For example, let us take a very simple trading plan: Trade the first two-legged HL or LH of the day with a stop loss and profit target of +2 points each. You could add an additional requirement of the entry side tail being 2 ticks or less.

If you want to follow this trading plan, you would wait for a two legged HL and buy above any bull bar with a 2 point stop and target. Similarly, you would wait for a two legged LH and sell below any bear bar. If the pattern does not trigger and turns into a HH or LL, you no longer take the trade and do no trade for the rest of the day (unless you have another setup in your plan).

On the other hand, if it does trigger there are only three ways you get out of the trade:

  1. You are stopped out
  2. Your target is filled
  3. A signal sets up in the opposite direction to your position and is triggered
Discipline is the precursor to consistency. Discipline does not itself lead to consistency, but it does tell you if any of your setups are worth working on or should be dropped from your list. You still do need to find setups that work and once you find one, you are on the way to consistency. New setups that you want to try can be added one by one and discipline is what helps you weed out setups that are not worth trading.

Tuesday, November 29, 2011

Impatience

A key requirement to be a successful trader is patience. Even very experienced traders will admit that their trading would improve if they work on their patience.

New traders are impatient and and long to be in a trade and until they take a position tend to see every tick as loss of opportunity. Once they are in, they are very impatient and want the trade to work right away and take them to profit. The moment they are out of a trade whether due to hitting a target or being stopped out, they want to be in again. Therefore, impatience makes traders overtrade.

Impatience, combined with greed and fear will force traders to have impaired judgement and results in inconsistent performance. Its very unlikely that a trader who is entering and exiting a trade every two or three bars to have a high success rate. Even a high success rate can be neutralized by a couple of poor trades if you focus only on small moves.

Patience for a trader, is being able to do nothing for hours while waiting for a proven setup o form and when it does appear, to act on quickly. After entry the trader should not exit as long as the stop is not taken out unless a setup in the opposite direction sets up and is triggered. The trade should terminate either by reaching a target or being stopped out. Patience and confidence in the setup will enable you to take larger profits.

Impatience is addressed by focusing on large moves. Looking for a large swing move will check your impulse to be in a trade since there are a small number of large moves in a trading day. Holding at least a small portion for a swing will also satisfy your need to be part of a move without having to re-enter every few bars.

Sunday, November 27, 2011

Fear

Being stopped out several times will wreck your confidence and the trader may turn into a victim of fear. Fear is always an immediate emotion and will paralyze you and prevent you from entering viable setups.  Often very good setups will move immediately after triggering and your hesitation will cause you to miss out. Fear will make you miss out on many solid trades.

Since good setups will often give a strong entry bar and the entry bar usually grows very quickly after the trade is triggered, you may curse yourself and enter mid-bar, a few ticks or a point above your ideal entry. This also means your risk is now larger by a point or so. This means fear forces you to enter on a large risk.

With a few exceptions a slight pullback after an entry trigger is a normal event and mid-bar entry may cause your stop to be taken out. A trader stricken with fear is unlikely to loosen the stop or add-on (unlike the greed stricken trader) but would probably reverse at the stop. Fear will cause you to be pushed around by every pullback and strong move the market makes.

Reversing every two or three bars will destroy any confidence you still have left in your ability to read market direction and you will get chopped up. Unlike the greedy trader who's account is killed by few large losses, the fearful trader's account dies by a thousand small cuts. If you are fear stricken, you should never reverse a position.

A loss for a fearful trader puts him "on tilt" and he is likely to make more mistakes if he continues to trade for the rest of the day. Fear is rather hard to overcome and the only way out is to realize that every setup has a certain percentage of wins and the remainder are bound to be losses. Some losses will be clustered close enough that it will appear that you have lost your ability to trade that setup. The best approach is to stop trading for a certain number of bars after a loss and stop trading after a certain number of losing trades for the rest of the day. The knowledge that your losses are limited per day in the worst case is a stabilizing force on your psyche.

"Be greedy when others are fearful" is easy to say but impossible to practice since you are the fearful one. The antidote to fear is risk management. Once you understand and accept the maximum losses per trade and per day, you already know how much you will lose in the worst case for any given period of time. If this is something you have already accepted as the cost of trading or learning to trade, fear will be much more manageable.

Thursday, November 24, 2011

Greed

Traders should not be ashamed to admit that greed is probably what motivated a lot of us to get into trading. After all, there is the promise of easy money or rather, lots of easy money that we can gain by trading. Greed may be good, but it will force the trader to make many mistakes.

One of the worst mistakes a trader can make is entering on a poor setup because "this could take off from here". You are afraid to be left out. This brings us to our first realization: Greed is just fear thats not immediate.

However, when you do get in on the poor setup, either because the signal bar was poor or because the pullback was too shallow or any other reason, you probably entered at a poor price point and a possible pullback will take out your stop unless you use a wide stop. From this we infer: Greed forces us to enter on a large risk

Often, even a large stop could be hit and you may resort to loosening your stop, which of course can still be hit so you end up taking a stop much larger than your profit expectation. A stop placement on entry is a statement that if the entry is correct, the price should never touch the stop. If you loosen stops habitually, you are not really trading with stops. Therefore, Greed forces us to disregard our stops

Some traders when faced with a wide stop will add on at the worse price so that they have a better chance of breaking even and a tighter net stop. This means that Greed forces us to throw good money after bad.

Ideally, you want to be very choosy about where you enter and understand that success lies in consistency (steady, higher percentage of wins) rather than depending on any one trade "taking off". The key to this is to take strong bars on deep pullbacks or at the ends of a trading range. However, if you do enter on a poor bar and it does not take off, remember that the first loss is the best loss. Take your loss and wait for the next setup. Refusing to accept being wrong and replaying the losing scenarios described above is the quickest way to a blown account.

"Be fearful when others are greedy" is a simplification. Fear is equally unproductive. The correct antidote to greed is caution. When you feel an urgency to enter, do not enter unless the signal is good and risk is acceptable.  Do not fret about letting a big mover pass you by. There is always another trade with a better signal in the very near future. Once you enter, let the trade fail if it needs to. You will never know what trades you are capable of reading and entering correctly if you don't let the market stop you out.

Saturday, November 19, 2011

Vacation

I'm on vacation till Jan 2012. I will continue to post articles regarding market psychology and trade management instead of the daily market commentary.

Meanwhile, this is a good opportunity for both me and my readers to revisit various posts in the blog.

Wednesday, November 16, 2011

Double Wedge


A double wedge is simply two wedges that terminate at the same bar. In the chart above, it may be argued that there are two wedges W 6,24,52 and W 34,39,52 or other variant. A double wedge can lead to a large move (b63-b81).

For a double wedge to form, a pullback from a recent swing point (b24) needs to be deep enough that the next leg is likely to need multiple pushes to take out. A strong deep move (b24-33) consisting of CT bars may also demonstrate counter-trend strength that will encourage with-trend traders to exit and counter-trend traders to enter beyond the swing point (above b24).

Tuesday, November 15, 2011

Reversal bars


Reversal bars often signal reversals, regardless of where they are. A well placed reversal bar (b6) can signal the end of a move (b1-b6) but so can an incorrectly placed reversal bar such as b15 signaling the end of the prior move (b10-b15).

