Giving Yourself Time and Room to Be Right (Part 2)
04/28/2009 12:01 am EST
Let’s look at another chart and see why traders are finding themselves stopped out of their positions in this situation:
As price makes new lows for the move, it “zooms,” or runs through, and closes below the Median Line. When price makes new lows, breakout traders establish new short positions by selling at the market, and at this point, these new positions have very little profit in them.
Once the selling dries up, price begins to pull back and many of breakout traders left stop loss buy orders above where they entered their short positions—and those stop loss orders are now being filled, driving the market higher. The rally after the new lows runs higher until all the stop loss orders are filled, then price settles back lower, making a marginal new low for the move.
Price has now closed below the Median Line three bars in a row, but it is making no progress to the downside. The traditional Median Line entry method would have been to sell a re-test of the Median Line as price re-tested it from below, but as I noted earlier, we have noticed that this entry set up has been degrading in quality over the past 18-36 months.
Also note that if you chose to sell a re-test of the Median Line as price approached it from below, there was no logical place to hide a stop behind prior swing highs.
Here’s a look at the pattern we have been testing, the “Lazy Z” pattern. Let me describe it for you:
- Price makes a new low for the move, zooming through a Median Line or a trend line.
- Because new short positions were taken by the breakout traders, a “wash and rinse” rally ensues, shaking out the “weak” short positions.
- Once the new weak short positions are washed out of the market, price goes on to make new lows for the move.
More tomorrow in Part 3.
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