Getting shaken out II - Poor setup bar.

Often in the heat of the moment or out of boredom or desperation or a fear of missing out, you may end up entering on a less than ideal setup. This happens to the best traders and I'm not sure if there is ever a cure for it. Although these trades may eventually work, you may have to sit through a multi-bar pullback. The more pullback bars you have to sit through, the greater the chances you will get shaken out of the trade.

A great example is b29. Its an inside bar after a very strong leg off a W. You may buy above it expecting a large breakout bar, but right after entry it turns into a bearish outside doji bar. Such an entry bar is extremely demoralizing and the trader will begin to see everything that's possibly wrong with the setup bar. It was a 3t doji bar with one body at ema. The entry bar gave a double top with the prior swing high. A second L could turn into an A2 short, etc. The likely result is that the trader will exit at a small loss and the price immediately starts moving up.

A second example is buying above b46 (instead of b47). Given that b46 is a bear bar, an H2 above it is highly likely to result in a pullback. The trader may start seeing similar arguments as to why the entry was incorrect and exit at breakeven or strong loss just before price starts moving. Technically, both entries worked. b28 low and b46 lows were respected. But 6t stops were hit. When signal bars are larger, larger fixed stops are also likely to be hit.

Note that waiting for a strong bar (b33, b47) would have prevented poor entries. A strong bar such as b47 often will insulate you from poor entries since sellers are likely to sell the close of that bar, preventing it from triggering. A poor entry will often give a second entry (b49 with b46) that will often have a better close or lower risk. Those should help you avoid being shaken out.

In general, only taking setups where you are likely to get a strong entry bar is the only way to avoid getting shaken out. These include A2, G2, W1P and 1PB.

Getting shaken out Part I - Large risk.

Large setup bars often have large pullbacks after entry or outright failure. The reason for this is simple. When the risk is large, risk management rules prevent many professional traders from entering on the breakout of that bar. (News related activity is a notable exception). The knowledge that large bars are unlikely to be successful setups also encourages faders to fade a large bar causing large bars to often act as trading ranges.

Limit traders often buy a pullback after a breakout and often on a smaller timeframe the pullback may be two or three legged. This will often cause a breakout pullback of a large bar to succeed.

Regardless of the profit potential, if the theoretical risk of a trade is large, a trader is likely to be very distressed if the market begins to pullback right after entry. This is very natural and its your body warning you that this is possibly a poor trade based on prior experiences.

If you have traded large bars and lost a few times, your body will learn to be alarmed when you place the trade when your greed tells you to do so. This is because risk causes stress and large risk causes large stress. When the pullback nears your physical tolerance but not your wide stop, you may despair and get out because you cannot take it anymore. Often, the market will take you out by a tick or two and turn right around. The lesson from this is that stops larger than what your physiology permit are probably useless and moreover, counter-productive.

The simple lesson from this is to not take trades where the signal bar is large. Another possible resolution is to use fixed stops for all your trades. If you only use 6t stops, your body will get comfortable with the risk and let your mind focus on high probability setups.

Breaks of Steep trends

When a trend is very steep such as the move from b5 to b23, the entire move acts like one leg and often act like a spike and channel with the channel acting like a second leg to the spike. Typically, most of the momentum is exhausted at the spike, causing the channel to be comparatively shallow in slope.

Since the channel is a W, you should expect 3 higher pushes and then a test of the channel start (b35 low) which could occur in the next day.

Since the channel is a weak trend, if its wide enough to trade, you can still take A2 and other deep 2 legged pullbacks until the third push is complete.

Donations

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If the situation does not change, I am considering working on this site less frequently and divert my time to other projects.

Choice of trading instrument: Is thinner better?

A highly liquid instrument such as ES can form tiny bars and give weak moves. A thinner instrument such as TF (shown left) usually shows clearly formed bars and often results in strong moves. So what should a new trader trade?

An experienced and profitable trader can probably trade any instrument with some adjustments to his technique. Some momentum type trading also works better on thinner instruments.

For a new price action trader, the correct answer is the more liquid instrument. Why? For many reasons, but mainly because while the bars look great on a thinner instrument, the information they carry is unreliable.

