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Wednesday
Oct272010

Charting the E-mini S&P Using Advanced Techniques

We focus on two very important things at Market Geometry: Our first priority is to help people become consistently profitable traders; our second priority is to teach traders to think about and manage trades like a seasoned professional trader. I have been a professional trader for forty years and I have been mentoring other professional traders since 1987, and I try to approach every person that approaches me to learn to be a better trader, no matter their level of experience, with those two goals in mind.

It always gives me a great deal of pleasure to watch someone I have been teaching mature into a full time professional trader, and I am proud to say there quite a few traders making a full-time living after either beginning their education with me or after I spent time with them correcting the barriers that had been keeping them from being consistently profitable.

One of the traders I am particularly proud of is Shane Blankenship. Shane spent many years asking questions on my free public forum, then took my Basic Market Maps Seminar and eventually entered one on one Mentoring with me. You can see Shane these days showing his charting and trading skills alongside mine each day at Market Geometry - He became such a wonderful chartist and trader that when I recently moved to Arizona, I brought him to Market Geometry to help me with the daily live Mid-Day Market Geometry Mentoring sessions. He's been with me six months and become indispensible. In this article, I am going to show you my re-creations of a week's worth of charting of the E Mini S&Ps Shane showed members live in our Mid-Day sessions, because they tell how a profession approaches the market, prepares and waits for a trade entry, then executes the planned trade flawlessly. He embodies what I try to teach at Market Geometry, and I hope you find this set of charts and the story behind them from a recent week in the E Mini S&P futures interesting and informative-I know I did!

  Shane generally charts day only five minute bar charts of the E Mini S&P futures; this means he is often staring at gaps created from the overnight action. Many traders do not like to deal with gaps or have trouble dealing with the meaning of gaps but Shane finds that gaps carry a great deal of information that he can use when 'Mapping' a market.

I tell this story to my students often to encourage them to think 'out of the box': In the early 1980's, one of the largest currency portfolio managers in the world kept three separate sets of data and charts for each Major Area of the world: He would keep data and charts on the New York currency markets, a separate set of data and charts on the Tokyo currency markets and a separate set on the London markets. Odd as it sounds, he would take positions based on the eight hours of the New York markets, positions based on the Tokyo market hours and positions based on the London markets; and yes, at times these positions conflicted. His thinking? Each of these Money Centers had flows that had to be dealt with and his data,  charts and positions were based on the flows for each of the three Money Centers.

Back to Shane's chart: The majority of the money that flows through the U.S. stock markets flow when the U.S. 'cash' markets are open, and they are best represented by charting day only session charts. Another way to represent the flow of cash that is popular with larger traders like myself is to chart day only futures that begin at 8:30 am CST and end at 3 pm CST, which mirrors the beginning and end of the New York Stock Exchange's main hours and the majority of the U.S. stock market cash flows as well. I personally like to chart 13 minute or 39 minute day only charts that begin at 8:30 am CST and end at 3 pm CST, because it gives me a unique look at the U.S. stock market [Yes, I ignore the final 15 minutes of trading of the E Mini S&P futures on these  charts, because the cash stock market has already closed]. But these are my re-recreation of Shane's charts.

As the week opens, and Shane prepares his charts, you can see that the market left five days of price action above the current price action, on day only charts; this formation, until closed, weighs heavily on the markets and you can see price sold off quite sharply on the following two opens. This chart ends on Friday's close.

Shane begins by connecting the extremes of the Open Gap, using a Simple down sloping Trend Line.

Next he looks at the action from the last two days of the prior week and notices an up sloping Simple Trend Line that connects three pivots [a Multi-Pivot Line] and adds that to his chart.

Now he begins to add potentially important details to his 'Market Map'. First, he makes a copy of the red down sloping Simple Trend Line and transfers it to the morning's high of the same day - and notices it catches the close of the day as well; he leaves this new parallel Simple Trend Line on the chart and measures the distance between the two lines.

Can you guess why he would be interested in the distance between the two down sloping parallel lines?

