Stock Trading
Trading stocks, futures
or the Forex is an intrepid endeavor.
The rate of failure for traders is very high, so high that, I decided to embark
on a mission to create a system that would greatly enhance a trader’s chances of
success. There is no magic bullet, of course, and therefore, a tool by itself
is not enough.
A trader also needs to
have a fundamental knowledge of trading and the financial markets. Trained
professionals have this knowledge, combined with a passion and commitment to
succeed. The average non-professional on the other hand, is busy trying to
succeed in their chosen profession – lawyer, doctor, accountant, engineer, etc
– and then tries to take the money they’ve managed to earn through hard work
and grow their wealth in the various financial markets.
In the recent past,
growing ones nest egg seemed quite simple, but that bubble has burst and the
realities of prevailing in a volatile market have returned. These realities
insist that a trader take the game very seriously. The game starts with
attitude. Make the decision to approach the financial markets and the
management of your money like a professional, and you will attain the desired
results. However, I must caution that if you adhere to the mindset, which
believes someone can take a seminar, or listen to an “expert” on TV or use a
software tool alone – without the requisite knowledge – the results may leave
you reeling.
The purpose of this
manual is to provide you with the knowledge that I believe is imperative to
realizing success trading financial markets. You will learn methods that will
generate confidence in what you’re doing, thus producing consistent results
that can be directly linked to your decisions and actions. You will no longer
be riding the roller coaster of seemingly unpredictable profits and losses with
your trades. Will you make money on every trade? No. There is no Holy Grail of
trading but if you have the knowledge and you use this knowledge, then you can
succeed. Cash Flow Ventures system helps you use your knowledge by providing
you with the information you need to make well-conceived decisions.
Developing a professional
attitude is where I would like you to start the process of becoming a
successful trader. Part of that is realizing that there is no perfect method.
Losing money on a trade is simply the cost of the game. No matter what business
you pursue, there will be losses and accepting this reality is the first step
to becoming a professional – a trader that trades on knowledge and information,
rather than emotion and prayer.
Next, I would like to
further extend your professionalism by suggesting to you that trading is mostly
about managing your money and knowing how to exit a trade. Most “experts”
preach a strategy of how to enter a trade, rather than how to exit a trade. In
my opinion, this is the opposite of how a professional sees the market. I will
teach you to make trades that are based on facts instead of prophecies,
conjecture and beliefs.
You will learn not to
waste your time and effort on useless rat races like picking the top and bottom
of a market. I will show you how to make the right trades at the right times.
You will go short when you should go short and long when you should go long.
Trading will attack your
emotions, so it is important that you be prepared to fight the good fight and
make the correct decisions. This is a simple formula; discipline, patience,
trading on facts, not opinion and learning how to lose by cutting losses short.
Or to quote Sun Tzu’s
“Art of War”:
“The good
fighters of old first put themselves beyond the possibility of defeat and then
waited for an opportunity of defeating the enemy. To secure ourselves
against defeat lies in our own hands, but the opportunity of defeating the
enemy
is provided by the enemy himself.”
Now that you have begun
building a professional attitude we can start discussing the many pitfalls
common to the art of trading. Most traders have the propensity of scalping
rather than trading. Scalping is when a trader realizes a quick profit and
immediately pulls the trigger and exits the trade. This practice is more acute
when the prior trade lost the trader money and it ignores the environment of
the market. A good trader starts with a plan and sticks to the plan. This can
be very difficult, but you’ll find that if you have the right knowledge and a
tool to help execute this knowledge, the task becomes more manageable.
Another pitfall is using
tight Stops, which pulls the plug on a trade right when the market is about to
accelerate in a direction beneficial to the trade. This may sound like good
money management, but it ignores the current state of the market and leaves
profits on the table. A trading plan will discipline you to react to the
realities of the market and therefore, execute exits based on sound decision
making logic that increases your potential to profit.
This course will help you
understand how to interpret the market, which will allow you to create a
trading plan that is conducive to who you are and what you wish to achieve in
the market. Every new day brings a new market and therefore, you must be
prepared to read each market individually and execute with conceived Stop and
Profit goals. There are no hard and fast rules when it comes to trading and my
course will not expound such boundaries, rather, it will enable you to use your
knowledge combined with a trading software to
effectively manage your trading objectives.