A reversal bar followed by a reversal bar in the opposite direction (b15,16 and b32,33) is usually a very strong signal, especially if the second reversal bar can be viewed as a 1PB in a new trend move, i.e. its the first pullback after a possible reversal.

Similarly, reversal bar failures are very strong with-trend signals. Often after a recent possible reversal, the failure of a reversal bar can often be used as an entry. You could enter long on a stop above b32 (for example if you did not already get a buy signal at b33)

A reversal bar of the wrong color such as b39 are usually traps and if the trend has been strong, may be traded as a continuation signal.

Small reversal bars (compared to prior bar or recent bars) are subject to failure such as b68 and you should only take second entries. The only exception is when the tail is at least as long as the body and you have additional signs of strength in the direction of the signal.

Monday, November 14, 2011

The first two legged pullback



On many days, the open may constitute an opening range made up of erratic moves (b1-25) that finally break into a trend (b26-b38). Some traders may get repeatedly stopped out on the initial range and their later trades will barely make up for their initial loss.

The trick to avoiding being chopped up on the opening TR is to wait for a trend attempt and take a clear pullback on a strong signal bar. This is essentially the philosophy of the 1PB trade.

Determining if a leg is a trend attempt is a bit tricky. Any two or three trend bars are a possible trend attempt. One bar does not usually make a trend (unless its very large). Once a trend is attempted, it will either reverse and a new trend is attempted in the opposite direction or a pullback gives a possible continuation of the orignal leg. A strong reversal attempt is 1Rev. A pullback is 1PB.

Today, there was a trend attempt from b3 to b5 and a weak reversal attempt on b5. Then possibly a second trend attempt from b6 to b9. Note that this bar is made up of weaker bars and is unlikely to succeed, especially in the absence of prior bull strength.

b16 represents the first two legged pullback of the day and is a possible 1PB long entry of the long trend attempt. However, the signal bar was a doji and the reversal was fairly weak. However, this is still a viable long entry. When the long entry failed to take out the old high, it turned into a first 2 legged LH, turning into a 1PB short at b20 of the original short trend attempt.

Another way to read this is that b2 and b9 represent two failed attempts to close the gap leading to a bear trend. Even though many traders may have correctly read b9 as a possible 1PB short, waiting for a strong signal bar (b26) is usually the right thing to do for a profitable entry. This is because shorting below a bull bar is always subject to failure, regardless of the correct read of the market direction, especially on a choppy open.

Sunday, November 13, 2011

Two strikes


A decent win rate and a favorable win size/loss size ratio is the key to accumulating profits. A trader with poor win rate is likely to have extremely high number of trades. For one, the moment he is stopped out, he looks to getting in right away and often operates in an emotionally distressed state and is bound to compound mistakes. Ironically, the more he trades, the worse his performance is likely to get.

There are some steps a trader needs to take in order to avoid falling into this very common trap. The first is that a trader should look for major turns in direction and on a given day there are unlikely to be more than five.  So the question a trader should ask himself is not if he thinks the market will go up over the next bar or two, but if its a major change in direction.

The ability to locate these turns require a trader to trade less than he normally would. A trader who trades with-trend off a non-overlapping signal bar with a strong close near the ema or trendline is likely to be at least 50% successful. So if your success rate is under 50%, the first thing to do is to trade nothing else.

The next thing you can do is to adopt a "two strikes" policy. If you lose two trades, you are done for the day. You should also be done for the day if you took five trades total. In the beginning, you may end up finishing your quota in the first half hour after open, but with over time, you will be able to stake out longer and be able to focus on large moves.

The chart above is meant to be illustrative but shows how a two strikes policy would work with a -1.5 stop and a +2 target. As seen from the chart above, there is a very good chance you will be stopped at two trades on a large number of days and conversely on some rare occasions, you may get four or five wins. Nearly half the time, it expects a loss on the first trade and nearly three out of four times, a loss on either the first or second trade.

Even so, there is an expected value (EV) of about a point accumulating per day. The loss policy above can be abbreviated as 2/5 (two losses out of five maximum). You can try other variations such as 3/6 or multiple contracts and targets or anything else that's suitable to your trading style. Note that positive expected value is a side effect and the main goal here is to improve your ability to consistently take good trades and focus on major moves. Note that on many days, there may be only three or four trades, so don't be surprised if you take in less than the EV.

Note that the -1.5 stop is tuned for my proven setups. Other setups may need a wider stop but your stop should not be larger than your target. A wider stop is likely to negatively impact your EV, so trades with wider stops should have a very large EV (such as 1PB or W1P).

Friday, November 11, 2011

Trend termination (TT)


Recognizing a potential trend is generally easy on a day like this: A large gap followed by two or three bars that close in the direction of the gap is a very strong trend attempt and taking the 1PB (b5) and holding it to swing termination or reversal is an easy decision.

Not all trends reverse and many of them simply terminate into a trading range. Determining the end of a trend requires some experience. There are primarily three ways a trend can terminate and today, we were lucky to have all three.

The first is a TTR made up of small overlapping bars made of mostly dojis. Given this criteria, we should already know around b22 that the trend has terminated.

The second is an extended trendline break. A move beyond the trendline for many bars and many points is a trendline break. The more number of bars it stays beyond the trendline, the fewer the points that need to be beyond the trendline to constitute a break. This means that a single bar thats sufficiently large can break the trend or a large horizontal or slightly sloping movement for about 20 bars (b21-39) can break the trendline without dipping too far below it.

The last is a failed reversal followed by a failed continuation. b22 was a poorly formed W and FF that was followed by a WP at b39 which was unable to take out the reversal bar.


Once you realize the trend has terminated, you should no longer be looking for with trend trades. Your best option is to wait for a new trend to break and enter on its first pullback. If the trading range following the TT is small, its best not to enter into anymore trades at all.  If the trading range is wide (8+ points), you can consider fading the extremes of the new trading range. Note that in general, you should cannot expect any entry in a trading range to make a large move. In general, you should expect a move that's roughly half the size of the trading range.

Thursday, November 10, 2011

Fire and forget


One of the reasons traders overtrade is that their sense of market direction is focused on the small movements. A second reason is that they become distressed and doubt their own entries as soon as the market moves against them. They may often reverse their positions with every bar or every other bar.

The right thing to do is to make a note of the kind of setup and let the market take you out. If your trade fails, it will take you out by hitting your stop and if its successful, it will take you out by reaching your targets. This will give you an accurate measure of what kind of entries you have mastered and what you need to work on.

If you are a trader who focuses on swing entries only, you have the luxury of having a very small stop (of say -1.5 points on the ES). For example on today's chart, short below b1 required a 7t stop but entires on bars b4 (1PB), b17 (W), b47 (fBO) needed very small stops. These setups are usually the ones that run for a large number of points, so do not be upset if your stop is taken out; it means a larger stop would have probably been taken out in any case. 1Rev and 1PB may need larger stops, but -2 points usually suffice.

Most trading platforms support OCO orders where you can set stops and targets to cancel each other. Once you set an order forget about it and wait for the next setup. If the next setup is in the opposite direction to the position you are in, close out your position and enter a new order.

This way, you stop focusing on profit and loss and focus on bars instead.

Wednesday, November 9, 2011

Fewer, better trades.


