Trading What I See

The last few bars yesterday broke out of a rectangle, but without any convincing volume. Remember that the most consistent pattern breakouts require volume to the upside and, although volume on down breaks is nice, it is not required.

Today’s first bar opened above the rectangle, but during the first three minutes shot down to tag the bottom of the pattern again, and then reversed back above it. Since the rectangle was only 1.8 points wide I wasn’t paying too much attention.

Rectangles have a minimum target of equaling their height after breakout, and in the Russell 2000, two points is the smallest size I will usually consider for a trade. It turned into a nice rally as I watched.

The pullback to point #1 is a type of trade I look for — a strong rally with a small pullback to the short moving average, in this case a Fibonacci 38%. The strength of the rally can override my normal expectation of a larger first pullback. Except there was one problem.

Because the market ran away from me, I was watching some other markets as I waited for the pullback. At point #1 both the SOX and the NQ were trading at yesterday’s lows. Maybe today the Russell is going to lead everything higher, but as a discretionary trader I don’t have to take every setup.

Often a correction will make a down-up-down pattern before completing, and at point #2 that’s what it looked like. If I can find another reason I will look for an entry trigger there. But wait! Now the ES and the YM futures have hit yesterday’s lows. The Russell is all by itself, oscillating around yesterday’s high. Something seems wrong here.

I have a rectangle marked through this topping area, but I couldn’t draw the lower boundary until after point #3. That was the release of the Philadelphia Federal Reserve report, showing the biggest drop in manufacturing activity in over three years. For my trading, all I care about is the time of the reports. It is the market’s reaction to reports that makes a difference, not whether they are good or bad.

Before the breakdown occurred, I decided that it looked like a valid rectangle (2.6 points wide), and both my moving averages had turned down so I considered point #4 a valid entry. After a hesitation at yesterday’s close (dashed blue line) we dropped through the rectangle target without a pause (yellow arrow.)

If you exited at the 2.618 Fibonacci measurement (taken from the top and bottom of the rectangle), point #5 could be another entry. It’s a low volume pullback to the fast moving average as the averages are pulling farther apart.

Has you noticed how flat the trading has been in the late afternoons? Six of the last nine days have ended with a long sideways move. I’m becoming very cautious about trades over the last several hours. Of course, now that I’ve written about it, it’s bound to change.