I will teach you how to
read Price and determine S/R levels, what to do when key levels are broken, how
to chart patterns/setups/gaps, money management, how to place orders and how to
define a trend.
The first step is to
teach you the best methods for making profitable trades. This is key to building confidence in your capabilities. Next, I
will show you why you should take all of the setups you identify. This takes
discipline but it is imperative to success. Finally, I will show you how to
manage trades after they have been executed. Combined, these steps constitute
your path to success as a trader and they must be taken seriously. There really
are no shortcuts. It will take a good work ethic and adherence to sound trading
methods to ensure that your trading goals are met.
The last element of a
successful trader is psychological fortitude. You have to be able to make a
trading plan and stick to it, no matter what. I can give you the knowledge you
need and provide an excellent tool to exercise this knowledge, but I need for
you to put your faith in the methods you will learn and leave your emotions,
greed, fear and opinion behind.
With that, lets get
started with the first lesson; How to Read Price Action. This fundamental will
provide the foundation for all that you will learn about trading. For you to
develop a trading plan, you must learn how to identify the Stop for a trade and
the Profit Objectives for each trade. Without these two components, you are no
better off than the average person trying to decipher the market based on broad
speculation and myth. And, the only way to learn these components is to be able
to read Price Action.
This course was
developed independent of any trading software. Therefore you will come across
techniques that require manual effort, such as drawing lines on charts, and the
like. In many cases, a trading software has features that eliminate the need
for any manual effort, but no trading software was developed to match the
techniques in this course verbatim, rather, this course is meant to provide the
student with information that is extremely useful with or without a trading software.
The intent of this course is to give the student baseline knowledge to take
forward when using a trading software.
Lesson One
To begin with, I must
emphasize how critical it is to look at the financial markets in the proper
context:
“The highs and lows of
the past are constantly being retested”
As a trader,
understanding how the market works starts with the understanding of “Price”.
The markets, for all their apparent randomness, actually cover the same ground
over and over by revisiting former pivot points – both high and low. An analogy
would be the Monarch butterflies who every year at mating time travel thousands
of miles back to Mexico, their home base. The market also has home bases and
continually travels back and forth between them. The S/R (support/resistance)
points I will teach you follow this model and we will cover this in detail in
the next lesson.
The concept seems simple
but it is often ignored or misunderstood and it is imperative to trading
profitably on a consistent basis. A good trader understands how price moves, so
we will focus on this in the first chapter, thus providing you with a firm
foundation to trade upon. It starts with being able to recognize the current
type of market. A “normal” market, which I will help you identify, is where
things are acting in a way conducive to trading. A “slop and chop” market, is where volatility makes the market overly risky.
By the time you finish this course, you will be able to easily identify both
markets and save yourself a lot of anxiety and heartache by picking the market
that is right for you. You will be in control and only trade when it suits your
goals.
That said, where trading
is concerned, nothing is perfect. However, once you examine the market and see
how it tests and retests previous highs and lows, you will see how this simple
concept can greatly enhance your ability to profit as a trader. There are many
other ways of determining S/R points, such as MA’s (moving averages). However
complex and worthy they may seem, I strongly recommend ignoring MA’s and
calculated numbers for S/R with one exception.
If you are told that “it
just bounced off the 20 period EMA” or something alike, I can show you a
correlating S/R point to which the market responded. I don’t believe the market
is driven by calculated numbers and have demonstrated this by plotting a 20
period MA, which revealed how rarely they impact a pivot point.
MA’s and Keltner Bands can be very effective at determining price or
to follow a trend. The Keltner Band middle band is a
20-period EMA, which is very helpful in identifying a market’s equilibrium
point. I’ve used this for charting myself, but I never pursue a trade simply
because a price is moving above or below the middle band or because an MA has
moved across another. Every trade I make is confirmed by the tools you will
learn in this course and is always based on price.
I am going to share some
basic Technical Fundamentals with you in this lesson that I think is very
important. All of the lessons you read in this manual will also be explained in
my Trading Academy Live.
The chart below is a
5-minute candlestick chart of the Dow Mini Contract. That simply means that
each black and white bar that you see on the cart below
represents a time frame of 5 minutes. If you’re going to
be day trading you will be using shorter time framed charts, but if you can’t
sit in front of your computer screen for a couple of hours everyday and you are
looking to improve your financial portfolio, then you will be looking at charts
with a longer time frame such as hourly or daily charts. No trading software is
running on this chart, this is just a candlestick chart with some horizontal
lines drawn on the chart. All I want you to learn from the chart below is how
to read support and resistance on any financial instrument that you decide to
buy or sell. Let’s get started!
