Trading What I See

It’s nice to end a trading example and have everything work so precisely. Not only did we hit and reverse at that 262% Fibonacci target I mentioned yesterday, but we did so at a logical time interval. Before I explain, a quick message.

I’ll won’t have computer access for a few days. Hope to be back online by Monday. In the meantime — Good Trading.

Lowell

The first chart today is just the completion of the patterns shown yesterday. As expected, we reversed right at the 262% Fibonacci extension, completing a nice A-B-C move. What I’ve added is a timing signal that I mentioned once before. In a triangle pattern, there is often a reversal just at the time that price reaches the apex of the triangle.

Like many other things I follow, I never trade this by itself, but as you can see in the example, Time and Target matched up exactly. Sometimes it is just a big bounce, and sometimes an actual reversal. Because of declining volume on today’s rise, I think this time it is probably just a bounce.

Since I won’t be commenting for several days, I’m including a Daily chart that shows some potential problems. You’ve just seen an example of the power of a 2B reversal. If you need a refresher, check this earlier post, or buy Trader Vic’s book from the link at the end of this post.

On the Daily we broke a well-established uptrend on February 27th. I’m sure you remember that day. We’ve spent the last two months trying to regain the earlier peak, and as soon as we did, the breakout failed. I prefer a cleaner top, but that certainly looks like a large scale Trader Vic 2B setup to me.

And the entire rise from the bottom in early March looks like a rising Wedge that broke down yesterday. If it is a wedge (and remember I don’t try to make predictions) the initial target could be around 760.

But the nice thing about day trading is that you can use these longer term patterns as general guidelines without becoming commited to any one direction. Do as I do and just trade what you see — one trade at a time.

Victor Sperandeo: Trader Vic - Methods of a Wall Street Master

You always wonder whether a long weekend will make a difference. Will Fibonacci calculations still work using the old data? Do you have to change your trading tactics?

Last week we had slow holiday trading. Then we had a day off for New Years. Yesterday there was a market closing for a state funeral. Today the market continued from where it left off as though there were no break at all.

Let’s start with a 15 minute chart to show some measurements. The gap this morning went up to the high of last Friday and couldn’t get any higher. Even on a 3 minute chart, no bar was able to close above that level (point B.) When we get to a shorter term chart you’ll even find a divergence there.

If you are not already doing it, always mark in the highs and lows of the last few days — most software packages will do this for you, but if not, draw them in by hand. Like Fib levels and trendlines, how the market acts at these levels is critical trading information. When the market couldn’t break that level and it corresponded to failure at the yellow down trendline, your trading bias should have switched to the short side.

Still working from last week’s data, the turn at point “C” happened at a logical set of Fibonacci measurements. The distance from “X” to “A” multiplied by 1.618 is exactly the distance from “B” to “C.” That’s called a Fibonacci extension, and the most common measurements are 0.618, 1.00, and 1.618.

And whenever price exceeds a previous pivot point (passing point “A”) you should measure external retracements — those are retracements over 100%. The most common is 127%, but if price doesn’t stop there it is likely to go to 162%. Point “C” just slightly exceeded a 162% Fibonacci retracement of the “A” to “B” distance.

Now let’s look at my trading chart - a 3 minute timeframe. At “X” you can see that there was no real breakout above Friday’s high (green line.) From there until just after lunch time (first blue arrow) it looked like we might just go sideways for the rest of the day.

But by 10:00 (Pacific time) my moving averages were starting to move downwards, and we were hitting a downtrend line drawn from “X” to “B”. Add to that a pullback to the blue declining moving average, and a short sale with a very close stop is possible. I like close stops, and will often use the blue (13 period) moving average as a trailing exit in case I’m wrong.

Two more pullbacks to the moving average (arrows) could be used for additional short trades, depending upon your trading style. All of them would have been profitable. The question is why I haven’t marked the last pullback (after “C”), which would have been a loser.

Here’s a Fibonacci measurement you won’t see talked about much, and it keeps me out of this kind of bad trade. When we’ve had a strong move, I’ll go back to the first pullback and draw a Fibonacci extension. A strong move will pass the normal reversal points (.0618, 1.0, 1.618, and 2.618) but it’s an unusual move that can get beyond the next level (4.236) without a good correction in the other direction.

Combining this with the 15 minute chart, point “C” is the target for three Fibonacci measurements - a good reason to quit chasing the downside for a while. It looks like a few days off didn’t affect the market’s memory at all.

Street Smarts: High Probability Short-Term Trading Strategies

This is a book full of short-term trading setups, and I think it should be in every trader’s library. Linda Raschke usually gets all the credit for this book, but Larry Connors was the co-author, and they take turns explaining some of their best short term trading techniques.

You’ve probably heard of Linda’s Holy Grail setup, and this is the book that made it famous. It is one of the most well-known (but not necessarlly well-traded) short term methods for playing pullbacks in very strong trends. Like all good trading setups, Linda gives you the exact settings for entry and exit, while using the Average Directional Movement indicator (ADX) to define the trend.

Like many of the strategies in the book, the Holy Grail (and most of the others) works on almost any market and in any time frame, whether you are a day trader or only look at charts on a weekly basis. The 25 chapters have over a dozen devoted to single techniques, with several that cover trade management and general market indicators. And as Linda points out in the introduction:

All you need is one pattern to make a living! Learn first to specialize in doing one thing well. We know two traders who do nothing but trade the “anti” pattern from a five-minute S&P chart.

That resonates with me, because one of my main entry techniques almost always triggers at the same time as an Anti pattern. The Anti is one way of defining a trend, and then trading pullbacks against it. The Holy Grail is a slightly longer term method of doing the same thing.