Remember, Dr. Andrews and Roger Babson were students of Sir Isaac Newton, who was a well known Mathematician and Physicist. But Newton was also the most well-known alchemist of his times, and although the term 'alchemist' has fallen in stature these days, most well-schooled scientists know that the alchemists of Newton's days, as well as those that proceeded him, laid the ground work for our most powerful scientific principles. Newton's work, in particular, holds many of the the keys to modern physics. His simple Three Laws of Motion spurred the work of Albert Einstein and Stephen Hawkins and continues to spur Physicists around the world more than 200 years after they were written. And most physicists believe his inspiration came from a treatise written at least several thousand years earlier, 'The Emerald Tablet'. Newton's translation of this simple alchemical work is still used as the best and most useful translation. When we look at its most well-known phrase, 'As above, so below', we may be looking at the inspiration for Newton's best known Law of Motion, 'For every Action, there is an Equal and Opposite Reaction.'

I marked where price interacts with these lines to make it easier for you to see why Shane might use these types of projections, as well as to spur you to ponder how these same lines may come into play later.

Shane measured the distance between the parallel down sloping lines and then projected that distance forward [or downward, in the probable path of price]; then he placed a Simple Trend Line with the same slope at that distance. The original red down sloping line was the Center Line, the line that captured the frequency of price-it was a Multi-Pivot Line as well. The Simple Trend Line above captures the first swing or pivot prior to the Center Line; this measures the amount of energy price can carry forward from the Center Line when it 'Reacts'. And of course, by projecting forward a line with the same slope with the same distance below the Center Line,  Shane now has a first Reaction Line, where price will have spent an 'Equal and Opposite' amount of energy; as Newton translated: 'As above, so below'.

Still working on his 'Market Map', Shane performs the same exercise with the up sloping blue Simple Trend Line: he copies the slope of the Simple Trend Line drawn from the low of the Gap Opening and adds a new Simple Trend Line with the same slope to the high of that day; this will serve as his Action Line and the original blue up sloping Simple Trend Line-also a Multi-Pivot Line-acts as the Center Line. Now he simply measures the distance between the two lines and projects it forward [in this case it projects below price, because that is the probable path of price and the natural path of a 'Reaction'] and then adds a new Simple Trend Line at that distance, below the current price structure. This new blue up sloping line will act as the Reaction Line, a measure of where price will have expended its reaction energy off of the Center Line, should it continue lower-and so it is named the 'Reaction Line'. He also adds a second red down sloping Reaction Line [I'll label it R2] in case price continues much lower.

He then adds a horizontal black Simple Trend Line - a Multi-Pivot Line - that connects the high of the Open Gap and a handful of upper pivots.

Shane has his Market Map for the upcoming day and is ready to see the opening action-and ready to look for the high probability trade set ups he uses when he trades this market in this time frame if one begins to develop.

This chart shows a zoomed in version of Shane's Market Map, along with the first five minute bar of the day session; when this bar closes, it is 8:35 am CST on Monday morning.

I highlighted two particular bars - both wide range bars and both bars that gapped open quite a bit to the down side. Note that in both cases, once the 'morning imbalances' are smoothed out by the market makers in the U.S. stock market, both in some individual stocks and in some large portfolios, the selling dries up. Then the larger traders, the Whales, begin buying out right, pushing the stock indices higher. They are trying to drag mid-sized and smaller retail players into having to chase these markets higher, in case price does indeed go high enough to fill the Open Gap. Look at the close on both extremely wide range bars: Price closes at or near the bar's highs.

But let's look carefully at Shane's Market Map. Remember the blue up sloping Reaction Line he added before the market opened? This up sloped line was based on a Multi-Pivot Line, in this case a Center Line, and the distance from the Center Line to the prior high pivot, which he had used to form the Action Line. As Newton would say, 'As above, so below'. Look at where price turned after the extremely wide range lower gap: Right at Shane's blue up sloping Reaction Line. And that's why he projected that line forward: 'For every action, there is an equal and opposite reaction' and if price sold off on Monday morning, an equal and opposite reaction from the Action Line, projected from the Center Line and its frequency was reflected by the up sloping blue Reaction Line. But that's far from the end of projections contained in Shane's Market Map.

I have been researching and teaching the concept of Lines of Opposing Forces, or Energy Points, for quite some time; I am proud to say it's one addition I have made to Technical Analysis. These Energy Points act as Price Attractors and often serve as areas where price makes a 'Change in Behavior'. I don't use them to anticipate turns in Price; instead I mark them and watch those areas carefully for price to exhibit Changes in Behavior.

