Impatience

A key requirement to be a successful trader is patience. Even very experienced traders will admit that their trading would improve if they work on their patience.

New traders are impatient and and long to be in a trade and until they take a position tend to see every tick as loss of opportunity. Once they are in, they are very impatient and want the trade to work right away and take them to profit. The moment they are out of a trade whether due to hitting a target or being stopped out, they want to be in again. Therefore, impatience makes traders overtrade.

Impatience, combined with greed and fear will force traders to have impaired judgement and results in inconsistent performance. Its very unlikely that a trader who is entering and exiting a trade every two or three bars to have a high success rate. Even a high success rate can be neutralized by a couple of poor trades if you focus only on small moves.

Patience for a trader, is being able to do nothing for hours while waiting for a proven setup o form and when it does appear, to act on quickly. After entry the trader should not exit as long as the stop is not taken out unless a setup in the opposite direction sets up and is triggered. The trade should terminate either by reaching a target or being stopped out. Patience and confidence in the setup will enable you to take larger profits.

Impatience is addressed by focusing on large moves. Looking for a large swing move will check your impulse to be in a trade since there are a small number of large moves in a trading day. Holding at least a small portion for a swing will also satisfy your need to be part of a move without having to re-enter every few bars.

Fear

Being stopped out several times will wreck your confidence and the trader may turn into a victim of fear. Fear is always an immediate emotion and will paralyze you and prevent you from entering viable setups.  Often very good setups will move immediately after triggering and your hesitation will cause you to miss out. Fear will make you miss out on many solid trades.

Since good setups will often give a strong entry bar and the entry bar usually grows very quickly after the trade is triggered, you may curse yourself and enter mid-bar, a few ticks or a point above your ideal entry. This also means your risk is now larger by a point or so. This means fear forces you to enter on a large risk.

With a few exceptions a slight pullback after an entry trigger is a normal event and mid-bar entry may cause your stop to be taken out. A trader stricken with fear is unlikely to loosen the stop or add-on (unlike the greed stricken trader) but would probably reverse at the stop. Fear will cause you to be pushed around by every pullback and strong move the market makes.

Reversing every two or three bars will destroy any confidence you still have left in your ability to read market direction and you will get chopped up. Unlike the greedy trader who's account is killed by few large losses, the fearful trader's account dies by a thousand small cuts. If you are fear stricken, you should never reverse a position.

A loss for a fearful trader puts him "on tilt" and he is likely to make more mistakes if he continues to trade for the rest of the day. Fear is rather hard to overcome and the only way out is to realize that every setup has a certain percentage of wins and the remainder are bound to be losses. Some losses will be clustered close enough that it will appear that you have lost your ability to trade that setup. The best approach is to stop trading for a certain number of bars after a loss and stop trading after a certain number of losing trades for the rest of the day. The knowledge that your losses are limited per day in the worst case is a stabilizing force on your psyche.

"Be greedy when others are fearful" is easy to say but impossible to practice since you are the fearful one. The antidote to fear is risk management. Once you understand and accept the maximum losses per trade and per day, you already know how much you will lose in the worst case for any given period of time. If this is something you have already accepted as the cost of trading or learning to trade, fear will be much more manageable.

Greed

Traders should not be ashamed to admit that greed is probably what motivated a lot of us to get into trading. After all, there is the promise of easy money or rather, lots of easy money that we can gain by trading. Greed may be good, but it will force the trader to make many mistakes.

One of the worst mistakes a trader can make is entering on a poor setup because "this could take off from here". You are afraid to be left out. This brings us to our first realization: Greed is just fear thats not immediate.

However, when you do get in on the poor setup, either because the signal bar was poor or because the pullback was too shallow or any other reason, you probably entered at a poor price point and a possible pullback will take out your stop unless you use a wide stop. From this we infer: Greed forces us to enter on a large risk

Often, even a large stop could be hit and you may resort to loosening your stop, which of course can still be hit so you end up taking a stop much larger than your profit expectation. A stop placement on entry is a statement that if the entry is correct, the price should never touch the stop. If you loosen stops habitually, you are not really trading with stops. Therefore, Greed forces us to disregard our stops

Some traders when faced with a wide stop will add on at the worse price so that they have a better chance of breaking even and a tighter net stop. This means that Greed forces us to throw good money after bad.