One of the biggest errors for new traders is overtrading. Overtrading will eat away at your profitable trades and overall prevent you from being consistent. One of the first goals of a trader should be to reduce the number of trades taken per day to about five. Think about this: How many major directional changes do you expect in a day?

Reduction in the number of trades allows you to focus on larger moves instead of flip-flopping on every other bar. If you are a new trader, this will also help in limiting your losses.

The first step you need to take is to eliminate limit entries. There are some legitimate limit entries in price action trading, but trying to save two ticks should not be one of them. The skill level of market reading necessary to be able to consistently win at limit entries is very high and I am not too proud to admit that I'm not there yet. If you want to trade limits, remember that you should be entering only on bar closes and not where you fantasize the price may turn mid-bar.

The second step you need to take is to only enter on signal bars with a strong close and little overlap. The only exception to this is a 1Rev at ema, 1PB and any with-trend entry on a soft-trend day. If your strong signal bar does not trigger, let it go. Even if it gives a strong inside bar with an equally strong close, at this point its in overlap. The only exception to this rule is a FF after a large move.

The last step is to only trade proven setups such as A2, W1P and so on. "I think this will move up now" is not a proven trade. You may have noticed patterns that look reliable but they may not be tradable for various reasons. You should first attempt to trade them on SIM and then try with small size about 100 times before you can add them to your proven list.

Tuesday, November 8, 2011

Failed continuations confirm reversals


When a possible reversal pattern has triggered such as b23,24 2 bar reversal on the third push down but the original trend is still unbroken (because a trendline has not been broken), a continuation needs to fail before you can trade in the direction of the new trend.

A 2 legged move after a wedge move such as b29 is often a very good continuation signal and should be taken since it often leads to a move of similar magnitude. If this move fails as it did when b31 took out b29, you should look for setups in the new direction only.

So for example, while b39 worked today, on days when bars are smaller it is likely to fail. The correct trade would be to buy the A2 above b46 in the direction of the new trend and swing it.

Monday, November 7, 2011

Three push legs


Three pushes with small pullbacks between them as in b8,15,18 or b57,60,69 may act like a poor Wedge. This wedge will basically act as a single leg and is likely to give a pullback and then resume the original move, taking out the prior leg extreme.

For example, the three push leg down to b18 gave another leg down to b24 before giving a two legged move to ema, as did the leg up to b69.

A three push leg to ema or other barrier may give rise to a deep pullback or even reversal, especially at the beginning of the day. On the other hand a three push leg in the direction of the ema slope may give a pullback thats stopped at the ema as it did today.

Trading such a leg is simple. If the leg stopped at a barrier, take the reversal if the signal is decent. If not, wait for a pullback and continuation for at least another leg.

Friday, November 4, 2011

2 Failures to close gap


On many days when the market opens with a reasonable sized gap (4+ points), the market will try to close the gap twice. If it fails on both attempts, there is a high probability of a strong trend in the direction of the gap before the market tries to move against the gap.

The larger the gap, the larger the trend move before any attempted reversal.

Today opened with a reasonable gap and a doji bar b1 with a close near the low of the bar, which is a poor signal for a long and was likely to fail. The second signal was another doji but with a higher close and was also a failure. The presentation of poor counter-trend signal bars is a strong indication of continuation of the trend.

Two failures led to the market breaking into a trend and extending the gap all the way to bar 14. On the way, a fH1 at b9 marked a precise exit near the low of b14.

Video of trade available on youtube

Thursday, November 3, 2011

Choosing Scalp and Swing entries


The first hour of the day is likely to produce the high or low of the day and trades made then are most suitable for swinging. Occasionally, the AM fails to produce any trend moves and on such days, there may be a PM trend but normally the higher likelihood is the AM trend.

A 1PB is the best option for an AM swing trade, but on some days such as today, the 1Rev is the clearest swing entry. If the early trend move results in a strong reversal, you should always swing the 1Rev entry.

If you miss the 1Rev and the 1PB, you should then look for the first deep pullback such as b20 today. Its a terrible signal (an overlapped doji), so its alright to skip it.

The first 2 legged pullback such as b31 or b39 often provide a decent late entry into the trend, even though it may look like you are buying the top at that point. Lunch hours in particular are dangerous and many traders will correctly trade smaller volume or take only scalps.

Shallow pullbacks are invariably scalp setups since your swing stops are likely to be taken out during the next pullback. A deeper pullback is more likely to have a strong entry bar, causing the next pullback to miss your breakeven stop.

As the time left in the trading day diminishes, so do the options for a swing move. Unless you are in a late hard trend, you should be satisfied with modest profits. This is especially true for trends that broke early in the day since they should be expected to show some volatility due to profit taking.

Wednesday, November 2, 2011

Trading range day as a series of fBO


Since most days are trading range days, the trader needs to have a realistic expectation of what happens once the market takes out the high or low of the day or a significant swing point. Usually, the breakout is expected to fail, but the precise entry point to trade the failed breakout should be determined after two failed attempts to continue in the direction of the breakout.

For example, the strong breakout above HOD on b16 stalled and the market failed to continue twice (b20,b22) in a horizontal flag that effectively acts as a final flag. At this point, it should be clear that the market will attempt to re-test the low and you should no longer look for long trades.

The break below LOD on b43 was on a large bar, but the second attempt to continue the selling failed giving a double bottom at b47,55. At this point, until the DB is taken out, the market is expected to test the high once again.

Trading range days may be viewed as a series of failed attempts to generate a trend after breaking to a new high or low. Naturally, a two or three legged approach to the high or low without breaking out can also be treated as a fBO.

Occasionally, the breakout will give a successful BP, which can lead to a trend, especially after a DP on the other end.

Tuesday, November 1, 2011

Buying below and selling above overlaps on a TR day.


Trading strong trend days is not necessarily easy but certainly simple. You can basically take every reasonable with-trend entry and chances of success are high unless you are near the end of the trend. On a trading range day, things become much more uncertain and swing entries will be stopped out all the time.

A simple heuristic to deal with trading range days is to buy below overlaps and sell above them. For our purposes, an overlap is any trading range bar such as the outside bar b7, any bars that overlap such as b54,55 or any horizontal range such as b69-72. The only restriction is that the overlap be large enough for a scalp profit, say 4 points. A trend bar such as b48 should not be faded in this manner since there is a very good chance it could turn into a spike and channel or otherwise turn into a BP.

Once the overlap is in place, resolve to sell above it and buy below it. On a trading range day, there is a very good chance of a failure of any breakout beyond these overlaps and a very good chance it will at least take out the other end of the overlap.

Conversely, an overlap whose breakout fails and successfully takes out the other end on a trend day such as the BO above b7 which consequently took out b7 low, transforms the day into a trading range day and you should only trade at the ends of the range.

Monday, October 31, 2011

Anticipating late trend breaks.


On a large gap day where the open is beyond the range of the prior day, the likelihood of trending is high. If the first bar does not lead to a hard trend, there is a very good chance it will at least attempt to pullback to the ema and then break into a trend in either direction.

Once the day has stalled into a trading range, any trend break is likely to happen from the other end of the range, i.e, bull trend breakout from the bottom of the range and bear trend from the top of the range. This is why you should only buy low and sell high in a trading range.