In this case, you can see that Shane's red down sloping Second Reaction Line [R2] and his up sloping blue Reaction Line [which are Lines of Opposing Force or Lines with Opposite Slopes] cross at the area that coincides where price does indeed Gap Open - and price shows a Change in Behavior by forming an extremely wide range bar that closes near its highs. In many ways, you can think of these Lines of Opposing Force projecting a sense of a time where Price MAY exhibit a Change in Behavior. And in this case, Price and Time came together, and a Change in Behavior seems to be happening.

Although Shane's Market Map going into Monday's trading was 'picture perfect', he did not see a high probability trade entry set up that he uses on a regular basis to allow him to enter a trade. The majority of traders feel they must have an open position if they are watching the market; successful professional traders learn they survive and prosper by taking trades that have a successful outcome for them on a consistent basis. There are often days that go by when they 'know' where the market is likely going, but they have no edge, no acceptable money management stop or they don't see a high probability trade entry set up they use - and so they don't take a trade. We have seen that when we show live action and 'bar by bar' replay during our Market Geometry Live Mid-Day sessions, mid-sized and retail traders find it at first surprising that we watch without positions even when our Market Maps are so accurate that particular day and then they find it comforting, because it takes some of the pressure off of them to always have a position any time they are in front of the screen watching the market.

At the end of Monday, Shane made a single addition to his Market Map from Sunday night: He added a green up sloping Median Line [or pitchfork] to project the probable path of price if Monday's Gap Open Low was indeed a significant low and price continued higher Tuesday.

Tuesday, Shane took a personal day away from trading and wasn't present at the Live Market Geometry Mid-Day Session. But we all peeked at his Market Map from the night before to see if it had any relevance to Price. You can see that price Gapped Open higher, above the blue up sloping Center Line, above the red down sloping Reaction Line, above the green up sloping Median Line and above the black horizontal Multi-Pivot Line. If you push your chair back and look at the chart, you'll see Price gapped open above an area where these all meet or clump together - And you should consider this a form of Energy Point. This area is a Price Attractor, but you have to watch Price for it to tell you how it is going to react at this Energy Point.

Dr. Andrews, one of my early Mentors and the person that gave us Median Lines and did years and years of research on Action Reaction Lines, taught that if price zoomed through a Median Line, it would come back and test the same Median Line. This is one of the high probability trade entries we teach at Market Geometry, after we put in countless thousands of hours of research on various Median Line trade entry set ups. Now that price has gapped or zoomed above the Median Line, you can buy the retest of that Median Line; in this case, there was no acceptable initial stop loss at this point, so I would personally pass on the trade. But Price has left a poke with a double bottom formation that did recently test this up sloping Median Line. IF price retested the Median Line again within the next three to five bars, I would buy a retest of the Median Line [and in this case, a retest of the Multi-Pivot Line and blue up sloping Center Line as well] with a stop roughly five E Mini S&P ticks below the prior test, which was the low of the day.

This is a set of Shane's Market Maps from the week, but I could not resist showing the gorgeous trade opportunity he had prepared for when he did his Market Map the night before; again, he had personal business to take care of, and did not trade this day. But this is how I would have traded his Market Map [I could have written that Shane took this gorgeous trade or that I took it, but again, our focus at Market Geometry is to teach people interested in trading how to trade and manage their trades as professional traders - and there are simply days when you have other things to do, or you miss a set up. There's no shame in that! That's life as it really is! I know showing potential trades we missed or losing trades, as well as teaching people how to set up Market Maps and become consistently profitable traders takes a great deal of emotional pressure off of them; professional traders miss trades. There will always be another trade. And even the best professional traders have losing trades 35 to 40 percent of the time. If you can keep your Risk Reward Ratio high enough, you can make a very good amount of money with a winning percentage approaching fifty percent.

I note the high Risk Reward on the potential trade set up [6.5 to 1] and I also note that when price did turn lower on the day, it was right at the red down sloping Center Line from Shane's Market Map, a line he added to his charts Sunday night.

The cascade continues lower to test the black horizontal Multi-Pivot Line that begins with the original Open Gap; what was resistance has clearly become support and you can see though price tested this horizontal line, it then turned higher early Wednesday morning and climbed back to retest the red down sloping Center Line that had stopped the rise in Price the prior day, Tuesday. Shane waited patiently for a trade set up he recognized and he didn't see one until late in the day on Wednesday.