But a good trading toolkit will have more than just pullback patterns. Turtle Soup attempts to catch trend changes just as they happen. Momentum Pinball looks at the changes in direction in the three day market patterns identified in the Taylor Trading Technique. And Historical Volatility Meets Toby Crabel show one way to take advantage of the NR7 narrow range days.

Originally aimed at Swing traders, there are a number of the techniques that I use in my intraday trading from a three minute chart. Besides my version of the Anti, I’m constantly looking for Three Little Indians showing an exhaustion pattern with three symmetrical peaks. Or an 80-20 pattern that occurs at pivots.

And this is where I first ran across the Wolfe Wave pattern which, although I don’t trade it the way Bill Wolfe teaches, sometimes provides the overall structure giving definition to my own trades.

No matter what your trading style this is a book worth reading. You’ll probably find that you keep going back to it until certain sections become second nature, giving you a both a trading edge and a better understanding of the markets.

Although I try to avoid it, some days I get a directional mindset that would have me fighting the market throughout the session. Today was one of those days. Fortunately, I require more than a potential setup. Until I get an actual entry trigger, I patiently watch the market go against me without being in a trade. It’s a lot less stressful that way.

Some of my triggers require the moving averages to agree with the trade. Others require a Fibonacci pullback of at least a certain amount — or no more than a certain amount. A few require volume confirmations. After this morning’s drop, I got none of those.

We started with a gap-up opening, with little volume. I had no intention of entering here, because there was a 127% retracement level not too far away (red line.) I’ve had that marked on my 15 minute chart since shortly after the bottom was made yesterday. Remember that two of the common reversal points are 127% and 162% of previous moves. A gap into one of these measurements often means a false breakout.

And false it was. This is the Larry Williams Oops! pattern — a gap above the previous day’s high followed by a retracement into yesterday’s range. Larry says in Long-Term Secrets to Short-Term Trading that

It is the most reliable of all short-term patterns I have researched and traded.

You could have entered on the big blue bar as it crashed down through yesterday’s high (green line), or waited for the pullback a few bars later. Either way a nice short sale. That’s assuming you got out in time. Larry’s “official” trade is an overnight hold, so it would have turned into a loser today.

I always consider this just a day trade, and that 62% retracement is a logical place for a bounce. And that’s when I started thinking we would go down for the rest of the day. Look at that volume drop. We can’t have much of a rally on that kind of decreasing volume. We’re going to break through that yellow trendline and I’ll have another nice short.

Sure we will. As I’ve said before, when I’m fairly sure I know what is going to happen …. Which is why I have triggers. On this particular trade I need to see that trendline break. Or sit and watch the market. By the time I had decided the market had really turned, I wasn’t willing to go long. That’s one advantage of being a day trader. I get a new start tomorrow.

When you are day trading, anything you can do to make decisions easier or faster is to your advantage. Even when swing trading, as you scan through chart after chart, being able to interpret the information quickly allows you to be more productive.

I received a question the other day about my colorful charts, since most candlesticks have one color for bars that close higher than the open and another color for the reverse. I’ll be away from my trading desk today, and since I’m able to schedule posts that appear at a later time, we’ll take a look at Dunnigan Bars.

William Dunnigan was a market newsletter writer in the 1950’s, and spent much time searching for a mechanical system for trading stocks and commodities. For mechanical trading you must carefully define everything, and for Dunnigan “everything” included different types of bars. In his book One-Way Formula for Trading in Stocks & Commodities he talked about Inside, Outside, Up, and Down bars (but only used the last two for his One-Way system.)

Although I’ve coded my own color bars in programs like Metastock, QuoteTracker, and Ensign, someone saved me the trouble in eSignal by writing an EFS (script) appropriately named Dunnigan_Bars. I just modified the colors to make it easier to read on my black backgrounds.

A green bar has both a higher high and a higher low. A red bar is the reverse, with a lower high and a lower low. These are what Dunnigan used in his system. But I’m at least as interested in the other types.

The magenta bar is an inside bar. Notice how it points out the small pullback in this nice downmove. Sometimes that’s the only opportunity for a pullback entry in a fast, sustained move. And the blue outside bars often appear at reversal points, where they turn blue just as the bar starts in the opposite direction.

If you use exceeding the previous bar’s extreme for an entry (as I sometimes do), you can tell the instant it happens without looking at the price scale. The bar will change color, often from magenta to red (or green) as in this downmove.

Like candlesticks, they don’t actually add information to the chart, but they make it tremendously easier to see what is there. You’ll see them on most of my posts.

I saw a nice entry early this morning based on yesterday’s market action. Linda Raschke calls it Three Little Indians, but my setup also requires a DIVERGENCE on the last peak and there wasn’t one on my 3-minute chart. But looking over at the 15-minute timeframe, there was the divergence I wanted.

So I entered the trade. From the 3-minute chart. And was stopped out. Oh well, sometimes a good trade takes a second entry. And sometimes the second entry gets stopped out too.

My trading plan doesn’t call for third entries, so I watched as the market moved down to my target. The losing trade doesn’t bother me nearly as much as having made a basic mistake — mixing up time frames.

Knowing what is happening on a time frame above and below your trading chart is important, but each time period has it’s own patterns. The longer the interval, the farther away the stop will be. This trade worked if taken on a 15-minute chart, but it would required a 3 1/2 point stop, which is more than I will accept while daytrading. But that doesn’t mean I can move the setup to a shorter period just to get a closer stop. And I know that.

Alan Farley, in his excellent book The Master Swing Trader, calls this a Trend Relativity error. “They see their trades in one time frame but execute them in another. This trend relativity error often forces a new position just as the short-term swing turns sharply against the entry.” Sure did, Alan.