I’ve drawn 3 lines on
this chart, a blue line at 10568, which is resistance, a red line at 10526,
which is support, and a white line at 10547, which is the median or in the
middle of support and resistance. I only use three lines when I manually place
them on a chart and I move them up or down depending on which way the price is
moving. One of the chart formations that I watch closely is when there is a
trading range as is seen on the first chart marked by the red and blue
horizontal lines. The price will bounce off either support or resistance and go
to the median line and then bounce off the mid point, reverse direction once
again and make a big move through the red or blue line (support or resistance).
The other thing that
happens occasionally is the price reverses at resistance level (blue line) and
then penetrates the median line, but will not go all the way to the support
line (red line). The price will pause before hitting the red line, stop and
reverse back up to the median line, stop and reverse
again back down and through support or the red line into a big move
(illustrated in the second chart). All markets are always testing previous
support and resistance. The first chart is an example of what happens almost
daily on the Dow Mini and most other stocks and futures. If you don’t know what
a futures contract is just look at the back of the manual in the glossary.
What we are looking at on
this chart is what we call a breakdown of support levels. The price goes from
#1 up to # 2 and then reverses at the # 2 level (resistance) and then heads
back down to the support level of 10526 or # 3 previously # 2. The Price Action
then pauses at the # 3 level and then proceeds to break through # 3 into what
would be a great place to sell some contracts. You can clearly see that this
was a fantastic trade if you took it. The reason I drew the median or white
line is that stocks and futures will very often use the median as support or
resistance right before it goes and breaks through key support and resistance
levels as seen in this chart.
The Third chart is a copy
of the first chart except I’ve applied my trading software to it. I‘m not going
to cover how to use my trading software in this lesson, that will come later,
but I think you can clearly see how it broke the support pivot bar in red with
the red arrow and the word breakdown next to it. Pretty cool huh! You don’t need
to be an expert trader to have seen that trade.
The next 3 charts are
examples of support and resistance. I want to back up for just a moment,
sometimes I get so excited when doing a training that I get ahead of myself. I
mentioned the word pivot or pivot bar when talking about the software. On the
chart labeled pivots, I’ve put numbers next to all
the pivot points to clearly illustrate how to identify a pivot. To put it quite
simply a pivot is when the price moves in an up or down line and then reverses.
LESSON TWO
The next step for us is
to start off with Support/Resistance points, which is the logical progression
after the first lesson. Support/Resistance points or “Pivot Points” are an easy
concept to get after some practice. Occasionally, Pivot Points are
straightforward to see on a chart and other times they manifest themselves as
an “area” or “shelf”. To get the idea of what I’m describing, look at the
market as if it were going up or down a flight of stairs. The market moves one
step or support/resistance number at a time, which is easy to determine when
the market is trending, but much more difficult when it sticks in a trading
range. This logic is paramount to understanding why the market moves the way it
moves.
In a moment we’ll start
looking at how to find pivot points but first, I’d want to give you some
insight on the S&P 500. The S&P 500 moves in 3-4 point increments.
Therefore, I look to have my S/R points follow the same increments; 3-4 points.
Most people agree that the market finds support where it found support in the
past and the same is true for resistance and while this is very useful for
finding secondary S/R numbers, I recommend against using this method to find
primary S/R numbers.
High Surge/Pivot
High Low
Dip/Pivot Low
I find the primary S/R
numbers by reviewing high surges and low dips from the past. What I’m looking
for are pivot highs below the close for support numbers and pivot lows above
the close for resistance numbers. I prefer to use a 10 or 15-minute chart for
this exercise.
Something to keep in
mind:
Previous Support
penetrated becomes Resistance = SUP:RES
Previous
Resistance penetrated becomes Support = RES:SUP
My experience is that
having S/R numbers going up and down at the points laid out above best serves
the model. Typically, I will venture 25-30 points each way, as I’ve found that
this will cover the S&P 95% of the time. As important, the more recent
pivot points should be a priority. These can normally be found in the past few
days but at times, you may have to search back weeks or even months. For
example purposes, take a look at the 30-60 minute chart to find because smart
traders never trade off the 5-minute charts, rather they check hourly or even daily
charts when deciding what trades to make. A good
trading software makes this entire process simple, so that you can effectively
assess the markets.