When price began to show weakness by breaking out of a tightly coiling or congesting formation to the downside, he added a new down sloping Median Line. Although there was only a bit more than an hour to trade, he wanted to sell a test of the Upper Parallel IF price climbed back to test that high, with an Initial Stop Loss order above the high of the day. His Profit Target would be the down sloping Median Line, which was more than ten E Mini S&P points below where he wanted to enter, so this potential trade would have a Risk Reward of about three to one.

The sell off accelerated and never let Shane into the trade. You can see that even with just over an hour left to trade in the day, the 'imbalances' pushed Prices quite a bit lower; he had the right idea but sometimes, Price doesn't allow you to enter at a price with an acceptable stop loss -  and chasing price in a running market is usually a losing proposition. Again, we strive to teach traders to trade and manage their trades as professional traders manage their trades. Sometimes you have the right idea but can't find an entry with the right Risk Reward Ratio, or the Initial Stop Loss is too large for you or Price doesn't let you in; don't waste your focus being frustrated or angry! Prepare for the next trade - There will always be another trade opportunity!

Thursday also brings no action that Shane finds interesting enough to open a trade in the E Mini S&Ps. But by Friday's Live Market Geometry Mid-Day Mentoring Session, he is watching and carefully watching an area where IF price is going to exhibit a Change in Behavior, it will probably be here. This is the price area, off the original Reaction 2 Line, where the early week rally began. Price has left some markers, triple tops and a Multi-Pivot Line connecting some bottoms and tops, that Shane is watching closely. If he sees Price show strength and can find a trade entry set up with an acceptable Risk Reward and Initial Stop, he'll attempt a trade in this area.

Once price breaks above the triple tops, Shane feels confident the Original Reaction Line 2 will hold, as it did earlier in the week. He diagrams his trade out live in the Mid-Day Session. This trade will have a Risk Reward of four to one, which is quite nice. Risk Reward Ratios above three to one really help keep your trading account balance healthy.

Now Shane has to wait to see if Price will fill his Limit Buy order and give him a trade, winner or loser, in the E Mini S&Ps this week.

Price finally let Shane into a trade in the E Mini S&P futures just after the Live Market Maps Session ended Friday afternoon. He netted seven E Mini S&P points on this trade - which had a very nice Risk Reward Ratio of four to one. And although many people might think he spent the week kicking furniture because of missed opportunities, he had several nice trades in the U.S. Ten Year Note futures, so in truth, he had a very nice week trading.

I hope some of you take away an understanding that the market does what it wants and using your focus and energy being angry about not getting filled or about being away from the screen when a trade you were stalking finally hits - and you miss it - is only a waste of your focus and energy. Professional traders live with this day in and day out; those that are consistently profitable learn that this is a part of trading. How do we deal with it? We make our Market Maps, study the markets, do research, and manage the trades professionally that the market allows us to enter.

I hope it was interesting watching an entire week's set of charts and potential trade entries from a trader that I taught and mentored. He's now a full time professional trader and I certainly respect his charting abilities, as well as the way he has mastered himself, which is the most difficult part of becoming a consistently profitable trader.

That's why my tagline since 1987 has been:

"Master your tools, Master yourself."®

Timothy Morge

A print friendly version of this and all articles are located in Articles.

Wednesday
Oct202010

Get in, Get out, No One Gets Hurt...

I've written this over and over: Most traders are focused on entries and are sadly unprepared when it comes to Market Structure, money management and framing their trades to give them solid Risk Reward ratios and reasonable exit targets. Everyone is afraid they will miss the 'big move' and so they focus entirely on complicated entry techniques, techniques I would contend that give them many false signals; to me, simple is better and often, less is much, much more.

Watch how I stalk a trade using extremely simple lines, solid money management and Risk Reward. I pay strict attention to Market Structure, down to the detail of how each bar unfolds -the range of the bar, the relative length of the bar and where the bar opens and closes; if it sounds like work, it is! Trading can be quite tedious and I would never turn my own capital over to a curve fit indicator or model-I'll trust simple lines and solid money management over them every time.

Here is a wonderful example of using simple lines to make a Market Map. You wouldn't leave on a trip to a new destination without a map in your car, would you? You shouldn't trade the markets without first mapping out the major Market Structure and the defining characteristics of the current market - because you may have ideas about where the market is going but you never know where it is going. Always remember that price is always right and price goes where it wants to go.

