Friday, March 30, 2012

Revenge Trading I - Reversing where you would be stopped out

As I've previously posted, a trend first bar is just a trading range. However, a strong bear close that overshoots a bull channel TCL from the prior day is a sign of a move down. If a trader chooses to sell below b1 instead of waiting for a breakout pullback of b1, he may follow standard price action principles and move his stop above b2. Since b2 is had a strong close, he may simply decide to reverse where he is being stopped out. This is an unplanned trade and is a form of revenge trade.

This is caused by the trader having a plan for success, but not a plan for failure. He has very carefully visualized his setup, entry and targets. He may have chosen his stop, but being so sure of his trade, does not really expect it to be hit. After all, the setup is just too beautiful. How could it ever fail?

The failure of a beautiful setup usually means you are still in a choppy trading range and there is a very good chance that any setups near this area are likely to fail regardless of direction. The right thing to do is to wait out two swings or until the price moves some distance away from choppy action.

Since I had taken b7 and was stopped out, my plan required me to stay out for two swings or until the price moved some distance away from this setup, both of which meant I would enter on the 1st PB after the reversal at b15.

While some traders can retain clarity of thought after  a loss, many just wont be able to. For example, if an experienced trader shorted below b71 after reading it as an A2 short (since b69 is an L1 variant) and was stopped out, he may retain the clarity of mind to correctly short b74 as a W pullback. (but he could probably never do so if he reversed and went long during b73.)

However, under most circumstances its best to wait out two swings. A short below b50 DT was stopped out at b55.  Naturally, a short after 7 bull bars is likely to fail even if this was not  BW. After waiting two swings, i.e., close of b63, chances of a successful trade increase. The price has also moved the size of a recent bar or two away from the original price and has also given the trader some time to regain composure.

In summary, when you encounter a loss, always avoid getting back in right away. Have some criteria for re-entry. The chances of you reacting emotionally and urgently right after a loss is very high and puts you at severe disadvantage. In this state you are unlikely to be reading the market at your finest skill level. Let the market go for now and wait for better price action. Entering on strong bars is a great way to filter poor price action areas. Strong setup bars failing actually gives you a lot more information about the market since poor bars could fail anywhere but strong bars only fail in trading ranges/channels.

Thursday, March 29, 2012

Two swing trades a day

A swing setup is one where after filling your scalp target, the price does not come back to test your entry price. This enables you to move your stop to breakeven and let the market take you to higher profits.

In general, there is a swing setup in the early part of the day and one in the late part of the day. Often one or the other could be missing. If both setups are in the same direction, its a trend day and could consist of multiple small with trend entries where you could enter and ride the trend. If the setups are in opposite directions such as today, its a trend reversal day.

Its a valid trading plan to only enter on these two setups and hold for 4 points or more after taking a scalp profit of 2 points.  The trick to doing this consistently is to ignore reversals and only take the first pullback after a proven reversal.

For example, if you had to guess that b2 was a reversal, you would be sorely disappointed. b5 also would knock your breakeven stops out. The first pullback to a LH at b8 is the high probability swing setup.

Similarly, if you guessed b14 was a reversal, you would be disappointed. Even if you correctly assessed that b30 marked the low of the day, a buy above it failed to give 2 points and your stops below the entry bar were taken out. If you had the patience to wait for the first viable signal bar b53 at the HL, you would be able to swing till the end of the day.

In summary, a great way to take swing setups is to take the first pullback after a trend breakout or reversal and to ignore the actual lows and highs of the day.

Wednesday, March 28, 2012

Unable to hold, exiting early III - Recent losses

One of the most difficult tasks a trader faces is to not let recent outcomes impact their current decisions. For example, a trader who may have sold b3 and bought b5 and lost both trades may have also entered a short below b8. However, instead of letting it run, he may be tempted to take a quick profit and exit his position completely. This is mainly because the two very recent losses have impacted his emotions and judgements pretty intensely even though he may not realize it consciously. The human survival mechanism kicks in and forces the trader to get out at a small, certain profit and be closer to flat for the day rather than risk making the loss larger.

It is very hard to overcome this emotional impact and start with a clean slate so to speak since there is insufficient time for the trader to calm down and regain composure. The way I address this is to avoid trading for at least two swings or wait for the price to move away from the area where you had your loss.