Ideally, you want to be very choosy about where you enter and understand that success lies in consistency (steady, higher percentage of wins) rather than depending on any one trade "taking off". The key to this is to take strong bars on deep pullbacks or at the ends of a trading range. However, if you do enter on a poor bar and it does not take off, remember that the first loss is the best loss. Take your loss and wait for the next setup. Refusing to accept being wrong and replaying the losing scenarios described above is the quickest way to a blown account.

"Be fearful when others are greedy" is a simplification. Fear is equally unproductive. The correct antidote to greed is caution. When you feel an urgency to enter, do not enter unless the signal is good and risk is acceptable.  Do not fret about letting a big mover pass you by. There is always another trade with a better signal in the very near future. Once you enter, let the trade fail if it needs to. You will never know what trades you are capable of reading and entering correctly if you don't let the market stop you out.

Vacation

I'm on vacation till Jan 2012. I will continue to post articles regarding market psychology and trade management instead of the daily market commentary.

Meanwhile, this is a good opportunity for both me and my readers to revisit various posts in the blog.

Double Wedge

A double wedge is simply two wedges that terminate at the same bar. In the chart above, it may be argued that there are two wedges W 6,24,52 and W 34,39,52 or other variant. A double wedge can lead to a large move (b63-b81).

For a double wedge to form, a pullback from a recent swing point (b24) needs to be deep enough that the next leg is likely to need multiple pushes to take out. A strong deep move (b24-33) consisting of CT bars may also demonstrate counter-trend strength that will encourage with-trend traders to exit and counter-trend traders to enter beyond the swing point (above b24).

Reversal bars

Reversal bars often signal reversals, regardless of where they are. A well placed reversal bar (b6) can signal the end of a move (b1-b6) but so can an incorrectly placed reversal bar such as b15 signaling the end of the prior move (b10-b15).

A reversal bar followed by a reversal bar in the opposite direction (b15,16 and b32,33) is usually a very strong signal, especially if the second reversal bar can be viewed as a 1PB in a new trend move, i.e. its the first pullback after a possible reversal.

Similarly, reversal bar failures are very strong with-trend signals. Often after a recent possible reversal, the failure of a reversal bar can often be used as an entry. You could enter long on a stop above b32 (for example if you did not already get a buy signal at b33)

A reversal bar of the wrong color such as b39 are usually traps and if the trend has been strong, may be traded as a continuation signal.

Small reversal bars (compared to prior bar or recent bars) are subject to failure such as b68 and you should only take second entries. The only exception is when the tail is at least as long as the body and you have additional signs of strength in the direction of the signal.

The first two legged pullback

On many days, the open may constitute an opening range made up of erratic moves (b1-25) that finally break into a trend (b26-b38). Some traders may get repeatedly stopped out on the initial range and their later trades will barely make up for their initial loss.

The trick to avoiding being chopped up on the opening TR is to wait for a trend attempt and take a clear pullback on a strong signal bar. This is essentially the philosophy of the 1PB trade.

Determining if a leg is a trend attempt is a bit tricky. Any two or three trend bars are a possible trend attempt. One bar does not usually make a trend (unless its very large). Once a trend is attempted, it will either reverse and a new trend is attempted in the opposite direction or a pullback gives a possible continuation of the orignal leg. A strong reversal attempt is 1Rev. A pullback is 1PB.

Today, there was a trend attempt from b3 to b5 and a weak reversal attempt on b5. Then possibly a second trend attempt from b6 to b9. Note that this bar is made up of weaker bars and is unlikely to succeed, especially in the absence of prior bull strength.

b16 represents the first two legged pullback of the day and is a possible 1PB long entry of the long trend attempt. However, the signal bar was a doji and the reversal was fairly weak. However, this is still a viable long entry. When the long entry failed to take out the old high, it turned into a first 2 legged LH, turning into a 1PB short at b20 of the original short trend attempt.