A 1tf such as the one on b24 could lead to a trend but when the range is small, the likelihood is lower. A trading range typically tries to widen before it breaks into a trend. A common way to expand the range is to take out repeatedly both ends of the range until the range is wide enough. This is an expanding triangle breakout and any sharp breakouts can be faded until an upside break and 2L HL or a downside break and 2L LH.

The second option is to give a breakout pullback. b36 was a strong breakout of the trading range and gave a LH 3 push pullback to b53, which was also a DP. These are usually trend generators and should be taken.

Entering mid-range such as the entry at b28 should be avoided unless you have reason to believe you are in a trend (LL and LH) or you are entering on a BP. In general your best swing entries are near the ends of the trading range after the trading range has been made sufficiently wide by prior failed breakouts.

Friday, October 28, 2011

1tf point to change in direction


Failures often make very good signals and 1tf in particular make excellent markers of a turn in the market. 1tfs are also excellent with-trend entries, so you should be careful to distinguish between the two.

The classic 1tf is a failure caused by trying to take a reversal before a trendline break of sign of counter-trend strength. This is usually a continuation signal. Sellers below b14 (b14,15 inside bar variant requires an entry below b14) were trapped in a 1tf.

A 1tf can also be a reversal indicator in certain circumstances. For example, b25 was a 1tf above the prior swing high of b21 on an ii flag, which acts as a final flag. Similarly, the ii variant at b39 turned into a 1tf reversal. Final flag variants are often 5tfs such as b25 (went 5t above b24), but they can sometimes be 1tf as illustrated by b41.

There were another kind of 1tfs today. b6 trapped buyers in by triggering above b5 and took out its low by 1t before turning back up. Such a double trap followed by a 1tf is a kind of micro-wedge (3 pushes on 1m chart) and usually indicative of market direction change.

Thursday, October 27, 2011

Very large gap up


A large gap acts as a spike and if the price is very far from the ema, its very likely to pullback close to the ema. A 2 legged pullback to the ema is a very strong signal on a large gap day. The larger the gap, the deeper the initial pullback (b1-b14) and may look like a mini trend.

Just like a day that opens with a large spike bar, a very large gap day is likely to act like a soft-trend day with very shallow pullbacks. When the first higher low is a fL2 (b19,b22), its a very strong sign of an impending soft-trend day and you should never trade counter-trend.

On a soft-trend day, you can trade above doji bars (b42,58) as if they were bull bars provided they are close to either the trendline or the ema. When in doubt, you can always trade above a strong bull bar following the doji signal bar (b43,b59)

Wednesday, October 26, 2011

Anticipating AM trend reversals.


I have often stated that consistent success lies in the ability to get in on a trend early, especially the AM trend. Often an absence of an AM trend may mean a potential PM trend if the day opened on a large gap but on many days its just a TR day (regardless of gap).

Occasionally, however, we get an excellent AM trend which breaks and instead of turning into a trading range, reverses into another excellent PM trend.

To anticipate such moves, watch for a large gap and an open within the range of the prior day (b1). If the trend move breaks an extreme of the prior day in three pushes (b5,10,18) and gives a reversal signal (b18), there is a very good chance the next two legged pullback (b45) will break into a trend. This trend should be expected to at least take out b1 and therefore is an excellent swing candidate.

Tuesday, October 25, 2011

Huge open bars


Large bars on open are rare, but when they happen, your best bet is to enter early. One method to enter is on a 5t move from the open and only in the direction of the gap. So for today, you would short when the price hits the purple line shown above. On most days with large gaps, the price will not take out a breakeven stop at this point for the rest of the day or until there is a W or other reversal.

Large bars represent trading ranges and large bars on open are no different. A sequence of large bars is invariably followed by a pullback and a test of the extreme regardless of how deep the pullback is.

This is because the large bars represent a spike and with trend spikes are usually tested. A large range in one or two bars (b1,2) often sets up a narrowing triangle (LH,HL,LH,HL...) as the market tries to find a balance between the two ends of the range.

The safest way to trade a triangle is a triangle BP.  Basically, wait for 2 HL or 2 LH to be taken out (b41,23 taken out at b62) and then take the next pullback. If the pullback is 2 legged as in b68, its usually an excellent setup.

Until the triangle breaks out however, you can take with-prior-trend entries only and best if they violate a trendline. Trading a triangle against the prior trend is dangerous and should be avoided. Watch the poor entry bars and pullbacks for buyers above b8, b23 and b58.

Monday, October 24, 2011

After the trendline break


Regardless of how strong the trend was and how great the signal bars are, the trend terminates after a trendline break (b29-39). A trendline break that goes for several bars and several points should mean you no longer look for with trend signals.

There fore b35 is not an H2 or A2 and neither is b41. It however, is a good trade since a trendline break after a strong move is expected to re-test the prior extreme.

After a trendline break, you are in a trading range and you should only expect two legged moves that may not go to the other end of the trading range. For example, b53 gave two legs to b73; b59 gave two legs to b67; b73 gave 2 legs to b79. There is no telling how far any leg can go and b77 buy went only a point above prior swing high. This is why trades mid-TR should be avoided. They are unlikely to have many participants and their strength is suspect.

On the other hand, you should fade weak breakouts and take strong breakout pullbacks. Despite being a strong bar b52 was a weak breakout. It was on a third push up (b45,49,52) after a TL break. The oio after the breakout (b52,53,54) setup a reversal. The BP at b59 was weak (TR bars b58,59). b68 on the other hand, was a strong BP short.

In summary fade weak breakouts at ends of range and take strong BPs only after a TL break and avoid trying to find continuation trades.

Friday, October 21, 2011

Channel pullbacks


On a day that starts with a large gap and starts off with a strong trend, you probably expect a decent move off a the first two legged pullback. However, when the pullback looks like a channel, its a good chance will act like just one leg and a second leg needs to be complete before the trend resumes.

The outside bar on b18 and the distance from the ema precludes any entry above b18 so the next logical setup is b21. b21 is a possible WP but since it was really one leg and not a low momentum move (i.e., not tiny / doji bars) it is probably one leg and another leg down is to be expected.

A failed 2 legged attempt to take out the high at b29 is a failure and therefore high probability short for at least two legs down.

Thursday, October 20, 2011

Anticipating mid-day reversals


When an AM trend breaks out from the opening range, its very useful to know if the trend will run to the end of the day, break and turn into a horizontal range or reverse and attempt to take out the other extreme of the day.

One of the earliest signs of an impending mid-day reversal is display of strength in the early bars. b7 and b9 today demonstrated the willingness of buyers to buy with strength taking out stops of bears. Generally strong counter-trend activity at a given price indicates a potential stronger  activity at a better price.

So when you see a potential reversal such as b34,35, its a good idea to exit your trend positions on the AM trend and look to enter on the reversed trend, which could run for the rest of the day or at least until it takes out the prior extreme (b62).

Days that open very close to the prior day's close and trends that break out of high areas of congestion are likely to reverse due to the magnetic effect of a tight consolidation area.

Wednesday, October 19, 2011

The AM and the PM trends



As I've posted before, the trader's best bet is to get on the AM trend and figuring that out should be the first goal of swing trading. On most days 1PB and occasionally, 1Rev turns into the AM trend. This is especially true if the day opens with a large gap from its close and especially if the open is beyond the range of the prior day.