Not trading for a couple of swings protects you from going into tilt mode. Not trading around the same price protects you from choppy action. If you took a decent looking signal and were stopped out, there is a very good chance you are in some choppy waters and should expect to be stopped out again. Letting the price move away allows some time to pass and is likely to give you a better setup for the next trade.

Tuesday, March 27, 2012

Trading on tilt and prevention

If a person is hit once, he may try to hit back; if he is hit twice quickly before he can react, he may try to run away and if he is hit three times before he can react, he may go berserk and try to kill or be killed. To some degree this is a survival mechanism and applies to most human interactions. Repeated harassment of someone is also likely to cause the suicide mode to kick in and I have discussed how Poker players can go on tilt if they are in a bad beat.

Losing a trade causes similar reactions to losing a poker hand. This is because a moderately good trader expects his trade to work and is often shocked when successive trades are lost one after another. The more trades you lose in succession, the more you are likely to throw caution to the winds and enter on poor setups trying to make back the money you have lost. Narrow days such as today are extremely dangerous to any style of trading, be it scalping, swinging, with-trend or counter-trend.

You may not even realize you are a trader that can go on tilt, but its very obvious from your trading history. If most of your days have a small steady profit on a few trades but a few days have huge losses with a large number of trades, you are susceptible to tilt. All kinds of bad trading habits that you thought were kicked for good will re-surface when you are on tilt and you will lose trade after trade and you may end up blowing your account on a single day.

There are a few simple things you can do to minimize the damage when going on tilt. A very important technique to prevent a string of losses is to avoid trading for at least two more swings right after a loss. For example, after my loss of b8 buy at b12, I need to sit out until b17. With a few exceptions, taking the very next signal is inadvisable unless the failure move went some points beyond your signal bar.

The first thing you do when you lose a trade is to ask yourself if you made a mistake (poor signal, incorrect read, etc). If so, note it down right away in a journal. The very act of noting down a mistake disengages your mind from the chart and forces you to acknowledge your mistake. The next thing you do is to step back from your computer, perhaps get a glass of water to drink or do a couple of push-ups. This is analogous to walking away after being hit instead of risking life and limb in a fight. This also calms the urgency you may feel to get in right away and helps you to avoid trading for two swings. If you encounter a second loss right away after returning, you are less likely to go on tilt.

After two or three losses, halt your trading for the day. Traders who go on tilt usually do the least damage if they are able to stop early. The more they trade trying to make up the loss, the larger their daily loss. Its a rare trader who has gone on tilt and recovered in time to make up the loss and end the day a big winner. You will never be able to halt after two losses unless you are also able to step back after a loss and perform the rituals above.

Often, the reason for your string of losses is something you may be unaware of. Perhaps you didn't get sufficient sleep or are hungry or had too much to drink the prior night or your internet connection is sporadic or you are trading the wrong contract. In any case, if your win/loss pattern is very different, you should halt trading for the day.

A fixed maximum daily loss is the perfect complement to a fixed per-trade loss. Celebrate your freedom from the trading desk when you hit it and go out and enjoy your day.

Monday, March 26, 2012

Signs of an extremely strong trend

When the prior day has formed a strong signal bar on the daily chart, the next day can often be a large trend day. A large trend day can often be held for a swing till the end of the day.

Signs of a strong trend:

  • Strong close prior day (b81)
  • Large gap, no selling (b1, b3,5)
  • Strong breakout from opening range (b8-10)
  • 20 bars or more before reaching ema (b33)
  • Multiple A2 and fL2 (b47,54,62,75)
  • Small moves off counter-trend signals (b22,28,33,64)
  • Sideways pullbacks (b43-47, b51-54,b61-65)
  • failed W (possibly W42,50,59)

On a very strong day, its acceptable to trade overlapped signal bars and doji signal bars as long as they are with-trend.

Friday, March 23, 2012

Unable to hold, exiting early II - Recency Bias

Recency bias is our ability to recall recent events and experiences more readily than earlier ones. This means that anything you experience recently is likely to have a disproportionately strong impact on your decision making than older events. Recency bias is very hard to fight since its an essential part of our cognitive and learning processes.

