The monthly S&P500 Emini futures candlestick chart has not had a pullback in 14 months. This has...
A Great Trading Plan in Action (Part 1)
10/18/2011 8:00 am EST
This multi-part article series will review a well-planned and executed trade, explaining the various steps that paved the way for success and safe profits.
As a trader, there is nothing more fulfilling than watching a trading plan play out exactly as you designed it. As an educator, it is equally exciting to watch a student plan a trade and then watch that plan unfold, step by step, as the student artfully executes it. Let me take you step by step through a recent trade by one of our students at Market Geometry.
During a live training session I was running a few Mondays ago, we drew out the following map of the 240-minute AUD/USD (the Australian dollar against the US dollar):
When we sit down to chart, we begin with a blank chart and work our way, step by step, using market structure, the context of the market’s ebb and flow, and then add lines to build a market map. This is the method we use when we teach people to read the markets for themselves in our live mentoring sessions.
On this particular Monday, we began by noting and marking a “Sunday Gap Rip” had occurred. When markets first began trading literally 24 hours a day, from Sunday afternoon until Friday afternoon, gaps became less and less common occurrences, but the recent high volatility in the markets has begun spinning more and more gaps into the picture. Traders not experienced enough to remember how to deal with them have to do their homework to understand the implications of gaps and how to deal with these gaps.
One of the ways I have found to help traders think about open gaps is the “gap rip.” Imagine printing out a chart and ripping it down the middle, separating price into two discontinuous sections. You have two charts of the same commodity or currency but they are no longer connected.
When a market gaps open and the gap remains open, this is exactly what has happened: the price action was so violent it disconnected the current action from the prior price action.
The first open gap lower on the chart occurred on a Sunday opening and it not only disconnected the current action from the prior price action, it broke below prior minor swing lows to the left. At that point, we added a red major down-sloping Median Line and its parallels to give us the probable path of price. We then noted that after heading lower, price climbed back to retest the open gap area but failed to climb higher to test the red, down-sloping upper parallel.
When price broke back below the gap zone with a wide range bar, we added a green, down-sloping inside Median Line and its parallels that seemed to be doing a much better job interacting with price action.
Three bars later marked the end of trading on Friday. When trading resumed on Sunday afternoon, price gapped open lower once again, and the gap remained open, literally ripping the price action from the prior week away from the unfolding price action of the upcoming week. These are signs of a violent move lower. The sellers have a lot to sell and they are pressing to sell before price slips further away from them!
The last three bars deal with the price action on Monday, when we were hosting our live mid-day mentoring session. If you look above at the first open gap, I marked the timing of the horizontal consolidation with a dotted magenta line and then transferred it down to the current opening bar from Sunday night. This dotted bar serves to remind me that price consolidated for that amount of time above, at the prior open gap, before beginning its violent move lower.
I put it in place now because one of the Newtonian Laws we use over and over, as stated in the Emerald Tablet, “As above, so below,” generally comes into play in these situations (“For every action, there is an equal and opposite reaction”).
I will watch closely as price unfolds and I literally expect a violent reaction as price reaches the end of the magenta dotted timing bar.
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As I pointed out my feelings about this timing bar and its relationship to the “gap rip” to the members attending the live session, I also circled the confluence formed by the red, down-sloping Median Line and the green, down-sloping outer parallel and remarked that the area of confluence (or Energy Point) coincided with the end of the timing bar, and that the Energy Point would hit around Friday.
I told everyone it should be interesting to watch how price played out between the present (that Monday) and Friday. If it formed a mature structure with some horizontal consolidation, I would expect there might be a great opportunity to short this market on Friday if price had not significantly violated the open gap area.
I finished marking out the chart and saved it in my charting program so we could revisit it later in the week to see how price had unfolded. We also put this chart on alert as a part of everyone’s homework for the week.
As it turned out, we did not revisit this chart on Friday, though it was on everyone’s homework alert. But let’s see what one student did with the simple map I drew on Monday as Friday approached:
Though we did not revisit the potential trade set-up on Friday, at least one of our students did her homework! As Friday approached, she entered her limit sell order at 1.0370 in the Australian dollar with a 41-pip initial stop loss order.
She noted on her chart that price had consolidated in a horizontal fashion all week and there was selling pressure at the open gap area all week long. She placed her stop loss order above that selling pressure at the same time she placed her limit sell order and waited patiently as Thursday turned into Friday.
She was letting price catch up with the price action, and when Friday came around, she was rewarded with a fill in her limit sell order. She noted on her chart that she was planning on holding the position over the weekend. She also marked several potential profit objectives with purple horizontal lines, just below 1.02, around 1.01 and the last at 0.9925. Any of these objectives, if reached, would give her a solid risk/reward ratio that is, at minimum, well over four-to-one using a 41-pip stop.
Tomorrow in Part 2, we’ll see how the trade looked after the weekend.
By Tim Morge, founder, MarketGeometry.com
If you want to learn how professional traders plan their trades, we’re hosting a seminar on Saturday, October 22 via the Internet. You can see all the details by clicking here.
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