When the open is near the close of the prior day, the AM trend may not be very strong unless the distance to one of the extremes of the prior day is large. On a day such as today, that sometimes can lead to a large PM trend.

Note that absence of an AM trend is no guarantee of a PM trend. Often there is no trend the entire day and the day may become a small pause bar or inside bar on the daily chart. However, sometimes trend generation patterns can cause a PM trend to breakout.

The easiest trend generator to recognize is DP, the double top pullback on b46. This is the bearish analog of the double bottom pullback. A double top pullback is characterized by a double top that is well defined, i.e., several points and bars large and preferably the second low(b33) takes out the first low (b23). A two or three legged pullback (b33-45) that cannot reach the second high (b28) completes the DP. If this forms near the top of the trading range, its a high probability trend generator and should always be swung.

The possible target is twice the prior range (b7-b13) and often this is a large move. DP should not be taken if its at the wrong end of the TR (i.e., bearish DP near the bottom of the TR) or the range is too tight (4 points or less).

Tuesday, October 18, 2011

Kinds of 1Rev


One of the reasons 1Rev has been hard to explain is that its really a composite of various kinds of setups that happen to reverse at the high or low of the day during the first hour. Some days have more than one kind of 1Rev, leading to multiple labels on the chart. To make it easier to explain, Im splitting it into simpler components, hoping this would easier to explain and adopt.

The first kind of 1Rev is actually a fBO of the opening range. If the fBO produces a decent signal and the range is sufficiently large (say 4 points) then it should be tradeable for at least a scalp. This is best labeled as fBO instead of 1Rev.

The second kind of 1Rev is a reversal of the HLC of the prior day. Normally a such a reversal usually seeks the one of the prior day's extremes. This should probably be called Opening reversal (OR).

The third kind of 1Rev is a pullback from a gap to the ema and reversal. This can act like an A2 and is usually a high probability setup.

The last kind of 1Rev is a trend move from the open that violently reverses (b7,8). The last two are high probability high or low of the day and can lead to swing till end of day (as today did).

The first should simply be labeled fBO. The second can be labeled OR. The third and the fourth are traded similarly and should probably be labeled XOD (extreme of day).

I will move to the new nomenclature and avoid using 1Rev as a label. When more than one kind of 1Rev occurs, I may simply put 1Rev for brevity but will try to put the individual components where possible.

Monday, October 17, 2011

Adding on


Many traders add on fresh contracts if the price moves against them. Personally, I think this is a poor choice to make. If you were wrong earlier, you are probably wrong now with a larger size. Occasionally, however, it makes sense to add on fresh contracts provided the odds are with you.

For example, today I went short below b4 and when the price moved against me I added on 1.75 points higher. Normally, I would be stopped out here but at this point it made sense to add on instead.

The conditions to add on for me are the following:

  1. The potential reward for being right is huge and the potential loss for being wrong is small: After b4 triggered, my stop was above it, so my add on position had only 4t risk but since it was a 1PB setup, the potential reward was 4 points at least, possibly 8 points or more.
  2. Entry is with-trend: The gap down, the strong b1 below ema, the failed H1 (already triggered) all point to at least a test of the low of b3, giving a with-trend entry.
  3. You were expecting a pullback due to price action: b4 had an entry side tail and most of it was overlapped by all prior bars so a pullback was very likely. Since you already expected a pullback you can enter lighter the first attempt and add on at the pullback.
  4. You are trading within your comfort zone: If you cannot be comfortable holding the extra contracts, you risk being shaken out mid-bar.
The following are poor reasons to add on:
  1. Your counter-trend trade went against you: This is the simply the best way to go bankrupt, throw good money after bad. Be a strong trader and let it stop you out. This will train your brain to enter on higher quality setups only.
  2. You think this will be a huge move and want to add on more contracts after the price has moved in your favor: This is usually a poor move. You should be getting out of your scalp position once the price moves in your favor, not adding on fresh contracts.

Friday, October 14, 2011

Limit entries in a channel


A channel is a leg made of overlapping bars with very little pullback. This means that channels do not give a clear entry. Occasionally, you get a small bar such as b8 and you could enter using it as a signal bar. However often you do not get any such bar and when it does you may find yourself buying at the top of the channel as the buyers above b22 discovered.

One of the characteristic features of channels is that their first breakout almost always fails. This allows us to enter at the channel trendline whenever a bar closes very near to it. For example, b11 close could be sold and b17 close could be bought. This works very well with the first close near the trendline. Subsequent closes such as b15 close did not fare that well.

Weak closes such as b21 or closes that are far away from the trendline such as b19 and b13 are suspect since there is still plenty of room to the trendline. These should be avoided.

Extending these to general trends is a bit harder. In theory, you should be able to buy any strong bear close near a bull trendline such as b49 or b61 and sell any bull close near a bear trendline. However, unlike channels, where the first breakout is a high probability failure, a general trend such as the one from b35 to b79 is not expected to fail any trendline break attempt with such a high probability.

Thursday, October 13, 2011

Final Flags


A final flag represents an area of high probability reversal. A classic final flag is a horizontal flag made of overlapping trend bars. These bars are likely to be large when a bear trend is ending (b18-23) but may be made of smaller bars when a bull trend is ending (b65-67). If the bars are not trend bars, a continuation is more likely than a reversal.

A normal flag moves counter to the direction of the main trend (b32-38, b53-b60) and represents early traders exiting, counter-trend traders being trapped in and new traders moving in, taking the price to a new extreme. The deeper the pullback, the more likely the with-trend pullback entry will succeed.

A horizontal flag on the other hand does not represent the early traders exiting. Their target is very close and they are holding to exit on the next push. Counter-trend traders do not get trapped and new traders are unlikely to enter on a very shallow pullback.

A horizontal flag on the third push is very likely to be a final flag and you should look for favorable entries. If the risk is too large as in b23, its best to wait for a second entry (b38) or enter on the first pullback after the trend has reversed. This is because there is a rather high risk of being trapped when then the entry is counter-trend and the risk is large (b19 buyers).

If the flag is made of smaller bars (b65-67), an entry after a with trend break and failure is preferable to avoid being trapped (shorts below b66 were stopped out). An ii variant such as b69,70 makes an excellent FF entry, especially when overshooting a TCL.

Wednesday, October 12, 2011

Inside bar reversals


Inside bars reversals are pretty hard to read accurately. Why did the breakout below b11 fail but b15 give a scalp profit? Why did b44 take out the stop beyond the entry bar (b44) before giving a scalp profit making it a poor signal while b62 turned into a great swing trade?

All these bars had strong closes yet two failed and two succeeded. Using a little bit of common sense, we can reduce our chances of taking an unprofitable inside bar entry. b12 is the first attempt to break the trend and failure is expected. B15 was the second attempt and an overshoot, so it should give at least a pullback.

Similarly b44 was the first attempt to fail a strong breakout (b41 was 50%+ beyond prior HOD) and was unlikely to work. b62 on the other hand was a third push up after a trendline break (TL b4-b25) and a TCL overshoot.

Swing moves often end with inside bars and these are usually great with trend entries. For example, b19 ii indicated a possible swing end as did b54.