I further advise keeping
a log of unfilled gaps, as the market fills these gaps at some time in the future,
most often on the same day but sometimes weeks or months down the road.
In this regard, here are
some words to live by?
“UNFILLED GAPS
ARE HIGH PRIORITY SUPPORT/RESISTANCE POINTS”
Lets use the following
chart to show the support and resistance points in a day of trading. On this
chart, the red arrows are support points and the blue arrows are resistance
points. I suggest identifying these numbers concurrently until the concept
becomes second nature. As shown on the chart, I’ve made some guesses about resistance
points above 1373, as anything beyond is record
territory. So, we want to find gaps of 3-5 points, using the most recent
numbers, because they are the most reliable.
So the S/R numbers I came
up with for that day are:
Resistance
Support
1365
1369
1373
1377
1382
1386
1391
1353
1349
1344
1340
1336
1330
1327
Note: Typically, I idenitify 6-7 resistance points above yesterday’s close and
6-7 support points below yesterday’s close.
Finding Key
Support and Resistance Areas
A critical skill in
trading is being able to identify key S/R areas that develop in the market.
Over the course of time, these key areas become markers for big moves and
therefore, an opportunity to make a trade that is advantageous to you. Here’s
the concept; if the market finds support or resistance at one level, over and
over, these levels give us a view into the market’s long term trends and, if we
can see this trend, we have an advantage because the market generally moves a
long way in one direction or the other once these levels are broken.
Vision is critical to
making advantageous trades. For instance, if we’ve been tracking the market and
identify 1313 as a key level of resistance, and we are long on our trade, this
information would indicate that we should stay in the trade once 1313 is broken
because time has shown that the market will keep moving in that direction for
another 4-8 points. Think about all the times you’ve exited a trade and then
the market makes a big move. If you had known about the key levels of
resistance, you might have been able to see the big move coming and you
wouldn’t have left money on the table.
Such levels can occur
during one trading day or over the course of time. You can use the 30 or
60-minute charts to find these levels and then use them on the next day of
trading. As you become more proficient at reading price action on a chart,
these key levels will be very obvious. Just remember to use horizontal lines on
your charts.
The next chart identifies
several of these key areas. From the previous day, we know that 1313 is a key
level. As the day progressed, 1306 and 1310 materialized as key levels.
Air Pockets
Air pockets are another
good indicator of key support levels that develop subsequent to the market
turning sharply up or down. Once the market has retraced itself with a sharp
move, it leaves in its wake a pocket or zone. The following chart demonstrates
this phenomenon.
As you can see, on the
16th there was an abrupt rally from the 1325 level. On the following day, the
market gapped up but then experienced a rapid sell-off, which ended in support
around the 1333 level. Then, on the 18th, the market turned down and stayed range
bound for most of the day with a late sell off, closing at the 1335 level. It
should be clear that the 1333 level or area is a key support level and that if
the market breaks through this point, it should keep heading south to about
1325. My name for this is “Air Pockets” but feel free to apply your own
nomenclature.
Now, let’s follow this
market and see what happened on the 19th:
As you can see, the
market turned down sharply, opening a couple of ticks south of the 1325 level
at 1324.80. If you had traded the Globex session, you
would have caught the early movement.
Here’s another example
from 8/26 with two occurrences.
This chart shows the
reaction low of 1355 after some news from the Federal Reserve. It then rallied,
retracing up to 1362, where it rallied with gusto up to 1387, which formed the
1362-1355 Air Pocket. On the next day the market turned down before finding
support at 1377, where another Air Pocket formed without sufficient key support
until it hit 1362. When the market went through 1377 it dove for 1368, then sunk to 1365 before closing back at 1368.
Hopefully, you can see
how the same numbers keep popping up. What you should be able to harvest from
that days activities is that on the following day, if the market went through
1365, you could bet that it would sink to 1362 and, if it busted through that
point, 1355 would be very likely.
The following chart shows
us how the market played out on the next trading day:
The market opened where
it had closed in the previous session and began selling off. It plowed through the low of the day before, 1365, and went to
1362. Then, after a quick rally, it dove to 1355. This was somewhat surprising
because typically the market would have found support at 1362. Having found no
support there indicates that there was still a downside, which finally found
support at 1354.60.
