Friday, March 30, 2012
Revenge Trading I - Reversing where you would be stopped out
As I've previously posted, a trend first bar is just a trading range. However, a strong bear close that overshoots a bull channel TCL from the prior day is a sign of a move down. If a trader chooses to sell below b1 instead of waiting for a breakout pullback of b1, he may follow standard price action principles and move his stop above b2. Since b2 is had a strong close, he may simply decide to reverse where he is being stopped out. This is an unplanned trade and is a form of revenge trade.
This is caused by the trader having a plan for success, but not a plan for failure. He has very carefully visualized his setup, entry and targets. He may have chosen his stop, but being so sure of his trade, does not really expect it to be hit. After all, the setup is just too beautiful. How could it ever fail?
The failure of a beautiful setup usually means you are still in a choppy trading range and there is a very good chance that any setups near this area are likely to fail regardless of direction. The right thing to do is to wait out two swings or until the price moves some distance away from choppy action.
Since I had taken b7 and was stopped out, my plan required me to stay out for two swings or until the price moved some distance away from this setup, both of which meant I would enter on the 1st PB after the reversal at b15.
While some traders can retain clarity of thought after a loss, many just wont be able to. For example, if an experienced trader shorted below b71 after reading it as an A2 short (since b69 is an L1 variant) and was stopped out, he may retain the clarity of mind to correctly short b74 as a W pullback. (but he could probably never do so if he reversed and went long during b73.)
However, under most circumstances its best to wait out two swings. A short below b50 DT was stopped out at b55. Naturally, a short after 7 bull bars is likely to fail even if this was not BW. After waiting two swings, i.e., close of b63, chances of a successful trade increase. The price has also moved the size of a recent bar or two away from the original price and has also given the trader some time to regain composure.
In summary, when you encounter a loss, always avoid getting back in right away. Have some criteria for re-entry. The chances of you reacting emotionally and urgently right after a loss is very high and puts you at severe disadvantage. In this state you are unlikely to be reading the market at your finest skill level. Let the market go for now and wait for better price action. Entering on strong bars is a great way to filter poor price action areas. Strong setup bars failing actually gives you a lot more information about the market since poor bars could fail anywhere but strong bars only fail in trading ranges/channels.