To Summarize:

  • Inside bars are excellent signal bars for failed breakouts but not for any arbitrary reversal. It can be argued that b15 and b62 were breakout failures while b11 and b42 were not.
  • Inside bars make good signals when there is a TL or TCL violation
  • Inside bars are good signals with-trend or at the end of swings 

Tuesday, October 11, 2011

Trend breakage


A small dip below the trendline such as b22 does not actually break the trend. A large move such as b34-40 on the other hand breaks the trend and the market becomes range bound. At this point, all with-trend entries are no longer viable. For example, b41, in spite of having a strong close is not an A2.

Once you notice the trend is broken, only take trades at the extremes of the trading range. Preferably, you should take fBOs of new highs or BP if the breakout is strong. Occasionally, you will be able to take a DT as in b55 today or possibly even a DP (if b69 was a stronger close).

Many setups in a trading range are actually traps. You tend to see a lot of setups such as b45,46 and b72,73. It may appear that another strong leg is imminent but the move usually fails if its mid-range or a successful break of the range is a requirement for success.

Even setups at near the end of the range need a strong bar (b55) to expect a reasonable chance of success. The possibility of overlap and pullback is very high, so trading is generally dangerous. Its especially dangerous if the range is small (5 points of less), mid-range and made of taily overlapped bars.

The patient trader should wait for a trend break and enter on the first pullback, swinging a portion of the total position. If you must trade, fade every two or three legged move.

Monday, October 10, 2011

Traps III - Poor signal bars


The hardest kinds of traps to avoid are ones that give good patterns but poor signal bars. Unfortunately, these poor bars work a sufficient fraction of the time that they are hard to resist.

For example, b22 was a poor looking buy bar but worked for a small scalp. b35 on the other hand failed despite being closer to the ema. b42 was a bar with a entry side tail and yet it worked. b61 was a doji but worked very well.

How then, is a trader to distinguish between signal bars when they could work or fail with equal probability? On many strong days, especially soft-trend days, good signal bars are rare. Is sitting out of most of the trading day the only option? It certainly is the safe option and for most traders, possibly the best option but there are some heuristics that allow you to select your entries with higher chances of success.

Overlapped signal bars such as b35 and one legged pullbacks such as b22 are weak. You should never buy a poor bar at the top of a flag. Combined signals such as b61 DT and G are strong. With-trend signals such as b72 G2 are strong. Counter-trend signals such as b16 and b57 are marginal and only CT signals after a clear break of the trend such as b48 should be traded.

Friday, October 7, 2011

Traps II - Overlaps


While traps made of bars in the wrong place need some experience to recognize, traps caused by overlaps are a bit easier. Basically as long as you remember overlaps are trading ranges and resolve to only buy below and sell above them, you can keep out of trouble.

For example, b9 is a possible 1PB but since its a mid-range overlap, there is a very good chance of it failing and you should watch out for a sell signal above. A failed breakout at b13 is very likely to at least take the stops out (low of b9) and you should exit any long positions and reverse here.

While b23 on its own may look like a strong reversal bar, most of it overlaps two bars and is effectively a trading range. Worse is buying above b27 assuming its a second leg or above b29 assuming its a shaved reversal bar. Moreover, b23 is the first attempt to reverse the leg down and is likely to fail, i.e., its low should be taken out (as it did during b31).

The only time you can take an entry on an overlap is if both bulls and bears are already trapped AND you are entering with-trend. For example, b64 was a possible long entry after bulls above b61 were trapped out and bears trapped below b62.

Thursday, October 6, 2011

Traps I - Bars in the wrong place



Many traders lose money because they do not recognize traps in time and once they are in, they will hold hoping for a miracle. With some experience and pain, any trader will eventually learn to recognize traps and avoid them.

There are many kinds of traps, but they have some common features. The first is that the bar taken alone probably looks great. For example, b1 today was a reversal bar at the ema with a very strong close. A new trader can be forgiven for  assuming that its breakout will lead to a strong trend. However, a reversal bar needs to dip beyond a prior swing to be valid -- if not, its just a trading range bar.

b14 is a similar trap. Although it did give a decent scalp move, being the first attempt to reverse a strong move from the LOD is unlikely to succeed and strong traders added on at the ema instead of shorting.

b44 seemed to be a possible bull reversal bar at the ema but its placed after a long string of bear bars. What is more, b36 was a failed H2 and should lead to two legs down, so b44 is unlikely to be a successful trade.

b65 comes after a possible major reversal (MR) and is unlikely to turn around without at least 2 attempts down. b69 on the other hand would be an OK trade if it was a small bar at the top of the flag since its a possible failure after a second attempt up.

Wednesday, October 5, 2011

Price Action Basics X - More than bars


As I've posted many times before, you can trade very well by focusing on good bars and common sense. However, bars do not always tell you the full story. The context of each bar and the market's current place in the nine transitions is very important to distinguish between a strong and a weak bar.

For example, b13 and b72 were overlapped bars and the indicator filtered them out. However, b8-13 represented a 2 legged pullback after a strong breakout and should work like a breakout pullback. Similarly, b72 was a second HL after a second HH and is a trend break. Both bars worked very well for swing entries.

On the other hand, b19 despite being a strong inside bar on a W move up gave a pullback that took out break-even stops while b30, despite being a doji bar let the swing position advance unmolested to +8 points. The reason is simple. At b19, we were still in a bull trend and b22 was seen as a deep pullback and attracted buyers. b30 on the other hand was 3 pushes to a LH after the TL break (b19-22) and attracted sellers.

b51 was a decent inside bar, but it came after a 3 push breakout of the trading range. Although the trade worked on this instance, its a low probability trade since a 3 push BO of the trading range is likely to fail and seek the other end of the trading range.

While bars filter out bad entries, if your aim is to take very few trades that swing for a lot of points, you need to be able to read the nine transitions fluently to make the optimal decisions. Never swing trades because you don't want to be left out of a large move based on just one bar. When in doubt, take only deep pullbacks near support such as ema, trendline or prior swings.

Tuesday, October 4, 2011

Runaway trends


Runaway trends are hard trends with large bars and no pullbacks such as the one from b70 onwards today. Runaway trends are extremely hard to trade but you have a few options:

Buy above small bars: For example b77 was a relatively small bar in the rally. Small bars present an acceptable risk and may traders are likely to enter with you.

Buy closes of bars with entry side tails: This is dangerous and should not be attempted unless the bars are small since the risk of pullback is very high and you would need a stop below the bar.

Buy on limit at micro-trendline: An MTL violation such as b75 is a high probability entry in a strong trend. If the prior bar is small, the stop may be acceptable.

Switch to smaller timeframe charts or volume charts: The 1m chart provided 2 legged pullbacks around b74. The first two legged pullback on the 1 minute chart in particular, is a high probability entry in a runaway trend.

No matter where you enter, after your scalp exit, you should swing the remaining position until the trend runs to termination. If the trend begins in the AM, it is likely to break and turn into a shallow sloped channel. A late trend break is likely to run into the close of the day.