For example, today I exited a bit earlier than I could have when I bought above b9. When the initial move off a first reversal (b9-29) is strong, you can often swing a trade till the end of the day or an obvious overshoot of the TCL. However, after adapting to the recent narrow range days, I exited at +6  right above b24 instead of my planned +8.

The permanent solution to this is to accumulate experience and develop the skill to quickly recall and adapt to changing conditions. The more experience you accumulate, the less recency bias impacts you. The tactical solution however, is to trade mechanically and stick to the plan. At the least, I should have exited on an L2 (after fL2 b21) below b30 for my swing position.

Thursday, March 22, 2012

The first opposing trend bar in a channel

A channel provides few entries and can drag for many points. One of the most reliable entries in a channel is to fade the first opposing trend bar (b15, b27, b60). You can usually sell the close on limit with a tight stop say 2 or 3t. This works particularly well if there were no opposing bars since channel inception.

The reason it works is because this is essentially a first channel breakout that you expect to fail. Note that you need a trend bar with a strong close. A doji such as b57 or a weak close such as b11 is usually not reliable. Often this is just an optimization since you get a signal right after (b16, b30, b61) and you can simply choose to trade it with a normal stop entry.

Wednesday, March 21, 2012

Unable to hold, exiting early I - Drawn out move

Human beings are naturally impatient and this often works against trading profits. While being unable to hold for long durations is far better than being shaken out, it can often cut profits deep enough to be of some concern.

For example, today if a trader bought b19 and held through the horizontal movement around b20-24, he would probably plan to exit on an L2 if the signal is good or on the third push up. Technically, he should exit when the price ticks below b37 or just above b35 (during b39) and then wait for more price action.

However, the sideways movement right after entry is likely to have caused him some distress and question the strength of the setup. He may consider the movement as BW and expect any BO above to fail and cause the market to drop below. He may read the bear bar b23 as a break in the trend or b21 and b23 as two interruptions in the trend making b26 a third push up to the ema and exit (or worse reverse his position). After all, thats exactly what happened at b10-13. If b21 had been a large trend bar with a strong close, he would have less of a problem sticking to his plan.

The solution to this to understand what b20-24 really is. Its an attempt to fail the reversal and many reversals have such a pattern right after if the entry bar is not a large trend bar. b15 was an fH2 that triggered off the first attempt to reverse at b9 and succeeded in failing the attempted reversal. b23 was a signal bar that attempts to fail the reversal off b19, making it an fH2 if it triggered.

Price action such as b20-24 is to be expected right after a reversal if the entry bar is small and the trader has two techniques to deal with it. First, take a first profit at +2 and move stop to breakeven for the remaining position. The very act of taking a profit increases your confidence in the setup and your trading in general. The act of moving the stop to breakeven releases anxiety since the mind perceives lighter risk. Once you hold through the first pullback, sticking to your plan becomes much easier.

Tuesday, March 20, 2012

Getting Shaken out V - Mid-bar decisions

One of the troubles that plague discretionary traders is that they are impacted by every tick of the market. Whether the bar grows or pulls back, flips green to red, approaches their stops or moves away will drive all kinds of elation and anxiety in them and this often drives them to make rash decisions.

For example, today if a trader bought b4 and moved his stop below b5 after it closed, he should simply wait to either be filled on his target or be stopped out. A weak trader may see b6 turning red when its  near its bottom and may wonder if it could turn into a 1PB short. He may feel compelled to exit his long position or even reverse mid-b6. He may reverse to long by buying above b7 and get stopped out at b11 and so on.

This kind of trading consists of second guessing yourself on every tick and changing your decision based on mid-bar appearance. Note that most trading methodology is based on how a bar looks after its close and not how it looks mid-bar. So there should be absolutely no reason to make a decision mid-bar.

Once you enter a trade and set a stop, it means that you are willing to tolerate a pullback until your stop. If you cannot tolerate a shallower pullback, then you need to find a trading system that allows a smaller pullback.

The right thing to do is to let the market either fill your target or stop you out if you are wrong. The only time you should exit early is if the market presents a reasonable opposing trade that you may have taken if you were flat. For example, The DT and W at b24 made me exit my swing long earlier and the long near b64 low was no longer viable after the final flag/1tf/W at around b72 and I exited it before my target was filled.