Take b5 today. It was a doji on ES but It was a nice strong bull bar on TF. At first glance it may look like a 2 legged move to the ema or otherwise a sign of strength. The bar triggered and stopped out buyers. On the other hand b5 was a doji on ES and more important, it did not trigger. Shorts below b4 did not get their stops taken out. Pullbacks after entry are of acceptable size.

Stops on thinner instrument need to be larger and unless you are capable of consistently taking targets larger than your stop, you should avoid trading thin instruments.

A new trader should not focus on making money but on doing the right thing and trading correctly. Once your percentage of wins is high, you can simply trade larger size to make the same amount of money that a thinner instrument would provide.

Once your size increases, (a good problem to have) you may not be able to trade thin instruments without significant slippage. That said, a thinner instrument with a small tick size such as NQ is often a good choice for new traders.

When reversal bars don't trigger - II

One of the surest signs of a strong trend is that reversal signals will have no takers. This is because traders find the bear close to be a buying opportunity and in most cases, you should cancel an order if it does not trigger from the signal bar.

For example b36,37 was a possible sell signal after 3 pushes up, However, since it did not trigger, you should consider going long instead. This would allow you to buy above b41, a strong close after two legs down in a strong trend.

Similarly b62 was a possible 1tf after a shallow TL break making it a major reversal candidate. But since it did not trigger, you should not go short. However, due to the trend break, you should not look to go long either.

The right course of action is to wait till the range is 4 points or larger and then trade fBOs or wait for a BP or other new trend.

Trigger happy

The English have two qualities that I admire: caution and courage

                                                              --Napolean

Caution without courage is timidity. Courage without caution is foolhardiness. A trader needs to develop caution tempered with courage to protect from being swayed by emotions.

The opposite of the trader who fears getting into any trade is the trader who gets into every possible trade. The truth is, the over-trader is simply scared of missing a big move, which he thinks will happen "anytime now". Fortunately, this mistake is rectified very quickly as soon as the trader blows his fifth or sixth account. But by then, he has turned into a fearful trader.

For example, a trigger happy trader may buy the close of b1 reading it as a reversal bar and a strong close indicating a possible bullish trend from first bar (T1B) day. To his horror b2 starts selling right from its open into its close. At this point, he may turn short below b1 or below b2. If he's lucky, he's scalped out and is close to breakeven by the close of b3. If not, he may buy b4, then sell b8 and by the time b11 appears, he is emotionally exhausted, possibly down by a few points for the day and has thoroughly exercised his expletive vocabulary.

The sense of urgency the trader felt as he entered every trade so far is his very undoing. This is the exact feeling a car dealer will try to induce in a customer at the dealership. "If you buy right now, you get this and this" or "tomorrow, we may not be able to work out such great financing", etc.

Without the emotion of urgency, our trader may read the chart differently. For example, if it was presented bar by bar a month later,  since he's not tormented by an urgency to make money, it should be apparent that b1 was a doji and not a reversal bar and its close or breakout does not merit a buy. Similarly, selling below a doji on the first attempt is dangerous.

The over-trader thinks like a gambler. To him any trade has the same chance of success or failure, sort of like betting on red on the roulette wheel. He will bet on every spin since every spin is essentially the same. Traders however, need to think like poker players. Only play good hands and muck poor hands. A  better analogy is to think of trading like hunting. Its insufficient to spot a prey that would make a fine meal. Everything should be positioned for a successful hunt before you risk life and limb to chase it.

The trick to trading successfully is to only take setups that you are certain will work. Its insufficient to correctly read the direction of market movement. In the beginning that may mean you are just watching the market day after day, without taking any trade. This is very important and you should not skip it. What you are doing is removing the fever and developing the patience of a hunter. Over time, you will be able to read patterns where your probability of success is high.

Keep a list of proven setups handy. At any point you feel the urge to enter, ask yourself: Is this a setup I know is high probability? If not, pass up the trade. Its not worth it to find out. If you feel you cannot control yourself, trade it on SIM. But eventually, you need to let it go without even resorting to trading it on SIM. Once you enter, follow your risk management strictly. If it stops you out, so be it. That data goes into your statistical database and is essential to selecting the best setups for you.