Monday, October 3, 2011

Price Action Basics IX - Scalp and swing entries


A scalp is a pre-defined amount of profit that the user expects to take, regardless of the parameters of the trade. ES traders often have one point as their scalp size, forex traders have 10 pips and so on. Technically, the smallest possible scalp is 1 tick in futures and 0.01 in stocks. In general a scalp is around the same size as the risk (distance from entry to stop). Traders who enter on stops above signal bars need to adjust their trading to resize their scalp size with changes in signal bar size.

A swing is a large undetermined move many times the size of the original risk. Swing entries are essential to be a profitable trader since scalp entries are likely to be breakeven at best for the new trader.

Not all entries are swingable. To be swingable, you should have a reasonable expectation that the next pullback will not take out your breakeven stop. For example, today b23 or even b26 was not a swing setup, only b30 was. Only trend continuation setups (i.e., setups that are likely to continue the trend to a new extreme are swingable. The best swingable setups are: 1PB, A2, W1P. BPs and fBOs in particular are not usually swingable.

Usually, second attempts, failures (such as the 1tf on b30), the first pullback in a new trend are swingable. You do not need to bother adding a runner to your trade unless you expect the trade to be swingable.

Entering only on swingable trades highly improves your win rate in addition to your profit per trade. Always try to correctly read if a setup us also a swing setup before placing your trade.

Friday, September 30, 2011

Price Action Basics VIII - The opening range and its measured move.


On some days, there is no clear initial trend and the first few bars of the day are simply a trading range. Two up and two down moves that don't go too far from the open make an opening range. On many days there will be no successful breakout of the range and the market will oscillate between the bounds of the range and every breakout attempt will fail.

When the market fails to break out twice (b11 and b27), it normally tests the other end (b61).
However, when the market does breakout successfully, it will often reach the measured move of the opening range.

A three push failure (b3,11,27) on one end of the TR often results in the successful break on the other side. A simple but fairly successful way to trade these moves is to take the first HL long and the first LH short of the day as long as they are close to the prior swing and hold till the other end is taken out. For example, you would buy above b19 and sell below b37 or b53.

A 2 legged pullback after a breakout(b69) is possibly the first A2 in a new trend and is a high probability trade.

Thursday, September 29, 2011

Price Action Basics VII - The Initial trend, 1Rev and 1PB


After zero or many fBOs off the first bar of the day, the market may attempt to trend. This is called the initial trend and if its strong, it may eventually persist till the end of the day. However, on most days, there will be an attempt to reverse the trend.

If b4 was the initial trend attempt, then b5 is its reversal. On the other hand b4,5 could simply be another fBO and b5 to b8 could be the initial trend. b9 would then be the first attempt to reverse the trend. If this attempt is feeble, then it will fail and turn into the first pullback of the trend or 1PB. Often the protective stop above 1PB is not violated for the rest of the day (including today). This makes 1PB often the best swing entry of the day.

For practical reasons, the first deep pullback is usually a better swing candidate. The W at b29 or the W1P at b36 make excellent 1PB entries and are often the best practical swing entries of the day. This is because a protective stop of a deep pullback is less likely to be taken out before yielding a swing profit and a deep pullback is easier to enter than a one bar pullback such as b9.

Today, there was an excellent PM move, but on many days, the AM trend is the only large move and the lunch and post-lunch hours do not yield any large moves unencumbered by choppy movement and stop runs. This is why mastering the 1PB entry is crucial to profitability.

Wednesday, September 28, 2011

Price Action Basics VI - The first bar


According to Al Brooks, the first bar represents the day in a nutshell on most days. As you can see, today that was not true. My modification is that the first one or two bars represents the AM movement. If the first couple of bars are strong trend bars in the same direction, there is a good chance of a trend move (either with or against the first two bars). If the first bar is a trading range type of bar or the first two bars are opposite colored and overlap (even though they are trend bars), then the market is forming an opening range rather than an opening trend.

The first bar is special, because it is the only bar thats guaranteed to give both a new HOD and LOD. From this point on, you can trade fBOs and BP of b1 and continue with every new HOD and LOD. A bar with tails such as b1 today should be considered a small trading range. Such an opening often leads to an expanding triangle open, which essentially is a series of fBO of every new high and low until one of them gives a two or three legged LH (such as b30) or HL and begins a trend move.

Trend bars on open show energy and will often lead to an AM trend. Those trends will often reverse and lead to a prolonged trend that could last all day.

A reversal bar on open will often give a sharp move that will turn around and take out the other end of b1. This is especially true if the reversal bar is in the wrong place, i.e., mid-range or a bull reversal bar above a small gap, etc.

Doji b1 can give a small fBO on one end of the bar followed by a prolonged move when the other side of the bar breaks out. But it can also lead to BW open.

Regardless, the size and form of b1 is only a guide and should not be relied upon religiously. There are various edge cases that are too numerous to list and can only be mastered with experience. The right way to approach b1 is as if its a trading range and trade it as if its a small trading range. That is to say, if there is a strong breakout, enter on a pullback and if there is a weak breakout, fade the breakout. Remember that fBO of small ranges is usually not worth the trouble and that applies to b1 as well.

Tuesday, September 27, 2011

Price Action Basics V: The Open Gaps


The open is a very complex set of topics and gap opens are an important source of information about the day's price action. Occasionally, the market opens very near to the close of the prior day (less than one average bar). This usually can be traded as if there was no gap and the open is simply continuation of the prior day's price action. Usually, the open almost always is a few bar lengths away from the close of the prior day. This is a small gap and usually this acts like a breakout or a trendline break. Usually, the market attempts to close small gaps giving either a pullback from the gap breakout or re-test after the gap trendline break. Sometimes small gaps will extend before closing and this will lead to a protracted trend after reversal. When a small gap extends, you usually have no idea how far it will go but you always know that the reversal will test the close of the prior day.

Gaps that give an open within the body of the prior day, especially mid-body are suspect. No matter which way they trend, they are likely to reverse sometime within the day.

In other words, most days are likely to trend trying to close the gap. Naturally, if it tries to close the gap in two or three attempts and fails, the market will usually give a large trend in the opposite direction. Keeping the above in mind is very important to determine 1Rev correctly.

The last case is the large gap (about a day's range). A large gap can lead to a large trend if it tries to close the gap. If it tries to extend the gap, it often behaves like a spike and channel with the gap as a spike. This often means its a soft-trend day. A large gap down can give a hard trend if it tries to widen the gap.

However, a large gap simply gives a trading range, which can lead to a gap closure late in the day (as in today's chart). A good metric for the trendiness of a large gap is the first bar, which if its a average sized trend bar is likely to lead to a large trend day. A doji or other poor bar such as today's b1 usually indicates a poor AM trend.

Determining the likely primary direction of the day improves your chances of a successful 1Rev and 1PB entry, which in turn allows you to swing for larger number of points and increases your profitability.

Monday, September 26, 2011

Price Action Basics IV: Trading ranges, Trends, fBOs and BPs



A breakout from a trading range is an attempt to create a trend and its failure is a move back into the trading range. A successful breakout leads to a trend. Similarly, a successful failure to resume the trend leads to a trading range. Today, b15 and b28 were failures to resume the trend and b67 was a successful resumption of the trend.

After every breakout, the trader needs to decide if he will fade the breakout or enter with the breakout on a pullback. In general, when in a trading range, a trade on the failure of the breakout is more likely to succeed and certain important signs are needed to trade with the breakout.

