The monthly S&P500 Emini futures candlestick chart has not had a pullback in 14 months. This has...
How a Professional Builds a Case for Entering a Trade (Part 1)
08/30/2010 11:41 am EST
As an educator, one of the best feelings in the world comes when you view a beautiful set of charts put together by one of your longtime students who brings together market structure, market context, and a simple, yet high-probability trade entry setup that plays out profitably once it is framed right. Carl has been on the Market Geometry forum for many years, has been to many of the basic Market Maps seminars, as well as our debut advanced Market Geometry seminar earlier this year. He has also been in one-on-one mentoring with me for quite some time. His trading has become more and more consistently profitable, but equally important, his ability to read, understand, and place current and likely market structure into a cohesive context has really taken his trading to a new level. Let's go through a set of Carl's actual charts that he marked as he began looking at this market, as this market unfolded, as he put together a cohesive trading plan, and as he executed his trading plan live.
This type of record keeping, even in a stream of consciousness form, is immensely helpful when any trader goes back to look through and judge their current thought process. I would highly recommend traders always document their trades, and of course, the more detailed the better.
On this chart, Carl is beginning to build his market map. The upper red horizontal line is a multi-pivot line that cuts through price action, and in a sense, highlights a potential change in behavior. You can see that price broke below a major swing low, far to the left, at around 89 cents in the Australian dollar, but was able to recover from the spike low to retest the multi-pivot line at roughly .9070.
When price fails to climb and hold above the multi-pivot line and begins to trade lower, Carl begins to play “What if?” He draws in a blue, down-sloping Median Line, using the extreme swing high of the move for his A pivot, and the recent major swing low and swing high as his B and C pivots. At this point, Carl is simply working on a market map. He's reading the market structure and putting it into context. He is far away from any thoughts of a trade; he is simply drawing out the boundaries of the neighborhood, so to speak, as he becomes familiar with the territory. This is what any good mapmaker would do when evaluating a new territory.
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Now price breaks below the shelf featuring a minor swing low. Note that Carl added a red, dashed horizontal line to mark this price action. You can tell by his comments on the chart that this break of the red, dashed horizontal line hasn't yet convinced him that a significant, tradable downtrend has begun. He is still playing what if, though perhaps his market map is becoming a little more readable as the price action unfolds.
Carl zooms in on his current market map and adds a set of up-sloping lines. He first connects a series of highs and lows with an up-sloping yellow line, then he copies the slope of the line and adds a parallel up-sloping line off the lowest low connected to his lower horizontal red line. He measures the distance from his lower up-sloping line to the yellow up-sloping line and then projects a new up-sloping line using the same slope and distance. Note that this simple technique projects forward where price will run out of upside directional energy—the high price makes as it tests the upper red multi-pivot line. Out of curiosity, he divides the distance between each projected line and his yellow center line.
The notes to himself say it all: By dividing the lines into quartiles, he sees the first dashed inner line catches a significant low, but before he gets too excited about one major touch, he notices the upper inner line, or upper quartile, isn't showing where price is running out of upside energy. These lines are projecting forward some frequency, but they aren't the entire story. It's just another puzzle piece he has put in place while fine-tuning his market map.
Price breaks below the prior significant low at the lower inside dashed quartile. It is now much easier to see that price is cascading lower, leaving lower swing highs and lower swing lows. He marks the last bar as a probable “zoom” bar, meaning it ran though the lower inside quartile and closed near its low, a sure sign of weakness. The probable path of price is down, towards a test of the red horizontal multi-pivot line.
You may note with interest that Carl has done a great deal of analysis and hasn't marked or mentioned anything that remotely sounds or looks like a trade idea. One of the practices we teach over and over during the Market Geometry sessions is to slow down! There have already probably been 100 potential trades if you tried to trade every squiggle since Carl began marking up this chart, but he is both trying to finish his market map and also looking for a high-probability trade that he personally uses, and so far, while he has done a great job adding market structure and defining the context of the current market, he is not yet ready to trade.
Price continues to head lower and is getting close to testing the lower red horizontal multi-pivot line. It's possible there will be large limit buy entry orders at the red multi-pivot line, but price hasn't come down to test it and “look behind the door” to see if there are “whales,” or large traders, looking to buy at that area. And as important, the double bottoms to the left where he began the red multi-pivot line would be forming his buy entry setup and he'd either have to put his stop below them or he'd have to use a cash or dollar-amount stop. We have shown time and again that stop loss orders are much more likely to remain unfilled when hidden behind market structure. In one-on-one mentoring, when a student finally begins relying fully on market structure to dictate where their stop and profit orders should be (because the whales will also have orders at or near those levels), their profitability generally increases nicely, and they marvel how often their stop was missed by two or three ticks or pips.
Carl's exact comment is “Can't do it; let's hit the layup,” which means he was considering the potential long, a “fishing expedition” for a long position in a downtrend, but the market map in front of him tells him that if he just remains patient, a solid entry will present itself. Too many traders feel they must trade if they are in front of their screens. If they missed entering the move down, they will fish for long trades as price continues to move lower. Carl is showing wonderful discipline and patience, and generally, the market rewards those who trade when they have an edge and stay out of the market when they do not. Carl is waiting to enter this market until he feels he has an edge (thus the term “layup,” or easy trade and high-probability trade).
More tomorrow in Part 2…By Tim Morge, president and founder, MarketGeometry.com
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