When reversal bars dont trigger

Shallow sloped, wide channels fool even the best traders into thinking a reversal is just around the corner. There are some ways to guess if a reversal would fail and one of them is that a reversal bar with a strong close refuses to trigger. Today for example, b9, b18,b45 refused to trigger despite having strong closes. This usually means that sellers are selling the close of the strong bar instead of buying it. It also shows lack of confidence on the buyers side and you should look for continuation trades in the original direction.

An overshoot of the TCL and a strong signal such as the oio at b73 is an essential requirement to take a reversal trade with any hope of success.

Freezing, inability to pull the trigger

Traders often complain that they are unable to enter what may be a good setup. Sometimes signal bars are weak or the move itself it hard to discern. Know first that these are extremely valid concerns. Your body has learnt to be cautious and will react vicerally causing you to pause due to the accumulated stress of prior mistakes. In principle, this is exactly like getting a static electric shock when you touch a metal surface. If done often enough, your body will refuse to touch the object even when you command your hand to do so.

You can reduce the impact of the reaction by reducing your trading size. Trade only 1c or trade 100 shares of SPY or even 10 shares. If you wish you could even trade on a simulator and risk no money at all in the beginning and slowly move to real money using very small size.

One way to work on eliminating the freezing reaction with this is to evaluate your setups objectively, rather than subjectively. In general no setup is perfect and waiting for very clear setups often means you rarely trade. This is actually not a bad thing for a new trader.

Alternatively, a trader may choose to let something else compensate for weakness. For example, you may choose to take a weak bar if the pattern is clear, such as the 1PB at b8. It was effectively an L2 at a lower high after a strong bar b3. Another strengthener is the ema, so the FF and W at b16 for example could be tradeable based on being at a strong place.

Conversely, a trader may choose to take a strong bar even if the pattern looks uncertain such as the 1Rev at b1 or the fBO at b65. So a weak pattern with a weak signal such as b39 can be ignored until you develop the experience to read them correctly. While b39 did work, this would save you from reading b33 as an A2 for example. But once you have an objective set of rules as to what is tradable, you should follow it.

The key to trading success is to follow your objective criteria with discipline and let the market stop you out if you are wrong. Without this, there is no way of measuring what setups work for you and what do not. Once you have the data, you can winnow your setups and trade only the ones that work best for you.

Don't focus on winning or losing. You are collecting data about your setups and losers are a necessary part of the data. Once you accept losing trades as part of what you seek, your freezing reaction will fade over time.

I understand the setups, but am unable to trade

Many traders have contacted me privately and mentioned that while they understand the setups and can recognize them post-market or often real-time, they are unable to trade them. Some of it is due to being in a counter-position but a lot of it due to various psychological reasons.

Some of the symptoms and reasons are:

1. Freezing/unable to pull the trigger: This is due to fear of being wrong.
2. Impulse/Chasing: Freezing often leads to chasing, i.e. entering where you should be exiting. This is fear of being left out. Late entries mid-bar fall into this category.
3. Being shaken out: You havent mentally accepted your risk.
4. Unable to hold, exiting early: You are not confident of your read.
5. Revenge trading: Emotionally upset at loss, want to win right now!
6. Fading a strong trend instead of trading with trend: Perfectionists fall for this since they want the market to validate their genius ability to predict where the market turns exactly.
7. Letting a winner turn loser: Caused by greed and high expectations.
8. Scaling into a losing position: Caused by the need to be right. Trader will continue to scale in until the pain of losing money is greater than pain of being wrong.
9. Reversing your position on a loss: Some setups are reversible, for example failed A2 is usually an indication of two more legs in the new direction. However, this is about reversing your position on any failed trade without knowing if its reversible.

