Large stop fading

In an earlier post, I spoke about the difficulties of fading moves with a fixed stop and how larger stops such as half the prior bar may be more appropriate. Today's results are preliminary, but show how such a move may be put into action.

My standard 10t stop would have been taken out for trades #2 and #3 but a larger stop above half the fade bar (i.e. 21t above 42t long b5 and 17t above 34t long b10). These stops are effectively twice as large as what I'm normally comfortable with and I would need to find a way to somehow make these smaller.

The good thing about this approach is that during hard trends such as the first few swings today, a larger stop is likely to pay off better while for a tight range, the stops are likely to be smaller giving an overall reasonable risk:reward ratio.

The nature of experimentation

Almost any new insight requires observation and experimentation. Observation digs up potential patterns of price action that may be exploitable or simply points to things to avoid. Experimentation gives you objective data that allows you to select the best of these observations and rule out the rest.

In general, weak and mid-range opens (such as today) are best for experimentation. You should try not to experiment on days that are likely to trend and give a large profit. On smaller days, you can check patterns without an expectation of a large win or loss.

Some experimental goals can be:

Charts other than 5m chart: The first few trades of the day were placed on tick and volume charts. Turns out its harder than I expected. Or perhaps my mind has not yet adjusted to them for CL.

Targets and/or expected pullbacks: #5 and #6 confirmed a pullback once the price overshot the TCL.

Pattern Completion:  #8 was a trade that confirmed the TL break down to b20 and test of prior high at b37 does test the other end of the range (gives new LOD).

You would need to collect sufficient data (at least 40 samples) until you can plan a trade around it. A combination of a pattern and target by themselves do not guarantee its tradable. You would need to actually trade them to ensure your target is reached before you are stopped out.

Most observations are not tradable and most experiments fail, and therefore I generally disclose but don't explain them. However, once in a while, a very useful observation can give your edge a boost. And these little boosts change you into a profitable trader.

The illusion of versatility

Tight days are extremely hard for a trend trader. They are exceptionally great for faders. A trader who could switch between the two based on market action should be able to profitably trade any market.

However, there are some barriers on the way to this goal: Fading in general is extremely hard. As you can see, four of the five failed trades today were fades. The first reason for this is that there is simply no way to determine a stop, let alone a fixed stop for a fade setup. For example, although the fade of b20,21 OL (#5) was an acceptable idea, there was no way to determine how large the stop should be. You could have a large stop (about half the size of the overlap) or stop by bar count instead of ticks but this is something yet to be investigated.

The second reason is that there is also no easy way to determine an appropriate target. For example, the fade of b31 (#7) had a MFE of only 8t. You would need to exit on the close of one bar in your favor to keep the odds on your side.

The third and most important reason perhaps is that its very tough to switch between mindsets during the same trading session. Fading and Chasing are opposite in temperament and switching between them needs much more practice than is apparent at first glance.

Breakout

Predicting a significant breakout with high certainty is still an unsolved problem in price action. In today's chart, correctly predicting that the bear breakout from b7 would fail but the breakout from b22 would succeed is very hard to do.

Until the market breaks into a trend, the market should be considered to be in chop and overlaps should be faded. Of course, this is optional, you can simply wait for a successful trend and only trade the trend.  A trader attempting to fade overlaps would probably sell an obvious OL at b21 but when it appears to give a sustained breakout, he should trade it with the expectation that it may break into a trend.

A small bar right after a breakout (b23) usually is an acceptable entry to get in a with-trend trade. If you choose to wait for a pullback, you could enter on the first tail (close of b27) or any signal bar with a strong close such as the pullback at b29 or better yet, the strong inside bar at b31.

In general, a huge bar (b33) is usually a great place to sell, even if you dont believe the move is over. This is because large bars are usually followed by a trend pause or termination event.

Fading overlaps

We have seen how we fading overlaps and scalping bars are viable ways of trading chops and trends respectively. Almost all price action is derived from these forces working at various strengths at different points of time in the market.

This is why buying the first tail of a trend move such as close of b3 is a viable entry and also why you should expect traders to buy below large dojis (b11) and sell above them.

At first glance, there seems to be a simple principle to fade overlaps: be liberal with your stop and conservative with your target. For example, when I tried to fade b11 high on the close of b17, my stop was too tight (5t) and while my first target of 20t was filled, my runner was taken out at breakeven.

This implies higher risk for smaller profit and this is something traders generally try to avoid. A second option is to fade only the second overlap (b33 instead of b30). However, this will occasionally make you miss a large move (b38 fade) or stop you out (b54 fade).

Taking swing trades on a fade setup with low risk and high reward is still an area of research at this point. For example, today a short at close of b33 with a stop above it would be such an entry.

Trend acceleration

Trends normally go flatter with time but sometimes (often due to news) the trend can actually accelerate. This is observed by the price making steeper and steeper trendlines. Such an acceleration eventually pauses and can reverse the entire move or go into an extended pullback as on this day.

An accelerated trend is usually a hard trend and you can buy shallow pullbacks and one legged pullbacks. Note that you should have very large moves with-trend and very shallow moves counter-trend for something to be a hard trend. The moment shallow pullbacks stop working or you see a deep pullback, the hard trend is likely over.

Trading narrow ranges

If you love trading trends and fading large trading ranges, the kryptonite for you is a tight trading range. Scalpers and faders however, can do well in such a market.

When you sense the market may be trending, i.e., higher highs and higher lows or lower highs and lower lows(b15-29, b29-35), you can attempt to trade with the trend. However, if the bars suddenly turn into dojis (b36-38) or turn into overlapping sideways bars (b43-60), you should stop trading.

A versatile trader can switch between trend trading and fading and trade any such day but such a trader has to first master both techniques individually before attempting to interleave them in the same trading day.

Small and large targets

Many traders enter a trade with no idea of targets. They enter purely on the setup strength and lots of hope. One of the consequences of setup strength trading is that you need to take a fixed target or scalp exit most of the time.

My trading style has evolved over time from pure setup strength to keeping track of potential targets as the price action unfolds. This ensures that unless I have a decent target in view, I sometimes do not take trades even on good looking setups.

Some large targets are obvious. For example, a strong breakout beyond a trading range is likely to fill a target thats a measured move of the size of the trading range itself. A weak breakout on the other hand is likely to test the other end of the trading range. This means that a breakout attempt out of a trading range is likely to give a reasonably accurate large target.

Smaller targets are simpler to estimate. In a trend move, a deep pullback is likely to take out at least the prior swing. So if the pullback is greater than your stop size, its usually an ok setup to take.

Some targets are indefinitely large. For example, the first pullback on an early trend start may continue indefinitely into the end of the day or at least until the trend is exhausted or otherwise terminated.

For example, today if you took b2 long, your target is the other end of b1 (a large bar is a TR). If you sold anywhere above b1 your target would be the low of b1 filled at b41. A deep pullback to b62 would give a target of the prior swing point b41 low.