Another way to read this is that b2 and b9 represent two failed attempts to close the gap leading to a bear trend. Even though many traders may have correctly read b9 as a possible 1PB short, waiting for a strong signal bar (b26) is usually the right thing to do for a profitable entry. This is because shorting below a bull bar is always subject to failure, regardless of the correct read of the market direction, especially on a choppy open.

Two strikes

A decent win rate and a favorable win size/loss size ratio is the key to accumulating profits. A trader with poor win rate is likely to have extremely high number of trades. For one, the moment he is stopped out, he looks to getting in right away and often operates in an emotionally distressed state and is bound to compound mistakes. Ironically, the more he trades, the worse his performance is likely to get.

There are some steps a trader needs to take in order to avoid falling into this very common trap. The first is that a trader should look for major turns in direction and on a given day there are unlikely to be more than five.  So the question a trader should ask himself is not if he thinks the market will go up over the next bar or two, but if its a major change in direction.

The ability to locate these turns require a trader to trade less than he normally would. A trader who trades with-trend off a non-overlapping signal bar with a strong close near the ema or trendline is likely to be at least 50% successful. So if your success rate is under 50%, the first thing to do is to trade nothing else.

The next thing you can do is to adopt a "two strikes" policy. If you lose two trades, you are done for the day. You should also be done for the day if you took five trades total. In the beginning, you may end up finishing your quota in the first half hour after open, but with over time, you will be able to stake out longer and be able to focus on large moves.

The chart above is meant to be illustrative but shows how a two strikes policy would work with a -1.5 stop and a +2 target. As seen from the chart above, there is a very good chance you will be stopped at two trades on a large number of days and conversely on some rare occasions, you may get four or five wins. Nearly half the time, it expects a loss on the first trade and nearly three out of four times, a loss on either the first or second trade.

Even so, there is an expected value (EV) of about a point accumulating per day. The loss policy above can be abbreviated as 2/5 (two losses out of five maximum). You can try other variations such as 3/6 or multiple contracts and targets or anything else that's suitable to your trading style. Note that positive expected value is a side effect and the main goal here is to improve your ability to consistently take good trades and focus on major moves. Note that on many days, there may be only three or four trades, so don't be surprised if you take in less than the EV.

Note that the -1.5 stop is tuned for my proven setups. Other setups may need a wider stop but your stop should not be larger than your target. A wider stop is likely to negatively impact your EV, so trades with wider stops should have a very large EV (such as 1PB or W1P).

Trend termination (TT)

Recognizing a potential trend is generally easy on a day like this: A large gap followed by two or three bars that close in the direction of the gap is a very strong trend attempt and taking the 1PB (b5) and holding it to swing termination or reversal is an easy decision.

Not all trends reverse and many of them simply terminate into a trading range. Determining the end of a trend requires some experience. There are primarily three ways a trend can terminate and today, we were lucky to have all three.

The first is a TTR made up of small overlapping bars made of mostly dojis. Given this criteria, we should already know around b22 that the trend has terminated.

The second is an extended trendline break. A move beyond the trendline for many bars and many points is a trendline break. The more number of bars it stays beyond the trendline, the fewer the points that need to be beyond the trendline to constitute a break. This means that a single bar thats sufficiently large can break the trend or a large horizontal or slightly sloping movement for about 20 bars (b21-39) can break the trendline without dipping too far below it.

The last is a failed reversal followed by a failed continuation. b22 was a poorly formed W and FF that was followed by a WP at b39 which was unable to take out the reversal bar.


Once you realize the trend has terminated, you should no longer be looking for with trend trades. Your best option is to wait for a new trend to break and enter on its first pullback. If the trading range following the TT is small, its best not to enter into anymore trades at all.  If the trading range is wide (8+ points), you can consider fading the extremes of the new trading range. Note that in general, you should cannot expect any entry in a trading range to make a large move. In general, you should expect a move that's roughly half the size of the trading range.

