Handling unclear signals

Often you get signals that should be good but the bars end up bad or slightly off. Normally, its best to let them go and wait for a second better signal. Signal bars can be bad for various reasons. First and foremost, they are not the right color. You need a bull bar to buy long and bear bar to short. The second reason is that  the risk is too high because of bar size. The first hour most reversals can work and some traders do trade any reasonable signal.

In the chart above, is b2 today a first reversal? Since the big bar b1 would act as a trading range, b2 could be breakout and a small pullback could lead to a breakout pullback stopping you out. If it had even a single tick bull body, it would probably be worth the risk.  Similarly b7 could give a breakout pullback since the actual breakout was on bar 6 an additional bar increases the chances of breakout pullback. b9 was indeed a first pullback with an entry above b8 for long or below for short. b12 was just a large doji and not a reversal bar. A second attempt to go below it may be taken as an A2 short.

b25,26 was a down up bar reversal and I missed it along with b27 W1P. Often W1Ps give a channel and its hard to get in until a first channel break as it did on b34. Although b34 was a doji bar and possibly an H1, it was a high probability trade because it was a breakout test of the swing high b21 and also at ema.

The A2 entry above b50 was questionable because it forced a buy above the flag and one point above the previous entry. If you'd rather not wait for a second entry that usually presents itself as b52 did here, you should use a 8t money stop instead of a price action stop.

W1Ps are usually good for at least a point but sometimes I dont take them. b66 is an example. There was no clear reversal bar near the FF around b64 and the entry bar b65 was weak. b66 forced a short below the flag and I passed up the trade.

b74 was an example of an otherwise excellent bar that many may not have taken. A Gap reversal bar after an overshoot of the pullback but demanded a 10t stop. The entry went to a 5t failure and took out the stops below the entry bar. 8t stops were respected however.

In summary, if the bar is the wrong color, pass up the trade. If the bar is the wrong size, use a money stop instead of a price action stop. If the bar is a doji, take the trade if there are supporting reasons such as breakout test, ema, trendline support, channel overshoot, etc.

Tight Trading Ranges on Hard trend days

Two boxes in the  Trend transition matrix are labeled TTR. Since TTRs are full of failed trades but often lead to strong breakouts, detecting and correctly trading TTRs is very important to your trading success. One of the common types of TTRs are found on a hard trend day such as today. Usually, after such a hard move of 10 points or so, the market moves horizontally in a TTR and is essentially a very weak pullback.

The move from b16 to b35 is a down to horizontal transition and is a TTR. Except the short below b19, every single price action entry failed. This is a very important example of why you need to stay out of a TTR. The only single kind of trade you can take is a breakout after a failed breakout on another side. b28 broke above the previous swing high of b19 and failed giving an A2 short below b36. Even if you could not read the A2 correctly, the fact that the market gave a shaved trend bar at the ema after a failed breakout is sufficient reason to go short.

Detecting and exiting on a TTR: Although today the TTR was of short duration, sometimes the TTR can last till the end of the day or at least till the last 90 minutes. Exiting when you detect the TTR is the right approach and here is how I do it. If a hard trend day suddenly produces tiny bars and dojis such as b17 and b18, I will worry a TTR is forming and exit on the next bear bar or near the previous swing low. Then I will wait for a failed breakout and assume we are are breaking out in the opposite direction especially if the failure would break with trend (most TTRs are w/trend flags). Occasionally TTRs will give a double bottom pullback and reverse up and I will usually take that trade only if the other side of the TTR is at least one 6 ticks away.

Today's Summary

A strong trend gives very few successful counter-trend trades while a hard trend has legs that move many points. This usually means a hard trend can give a windfall if you swing it yet it can erase all the winnings if it does reverse. My approach is to take some or all off whenever I expect the market to go into a tight trading range and re-enter on the next signal. Traders who trade large number of contracts can simply keep taking profit at every swing extreme or preset targets of +2, +4, +8 etc.

The first bar today was a doji with a 1t body but its entry bar was a strong bear bar. A gap day with such a strong entry bar is sufficient cause to short below it. Cautious traders could enter below the first pullback at b9. The actual entry is below b8, which happens to be the entry bar of the b7 longs and will likely cause a selloff. This is also a failed H1 trade (fH1) that should give a measured move of just under 5 points. 

The TTR fBO trade described above is also a very obvious trade once you are able to read it correctly.

b41 was a possible W reversal but there were plenty of signs that the signal was bad. b43 was an outside up bar that never triggered. The db bar b43 was a doji, which like the outside bar was a trading range type of bar. You did ok if you bought above any of these but its doubtful it would reverse hard. There was no W1P and therefore the Gap bar at b50 was a good short and could be held till a new LOD.

Consolidation and breakout

While today's first bar was the ideal size (2 points for an average 10 point day) with only 1t on each end, the fact that it occurred without any gap from Friday was good reason to believe this was a trading range bar. A good bear bar near its top would be a good short candidate and a possible 1st reversal. However, we got a doji inside bar after a bull bar and while this works, there's a good chance that there could be a higher low that does not give a scalp profit so the right decision is to pass on the trade and wait for a higher low or a break below the bar and a possible reversal up.