Then, the market climbed
to 1365, or, the previous sessions low: support broken becomes resistance.
Next, the days lows were tested and when they didn’t hold, a new low of 1350.60
was established, which became the support number for the next trading day.
In the next two examples
something very interesting occurred:
This chart shows a steep
slide in the market and an eventual upturn on 9/3.
Then, look
what happened on 9/7 (the market was closed 9/6 for a holiday):
Here is another example,
which gives some insight into the following week:
I would suggest that in
the next week the key levels of 1429 on the long side and 1403 on the short. If
things go really south, 1387 is likely. So, lets see
what happened.
Let’s see what happened
on Tuesday of that week:
First, the 1403 level was
tested before a rally. It then vacillated back and forth before breaking
through 1403 and landing on 1390.
But, later in the week,
the market took off.
On this particular
morning, the Labor Department released news that was
market friendly. Then, the futures took off in the Globex
session and the market jumped up 17 points to 1429. From there, the market kept
going, finally hitting a high of 1452.
Here’s another example:
In this chart, there was
a preceding down trend going into 3/3. A countertrend
rally pushed up to 1415 and then failed, which is key resistance. Also, look at
the gap between 1385 and 1400. So, had the rally continued through 1415, it
would have had a nice run.
Here’s what happened the
next day:
On March 3, the market
slid down and then jumped back up, filling the gap. Then, it stayed in a
downtrend the remainder of the day. Early on, 1405 was broken, but it recovered
back to 1410, before dropping and trying to stay at 1405. From there is dropped
to 1399, bounced to 1405 and then everything broke loose, closing at 1385.
Hopefully, you’re
starting to see the importance of understanding price action. It doesn’t matter
what market you’re in, price action works the same and if you can read it well,
which takes some time, so be patient, you will be able to see opportunities and
make advantageous trades.
OBJECTIVES
As we discussed earlier,
to be successful you have to have a plan – objectives. Your plan will contain
both stop loss and profit objectives that will be determined by the support and
resistance points you identify. Here is a chart that starts to explain how to
plan for profit objectives:
As you can see, the
market is simply climbing up and down a staircase. And, each stair is a prior
support or resistance level established by the market. Mathematical wizardry
does not come into play, nor does opinion or luck. The market is only concerned
with where it was and what happened while it was there.
Price is the only thing
you need to concern yourself with. If you can read price, you’re ready to
trade.
LESSON THREE
Thus far, in Lesson 1
we’ve covered Price Movement and how Market Price Action is not arbitrary and
in Lesson 2 we learned Support and Resistance and how to identify these
important levels on a chart. In Lesson 3 we will go deeper into charts and
learn how certain formations can help us with market timings, so that we can
make advantageous trades.
CHART PATTERNS
Chart patterns can be
important indicators for when to enter a market. In this chapter I will cover
various formations, such as Flag/Continuation Patterns, ABC (or 123) setups,
Triangles/Range Contractions, Stair Steps, Ranges and Head and Shoulders
Tops/Bottoms. Along with these concepts, I will interlace some strategies that
will help you take advantage of these formations within a variety of market
conditions. These are powerful concepts, which could provide you with a healthy
income.
FLAGS
The majority of the
aforementioned formations can be used within any time scenario but because
continuation patterns, such as Flags and ABC, take advantage of a known trend,
they provide the greatest opportunity to profit. Once you have these concepts
down I will share some of my techniques for how to setup trades and how to get
the timing right. However, first you need to become adept at identifying these
formations.
Bear Flags Bull
Flags
Flags are quite a simple
concept and can be found after the market makes a move in one direction or the
other. Typically, they are horizontal moves or even a bit opposite of the
preceding move. I’ve found that they are easier to see in down trends but you
will see them often in up trends as well. In the case of up trends, the low
point in the Flag most often remains higher than the Resistance level that was
just broken, however, this scenario can develop slowly, perhaps over an hour,
so patience is imperative. The key is whether or not the Support/Resistance
holds, not the duration of time. I prefer to look for a high quality Retracement/Flag, which is illustrated in the above charts,
where the market pauses or moves semi-sideways. Such pauses, which lack the
look of a typical Retracement, are excellent
indicators of a bullish or bearish market, with a strong move likely to follow.