Fire and forget

One of the reasons traders overtrade is that their sense of market direction is focused on the small movements. A second reason is that they become distressed and doubt their own entries as soon as the market moves against them. They may often reverse their positions with every bar or every other bar.

The right thing to do is to make a note of the kind of setup and let the market take you out. If your trade fails, it will take you out by hitting your stop and if its successful, it will take you out by reaching your targets. This will give you an accurate measure of what kind of entries you have mastered and what you need to work on.

If you are a trader who focuses on swing entries only, you have the luxury of having a very small stop (of say -1.5 points on the ES). For example on today's chart, short below b1 required a 7t stop but entires on bars b4 (1PB), b17 (W), b47 (fBO) needed very small stops. These setups are usually the ones that run for a large number of points, so do not be upset if your stop is taken out; it means a larger stop would have probably been taken out in any case. 1Rev and 1PB may need larger stops, but -2 points usually suffice.

Most trading platforms support OCO orders where you can set stops and targets to cancel each other. Once you set an order forget about it and wait for the next setup. If the next setup is in the opposite direction to the position you are in, close out your position and enter a new order.

This way, you stop focusing on profit and loss and focus on bars instead.

Fewer, better trades.

One of the biggest errors for new traders is overtrading. Overtrading will eat away at your profitable trades and overall prevent you from being consistent. One of the first goals of a trader should be to reduce the number of trades taken per day to about five. Think about this: How many major directional changes do you expect in a day?

Reduction in the number of trades allows you to focus on larger moves instead of flip-flopping on every other bar. If you are a new trader, this will also help in limiting your losses.

The first step you need to take is to eliminate limit entries. There are some legitimate limit entries in price action trading, but trying to save two ticks should not be one of them. The skill level of market reading necessary to be able to consistently win at limit entries is very high and I am not too proud to admit that I'm not there yet. If you want to trade limits, remember that you should be entering only on bar closes and not where you fantasize the price may turn mid-bar.

The second step you need to take is to only enter on signal bars with a strong close and little overlap. The only exception to this is a 1Rev at ema, 1PB and any with-trend entry on a soft-trend day. If your strong signal bar does not trigger, let it go. Even if it gives a strong inside bar with an equally strong close, at this point its in overlap. The only exception to this rule is a FF after a large move.

The last step is to only trade proven setups such as A2, W1P and so on. "I think this will move up now" is not a proven trade. You may have noticed patterns that look reliable but they may not be tradable for various reasons. You should first attempt to trade them on SIM and then try with small size about 100 times before you can add them to your proven list.

Failed continuations confirm reversals

When a possible reversal pattern has triggered such as b23,24 2 bar reversal on the third push down but the original trend is still unbroken (because a trendline has not been broken), a continuation needs to fail before you can trade in the direction of the new trend.

A 2 legged move after a wedge move such as b29 is often a very good continuation signal and should be taken since it often leads to a move of similar magnitude. If this move fails as it did when b31 took out b29, you should look for setups in the new direction only.

So for example, while b39 worked today, on days when bars are smaller it is likely to fail. The correct trade would be to buy the A2 above b46 in the direction of the new trend and swing it.

Three push legs

Three pushes with small pullbacks between them as in b8,15,18 or b57,60,69 may act like a poor Wedge. This wedge will basically act as a single leg and is likely to give a pullback and then resume the original move, taking out the prior leg extreme.

For example, the three push leg down to b18 gave another leg down to b24 before giving a two legged move to ema, as did the leg up to b69.

A three push leg to ema or other barrier may give rise to a deep pullback or even reversal, especially at the beginning of the day. On the other hand a three push leg in the direction of the ema slope may give a pullback thats stopped at the ema as it did today.

Trading such a leg is simple. If the leg stopped at a barrier, take the reversal if the signal is decent. If not, wait for a pullback and continuation for at least another leg.