The down up reversal at b6 is a first reversal and should be taken. this should be good till the hod at least. Since this is down up reversal and not an inside bar trade, the entry is above the bull bar. The almost outside up entry bar of b7 gives a possible move to 1291.50.

b10-b12 is a ii variant final flag and could lead to a move down. However, we are expecting a first pullback after a first reversal and folks who want to go long may skip the short trade and take a two legged higher low for a swing.

b17 was a gap bar and a two legged pullback to a higher low and is the best swing option for the day. This should attempt to break above the HOD and try to get a measured move of the pullback, that is 1294.75.

The move to b37 was a 2 legged poorly formed A2 signal and a rather shallow pullback. This is a TTR  consolidation and its perfectly fine to get out at this point and wait for the market to breakout.

The market moved to b61 as a poorly formed W and gave a reversal bar exactly at the b7 measured move. This reversal bar did not trigger, which was a bullish signal and shorts are best avoided at this point since there are no signs of bearish strength yet.

While I normally buy above bullish bars, b70 was a small bear bar that had lots going for it. A 2 legged pullback after a breakout at b61, an overshoot of the pullback trendline, breakout test of the A2 signal at b37 and the first trendline break. However, it was perfectly acceptable to buy above the shaved bar b71 or b78 breakout pullback and hold till the measured moves were met or end of day.

The day ended at 1295, 1t above the measured moves of the first pullback and the final trading range.

A triangle is a sign of consolidation and many traders exit their positions since a triangle could breakout either way although usually along the previous trend.

The poor reversal bars at b50 and b61 along with the generally strong trend indicated a bullish breakout and bullish breakouts usually occur after pullbacks such as the two legged pullback to b70.

Its important to note the examples of failed breakouts today. b2 broke above and failed giving a trend move to the other end of the range. b10 gave a 2 legged pullback, giving a long trade. b50 and b61 were  failed breakouts that did not generate a trade since the breakout bar did not generate a signal or trigger.

Four trades off nine transitions

Update: A setup chart is now in its own page.

The market could be moving in only three directions at any time: up, down or flat. From there, it could transition to any other or have a continuation in the existing direction. Therefore there are nine possible transitions the price could take.

An up to up after a failed down or horizontal move is a  trend continuation, an up to down is a trend reversal, the flat to up is a breakout and so on. There is a kind of trade you can enter at each transition, if you could spot it in time.

The complete set would look something like this:

As you can see, when a trending market flattens out, you need to exit your positions and stay out. Many traders make the mistake of also reversing their positions, but that can only be done when the reversal is clear such as a wedge reversal or a failed breakout of the previous extreme after a trend line break.

This means there are only four kinds of trades: Reversals, continuations, breakouts and failed breakouts. If you can master detecting and trading these transitions, you are already on your way to success.

Continuations: Most trending days have two or more continuations. Most continuations are A2, which is a 2 legged pullback to the ema. The simplest way to look at an A2 is the second attempt to end the pullback. As long as any of the bars that make up the pullback are near the ema giving an entry slightly above or below it, you can consider it an A2. Another way to define this is two failed attempts to reverse the trend, i.e. failed L2. Note that if your A2 entry is very far from the ema, you may get a 3rd push which turns into a W pullback to the ema. These should be taken just like they were an A2. In a strong trend, you may have H1s and L1s that work, but new traders should just stick to A2.

Reversals: Obvious reversals are rarer on a given day, but the Wedge reversal is likely to be the most successful. The most important requirement of a Wedge reversal is an obvious overshoot (more than 2t) and especially a second overshoot. It takes some experience to correctly read a good Wedge reversal, but the following signs increase the probability of a W reversal:

1. A second overshoot 
2. A strong reversal bar or a up/down bar that has no overlap with previous bars or overlap with the previous swing point
3. A strong entry bar (shaved or small tailed trend bar)
4. The entry bar low is not taken out by more than 1t
5. A one legged move to ema. (A close above the ema may end up giving an A2 long or short instead of W1P)

If at least three of the above are present, you can take the first higher low for bullish W or first lower high for bear W since that becomes a W1P. If the reversal bar was weak or W entry or W1P signal looks suspicious for example because its a doji or an overlap or large bar, sometimes you get a two legged W1P.

The following decrease the chances of a successful W1P.

1. Overshoot is small (a tick or two) and there is only a single overshoot
2. There is an overshoot but it does not look like extreme behavior (W are extreme behaviors)
3. W signal and entry bars are weak

The above signs of weakness may imply trend termination into trading range or a pullback and resumption.

Breakouts and failed Breakouts: Breakouts from a trading range are complex and are the hardest to read correctly, especially because most breakouts fail. However, there are certain signs of impending breakouts:

1. A double bottom pullback at the bottom of the range generally means the market may breakout at the top of the range. Similarly a DP at the top implies market will breakout at the bottom.
2. A breakout failure at one end of the trading range may breakout into a trend on the other end of the range, often giving a breakout pullback on the other end.
3. A W move and breakout to one end of the trading range may give a failed breakout, which in turn  breaks out from the other end of the range.