The best method I’ve
found for analyzing a Profit Objective once a Flag has formed is to review the
length of the preceding move. Prior moves, which are sometimes called “Poles’,
very often indicate the length of the following move. Of course, this method,
like all the concepts I will share with you, is not carved in stone, but if you
include the support and resistance numbers you will become highly consistent at
judging the markets next move.
I’ve found the following
two methods to be the most successful when trading Flags. The first one is to
place a Stop above/below the high/low of the formation, which is a bet that the
trend will continue or resume. The second way is to attempt to time the point
where the Flag ends and where the resumption of the trend continues. The first
method is conservative, wherein you make the market prove itself by coming to
you. The second method allows you to enter earlier but may result in you having
to chase a move should the market turn unexpectedly. Use whatever approach you
feel most comfortable with but you may want to place protective Stops above the
high/low of the Flag.
“One of the
tenets for identifying a Flag is that it be preceded by a very sharp and strong
move (Pole), preferably breaking a previous Support or Resistance area”
Here are a few more
examples:
ABC SETUP
The ABC Setup formation
arises frequently and can be used with any timeframe. In my opinion, this is
the most advantageous formation. It acts something like a launch pad, forming
alone or even within other formations. You can also call these 1-2-3 Setups, as
they consist of 3 points, as shown below:
In both of these charts,
point “A” is the high or low of the formation. The next step is for it to be
followed by a higher or lower point at “B”. The final point is the key point
“C”, which must be a higher high or a lower low. One strategy to trade this
formation is to place a Buy Stop directly above the “B” or a Sell Stop directly
below the “B”, depending on the setup and then watch the market trade back
through “B” again. To cover yourself, place a Stop Loss below or above “C”. You
will often see this setup happen over and over within a trading day and nearly
all major moves start with an ABC Setup.
Here are more examples:
You can also look at ABC
formations as a “W” or an “M” pattern, as this helps to identify them.
The chart below
illustrates this concept:
For best results, find
ABC Setups that happen over a longer term, such as a 4-6 minute chart. The
2-minute charts can be helpful in determining an entry point but they are less
effective at finding ABC Setups. The shorter-term charts contain too much clatter
and could lead you to making bad trades.
With ABC formations, we
are letting the market setup a position, “B”, and then following a “higher low”
or “lower high” back through it again. This is in line with everything I’ve
stated thus far about how the market retraces itself. In the ABC Setup, the
market makes a low/high and goes back through it again to “B”. The bulls/bears
then try to propel the market up or down but because the market finds
support/resistance at a higher high or lower low, they don’t prevail. Our trade
is solid because we’ve followed either strength or weakness via the ABC Setup
and we have an advantage.
You want to keep on the
correct side of the momentum by following the higher lows or lower highs. The
ABC formation allows us to simply trade with the momentum swings that happen
throughout the day. They give us a view that the average trader doesn’t have
and therefore, we see which way the market will move in advance.
Here’s an example of
recent Price Action:
The Bond Market represents
a very good environment for trading because it is so liquid. However, the Bond
Market is not as volatile as the indexes and therefore presents fewer trading
opportunities each week. The next two charts are examples from the Bond market:
TRIANGLES / RANGE CONTRACTION
Triangles are another
formation that provide insight into the markets
destination. We will discuss 3 types of triangles: Symmetrical, Ascending and
Descending. Symmetrical triangles are exactly that, with nearly identical lines
coming together; one descending along the Pivot Highs and another ascending
along the Pivot Lows. Descending triangles have more of a horizontal line on
the bottom and a descending line coming down the trend line. Ascending
triangles characteristically have a rising lower trend line that meets a
horizontal upper line.
I suggest looking at
these triangles in the following way: Symmetrical triangles are a continuing
pattern from the previous trend. Ascending triangles are more bullish,
typically following an upward trend and Descending triangles are bearish.
Trying to predict which way the market will turn out of one of these triangles
can be quite hazardous, so we will use a strategy that yields a more consistent
result.
From my perspective,
these triangles are really no more than a resting spot where the range
continues contracting. We know that the market will bust through this range, so
I wait for the range to drop roughly 3 points before bracketing the range with
a Buy Stop above and a Sell Stop below. Many times you will see this scenario
produce an ABC Setup.
Below is a chart that
shows a Symmetrical triangle in action. On the chart, I’ve selected two points
to place stops, above, a Buy Stop at 1329.20 and below at 1326.50. If you play
a triangle this way, all you have to do is wait for
the market to initiate your trade.