But there are markers we can read that will show us the likely path of price or show us signs that the market has just done something significant - Learn to pay attention to these signs!

On this chart, price was in a nice orderly down trend, in a formation I named a Rolling Chop many years ago. It is testing the Upper and Lower set of Simple Trend Lines that have the same slope - These lines differ slightly from simple channels because of how I 'found' the correct slope and applied these lines. Let me explain: I used the Major Swing High and connected it to the high of a wide range bar that opened near its low and closed on its low. This type of bar is a marker for weakness. Now look at the next bar: It, too, was a wide range bar and it gapped lower, opening on its high and making a new low for the move. But then it rallied to close on its high and this is a sign that there are buyers in that area.

Even though price seems to be in a down trend, I don't ignore that price just made a wide range bar, opened on its highs and closed on its highs; instead, I copy the slope of the down sloping Simple Trend Line drawn from the Major Swing High and add a new down sloping line from this wide range that closed on its highs. This bar represents the 'buy area' of this Market Map at the moment, but it's important to understand the buy area moves lower as each bar unfolds, because price IS in a down trend. People that follow my work have heard me state countless times that you have a ten percent edge when you trade with the trend - when you trade in the same direction of the slope of the lines on your Market Map. In a down trend, support areas [other than support from pure Market Structure] and profit targets tend to move lower as space and time moves on; the opposite is true in an uptrend.

There's an important line drawn on this chart that I purposely did not name or point out. See if you can identify it!

IF price is going to remain in this down trending Rolling Chop Formation, there's a line price should not significantly violate. The pullbacks to this line are the pendulum swings that define the back and forth action of a moving or rolling market. But what if the pendulum swings go too far?

Do you see the line? What would it take for you to suspect that this Rolling Chop Formation has been violated so far that it is no longer valid?

You should have your Market Map in front of you and be looking for road signs, as well as signs on the road that trouble may be ahead!

Price opened higher and traded higher all day, closing on its high. Look closely at the dotted green down sloping Simple Trend Line price opened above: This line had been defining the Rolling Chop Formation on the top side, but if price was moving in a less orderly fashion, it would represent what I call the 'Change in Behavior' Line. When price opens above this down sloping line and trades higher, closing above it, it's a sure sign of warning for traders that think the market is in a clear down trend.

Is the down trend over? No, no material damage has been done to the overall down trend. No Major Swing Highs have been broken to the up side; but the Rolling Chop Formation and its trade plan are dead.

As you look at the prior chart, you should be drawing a Market Map [either in your head or you can literally add the possibilities onto your live chart] that maps out where price may run into resistance. And it's important to decide when projecting that area of resistance just how important that area is: Is it an area where Limit Entry orders are likely to be waiting? If so, do you want to consider looking for an entry set up for your own account in that area?

Is the area a key to the probable path of price? If price brings the pendulum to this level and this level is a 'make or break' area for the trend, you should be deciding what you want to do at this key level:

  • If you like the Market Structure and price action that brought price to this key area, it's a wonderful place to enter for a potential reversion to the trend [if you have a quality entry set up and stop] because your entry will be 'close to the bone', meaning you will have entered well before most traders take positions in the direction of the trend and will most likely have a much better entry price.
  • If you don't like the way price headed toward this key level, 'buy another bar' or two, which means watch how price acts when it gets to this area. If price begins to stall at this key level and build Market Structure you are more comfortable with, begin looking for a trade entry set up-though these areas often spawn quick turns IF price is about to return to the prior trend, so by waiting for more information, you may miss a 'close to the bone' entry.
  • If you are uncomfortable with the price action that brought price to this key level and you see nothing that relieves that uncomfortable feeling, stay out, don't waste too much of your focus on the market. Wait until you see Market Structure you can 'see', that you know you can trade successfully, before spending time, energy and money on this market.

On the chart above, I added my Market Map and marked out what I thought were two key possibilities if price continued higher: 1] Price often doubles a range, even a Sloped Range, and then returns back to the prior trend; 2] Price often runs into Limit Entry orders at a Multi-Pivot Line. These orders are left above the current price action by the larger traders [the Whales] in a down trend, in case price pulls back to levels that give them a quality entry on a pendulum type pullback [and the opposite in an uptrend, of course].