In addition there are poor trading habits that cause lower success rate:

1. Trading off poor signal bars: Poor signal bars sometimes work but it takes experience to trade them correctly. In particular, they need to have some strengthening factors such as being a BT or being on the ema. Most traders would do best to skip the trade and let it run without you.
2. Trading BW/OL: Most trades in BW/OL are likely to fail. Yes, some breakouts do occur out of BW but you are usually better off trading the failure or BP of the breakout.
3. Getting  in before the signal bar triggers: Some traders are anxious to get a better price so they buy before the signal bar triggers.

I would like to address these in various blog posts showing where on the chart such an error may occur and how to avoid them. This will change the format of the charts for a few days. If you made a certain error on a given day, you could let me know and I will add it to the day's chart.

If you have any common mistakes that you would like me to address, just post a comment on this blog post and I will add it to the list.

Narrow range days distort your perception

Narrow range days are typically terrible for me and force a lot of errors. I have learned to cope by sitting out most of the day. If the first two hours have a range of 6 points or less, its best to be very cautious and only scalp every trade. The reason is simple. The tight range will act as a magnet and will cause any breakout to fall back into the range.

One of the hard things about trading a narrow range day is that it distorts your perception. For example, b37 was a possible BP trade with b29 being a possible BO above HOD. If the range was wider, it would be fairly obvious to trade only shorts near the upper part of the range and b37 would be a poor decision. Similarly, the second fBO at b43 may have broken into a trend and b66 is a possible A2 but if the range was wider, it would be obvious that b50-65 was a horizontal flag and a possible FF.

Tiny bars, shallow pullbacks, poor signal bars distort your perception and force many incorrect reads of patterns and signals and the narrowness of the range reduce profit potential and probability of every trade.

Trend termination (TT): Double Top

The first pullback in a new trend is usually the deepest and the following pullbacks get shallower. As pullbacks get shallower, they attract fewer new buyers since profitability of buying a pullback is proportional to the depth.

Eventually, the pullbacks are so shallow (b52, b58) that they do not find buyers and early buyers will exit near the high. This will lead to a double top or double bottom and terminate the trend.

Since this is a termination and not a trend reversal, you would need to wait for a new trend to break out before entering a new trade or only trade fBOs.

A2 variants on small bar days

When bars are relatively small, A2 can form that are hard to read and enter. This is particularly true for the first pullback of a new trend since its hard to anticipate. There are two methods to attempt to read these.

The first is a fH2 or fL2. When a trend has just started and the first pullback is near the ema, if it attempts and fails to move against the trend twice, you have an fH2 or fL2. For example, b17-b19 was an fH2. If b19 was a smaller bar (even if it was an outside bar) it would be an acceptable entry. When the bar is larger, the risk of a large pullback reduces the probability of success of entering on an outside bar, even when its an fH2 near the ema.

The second is an A2 variant where the first attempt is an inside bar. For example, b33 was an inside bar with a higher low and higher close. This makes it an H1 and the next attempt above b35 effectively makes it an A2.

The most important precondition is that a trend should exist or have recently broken out. The DP at b13 is a trend generator, so the next fH2 is a high probability trade and the W at b27 reverses the trend and therefore the A2 at b35 is a high probability trade.

Trend termination (TT): TTR

We clearly know that when a trendline breaks, the trend is over. There could be a reversal if the break was strong and if not, a trading range. Often the trendline break is obvious even when a trendline is not drawn on the chart. For example, today, b46,47 broke the trendline decisively.

If you were holding a long position, when do you get out? You could wait for a test of the high and get out at b70, but you would need to hold for most of the day just to get a good price. You could also perhaps exit on any strong bar such as b50 or exit on the next L2 such as below b55. However, it does not save you much time.

Ideally, you would exit on the close of b24. How can you predict the trend move will not go much further for a while? A trend by definition should have mostly trend bars. When the bars turn into a TTR (b19-23), there is a good chance that the trend is nearing termination or at least a deep pullback. Any strong bar after it is a very attractive exit for someone who bought the reversal at b8.

Usually, there is a second chance if the move up was very strong (no deep pullbacks). You could also exit at the high of b24 or a tick below it and would be filled at b44.

Remember that trend termination is not reversal. Its just an indication that the best option is to exit your positions and wait for a fresh trend to break.

