Determining continuation versus reversal

Often you may ask yourself if the trend has really ended or is this just a pullback. And if its a pullback, is it going to be a one legged, two legged or three legged pullback. Or perhaps its a channel down.

For example in today's chart is b25 a 2 legged pullback or was b19,b24 a double top that we should sell? The answer is simple. In the absence of a trendline break or trend channel line overshoot, always assume the trend is still on and go with trend. The wide overlaps make it difficult to take a price action entry above b25 or 26 or even b30. One option is to buy above the signal bar (b25 or 26 in this case) and allow one pullback below your entry bar. You could also buy part of the position at the expected pullback, i.e., below the twin bars b27,28.

On the other hand what about b46? Is that a W1P or just a leg up in a two legged move to the ema (eventually at b51). Whenever you ask yourself if this is a W you should ask if this was in any way an extreme move. The move from b31 to b37 was indeed a sharp move and tagged the trendchannel line but did not otherwise exhibit signs of a W reversal.

• There was no obnoxious overshoot. 
• There was no reversal bar
• The entry bar b38 did not actually trigger theoretical entry below b36.

It was indeed the third push up and there was a micro trend channel line overshoot, so this could still work like a marginal W1P. Often when the signs are ambiguous you may just get a deep pullback or a trend line break as it did today. Its perfectly alright to take a weaker W1P for a scalp or wait for the next entry.

B56 gave a two legged BP short of the ema. b54 had a lower high and lower close and divided the move into two legs. This is a very strong signal that you should take.

If for some reason you did buy above b51 assuming its an A2 long, the two legged move to b56 should tell you to exit or reverse.

Also keep in mind the overall price action context. The horizontal trading range between bars 19-30 could act as a magnet forcing any breakout to be pulled back into the area.

Pullbacks are just smaller trends in the opposite direction and an overshoot of its trend channel line or trendline break and test is the best way to determine if the pullback has ended. In general one legged pullbacks should only be taken in very strong trends, 2 legged pullbacks can be taken anytime unless the moves shows strength in the pullback direction (such as breakout bar). 2 or 3 legged (W) pullbacks can be taken if they show an overshoot. Most pullbacks that end at trendline or ema without breaking it giving  a good signal bar can be taken.

The rule of ten: A trading plan

You are a rank beginner and you have no idea how to start trading. This is my advice on how to get started. The first step is to trade on SIM only until you unlock the following achievements.

The rule of ten

1. At least 10 points every week
2. For 10 consecutive weeks
3. With at least 10 days of no losing trades
4. At least 10 consecutive winning days
5. Biggest losing day at most half of average winning day (i.e. if your average winning day is +2, your max loss day should be -1)

All the above proves is that your technique is right. You should now start trading real money. You will probably start to lose money right away. That's ok, because you know that your technique is right and you only need to work on your emotions. If you are entering a lot more trades per day than you would mark on the chart at the end of day, then you have to work on your emotions. Eagerness and impatience are signs of a losing inexperienced trader. Caution and patience are signs of an experienced winning trader. When you feel any urgency to enter a trade mark that on your chart and see how it went at the end of the day.

My best trades are A2, W1P, DP and fBO. You should start with A2 and stick to A2 only. Why? Because trying to trade W1P may trick you into seeing reversals everywhere. Similarly DP and fBO may trick you into seeing breakouts and failed breakouts everywhere. With A2, there is a very good chance the trend is going to continue.

Trading SIM is like juggling 4 flaming knives while riding a unicycle. Trading real money is the same, except a monkey sitting on your head and messing up your act. So the first thing you do is juggle only one flaming knife. A small one. That's A2. The next thing you do is get off the unicycle and stand on firm ground. That's basically watching only one chart, either the regular trading hours or 24 hour chart and nothing more. There really is not much you can do about the monkey, just hope he gets older and calmer with time.

Once you consistently make money with A2 and satisfy the rule of 10 with real money, add W1P only to SIM until rule of 10 is unlocked for it. Then you can trade both with real money. Then you can add DP to rule of 10 and finally fBO.

At this point you should be catching most of the big moves of any day, dont worry about any small moves you have missed. You can't hope to catch every move with high probability.

Finally you can choose to add the following: failed first channel breakout, G2, 1st pullback of the day, first reversal of the day, L1 and H1 on hard trends and expanding triangle.

Note that having a lot of trades in your toolbox is not the important factor. What is much more important is how consistent you are with any given trade.


See Also:


Trading plan: Trading Range day
Trading plan: Trend days
Trading plan: Hard Trends
Trading plan: Soft Trends
Trading plan: Spike and Channel days

Trading hard trends

Trading a trend with sharp moves and long bars is very hard since you get very few entries and every entry moves a large number of points. When you see two or three trend bars with very little overlap, you already know its one of these days. Often the best entry is the first pullback, which in the case of a hard trend like this is a special kind of failed H1 (fH1) that usually gives a measured move down. The harder the move before the pullback and the weaker the pullback as today, the greater the chances of meeting or exceeding the measured move. Often after the measured move is met there is a tight trading range, so I exit and wait for more price action. On majority of the days, holding a fH1 till the end of day can pay profitably as it did today.

But what if you missed the fH1 entry on b10 or exited with a couple of points?

