How a Professional Builds a Case for Entering a Trade (Part 3)

09/01/2010 12:01 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

(Continued from Part 2)

Has his patience finally paid off? He has the gun cocked; let's see if he is ready to pull the trigger!

Then “sitting in the weeds” looks like it may pay off for Carl. Price trades higher, but the price action as it retests the red, down- sloping upper parallel is “clumping,” or struggling. He also notes there is a well-known Fib retracement area just above where price is stalling, and there are probably quite a few orders from traders who use Fib tools as their main indicators to sell at that level. If you put this all together and you are Carl, it spells a trade entry signal he recognizes.

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He gets short at the retest of the blue, down-sloping upper parallel after price breaks below the bottom of the clumping bars. His initial stop loss order is just above the multiple tops made by the clumping formation.

His profit target? He'd like to get his money out based on the structure of the market, just above prior major lows and at the blue, down-sloping Median Line.

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He took his time and drew a very detailed market map. He was extremely patient, waiting to trade until he recognized what looks to be one of his “layup” patterns, the ones he relies on regularly. He framed out the trade in the context of the current market: This should be the pendulum pulling back to a quality sell area, and if so, a change in behavior is occurring. Price should now begin breaking prior swing lows. Let's see how he manages the trade now.

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You can see that after a handful of bars, price forms a wide range bar, falling all the way to the lower multi-pivot line. Were there buyers there this time down? Look at the close, well above the retest of that horizontal line where the Whales were buying before. That's generally a sign of large limit buy orders. Traders opened the door, peeked in, and ran back up the hallway, closing the bar quite a bit above the area where they found the orders resting.

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By the way, though it isn't marked on this chart, Carl is now working a breakeven stop loss. There is no closer structure he can hide behind, and price is now testing key support. Should it rocket out of the hole, he has collapsed his risk so he will lose nothing on this trade.

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Now Carl notes that even though there are large orders to buy at the red, horizontal multi-pivot line, price is no longer backing away; the buyers are not getting much upward movement. If they don't get upward movement in the next bar or two, they have two choices. First, pull their limit buy orders and let the breakout sellers get short, then buy with both hands and see if they can start a “wash and rinse” higher and trigger the stop loss orders on the new short positions. Or secondly, if price breaks through their limit buy orders, they can try to flip their position and go with the rolling market.

The next few bars are key here, and the market context tells Carl the real battle is at hand!

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Did the Whales pull their limit buy orders or did the market simply roll over them? It's too early to tell, but a “wash and rinse” would be in the back of my mind. But at this point, Carl has market structure on his side and a great entry price, so he is hiding his stop profit order well above the action, where any “wash and rinse” might take him out of his position prematurely.

Price has now zoomed the red, horizontal multi-pivot Line, as well as the inner quartile, the sloped line of maximum excursion. Price entered into new territory. As a mapmaker, what do you do? Do you continue to drive with no sign posts and no familiar territory?

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Carl realizes immediately that price is in an uncharted part of his market map. He pushes his chair back for perspective and immediately sees a down-sloping multi-pivot line that catches major tops to the left and projects it forward, then noticing that price is testing this multi-pivot line now. His profit target is well below this line and the market is rolling lower. He has a great price on his entry, and now he has both market structure and the current trend in his favor. He refused to chase price and instead waited in the weeds for it to come to him, giving an entry “close to the bone.” Now he has the luxury to manage the trade as price unfolds in front of him, and the smaller, normal noise of the market—the “squiggles”—shouldn't approach his current stop profit order.

More tomorrow in Part 4…

By Timothy Morge, president and founder, MarketGeometry.com

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