The poor first reversal and triangle open

When a day opens right in the center of a previous day, the price will oscillate up and down trying to find resistance and often results in a trading range day. On such days taking every reversal is feasible if the swings are large (say 6+ points).

Usually, the price forms an expanding triangle as it takes out every new extreme. Occasionally such as today, we get a triangle breakout. Two lower highs interleaved with two higher lows form a triangle as we had at the open with b4,5,7,8,9 Triangle breakouts into trend often fail and turn into expanding triangle breakouts as we saw today but can result in a runaway trend if the open is on a large gap up or down from previous day.

When the first reversal is not clear as in b3 due to bear close, small reversal bar compared to previous bar and no overshoot of TCL, the price often fails after taking out the first bar as we did today at b13.

Once we got a poor A2 long at b40 that no one took, the trend basically ended and the best thing to do is to wait for a breakout. A late DP breakout at b78 may have started a late break into a down trend that may continue tomorrow.

The obvious first reversal

Days that have small trend bars that move 3 or more points from the open bar and reverse after a trend channel violation on a reversal bar that has at least a 2t body (regardless of color) are clear and obvious first reversals and should be taken. If the reversal bar is about the same size as the previous bar, it increases the chances of a successful reversal. These can be taken even if they do not have prior strength in the day as long as there is some indication of strength such as a prior attempt up (the gap) or strength from yesterday.

If on the other hand the first one or two bars is large, its possibly a trading range and you should look for an expanding triangle breakout into trend. When in doubt due to multiple large bars, if the second attempt in a direction fails, you can take a trade in the opposite direction. If nothing is clear wait for a breakout and then take the first pullback.

A clear first reversal is likely to bring in lots of traders and you can expect a strong trend in the new direction. A weaker first reversal may not go much beyond the first bar before it gives a pullback. So on most days, the first pullback is easier to read and safer to enter and you can avoid the first reversal completely.

oio reversals and failures

I've often spoken about how outside bars are trading ranges and are often fade candidates. I also mention oio reversals. How do you distinguish between a legitimate oio reversal and just a trading range bar?

There are several factors that may make an oio successful. For example prior strength, an overshoot, the two outside bars being of comparable length but the most important factors are the entry bar size and its low holding through pullbacks.

When the latter outside bar is large, the stop is too large and consequently many buyers will not enter, and those who do will use various money stops of 4t or 6t etc., in other words, these buyers are weak. If the entry bar is weak and its low is taken out as in b13 or gives a sell signal beyond its low as in b34, then its a high probability short.

If the entry bar is a strong trend bar as in b46 and its low cannot be taken out on multiple attempts, then the trend will terminate. A poor reversal signal b45 followed by a poor continuation signal at b51 is a sign of trend termination and one should be looking for breakouts into new trends at this point.

But until a trend terminates, oio failures are possibly your best bet to get into a hard trend move since they present such few opportunities to get in late if you missed the 1PB entries at b7 or b13.

Trend terminations and breakouts

Today's post addresses the second row of the nine transitions.

The easiest type of pattern to read in real time is a continuation and the hardest type of pattern to read is the breakout and for a variety of reasons. The most obvious reason is that most continuations succeed and most breakouts fail.  Breakouts can fail multiple times before they eventually succeed as was the case today.

Before you can read breakouts, you need to be able to detect when a trend has terminated into a trading range. The simplest and the easiest way is to look at the two recent highs and lows. If they are sideways, the trend has ended. Trends terminations (TT) usually have weak reversal signals that not many will take such as the poor oio reversal at b35-37 and give a weak continuation signal such as the bull bar A2 short at b44 that very few took. Trends can also terminate into TTRs or by eventually breaking a trendline. Although the trendline broke at b66, the trader should already expect a trend termination at the poor oio at b37 and confirmation by the weak A2 at b44 and the two legged failed breakout at b57.

The expanding triangle (XT) breakout is comparatively the easiest to detect and trade. An expanding triangle is simply a series of fBOs, each enlarging the range after trend failure. The trading range after trend termination begins with the reversal or climax pattern itself (b35 high to b37 low) and every move is just an attempt to expand the range. Once both ends of this pattern are taken out, you can take trades and expect them to move to the other end until you get both a HH and HL for a bull breakout or LH and LL for bear breakout into trend. Note that the breakout could be either up or down regardless of the direction of the previous trend. The HL or LH will usually be a two legged move and today the doji bar b70 separated the two legs down.