Being able to accept a loss at your stop will also enable to hold till your target is filled. If your stops are regularly taken out, you can simply drop that setup. If your targets fall short all the time, you can learn to have a bit more modest expectations.

Monday, March 19, 2012

Simple 1PB

The simplest 1PB consists of a trend move from the first bar, i.e., at least two trend bars that break beyond the first bar (b2-b4) and then a pullback to a higher low. If the bar that began the pullback is a reversal bar (b5), then its best to take a 2 legged PB or a second entry. A mW such as b6,7,9 today can also act like a 2L pb.

Factors strengthening the 1PB signal are:

  • A two legged PB or a mW PB
  • strong close on signal bar
  • signal bar not too large
  • signal bar at ema or trendline

A 1PB that takes out the prior extreme of the day in one leg can often be held till the end of the day. A 2 legged move however often stalls or reverses at the extreme of the day and its best to exit and wait for the next signal.

Friday, March 16, 2012

First bar: doji - Tight days.

A doji first bar can give a diverse range of days from tight ranges such as today to large trend days and wide trading ranges.

A tight day such as today is extremely dangerous to trade if your first target is 2 points or larger. Halving your target is poor risk management since you cannot practically also halve your risk. So a 6t risk with a 4t profit potential requires far higher probability of success and even then the rewards are usually not worth the pursuit.

Any trend attempt that rapidly degrades into doji bars (b16-20) should always raise suspicions of poor trading action and you should sit out until the bars become normal or price breaks out. Most bars after the initial move were in a 3 point range and the probability of success of price action entries is extremely low so its best to sit out.

Thursday, March 15, 2012

The ideal first reversal

The simplest to read kind of first reversal is a trend move from open consisting entirely of trend bars that penetrates a support such as HLC of prior day or ema (today was both C of prior and ema) and gives a reversal signal.

If the reversal signal is weak (for example, it has a large entry side tail or is a bar of the wrong color), it is likely to take out the low and try a second time.

Such a 1Rev is often the low of the day and will close near its high so its a good candidate for a day long swing. In practice, if you get a very sharp move (b31-35) that looks like an overshoot and gives a decent profit, its a good practice to take some or all off and wait for more price action.

Wednesday, March 14, 2012

Getting shaken out IV - Recent losing trade

A recent loss shakes your confidence in your next trade often without you noticing it. For example, suppose you shorted b9 and were stopped out on the next bar at b10 high. Another setup bar forms at b11 right away and you re-enter. Chances are high that anything other than bear trend bars will force you to exit early. So when b16 is forming and looks like a bull bar near its high, you may decide to exit on the next tick above and get out exactly where stronger traders add more to their short position.

Its likely that if you did not have a recent loss, the pullback wouldn't bother you that much. Its important to know how wins and losses impact you and to learn not to be overconfident after wins or scared after losses. One way around this is to let some time pass after a losing trade. If you choose to wait for two swings (b10h and b15 l) and only take an entry after that, you may possibly read the fH1 at b16 correctly and hold longer.

If you are a trader who often or even occasionally experiences a series of losses every few bars, you need to follow the two swing wait rule after exiting any trade regardless of whether its a win or loss.

Tuesday, March 13, 2012

Trading FOMC

Trading FOMC is rather tricky. I used to trade breakouts of prior swing points during FOMC before I was a price action trader but have since moved to the more accurate method of treating FOMC initial bars as a trading range and trading their fBO and BP.

For example, the actual FOMC announcement resulted in b58, which was a large outside bar. Such a bar is a trading range and its BO can usually be faded. b59 was a rather weak bar with a small body compared to its tail size but had a strong close. If this bar was near the high of b58 it would be ideal since it would not force a short mid-TR.

On the other hand a 2L fBO at b65 provided an fBO entry on the other side of b58, which resulted in a large rally.

Note that not all FOMC announcements result in large moves but when they do, its usually a good risk to reward ratio. I recommend fixed size stops especially for large bars to limit your losses.

