Trading What I See

Evidently the 127% external retracement was the correct turning point from yesterday’s close. But remember, there were too many other potential reversal levels. If that had happened intraday it was only a trade to consider with extreme caution.

After a gap and a 50% retracement, the market completed a small A-B-C (red) for a Measured Move. The next three hours created a sideways pattern that eventually turned into a rectangle. Although it takes four touches (two on each side) to confirm a rectangle, each touch of the top was on less volume. That’s a strong hint that a consolidation pattern is forming, and a rectangle was a likely possibility starting just after 9:30 (Pacific time.)

Rectangles can go on for a long time, but remember the importance of forgotten trendlines or trendlines drawn from the first small pullback. At the second bottom marked “B” price bounces from that trendline and then makes a volume breakout from the rectangle. The market didn’t even slow down at the rectangle target (width of the pattern), but went to the 100% Measured Move of the larger formation to make the high of the day.

There were three close targets for the high — the yellow parallel (not quite hit), yesterday’s high (green line) and the C=100% blue target. Unlike yesterday’s close, two of the three were exact hits, and the third was close. Certainly a point for partial profits if not a complete exit.

Take a look at the earliest pivot marked “B.” That was certainly a potential entry, and although it’s hard to call it a successful trade, it shouldn’t have been a loser. I’m often an impatient trader, and my exit would have been during the sideways action in the center of the rectangle.

If you had more patience, the false break to a new high should have been an exit. Compare that action to the Spring pattern that often appears on my charts. A break to a new high for any move must have a volume increase to be trustworthy. Any reversal after a low volume breakout should be considered as a potential exit signal.

I’ll be on the road all day tomorrow, so there is the possibility I won’t manage a post in the evening. If not, I should be back on Friday. Good Trading.
Lowell

The market has had plenty of opportunity to move higher over the last few days, but the Russell just couldn’t seem to build up any momentum after its breakout last Friday.

This morning gave an opportunity for an early short entry when it set up a nice divergence at the open. However, after the lack of carry through over the last week, I was perhaps too cautious and just watched for the first three hours. Until 9:30 it looked like we would just stay inside yesterday’s range.

The break below yesterday’s low produced a volume spike, and the next four bars tried unsuccessfully to pull back on low volume. I will only take a breakout to a new high or low under specific conditions, usually after a pullback to support or resistance. That allows a close stop on the other side of that level, and that’s what we got during the lunch hour.

Once in the trade, the only question was where to exit. I try to hold more that a single contract so that I can exit part at the first indication of a reversal. But what I am always hoping for is a move like we had this afternoon.

I’ve marked the likely turning points of an A-B-C pattern in yellow — 100%, 162%, and 282% of the distance from this morning’s high to point “A.” Each time we reached one of those Fibonacci levels there was no hesitation, and therefore no reason to exit.

After passing the 162% level it was time to use the faster moving average (13ma) as a trailing stop for half the position. The actual double bottom gave a nice divergence for a final exit. It turned out to be a nice finish to a very boring week.

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.

When we tried to break out this morning, there was no volume behind the move on the 3 minute chart. It looks OK on this 15 minute (shown), but in real time there was only a slight increase over late yesterday afternoon. The breakout lasted less than five minutes, and we were on the way back down. Repeat after me — upside breakouts require volume increases if you want consistent results.

At 7:30 (Pacific) we made a double bottom against a low formed yesterday. When we moved back up, that completed the fourth point of a rectangle pattern. It’s easy to overlook on a shorter timeframe. That’s why I always keep a 15 minute chart visible, although I seldom use it to take trades.

Even before the rectangle pattern formed we had tradable information. Point #2, just after the open, was a Test of Top. The first test of a previous high will often fail. Alan Farley, in his book The Master Swing Trader (highly recommended) talks about this situation when writing of his 3rd Watch pattern.

Use 3rd watch strategy to trade triple-top breakouts. …. Both ascending triangles and rectangle formations rely on the same price mechanics. Channel resistance often breaks on the third high as momentum triggers bar expansion.

On any timeframe when you have Tests of Top, consider having a reversal bias on the first test (#2), and a breakout bias on the second (#3.) You’ll find you are often leaning in the right direction.

We’ve already exceeded the minimum target for a rectangle with only a slight pause before moving on. Tomorrow we’ll see what happens when (make that if) we reach the top of a parallel channel.

This morning I was sure I had identified a TRIANGLE pattern that immediately broke to the downside. Fortunately I require more for an entry signal. Sometimes the lack of a trigger is the only thing that saves me from a bad trade - prices quickly reversed back up through the “triangle.”

After what looks like a nice volume breakout, prices reversed again, back into yesterday’s ending consolidation pattern. At 8:30 came the only entry signal of the day. But it’s Friday. And it’s late August. And my longer moving average is flat rather than down. Pass on that.

That’s when I drew the two orange support/resistance lines on the chart, and decided I wouldn’t trade until they were broken. That only happened during the last hour of trading, and if you’ll notice by the volume decrease, everyone had gone home. Guess it’s weekend already.