The classic A2

Today's post is regarding continuation in a trend and represents the top left corner of the nine transitions.

A 2 legged pullback that gives an entry just above or below the ema is called an A2 (for 2 Legged move to Average). The ema used by Brooks system is a 20 bar exponential moving average. A well formed A2 looks like the one from bars b12 to b20.  The move is mostly trend bars and there is a clear trendline break of the pullback at b16 and a second leg down to b20, which closed strong.

Not all A2s are that clear. Sometimes it may be as simple as 2 failed attempts to turn down such as the move from b31 to b35. b32 tried to fail the new high and so did b35. The bars were dojis, which are trading ranges. Normally A2s that are made hard to read dont go very far and are best passed up. The only exception is during a soft trend day when every entry is an A2 made of overlapping bars.

If an A2 is not made of good looking bars, you may wish to wait for an additional confirming signal to increase its chances of running for a swing such as a double bottom or G bar. For example, b50 was a G2 bar in addition to being an A2 long entry. Since G2 itself is a high probability trade.

Exiting a swing position

"Profit often, profit early" is a good principle on how to exit your positions. You should always exit one contract at +1, this gives you strength to hold through a pullback to breakeven or slightly below since you wont be fretting over lost profits or fear a good trade turning bad. Exiting additional contracts at +4, +8 and +10 with a stop below the previous swing low is a good practice and is practiced by many price action traders. Today's post represents the top central orange cell labeled 'TTR' in the nine transitions.

Today presented very few low risk entries and the earliest entry was the 1PB at b6. You could hold it till the end of day, but often the market tells you it may not pay to hold till the end of day. Today presented some of these signs that should not be ignored.

A healthy trend prints strong trend bodies. When it can no longer do that and tails and overlaps dominate, you should watch for trend weaknesses such as trendline breaks or climax bars.

The earliest sign was a possible horizontal FF from b14 to b16. The fact that its breakout on b17 failed right away was a sign to exit on strength. The shrinking bodies and growing tails approaching a trendline that has been tested at least four times already signalled a possible trendline break which we got on the move down to b23. Since this was a first trendline break after a sharp move, a test of the HOD was a high probability event. If you entered above b6 today, you could try to exit at 1319.75 giving you +6. The price crossed it by one tick and turned down into a reversal bar.

As I have noted before, an end of an up move does not automatically mean you should reverse your position. Often strong trends give horizontal flags that later break in the direction of the original trend. However, sometimes it breaks in the opposite direction as it did today and the right thing to do is to exit and wait for more price action.

Developing your trading skills

Having a trading plan and having a list of best setups does not guarantee trading success. Practically everyone knows common setups such as entering near ema or trendline in a trend or fading breakouts in a trading range. Yet most people lose money trading. The reason is that learning to trade is not like memorizing a phone number, but rather like learning to swim. You can read all you want about various swimming styles and how your arm should cut into the water at the correct angle, but once you jump into the water, you may come close to drowning the first few times.

Trading the same few setups repeatedly is a far better trainer than doing everything you may have heard of or read about. Even if the best trader in the world tells you his best secret, you will still lose money until you have traded the setup often enough to master it. The setup is irrelevant. Your practice and mastery of it are far more important. Learning to trade is about working on yourself, not about gaining some magical secret that will make you rich.

Some people are just not cut for trading and will ultimately give up or go broke.  The mindset needed to be a trader can be developed by practice, but for some its part of their very nature. The following characteristics define a good trader:

• An appetite for risk
• A tolerance to loss
• An understanding of probability

An appetite for risk does not mean you love gambling. Risk means you are able to put something on the line to get something of higher value. When you fly on a plane, you are at a tiny risk of killing yourself. However, the risk even though severe is low enough that it does not bother you and the reward is high enough that you are willing to take it. The first time when you board a plane, it may have caused some excitement and terror but flying repeatedly removes the emotional element of air travel.