2 Failures to close gap

On many days when the market opens with a reasonable sized gap (4+ points), the market will try to close the gap twice. If it fails on both attempts, there is a high probability of a strong trend in the direction of the gap before the market tries to move against the gap.

The larger the gap, the larger the trend move before any attempted reversal.

Today opened with a reasonable gap and a doji bar b1 with a close near the low of the bar, which is a poor signal for a long and was likely to fail. The second signal was another doji but with a higher close and was also a failure. The presentation of poor counter-trend signal bars is a strong indication of continuation of the trend.

Two failures led to the market breaking into a trend and extending the gap all the way to bar 14. On the way, a fH1 at b9 marked a precise exit near the low of b14.

Video of trade available on youtube

Choosing Scalp and Swing entries

The first hour of the day is likely to produce the high or low of the day and trades made then are most suitable for swinging. Occasionally, the AM fails to produce any trend moves and on such days, there may be a PM trend but normally the higher likelihood is the AM trend.

A 1PB is the best option for an AM swing trade, but on some days such as today, the 1Rev is the clearest swing entry. If the early trend move results in a strong reversal, you should always swing the 1Rev entry.

If you miss the 1Rev and the 1PB, you should then look for the first deep pullback such as b20 today. Its a terrible signal (an overlapped doji), so its alright to skip it.

The first 2 legged pullback such as b31 or b39 often provide a decent late entry into the trend, even though it may look like you are buying the top at that point. Lunch hours in particular are dangerous and many traders will correctly trade smaller volume or take only scalps.

Shallow pullbacks are invariably scalp setups since your swing stops are likely to be taken out during the next pullback. A deeper pullback is more likely to have a strong entry bar, causing the next pullback to miss your breakeven stop.

As the time left in the trading day diminishes, so do the options for a swing move. Unless you are in a late hard trend, you should be satisfied with modest profits. This is especially true for trends that broke early in the day since they should be expected to show some volatility due to profit taking.

Trading range day as a series of fBO

Since most days are trading range days, the trader needs to have a realistic expectation of what happens once the market takes out the high or low of the day or a significant swing point. Usually, the breakout is expected to fail, but the precise entry point to trade the failed breakout should be determined after two failed attempts to continue in the direction of the breakout.

For example, the strong breakout above HOD on b16 stalled and the market failed to continue twice (b20,b22) in a horizontal flag that effectively acts as a final flag. At this point, it should be clear that the market will attempt to re-test the low and you should no longer look for long trades.

The break below LOD on b43 was on a large bar, but the second attempt to continue the selling failed giving a double bottom at b47,55. At this point, until the DB is taken out, the market is expected to test the high once again.

Trading range days may be viewed as a series of failed attempts to generate a trend after breaking to a new high or low. Naturally, a two or three legged approach to the high or low without breaking out can also be treated as a fBO.

Occasionally, the breakout will give a successful BP, which can lead to a trend, especially after a DP on the other end.

Buying below and selling above overlaps on a TR day.

Trading strong trend days is not necessarily easy but certainly simple. You can basically take every reasonable with-trend entry and chances of success are high unless you are near the end of the trend. On a trading range day, things become much more uncertain and swing entries will be stopped out all the time.

A simple heuristic to deal with trading range days is to buy below overlaps and sell above them. For our purposes, an overlap is any trading range bar such as the outside bar b7, any bars that overlap such as b54,55 or any horizontal range such as b69-72. The only restriction is that the overlap be large enough for a scalp profit, say 4 points. A trend bar such as b48 should not be faded in this manner since there is a very good chance it could turn into a spike and channel or otherwise turn into a BP.

Once the overlap is in place, resolve to sell above it and buy below it. On a trading range day, there is a very good chance of a failure of any breakout beyond these overlaps and a very good chance it will at least take out the other end of the overlap.

Conversely, an overlap whose breakout fails and successfully takes out the other end on a trend day such as the BO above b7 which consequently took out b7 low, transforms the day into a trading range day and you should only trade at the ends of the range.