You will find that this
strategy is much more conducive to profit than trying to foresee which way the
market will turn out of a triangle. In most cases, if you’re trading the
S&P 500, Symmetrical triangles will turn in the direction of the trend that
led into the formation, however, Ascending and
Descending triangles are much less consistent. By employing this strategy, you
will place yourself into a trade that’s headed in the right direction, with
your Stop Loss covering any potential downside. After the trade is in motion,
you can move the Stop Loss to protect your upside. The more you practice
examining charts and identifying triangles the better your chances of seeing
them when the market is live.
If you’re trading the
S&P 500 or NASDAQ, keep a keen eye open for a false breakout, wherein the
market first breaks in one direction, stops, and then turns the other
direction. If this occurs, simply be prepared to reverse your direction with the
market and although you may miss the first section of the break, you will still
have an opportunity to recoup any loss you may have incurred, plus turn a tidy
profit.
HEAD & SHOULDERS
Another reliable
formation is Head and Shoulder patterns. These happen most often after an ABC
Setup and can occur at both top and bottom. Look for a trend that precedes the
pattern and the formation will be much more reliable. Below, you’ll find what a
Head and Shoulders formation looks like when it sets up definitively. In the
real world, however, you will not always find these formations with such
clarity, so be prepared to invoke a little imagination.
Like the other
formations, you can either trade Head and Shoulders patterns aggressively or
conservatively. The Aggressive approach is to enter the trade after the right
shoulder forms. The conservative method is to place a Sell Stop below the
neckline. In order for either trade to work, the neckline must be broken.
RETESTS & FAILURES
Retests occur when the
market tests a prior high or low. They are part of a continuing process that
stretches across all timeframes. Failures happen after a retest, when the
Market is incapable of piercing a former high or low. This is how double or
even triple tops/bottoms materialize.
When
the Market is testing a prior high or low pay close attention to Price Action. See if it pauses or hesitates or, is there a
clear and concise rejection where the price moves up or down rapidly. Here are
some good pointers to keep in mind when watching the Price Action and you’re Long: If the Market is Retesting a prior high or low and
pauses, then the chances are good that it will proceed through the prior high.
However, if Price is rejected soundly, then either exit on the next up bar or
tighten up your Stops.
Failures fall into one of
three categories. Let’s get familiar with these and then I’ll discuss how to
analyze the strength or weakness of each Retest.
Marginal – This type of Failure is characterized by a
condition when the Market pierces a new High or Low, but only slightly. Be
suspicious of misleading conditions, when the High or Low is only exceeded by a
half point to a 1 point. Sometimes, the Market will reverse itself quite
rapidly in such cases.
Matching – A matching Failure is literally that; when
the Market matches a prior high or low exactly. This occurs very often and is
typically Bearish when a high is tested and Bullish when a low is tested.
Failures to reach
the High/Low – This Failure
occurs when a previous High is tested but it falls short by 1-2 ticks. They are
frequent in nature and may also apply to situations where the Market previously
exceeded a high or low by 1-2 ticks. As a rule of thumb, these Failures are
Bearish on the High side and Bullish on the Low side.
Here’s what you should
look for after a Retest and Failure. When the Market tests a high or low, and
it fails, then its natural retreat should be to the prior Support/Resistance
level. Therefore, if the Market were to test a high of
1680 and the previous low was 1665, having failed to pierce that high, the
Market should run home to 1665. At least, that is what happens in most cases.
On particularly robust
trending days the Market may test a High or Low several times before finally
surpassing that level. In each case, it may look like a Failure but the Market
is really only teasing the level, backing off, teasing again, and so on. This
can be very hard to decipher but as you gain more experience, the picture will
become clearer and clearer.
Learn to track these
Pivot Highs and Lows and you’ll develop insight into where the Market is
heading. The following chart demonstrates this activity:
STAIR-STEP PATTERN
As you recall, we spoke
previously about Support and Resistance and how the Market continuously test
prior Highs and Lows. You may also note that this whole process often looks
very much like the Market is climbing or descending a flight of stairs. If you
can recognize a Stair-Step pattern while it materializes, there are some
excellent trades that can be made. The next few charts show how this can work:
Very often the Market
will “test” prior levels right down to the tick, as you can see in the chart
above. I’ve found that such tests, that go exactly to the
tick of previous highs or lows, are excellent entry opportunities. Here
are a few ways you can trade in these situations. As demonstrated at Point 1
above, you could enter on a Stop at the last Pivot High (or low). Or, as shown
in Point 2, you could find a miniature Pivot within the continuation pattern
and enter on a Stop above that level. Finally, you could enter the Market just
after a strong bar that is rising/dropping off the level being tested, as seen
in Point 3.