Liquidity effect

Stampedes are caused by a large number of people running in the same direction. Any lone person standing in their way will certainly be trampled. This is essentially what a trend bar is. A large number of traders advancing in one direction.

When a stampede encounters a stampede in the opposite direction, the crowd usually wont go anywhere. There may be some pulling and pushing but nothing really happens. These are small doji and other trading range bars.

On thinly traded instruments, liquidity is low and even small number of people can stampede without encountering resistance easily (until they tire and rest). This is why the thinner the instrument, the more volatile it is. Liquid instruments however, move very slowly and small days are a necessary component of their overall move.

Price action within these small bars are murky as the chart today shows. There is pushing and pulling from both directions and one of them has to give very soon.

Even on a day like this, the best moves are simply bars with strong closes on deep pullbacks (b53). With the usual exception of 1PB (oio at b17), the best trades are usually with-trend, deep pullbacks on a strong close.

Trading range as a series of fBO

If trends can be seen as a series of breakout pullback, then trading ranges are a series of failed breakouts. I normally avoid trading fBO unless the range is wide enough to net an acceptable profit. In general that means if you like a profit of about 2 points, you want the range to be twice as much, i.e. 4 points.

The reason is that many fBO trades will fail to go to the other end of the range (b33,b40). Thus narrow trading ranges cannot be profitably traded using stop entries with consistency. Even weak wedges such as b40 are usually not worth trading.

The quality of signal bars is very important in entering any trade as it is directly correlated to success rate. The quality of the bars around the signal bars is equally important. On a chart with mostly well formed bars, you can take any decent signal bar but on a barb wire chart you cannot expect a move large enough to justify a trade.

But eventually, the market will move out of the tight range and create bars that become tradable (b75-81). If this occurs with sufficient time before the close unlike today, you can look for high probability trades.

Horizontal Tight trading range (TTR) or Dojistan

A prolonged horizontal barb wire pattern is nearly impossible to trade and can be labeled dojistan. Attempting to trade dojistan using stop entries will invariably lead to failures.

Anticipating dojistan is simple. The moment you see bars getting smaller than 1 point and when many of them are dojis, you should be cautious. Bars that are two ticks tall such as b55 are early warnings that indicate possible dojistan. Note that any bar thats 4t or smaller should be treated like a doji while in dojistan and is usually not a setup bar (b59, 62).

The only possible approach to trading the dojistan is to fade trend bar breakouts. By definition, dojistan is a tight trading range. Since most breakouts of trading ranges fail, you could simply sell the close of a trend breakout bar with a stop 1t beyond it. So for example, you could short b61 close and b74 close on limit.

The best approach however, is to do nothing. The one or two points you could make in a dojistan are not usually worth the risk and the energy you would need to put into it. Better price action is coming shortly, so just wait for it.

Deep vs shallow pullbacks

The most successful trades are off with-trend signal bars with strong closes and no overlap in a deep pullback. In particular, they give good swing entries that tend to go to 4 points or more.

The first requirement is that there is a trend. A trend should be fairly easy to spot. If the chart in front of you is moving from bottom-left to top-right or top-left to bottom-right, you are likely to be in a trend. The conventional definition is higher highs and higher lows for a bull trend and lower lows and lower highs for a bear trend.

The second requirement is a strong signal bar. A weak signal bar in a shallow pullback and overlap will work in a soft trend such as the earlier part of today (b23,33,41). However, once the trend is no longer soft, every such signal bar is likely to fail (b57,61,65).

The third requirement is no overlap, because overlaps are trading ranges and their breakouts are likely to be faded. However, if the signal bars are strong and at support, you can take some second entries since they can act like breakout pullbacks. If you are unsure, avoid overlaps.

The last requirement is a deep pullback. A deep pullback ensures there is sufficient room to the previous extreme to allow a profitable exit. For most trades, that equates to about 10ticks for a 2 point profit. However, as long as the pullback is deeper than a recent bar (b69) its likely to succeed with-trend.

Soft trends and hard trends are special in that they dont give deep pullbacks or good signal bars but nearly every signal works. But on the other 80% of the days, these rules will greatly reduce the number of trades you can take and greatly improve your consistency.