This point is the first pullback in the new trend and is the best swing entry for the rest of the trend.

Correctly trading a soft trend

The first step in trading a soft trend is to correctly identify it. Other than the first pullback, which can be deep, a soft trend's distinguishing feature is that pullbacks go only one or two ticks below a previous bar and usually fail to close below the previous bar. The second distinguishing feature is that counter-trend trades rarely succeed since most pullbacks overall do not go more than 4 or 5 ticks below the low of any bar.

The big difference between a hard trend and a soft trend is that in a soft trend, both pullbacks and breakouts do not go far for each swing.

Both hard and soft trends are traded the same way. In the direction of the trend only.

By bar 24 or so it was obvious that today was a soft trend and the correct way to trade this is  to buy above any bar with at least 2t body (regardless of color) after an L2 (failed L2 or fL2 entry). In the chart above, the red dots represent L1 and the blue dots represent L2. If you correctly enter your trades, none of your breakeven stops should be taken out as illustrated by the dotted lines. Entering above a doji bar or overlap usually means sitting through a pullback as with b47 and should be avoided.

Since your exits very closely map to your next entry, many folks will simply let it ride till end of day. This is usually takes experience not to get shaken out at the next pullback but its something a trader should try at least with 1 contract.

Wedges without overshoots, reversal bars or pullbacks

The ideal wedge has a clear overshoot on the third or fourth push and ends up in a clear reversal bar. The reversal bar's entry bar is a strong trend bar. A weak pullback gives a W1P that gives you an entry into the now reversed trend.

On trend days you probably will see a reversal like that. But on trading range days, you may have large swings that are best seen as 2 legs in each direction. None of the third pushes today resulted in significant overshoots, did not quite end in reversal bars and surprisingly sold off all the way down without any pullback. On days like this, you can pass up the wedge trades and simply wait for the next setup or if you are an aggressive trader, trade the third push as a W if it is a failed breakout.

The idea behind the failed breakout is that the breakout traders who buy above the previous swing high should not be able to make a scalp profit. You need a first entry that triggers and fails as in b18,b42,b65 and then a second entry comes into play very close to the previous signal. If the second signal bar has lots of overlap as in b44, you are better off waiting for a pullback above your entry bar and then taking the next signal. A very important requirement for a trade like this is prior strength in the new direction. A strong move in the later half of yesterday or early in the day are needed to enter this way or you may find yourself shorting a series of H1s on a strong day.

Keep the trend type in context while trading

Trends come in three broad varieties. The usual most common is the elastic trend, which snaps back and forth based on buying and selling pressure. Most traders expect every day to act like this and will lose big on the other two type of days.

The second type of trend is a soft trend which essentially maintains a slow grind (usually up) pulling back only a tick or two below previous bars. Shorting such days based on any standard setups is a recipe for bleeding your account every six bars or so.

The third type of trend is a hard trend day which moves (usually down) relentlessly. There are up moves, but none of them are worth trading since they take your focus off what you should really be doing: wait for a with trend move and hold till end of day or climax.

By the first two or three bars you should have already known that this was a hard trend day. And on hard trend days, there is only one rule: There are no counter-trend trades. Yes, the move from b15 to b19 was good but that was the exception. Most counter-trend trades lost today and almost any with-trend trade succeeded. The other interesting feature of hard trends is that overshoots need to be very deep to give pullbacks. And only an obnoxious overshoot with a large climax bar can terminate the trend. Hard trend days need to break and go into trading ranges before they can continue or reverse. On many days such as today, they will push relentlessly till the end of day.

There are very few entries from the perspective of a normal or elastic trend. Today we had the 1st reversal on bar 1. If you watched the bar forming, You would see it popped up 4 ticks in the first few seconds and then stayed down. A reversal bar off a sharp overshoot above a gap is a signal any trader should take. b5 was a 1st pullback and if it wasn't for the impending news which often runs stops is the best swing entry of the day.

If you missed that, there was an A2 on b23, which was also a good swing entry. The entire lunch move saw only failed H1s in a hard trend and you could short below any pullback that did not have a large tail. This takes some practice to do and I often let them pass. A final A2 at b75 gave 6 points. Its never too late to enter with trend on a hard trend day.