In the trading world, your risk is the distance between your entry and stop. It is smaller, but much more probable. You should be willing to lose that much without undergoing grievous emotional stress. If you are very risk averse, you will ultimately fail in trading.

You will have periods in your trading life where you have periods of extended successes and extended losses. A tolerance for loss means more than just being able to bear it. It means you have planned for this in your trading plan by perhaps having a second job or sufficient money put away from your good years. You should be able to go back to your notes and read them and maybe switch to to SIM trading for a few weeks until you get your mojo back.

All setups no matter how good will occasionally fail, and sometimes they will fail repeatedly. You need to understand that the risk you take and the reward you expect will pay off eventually and repeated wins and losses are to be expected. If they are causing you distress, you need to back off and switch to SIM trading. When you are distressed, you are on tilt and are more likely to blow your account.

The relationship between risk and probability is this:

reward * probability >  risk

OR

reward > risk / probability

So if your winning percentage is 50%, and you are expecting to make 4 ticks, your risk needs to be less than 2t. Another way to look at this is that if your winning percentage is 50% and your risk is 8 ticks, you need to make at least 16 ticks to just break even.

This is one reason I stopped taking any entry that is unlikely to give me at least 4 points. As you work on your winning percentage, you can take trades with smaller expected moves.  Once you understand this math, you can trade with confidence knowing that eventually you will be profitable as long as you follow this simple rule.

To summarize: Trading is a skill you acquire and you practice is key. Start slow and small and work your way to success.

First Channel breakouts

First channel breakouts are a high probability entry if you can correctly identify them. I usually end up not taking them, because I'm already in a position due to a prior entry and have just exited my scalp portion a few ticks ago. It does not make sense to re-enter unless the price action has shifted significantly.

The correct way to enter a first channel breakout long is if the price triggers above the bar that broke the micro-trendline. Therefore for the channel from b34 to b42, since the bar b43 dipped below the prior bar, an entry above it is a high probability entry.

On the other hand for the channel from b20 to b25, the channel was broken by b27, but a long above it was not triggered. A second bar that dips below the prior bar is more likely to be a 2 or 3 legged pullback or barb wire and you should not be buying above b28.

The move eventually gave two failed extremely poor sell signals, a doji reversal at b29 and a 1t ii short at b32 both of which failed and turned into an A2 long. Although technically the b32 ii is a possible long signal and would make it an A2, its such a poor signal that very few traders took it. If you did take a poor signal, you need a money stop of 8 ticks (which was not hit).

Prison Break: Breakouts from horizontal flags

Horizontal flags with alternating up and down bars (like the bars of a prison cell) often produce violent breakouts. Predicting them correctly is quite a challenge. Often there will be multiple breakouts that all fail until one of them breaks suddenly and moves many times the size of the flag.

Horizontal flags can also act as magnets and the move often retracts back to the horizontal area. So if you get a reversal, you should at least exit if not reverse your position altogether.

Like all breakouts horizontal breakouts are also best traded as breakout pullbacks. This article represents the yellow boxes in the first and third columns of the center row in the nine transitions.

Be aware that trying to predict breakouts is extremely risky, and usually you are better off taking a breakout pullback. Sometimes there are no breakout pullbacks, and you just need to let it go.

For example b6 broke through the flag and although it looked like a poor reversal bar with a large overlap, it failed to breakout of the other side and gave a sharp move down without any pullback to enter with trend. 

Another horizontal flag during lunch hour also showed a similar breakout. The first breakout at b42 broke above the previous swing high of b37 and failed to break below the swing low of b40. This made the DP entry above b54 viable or you could just take the BP at b61.

Horizontal flags generally break with the prior trend and away from the ema rather than across. Since yesterday's final move was down, todays opening flag should also break down. Similarly the lunch flag should break up.

Breaking Bad

The precise determination of the direction and entry of breakouts is one of the hardest aspects of trading. Even when you can get the direction right, many traders often get stopped out before the market has the eventual big breakout.