The Market, of course,
has a mind of its own and we can’t anticipate that levels will match to the
tick each time. If a prior move was too strong, the Market may not be able to
return to that level. Still, keep in mind the prior major Support/Resistance
level that was broken, because there may be opportunities for entries via
retraces back to that level.
The best advice I can
give you as a trader is to be patient, especially about learning and perfecting
these setups. Look for a trending Market, as this is where the best
opportunities will lie. Make trades when the conditions are in your favor – don’t force a trade.
RANGES
Perhaps you’ve noticed
that the S&P tends to fall into an extended lull within a range now and
then, particularly after a large move. There is nothing uncommon about this
phenomenon, as the Market, like everything, occasionally requires a bit of
rest. This happens quite often during the New York lunch hour, as well as into
the early afternoon. Beware, that these ranges, more often than not, result in
big losses for most traders, especially those using indicator/systems
strategies.
Becoming proficient as a
trader requires the ability to read the Price Action but it also insists that
you have a feel for the current Market’s environment. You have to be able to
modify your game plan on a moments notice, based on a variety of conditions,
and take advantage of situations. Be prepared to adjust your expectations based
on the type of Market you’re facing. If the Market is in a range, you will
trade differently than if the Market is trending.
You will find that
certain ranges have a flow or rhythm, which makes them excellent for trading,
while other ranges seem to constantly be changing, back and forth. Stay away
from Markets that are entirely unpredictable. Everything you learn in this
course is built upon the foundation of predicting future conditions based on
former or current conditions. If the Market is in a range, first find the
outside borders of the range. Using a horizontal line will help. Then, you need
to determine if the range is wide enough to trade.
Next, you want to find
the center of point in the range. I suggest using a
horizontal line. The Market will typically be hovering around a common price
point, which will correspond to the Support/Resistance point, or at least be
fairly close. Now that you have the extreme parts of the range identified (the
boundaries) you can trade through the center to the
extremes.
Here’s an example of such
a range:
In this chart, there is
an easy to find 5-point range; 1373-1368. Because of this rhythm, moving from one
extreme to the other, there is plenty of room for finding a Profit Objective.
This may look a little pedestrian, but I would preach that taking advantage of
even a small point range like this, 1.5 – 2/5 per trade, is still very much
worthwhile. Don’t get caught swinging hard for a home run and missing, when a
single is being handed to you on a silver platter. The way to play this is to
place Stops above/below the outside of the range and above/below the last lower
High/Higher Low, if one exists. This is what I meant by trading “through the center”.
As the potential for
profit on each trade is fairly small, keep your finger on the trigger and be
prepared to cancel trades that aren’t working and take quick profits on the
ones that do work. If the Market is trending, you will manage your trades much
differently. In the situation above, try to discover if one side is stronger
than the other. This can often be found by looking at the Market prior to the
range. If there was a strong trend up, then perhaps you can bet more on long
trades.
Here’s another example:
In this chart, the Market
goes short early, having been setup by an ABC. Then, during the lunch hour, the
Market fell into a lull or range, with 1379.50 as the center.
The strategy is to trade through 1379.50 to the extremes of 1382 and 1377. The
motive is profit and the profits are fairly low, so you need to move quick.
Many of the formations
I’ve discussed in this lesson are merely continuation patterns or resting
periods for the Market that result in a big move. The patterns serve to help
you discover Price Action as much as to provide opportunities to trade. Be
patient, make a plan, look at the Market, find a pattern and decide if it fits
your conditions for a trade.
You may have read or
heard about other patterns but I think you’ll find that all you need are a few
logical setups to find advantages. It will take some time to get these setups
down, but once you do, and once you are patient enough to let things develop to
your advantage, you will start to reap the rewards.
As we move through these lessons, I will share with you other tools that will help you fine tune entries into the formations we’ve covered in this lesson. For homework though, start looking through your own charts and try to identify different patterns. In time, you will be able to recognize how a day will go just by tracking the prior sessions. Then, you’ll be ready to ap