In general, its best to trade a breakout pullback after the breakout is successful.  If a breakout does not fail after two or three bars then its more likely to give a breakout pullback.

If you are a new trader, I suggest concentrating only on A2 till you have mastered it then move to W1P and then to breakouts and failed breakouts.

An exhaustive description of all the above require their own blog posts and I hope to put them here soon.

Signs of trend strength

Today's first bar was unlikely to be a first reversal, since it was between yesterday's recent swing high and low. However, folks waiting for the first reversal should heed to very strong and obvious signals the market gave regarding trend strength.

First, the entry bar above b1 was a shaved bar. This shows urgency on the side of longs. Second, the first reversal bar b3 did not trigger. When a reversal bar does not trigger, its a sign that there is certainly more up. Instead, the price broke above it, another bullish sign. The news reaction did a breakout test of the open at b6 low. What this means is folks who bought the open had more buy orders waiting at the same price. This usually means a strong bull day. b4 and b6 did not qualify to be first pullbacks since they would trigger a buy above the HOD. b8 was a doji after a weak close, and not really a buy setup. b13 was therefore the first pullback and could be held till the end of the day.

The red diamonds indicate poor reversal signals which in turn indicate trend strength. b7, b21 and b71 were poor looking reversal bars (they were bull bars or had large entry side tail). b34 and b38 were one tick inside bars. b57 did not trigger on the next bar. All these signs show bull strength and half-hearted shorting, which meant only long positions should be taken all day. This is because most good traders will not be selling those bars but in fact, will use them as points to add to their positions.

True there were overshoots at b7 and b21 but overshoots only imply a pullback is due. An obnoxious overshoot is needed for a real reversal. This is also why W1P is a much better trade than W.

The other strong trend signs today were the 20+bars above ema and medium sized bars. The fact that every single swing low was above the previous swing low is also the sign of a healthy trend. As long as many or all these signs are present, dont even think of counter trend trades.

The various kinds of reversals

Most traders are familiar with the reversal bar but such well formed reversal bars are found only in strong trend reversals, typically with obnoxious overshoots. Often you get Double top (b26,34) or bottom reversals, which many traders can spot. Occasionally, you get an inside bar reversal. These should only be taken if there is an overshoot and the entry still leaves room for a scalp to the other end of the outside bar. This is because large bars often act as trading ranges and there will be sellers above large bear bars and buyers below large bull bars.

For example the entry above b58 was exactly six ticks from the outside bar's high, making this a possible reversal bar if there was an overshoot. When there is no overshoot, these bars act as traps and you can sell below a bear setup such as the b62 inside bar. b67 did have an overshoot, but there was insufficient space above it. In fact, you would be buying the very top of the bear bar, which is a terrible entry. Regardless, it went up to become a 5tf. This could also be shorted at the inside bar b69.

The next and very important kind of reversal is the outside - inside - outside reversal we see at b73-75. When presented along with an overshoot, this is as good as a strong reversal bar. Normally the 3rd bar ticks above the inside bar trapping bulls in, then ticks below it trapping bulls out and bears in and then reverses up again. This kind of double trap results in a sharp move.

The last kind of overshoot is the inverse of the above, an inside - outside - inside reversal (b8-10). When present with a sharp overshoot as it did today, this also results in a reversal. For a bull reversal bar followed by a bear inside bar, you may want bears to be trapped before buying above it.

The ability to find high probability reversals allows you to hold your swing longer in addition to avoid getting in and out of low probability scalps.

First reversal vs first pullback vs first channel breakout

Day after day I post charts where the first reversal and pullback can be entered and held for a swing often till the end of the day. The first pullback is especially good for a profitable swing for at least the AM session. However, how do know which bar is the first reversal? Is it possible that b4 and b5 represent a first pullback that will continue to move to the bear side? Could it be a first channel breakout that has a high chance of resuming its down move?

Sometimes a reversal bar is obvious. Its almost the same size as previous bars and looks like a well formed reversal bar with at most one tick entry side tail (or 2t if bar is large). However many other days its not quite obvious. For example in today's chart is bar 4 not an obvious first reversal. However, any reversal that gives an entry beyond the first bar after giving a one point scalp should be taken. A second reversal can be taken if it is an obvious breakout failure of the other end of the first bar. If not, wait for a possible breakout pullback or hang on to your swing portion.

One strategy is not to take a questionable first reversal bar, but to then take the first pullback in either direction provided its a good setup. A trap in one direction such as b7 today also sets up an entry in the opposite direction. A good first reversal that ticks below a signal bar is usually good for another leg down (in essence turning into a first pullback trade) so reverse below the signal or even the entry bar. Typically if the first couple of bars are larger than 2 points (when average range is 10 points) or if the first two bars are up down or down up bars there is a good chance it will act as a trading range and you should look for either a failed breakout or breakout pullback when your first reversal tests the other extreme of the range as we saw yesterday.