Monday, March 12, 2012

Kryptonite days

A trader eventually graduates from having mostly losing days with a few winning days to the inverse: mostly winning days with a few losing days. But the losing days are likely to be disproportionally large. This happens occasionally due to the trader not being physically or mentally in top shape on that day due to lack of sleep, illness, relationship issues etc. But usually, this is because the trading system has a real weakness under certain kinds of price action that has been exposed by the market.

If you find yourself at this point, you are probably already a break-even trader. If you can tame or eliminate these disastrous days, you probably already made it as a consistent trader.

The first one or two disastrous days can be pretty devastating. This is because your initial success has encouraged you to increase size and your growing P&L has given you an enormous confidence boost. This probably meant you traded large size and re-entered every time you lost and at the end of the day were shocked to see a week or two's profits wiped out.

The very first thing you need to ask yourself is if you have lapsed into old habits. Confidence and a high win-rate can make you feel invincible like Superman and you may have lapsed into your old habits. Eventually Superman is taken down by Kryptonite. If your discipline has been good and you haven't yielded to the temptations of poor habits, there is a good chance that certain kinds of price action may simply destroy your success rate.

For example, today's wide slightly sloping channel is a kryptonite to AM trend traders such as myself. Narrow range days are also kryptonite for traders who like to take 2 points or larger on each trade. Overlapping signal bars are kryptonite for traders who like to enter on stops with a price action stop. Today was all three and if you know your kryptonite you can avoid it by not trading.

Similarly, trend days are kryptonite for traders who like to fade every breakout. Soft-trend days are kryptonite for traders who rely on only patterns for their trading decisions. Hard trend days are kryptonite for traders who take every reversal signal and so on.

The key is to know what kind of price action is unsuitable for your style and avoid trading on that day. Since realization comes too late, the best course of action is to exit after a certain number of losing trades on any day. Barring this, the second approach is to not take another trade for at least two swings after you are stopped out.

With experience, it may be possible to recognize the kind of price action and switch to a different style that's conducive to the current price action.

Friday, March 9, 2012

Anticipating DP setups

A prolonged horizontal move breaks a trend, but you dont need to wait that long to detect a trend termination. Any poor reversal (b66) followed by a poor A2 (b71) is sufficient criteria. Any cluster of dojis after a pullback starts (b15-b23) is usually also sufficient to declare a trend termination.

At this point, you are in a trading range and no longer in a trend. Any A2 or other continuation trade is likely to result in failure. Even if you missed reading the termination, entering only on strong signal bars would protect you from poor setups. For example, b26 did not trigger, b32 was a bear doji, b38 had a doji before it, b52 is an iii in BW. None of the buy setups were acceptable, so you wouldn't be buying them.

Sell signals were pretty poor as well, most triggering off bull bars or had dojis preceding them. The first acceptable sell was b55 inside bar and the next attempt was b63. A simple filter of not selling before a 1 legged close below the ema (b47) would have also kept you out of trouble.

At some point you would figure out that the trend has ended, regardless of your method of determination. At that point, you are waiting for BP or fBO. A DP is a kind of fBO that results from two failed attempts (b46,55) to break a barrier (b22 high) and a third attempt (b63) that falls short of the prior two attempts.

So while the DP at b63 is clear, its important to note that b32,38,51 is not a DP long. The reasons is that DPs only fade trading ranges and never extend them. So if the TR is narrow such as the horizontal move today, there's a very good chance that any DP like setup to go long will fail. A DP to go short however is more likely to succeed since the move up simply has brought us to the top of a trading range.

Thursday, March 8, 2012

Preferring deep pullbacks

The most important skill to master trading with trend is selection of the appropriate pullback to enter on. Depending on where you are in the trend, you have a few options. For example, let us suppose you determined that the W move and FF to b12 ended the bear move and is setting up a reversal of the opening trend. If you did not buy b12, you could always enter on the very first pullback. b15 high was lower than b14 on the March contract and you could have bought above it. i.e, Shallow, 1 legged pullbacks are acceptable right after the trend begins.

