How to Train Your Eyes to See Charts Like a Pro (Part 4)

08/19/2010 12:01 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

(Continued from Part 3 )

I see the blue, up-sloping Median Line and notice it caught the last touch of the upper multi-pivot line perfectly. Price tested it at the confluence of the Median Line and the multi-pivot line and ran out of upside directional energy—exactly where this methodology tells us it should. That means that after marking out Market structure (my first priority), then focusing on the context of the current market (my second priority), I added a set of sloped lines that caught frequency nearly perfectly (my third priority).

I should have all the pieces in place. Let's see if I can frame a trade!

chart

Click to Enlarge

There are lots of decisions to be made on this potential trade! To me, it is setting up as one of my favorite entries, a corner trade—one of the “bread and butter trades” I developed for my own trading and use on a regular basis. Corner trades work best on the bond and note markets and I developed them to be extremely high-probability trades, so using smaller risk/reward ratios are acceptable to me. My statistics show that price gives me the minimum target of eight ticks on corner trades 80% of the time when they are taken at areas where price should run out of directional energy. Market structure and context are really the keys to correctly identifying these trades: If price is clumping or grouping, but there is no market structure or context to support an entry, it has a much lower probability of success.

I don't like taking corner trades when the risk is over six ticks, though I have taken them with an initial stop loss order of eight ticks, if the circumstances warrant the smaller risk/reward ratio.

Let's evaluate the situation as I see it:

  1. Price is forming a clump, or grouping at an area where it should run out of directional energy, as well as at an area where it has found prior support: The lower multi-pivot line. This is a classic corner trade entry setup.

  2. The minimum price target, eight ticks, is at the double tops, so price will not have to take out the double tops before I either take my eight-tick profit or move to a breakeven stop loss order, collapsing my risk.

  3. Should price break above the double tops, the larger traders (AKA “whales”) should try to push price higher to fill the current open gap at 123 28, allowing me to consider taking partial profits just before that, at 123 26.

  4. If the open gap is filled, the next logical target would be just below the prior swing high, when price tested both the blue, up-sloping Median Line and the upper multi-pivot line at 124 16.

  5. Median Line theory tells us price should make it back to re-test the Median Line 80% of the time once it starts to break above market structure. By breaking above market structure, price is showing us there are buyers in the market. If price ran directly to the Median Line in the next bar, price would intersect with it at 125 03.

  6. The one negative I see in this potential trade setup is the size of the initial stop loss order. I always try to place my orders above or below market structure to allow the buildup of limit entry or limit exit orders from the whales to act as a buffer for protection. In this case, I will have to use an eight-tick stop loss order to hide underneath the one “poke” below the lower multi-pivot line. This is as large a stop loss order as I would use on a corner trade entry, and I am unlikely to take the trade if I am only interested in taking my profits at the minimum target of eight ticks. To take this trade, I have to feel it is realistic to set my profit target at one of the higher areas of perceived resistance.

How would you frame this trade? Is it worth the eight-tick risk, which is $250 per contract?

More tomorrow in Part 5…

By Tim Morge of MarketGeometry.com

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