If you can get in correctly, you stand to gain the best risk to reward ratio. This has led so many traders and algorithmic programs to concentrate their efforts on correctly detecting and entering a breakout. Today's entry represents the fBO or center square in the nine transitions.

Many traders concentrate on entering on breakouts and many others on fading breakouts since most of them fail. The truth is that breakouts in a trend usually succeed and breakouts in trading ranges usually fail. Even then, occasionally breakouts do succeed from a trading range and thus trends are born.

If you look at the chart from today, b3 was a possible first reversal and b8 was a possible first pullback. It was a tough trade to take since the signal bar was a one tick bodied inside bar with a large tail forcing you to buy in the middle of the range. A second entry for the first pullback at b21 was a much more decent entry but at this point, the trader finds himself in a trading range. At this point, the correct thing to do is assume every breakout will fail as we saw today:

• b37 attempted breakout of b21 swing low failed
• b50 attempted breakout above BW failed
• b52 attempted breakout below BW failed
• b65 broke above 3 swing highs, but eventually failed
• b74 breakout below triple bottom failed.

Many successful breakouts are a result of a failed breakout on one side of the trading range or a double bottom pullback on one end of the trading range. Today we had a marginal double bottom pullback at b52. What made the setup deficient was that the pullback after the double bottom was not sufficiently deep. This entry forced a buy in the middle of the range 3t higher than the double bottom entry and certainly closer to a recent swing high. A successful DP usually gives an entry close to the original double bottom entry and dips nearer to the double bottom. Another important clue that this DB was likely to fail was that the breakout happened on the third push with an overshoot. Normally for a breakout, this is OK if there is follow through. If not, its time to exit or reverse your positions.

The hardest thing about trading breakouts is that they mentally condition you to expect a certain type of move and you end up taking a marginal entry. For example, after the double bottom at b37, I was expecting a DP, and correctly read the failures of b47 break up from BW and b51 break below ema but ended up taking b52, despite it being marginal.

Trading failures on the other hand is far simpler. You could have traded every failed breakout in the list above and done very well today. And if for some reason the failure fails, you could always reverse and go with the breakout pullback.

Detecting and trading extremely strong trends

Folks who are used to trading with indicators often destroy their accounts shorting all the way to the top on a very strong trend day. Learning to identify a strong trend and going with it instead of against is very important to your trading success.

One of the biggest signs of a strong trend day is a large gap. Anything larger than half an average day is a large gap and you should be on the lookout for a strong trend move. Average to small size bars is a good indication this will be a strong trend day. A first pullback (b3,4) instead of a reversal is another indication the price wants to move up. A 1tf of the short entry on b4 is another indication of strength.

At this point you should be buying any pullback for any reason. A second one tick failure at b9 indicates a very strong day and you can even buy the low of any inside bear bar on limit as long as the bars are reasonable size. You can also buy above any bull inside bar to take an H1 entry. You can continue to do this until there is a strong trend break. However, when the bars get tiny, there is a real chance of a TTR, which simply a trend ending where an up move turns sideways and is part of the nine transitions. Buying only above bull bars reduces your chances of buying in the middle of a TTR as does buying after a deeper pullback since TTRs are normally shallow.

What about wedges? is b11 a third push up and therefore a wedge? The single most important thing to remember about Wedges are that they will not pullback without an overshoot and they are best tradeable after a trendline break. Therefore, b11 or even b20 should not be expected to give a large pullback. b43 was possibly a W since the move from b20 to b23 could be a marginal trendline break and it did overshoot a tick or so. However its a poor W without an obnoxious overshoot on a very strong day. Even though it did move 3+ points down, it was a harrowing move for nearly two hours. However this move did give a strong break of the trendline and the next W at b77 is more comfortably shortable.

The most important point to note about trading days like these is that you should have identified a strong trend day decided early in the day to only trade long or just enter after a deep pullback and swing till an obnoxious overshoot or strong trendline break.