Often you can also buy the first 2 legged pullback. For example, b28 was the first 2 legged pullback and in this particular case, there is always the risk that the breakout above b1 would fail and give a deeper pullback or reverse the move up but in many other cases, the first 2 legged pullback of a strong move often works even if its not deep. Normally, I will not trade a pullback that's not deep even if its the first 2 legged pullback. Exceptions are when its a soft-trend day, when the pullback is at ema and the signal bar is strong. b28 presented none of those conditions.

But what you definitely can buy is the first deep pullback. All shallow pullbacks (b15,18,28,30,35,39) can be considered part of the same larger leg and the first deep pullback should usually gives at least one more leg in the same direction.

A deep pullback is one where the pullback is at least 2 points from the extreme of the day and deeper than the size of at least one recent bar. Breakouts of deep pullbacks, (especially the first) are stronger and fill your targets quicker with a smaller risk of pullback to your entry price. This makes them excellent swing entries. If the breakout from a deep pullback goes much beyond the previous extreme, the chances of the trend terminating on a test of the prior extreme diminish and you can take the next deep pullback with higher confidence.

Wednesday, March 7, 2012

Getting shaken out III - Not taking the early profit

When you are trading only one contract, you should always take an early profit. A reasonable early profit could be your risk or slightly higher. When you are trading multiple contracts, you should sell some at an early profit for at least some of your contracts. For a -1.5 stop, I prefer to take a 2 point early profit. Psychologically, this act allows you to tolerate a pullback far more easily than simply holding it to the final target.

The early profit ameliorates your stress levels via a couple of pathways. One, it gives you a sense of accomplishment, marks success and gives a boost to your confidence for doing the right thing. Second, it lowers your holding size, reducing the stress you feel when the market pulls back against you.

For example, assume you bought b52 today and did not sell at +2 near the high of b56. Your reasoning is simple. It was a one legged breakout after a three legged pullback and should give at least one more leg up. However when the price pulls back to below your entry price on b62, and b62 mid-bar looks like a bear bar, the chances you panicking and exit at a flat or one tick loss are far higher than if you sell half your position at +2.

If you sold at +2, you are more relaxed and could easily place your stop at breakeven. Even if its hit, you wouldn't care too much since your trade is already a winner. If you choose to take a 4t extra risk perhaps you would see your new high. Even if the trade went bad, you would still net +1. This knowledge makes it easier to weather a pullback.

Holding a winning trade for a choice between a larger winning trade vs a smaller winning trade is far easier than holding a winning trade with a choice between a larger winning trade and a losing trade.

Tuesday, March 6, 2012

3 small pushes: Channels, Micro-wedges and wedges.

Three pushes in the same direction should not be automatically labelled a wedge. All three pushes do is to terminate a leg. After termination, the move could continue after a pullback or move in a horizontal trading range until a fresh breakout.

For example the channel from b2 resulted in three small pushes (b5,7,11), which resulted in a termination of the leg. The micro-wedge (b13-15) terminated the counter-trend leg.

The weak wedge (b26,29,34) terminated the second leg of the full move down from b2 and the price moved horizontally in a trading range for several bars.

The key takeaway here is that none of these three pushes were automatically tradable. the channel to b11 continued after the pullback to b24. The mW to b15 continued backup after a two bar move and the mW or small W to b34 simply terminated the trend without any clear direction.

A wedge needs to be very strong and end with a clear reversal bar for a high probability reversal trade. Even then, most traders are better off entering on the first pullback after the W reversal (W1P). If  you are in the old direction, You should consider exiting on the third push near the TCL (b11). or you could wait for the bar to close and exit on its close if the bar has a strong close (b34).

Monday, March 5, 2012

The first bar: Trend bar

The first bar, regardless of appearance should be considered to be a 1 bar trading range. Most traders would agree that two opposing trend bars make a trading range. This is true everywhere and when there is only one bar, you dont have information about the second bar to assume it would be continuing trend bar.

When the second bar is an opposing bar, regardless of appearance, chances are very high that what you have is a trading range. A buy above b2 would therefore be a buy mid-trading range, which is a low-probability trade. You need to buy near the low of b1 for a higher probability setup.

The right approach to trading two opposing bars would be to treat it exactly like any other trading range. Fade a weak breakout or enter in the same direction on a breakout pullback. So if b4 had a strong close near the low of b1, it would make a nice second attempt to fade b1.