One option is to short the close of every trend bar or its breakout. I personally find selling closes hard to stomach, since the pullback can be as large as the trend bar itself as with b13. My technique is to enter on any pullback and short below any small bar regardless of color until there is an obnoxious overshoot. Days like this nearly always have a huge bar with an obnoxious overshoot as in b31.

For example, shorts below b23, b26 were good entries. Aggressive traders would short any H1 expecting it to fail.

Once the sell climax occurs, the down move is over for a while and you should expect a pullback. This pullback does not have to go near ema but often tests the high of the sell climax bar. Usually this can be shorted at least once to test the low of the climax bar.

On days like these the best policy is to only trade in the direction of the primary trend since there is a very good chance there could be another huge move late in the day but very low chance of a sharp  reversal. For example although b62 had at least 3 reasons to buy, I would pass it up and only focus on short trades.

Optimal trading of breakouts and failed breakouts

Most breakouts fail and lead to a test of the other side of a trading range. Occasionally, the breakout succeeds and you need to enter it with trend on a pullback.

The following factors increase the likelihood of a successful breakout:

• Large breakout bar
• No overshoot of a trend channel line on the breakout
• Previous failed breakout on other end of the range
• A 2 legged pullback after breakout

A successful breakout is likely to move to twice the size of the range. For example, b63 broke above the afternoon trading range and gave a breakout pullback A2 bar b71 which moved to twice the range at b76.

A failed breakout on the other hand is likely to move to the other end of the trading range. For example, the failed breakout below b1 at b24 caused the market to turn up and test the high of b7.

So the correct way to trade a breakout is as follows:

If the trading range is small, as in the afternoon chop between b46 and b58, there is a very good chance the first breakout will fail. Scalp and reverse on the failure. If the range is very small, you may not even be able to scalp so just stay out till the range widens.

If the trading range is large such as the open move from b1 to b7, then you can enter on the failure if the failure signal is a bar of reasonable size such as b76. If the failure bar is large, enter on the first pullback as in b13 short or b29 long. You could scalp part and hold the rest until a breakout or test of the other end of the range.

Occasionally, the market will break a trendline and turn into a TTR as it did at b50. When this happens, its safe to get out near the top of the recent swing and wait for more price action. This is because a failed Breakout can quickly turn into a breakout and a deep pullback and you dont want all those profits to evaporate.

Large overlaps are trading ranges

Many days you will find signals made by large overlapping bars. Bars larger than recent bars should be faded, with the notable exception of breakout bars. This is because large bars ultimately overshoot one or many trend channel lines and will result in a pullback or reversal.

Overlapping bars are similar. They are trading ranges and there's a good chance their breakout will fail. Sometimes you get a breakout pullback but fading them using limit orders is feasible if there is a swing point nearby to place a stop under.

For example today, b2 was not particularly large but it was an outside bar, which often acts as a trading range. b3,4 provided a large overlapping area and there was a good chance a breakout from this would fail. If the b5 was a green bar, it would have been a clear first reversal. However I passed on this trade since there was a chance of another leg down to ema.

The breakout bar b8 was a legitimate large bar and if there was a small inside bar after it, it would make an ideal breakout pullback (BP) trade.

As with the rest of the day, you can see wherever there are large overlapping bars, their breakout was most certainly faded. Often the breakout will test the other extreme of the overlap after failing, which means you can enter a trade if there is at least a scalp distance away from your entry. The overlap at b28,29 for example, allows you to buy a tick or two below the overlap with a stop below b27. If a swing point is too far, you could use 2t above a strong bar thats in the direction of your trade. For example, to fade the breakout of b19, you could place a stop above b18.

When the distance is large for example with b58,59 you could go with a price action entry above b61. The other option of course is a money stop of 2 points.

I personally do not trade this way, but I do use this information to avoid entering into traps. Breakouts of overlaps are usually traps and if you are strongly convinced of your trade direction, take a second entry. For example, is b73 a pullback after a double top (DP)? Maybe, but due to the overlap, I would avoid taking this entry and wait for another one such as b77.

The very best trades

There were probably hundreds of trades today but today was a great sampler of my favorite trades. The first pullback (1PB), Two legged pullback near ema (A2), Double Top or Bottom and pullback (DP), first pullback after Wedge reversal (W1P). The biggest moves come from these trades, and I make sure I enter them when I can read them on time. Today I missed the DP on b54 and possibly the A2 or 1PB on b18.

Trading only these four will still keep you in the black even with a 50% success rate since they often go to +4 points.

Trading Channels

Channels should never be counter-trend traded regardless of what signals you may be reading into them. This is especially true for a channel that has just broken out of a trading range. Every L2 or overshoot is destined to fail if you take a counter-trend trade. This is because a channel is just a trend on a slower timeframe. One option is to trade the slower timeframe. The other option is to enter half a position on every pullback bar. When there is a first break of the channel, you could enter the other half. For example, you could buy the close of bars 13,16,18,23,26, etc. with a stop below the previous bull bar.

The safest and the correct trade however is to wait for the first channel break and enter with trend after a 2 legged pullback. First channel breaks are fairly safe to enter at the ema with a tight stop. After the channel break, your odds of successful counter trend trades improve.

The best move of course is to be in the channel before it begins. A 1st pullback entry above b7 or a breakout pullback entry above b13 would let you swing the move until the first channel break and test above it.