Analysis of a Trade
Occasionally there is a situation where trade setups could be taken in either direction, and your decision can make the difference between a winning or losing day. Let me walk you through my thinking process for this morning’s action.
We ended yesterday’s trading inside a well-formed rectangle, and this morning’s first bar made a breakout move. I’ve shown in yellow the rectangle, and the upside price target that it created.
It seemed like everything except the Russell 2000 was making a big rally, but one item kept me from taking any long entry. It was the rectangle target. It wasn’t that we were too close — we had already traded right to that price. It just happened before the “open.” (Trading on the Russell e-mini futures only stops for a 15 minute maintenance period on weekdays, and on Monday morning it opens an hour before stocks.)
Often this “overnight” trading will provide important support and resistance areas, and I wanted to see that one broken before looking for an entry. But it never happened.
By 8:00 (Pacific) we had not only moved back into the rectangle, but we broke to the downside on an increase in volume. As we bounced off the 127% retracement level there were two potential trades. If we moved back up through the resistance created by the rectangle bottom, it would form a Wyckoff “Spring” (see yesterday’s post.) But it could also be stopped by that resistance and continue downward. Decision Time!
First the trade I didn’t take. I consider entries on three types of reversal trades; strong divergences, Trader Vic 2B SETUPS, and Springs. The last two are similar in that they occur just after a breakout. For my entry I use a technique that Teresa Lo used to teach — wait until price exceeds the bar that actually created the breakout. I’ve marked that with a blue arrow.
It came within a tick, but never hit my entry order. I had actually put in two entry orders by this time, the other one for a short sale if resistance held. I don’t necessarily recommend this procedure, and in fact seldom use it myself since it’s possible to end up with losing trades in both directions.
But remember this morning’s context. There were probably a lot of traders that had entered on that failing rally that I ignored. If they had to exit their positions, those disappointed traders would give an extra push to the downside. Like we got for the rest of the day.
My entry stop for the short sale was hit as we pulled away from the blue moving average. When we hit the 162% retracement level I took profits on half of my position and moved my trailing stop to above the blue moving average on the rest. Since this 162% Fibonacci retracement matched Thursday’s low, I really expected us to turn back up, but there were no divergences, and both moving averages were showing a strong downward bias.
As you can see, the trailing stop was much more profitable than an exit at that point. That’s why I try to run a wider stop after I’ve taken my first profits on a move.
The chart, so I could show detail, only has part of the trading day. After overrunning the 262% level a bit, we went more or less sideways for several hours, and then continued our downward course. Where did we stop? What Fibonacci level comes after 2.618? The next Fib is 4.236. And that is precisely where we reversed today.