The signs are:

  1. Breakout is strong (i.e., half or more of the breakout bar is beyond the break point)
  2. Strong close
  3. Second attempt to breakout
  4. Poor attempt to fail the breakout


Lets look at these one by one:


  1. Strong breakout: b27 and b67 were both very strong breakout bars, but b67 was more than halfway above the break point. Even though b27 was less than halfway out, there was a good chance that a 2 or 3 legged pullback could give a second attempt up. On the other hand b10 was a weak breakout with weak close.
  2. Strong close: A strong close beyond the breakout point indicates that there were insufficient fade orders at the break point. A weak close followed by a deep pullback (such as b29-46) indicates possible failure of the breakout. A weak close such as b10 indicates fade orders were waiting and a failed second attempt (b15) is likely to seek the other end of the range.
  3. Second attempt: Second attempts are stronger than first attempts and second attempts of strong closes usually are very successful. An fBO (b28) that fails to take out the other end of the range (b15 low) should be treated like a deep pullback and is a possible trend break (HL after HH). This is especially true after a fL2 such as the one at b50.
  4. Poor attempt to fail the breakout: b11 and b15 are strong attempts to fail the breakout. Usually, when the first failure is pronounced (b11,12), the second will usually go much further (b15-b27). If the bar after the breakout bar is a reversal or inside bar with a strong close such as b28, there is a high probability of at least 2 legs down, possibly deep. If the attempt to fail the breakout is poor such as b67, and it does not trigger, the chances are very high that the price will seek a measured move of the prior range (b28-45 met at b79).

Friday, September 23, 2011

Good and Bad fBO


I've often mentioned that trading with-trend in a trend is the easiest way to trade and fBO are some of the hardest trades to take. The reason is very simple. Market inertia dictates that when in a trend, the market is likely to continue in the trend and the with-trend entry is a high probability setup. A fBO on the other hand could turn into a BP or fail on the first or second attempts and work only on the third attempt (as a mini-W).

This is why unless the range is large, you shouldn't even bother taking fBO trades. With that caveat, we can still attempt to deduce the best and worst fBO setups.

The first fBO setup is b2, the failure of the breakout of the large bar b1, which acts as a small TR. Since the entry would be in the lower half of the range, it is likely to fail, esp. since its a first entry. If the entry was very close to the high of b1, this would be worth the risk reward only because the bar is large. If the bar were 4 points or smaller, its best to ignore the fBO of b1.

The second fBO is b6, an attempt to reverse the close of prior day and three pushes up (b2,4,6). This is a higher probability trade and can be labeled OR.

The next possible fBO/BP was b16, which was a strong BO and did not give a decent BP signal bar. At this point, we have a higher high and a higher low and we are in a possible bull trend and should not look to trade fBOs. Rather we should look for 2L PB to ema or TL and take with-trend trades or watch for a trend break. This means we would ignore b21 and even b24 if it was well-formed.

The one-legged move to and close below ema at b29 possibly broke the trend, so we should again switch to looking for fBO and BP. The three push to b45 is an OK setup, but normally, I avoid taking mid-range entries when the market is not in a trend. If we had been in a trend or the move to b23 was a strong trend, I would consider buying b47 as a possible G2.

The fBO at b55 is the most desirable kind of fBO. The bar that broke above the HOD turned into a reversal bar with out overlaps of any other bar. (A doji is an acceptable fBO signal at extremes of the day). A reversal bar or inside bar after the BO bar would also be excellent signals.

To summarize, good fBOs are three pushes beyond the trading range or failures immediately after the breakout when you are certain you are not in a trend.

Thursday, September 22, 2011

Risk of pullbacks and failures


Traders are often surprised at how violently their stops are sometimes taken out such as the short below b14 or the long above b15. Signal bar selection is very important if you wish to use stop entries to enter on the breakout of signal bars. Almost all failures for stop entries have a few common characteristics and mastering them will reduce your error rate.

1. Overlaps: Overlaps, especially large bar overlaps are the easiest risk to recognize and evaluate. In general large bars are poor signal bars regardless of overlap. Any overlap practically guarantees the trading range attribute of the signal bars and you should wait for a small bar at one end of the overlap (b16, b26) and take the fBO of the overlap. Overlaps of small bars such as b47-51 are usually ok to take a second attempt with-trend. These should never be taken in a trading range (expecting a breakout for example) and never the first attempt.

2. Dojis before reversal bars: Dojis represent a trading range and a reversal bar after the doji does not invalidate this fact (b21-22). A second attempt, especially after trapping traders in both directions (b35) may be an OK entry to take even with dojis.

3. First attempts: Its clear from the charts that first attempts (b22, b33, b60) are highly likely to fail compared to second attempts. First attempts should be reserved for very clear and very specific cases such as 1Rev (b3), W reversals (b72) and 1PB or at the very least only for excellent signal bars.

4. Poor signal bars: Poor signal bars (b11, b60) almost certainly will give a pullback simply because some traders will fade its breakout. This is why a second attempt is recommended if the signal bar is the wrong color, has a long entry-side tail or is a doji. Even if the first attempt succeeds, there is usually a pullback before the market moves too far from the entry off a poor bar.

If you consider bars that had minimal pullback, i.e., went a large distance before a pullback and hence are swing candidates(b7,64,72), they usually are well-formed bars with a strong close or are second attempts (b16, 35). Restricting your entries only to such bars should greatly reduce your error rate, which is a precondition to increasing your trade size.

Tuesday, September 20, 2011

Early and late trend breaks



Early trend breaks are easier to spot correctly and the probability of them giving a sizeable trend move is high. Late trends are rather hard to predict and they will often go only a small distance or fail. This is why 1PB (b9) is a very vital setup to master. Catching the major portion of the early trend move allows you to relax and ignore the low probability setups during mid-day and optionally jump into any late trend break.

Late trend breaks are often very hard to spot and you will encounter may false starts such as the possible W at b40 or the second W at b55. The DP b22,46,49 was probably a decent signal, but the spike on b56 took out any swing stops.

The clearest and simplest entry for any trend break is a BP (b66). Even though it looks like the bottom of the range, a BP often is worth the risk given prior signals such as the failed W and the DP.

However, reading 1PB and OR are vastly easier than reading a breakout from an extended consolidation. If you cannot trade 1PB consistently, its unlikely you will be able to predict the BO from an extended TR consistently.

Monday, September 19, 2011

Overlapping bars produce poor signals


Somewhere bear b11 was a fBO or 1Rev. Unfortunately, the bars were overlapping and full of tails, so my indicator could not catch them. On such days, I look to see if the 3m chart has clearer bars. Today it did:



The risk of trading 3m chart is that they are unreliable after the first hour. For example, 3m b68, b72 and b105 entries failed even though there were reasonable bars. However, in the first hour and only if the 5m chart has overlap overflow, the 3m can be used.

Often setups that are unclear on the 5m are clarified on the 3m. For example the LOD reversal was a inside doji bar inside a bear bar on the 5m, but an ii FF on the 3rd push on the 3m. This may enable a great entry on an otherwise poor day.

The psychological risk of trading time-frames smaller than 5m is that you get addicted to the small risk and good prices and trade them beyond the first hour. This is usually dangerous, esp. during lunch hour where even the 5m chart is dangerous.