How a Professional Builds a Case for Entering a Trade (Part 4)

09/02/2010 12:01 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

(Continued from Part 3)

As Carl says, after a near vertical move, price tends to coil, or congest. He takes the time to update his market map further when he sees a new down-sloping Multi-Pivot Line above the current action. He is playing “What if” as he thinks through the current price action and updates his map. He is asking himself, “What is the probable path of price here?”

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As you watch this unfold, what are you asking yourself? Would you have mapped out the market? Had the patience to wait for a quality trade (remember, I said earlier there are probably 100 trades in the wavelets of this market), or would you have chased price and been stopped out several times, like most traders?

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This is where patience really pays off! If you, as a trader, rush into a position and have a poor or mediocre trade entry price, you need price to give you near immediate gratification. If you are a breakout seller and got short below the red, horizontal Multi-Pivot Line after it gave way, you have a poor entry price and may even be stopped out by now on this pullback, which is a natural congestion after a near-vertical pullback.

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Carl was patient, and this is a small squiggle that doesn't bother him at all. As he said, price is probably still going lower, but it will go down at its own pace. And since he framed this trade out beautifully and has great trade location, he has the luxury of watching while price “plays its cards.” There is no need for him to feel any sense of urgency.

Is this how you trade, or do you chase price and then pray the small pullbacks won't stop you out?

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As he watches price unfold below the red, horizontal Multi-Pivot Line, Carl updates his market map with a down-sloping red Median Line and its Parallels. This red, down-sloping Lower Parallel has been tested already, so it is probably carrying the frequency of the current price action. Note the confluence, or Energy Point, where the down-sloping Median Line intersects with the red, horizontal Multi-Pivot Line—it may come into play.

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Price doesn't make it higher to test the Energy Point; instead, it begins to cascade lower. And Carl's red, down-sloping Median Line and its Parallels seem to be doing the job. Carl's market map continues to do an excellent job showing the probable path of price.

Now Carl makes a very important reminder to himself: Price probably needed to rest, so relax and let it do what it needs to do. The ride lower may be slower than some traders would like, but price goes where it wants to go, and at its own speed. If you have framed your trade out correctly and gotten in at a quality level, this is the time when you want to make sure you look at your market map several times and relax! Price has slowed down, but there is no rush! Let it play its hand, and don't be in a hurry to move stop profit orders too close to the action (something I see traders do far too often) or get nervous.

You have a trading plan written down, right? Just relax and follow the plan!

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Carl gets paid well for taking the time to create an extremely accurate market map, for having the patience to wait to trade until he saw a high-probability entry set-up, and then framing out a trade based on the current Market Context and Market Structure. Then he followed his plan and because of his wonderful entry level and the accuracy of his Market Map, there was never any reason to be anxious as price cascaded lower.

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There is one extremely important piece of wisdom that Carl casually puts on this chart: He planned to take profit just above the prior Major Low, at the yellow horizontal line. That's how he framed the original trade, and when price filled his Limit Buy order, he comments, “We got our money, take a break and see what happens next!” He needs to restore the energy and focus he expended on creating this wonderful market map, patiently watching and waiting for his “layup” trade, framing it according to his market map and the then-current Market Context, and then executing his trading plan step by step.

Very few traders start out with a market map, many traders don't start out with a trading plan, and most don't frame their trades. Instead, they see the market moving and find a way to get in and try to find a profitable way to exit their new position. Compare that type of trading with the choreographed ballet Carl just performed! Many of the traders who are just trying to find entries are also entering new short positions or are adding to short positions because price has just had a one bar zoom below the prior Major Low. But beware the Whales! As Carl noted: “These moves often end with a big spike as someone pushes price to pick it up lower...”

Try and imagine what Carl is describing while I describe what happens behind the scenes, from a Whale's perspective: As price approaches a prior Major Low, price accelerates. Prior Major Swing Highs and Swing Lows are generally retested if price gets close to them because traders want to “look behind the door” to see if there are orders at the prior Major Swing Low or Swing High. Sometimes, Whales simply leave their orders at or in a zone surrounding the prior Major Swing High or Low. But sometimes, they actively trade the area, especially if these Major Swing Highs or Lows are being tested during their time zone and they are wide awake and ready to play!

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Carl comments, “Notice how all the trapped players from the zoom kept price down,” and by this, he means some traders tried to buy where the Whales bought the first time price tested the red, horizontal Multi-Pivot Line, and much to their surprise, the Whale or Whales had pulled their orders. It's also possible that a Whale decided to flip his position and push price lower, whether to actually get short or to buy back in at a lower level. You can see traders were trapped long, as Carl commented, because there were consistent sellers on every rally once price broke below the prior support at the red, horizontal Multi-Pivot Line.

Carl makes a comment that highlights a trick right out of my own Whale Trading tool kit: If you are a Whale and you want to build a large long position, you also don't want everyone else to be long! In fact, you want to wait to begin to buy until the market looks absolutely horrible…or you make the market look absolutely horrible! If you look at the last bar on this chart, it looks like price is going to zero. No one in their right mind would step in and buy a large amount—unless they had engineered that last bar by tipping price off a cliff so that every Stop Loss Sell order and every trader's Sell Stop Entry order that tries to make a living selling new lows has been executed. The long positions are gone and everyone who is still playing is short—and Carl hits it on the head: “If a Whale wants to buy down below, he'll make sure they can't get out!”

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If I am the Whale in this time zone, I push price that last few bars, then hold out my hands as the stop loss selling begins just below the prior Major Swing Low. And for a small moment in time, it will be raining Australian dollars right into my hands. And as I feel the selling begin to slow, as I feel everyone is nice and short and much more comfortable (and remember, price is now below the prior lows, so for that small moment in time, those traders feel they have finally caught up with the market and now the big move must be coming), I “pull the string.” They were right; a big move is coming.

More tomorrow in Part 5…

By Tim Morge, president and founder, MarketGeometry.com

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