 Price gapped open higher, rose to the confluence formed by the Multi-Pivot Line and the down sloping line that marks the area where price effectively doubled its 'Sloped Range' and then turned lower. To stay within the down trend, price could only stretch the pendulum back that far-any further would have violated the key Market Structure; at least for now, Market Structure and potential Limit Entry Sell orders turned price back towards the down trend.

The return to the down trend does not last long. Price consolidates for a few bars, drifting higher and above the down sloping green line that mark the doubling of the Sloped Range. Once above this level, price accelerates its climb and when it trades above the Multi-Pivot Line, break out buyers and stop loss buying propel it even higher - these are the traders chasing price as it moves higher, either by choice or because they must exit their short positions.

There is one last obstacle in price's upward path.

Do you see it?

Do you think price will have the strength to move above it?

Price fails to trade above the Major Swing High; after failing, it turns back lower. But the green down sloping line that had been resistance now acts as support and after a few quiet bars, price turns back higher again. I call these areas that 'switch allegiance' Switchbacks and they are quite useful once you get used to looking for them. They often give you further important clues on your Market Map, clues most traders do not have.

IF price manages to break above the Prior Major Swing High, we will have seen a Change in Behavior and should be wondering if price has already begun a new up trend; should this happen, we'll have to completely revise our Market Map.

Price does climb above the Major Swing High, so I completely revise my Market Map. I mark the Pendulum Swing Pullbacks - note the second pullback is not as deep as the first pullback - and then I connect the lows and highs of the first and second swings higher to make them easier to see.

Now let me show you something I haven't marked on a chart shown publicly before: When price makes these Pendulum Pullbacks that are easy to spot, connect the extremes generated by the first two pullbacks with a Simple Trend Line and project it out in space. This line marks just how far price is rocketed higher by the 'slingshot' effect once the cocked Pendulum is released. Because the lengths of the Pendulum Pullbacks and the swings following them are not equidistant, the line has a slope. This sloped line shows the maximum excursion away from the swing lows and by connecting the first two extremes, we often get a very accurate measurement of where price will run out of upside directional energy.

Here's an updated Market Map. Price made an even shallower pullback and then a new high for the move-but note it didn't make it high enough to test the Maximum Excursion Line; the air is generally thin up there. Price had expended all its directional energy on that run up and when it turned lower, it left a huge Open Gap lower, followed by a extremely wide range bar that opened on its lows but closed near its highs-clearly there were large Limit Buy Entry orders when price fell in a near vertical fashion after the Gap.

Remember, traders [especially large traders] love to push price to fill an Open Gap, especially if they can sense the 'crowd' is caught leaning the wrong way. And after that huge Open Gap lower followed by an even larger Gap Open lower, there were no midsized or smaller traders long this market - Many had been stopped out of their long positions at very painful prices and some had even gone short after the Open Gap. Only the Whales were left to buy this market. If they were long, they were adding at these lower levels. If they missed the original run higher, price was approaching the area where price would most likely run out of down side directional energy. You can see where I added in what I consider to be the Change in Direction Line; until price begins to form mature Market Structure below this line, price was swinging, and swinging wildly, but it was still making higher highs and staying above key Swing Lows.

Price turned just about where it should have turned. Could you have entered there? There were many reasons to expect a turn in that area, but the size of the stops and the wild last vertical fall may have kept many savvy traders from taking this trade-at least 'close to the bone', right at the 'C' Pivot of the up sloping blue Lower Median Line Parallel. But the Whales were buying there, and you can see they immediately began 'pulling the string' on any traders that attempted to go short this market prematurely-because price was still above the Change in Behavior Line.

Do you think price is headed higher from here?

Do you think price is going to continue to trade in a range now?

Do you think price will plunge and break through the Change in Behavior Line, leaving the Whales stranded?

Price continues higher, not only breaking out of the current range but breaking out in style, with an Open Gap higher! Price briefly consolidates, catching its breath, and then heads higher again, in a near vertical fashion.

Price finally tests the Maximum Excursion Line and you can see this line, drawn from the first two Swing Highs of this move higher, call the turning point as perfect as possible.

Does this tool always catch the exact top? No, it's not realistic to think any tool works one hundred percent of the time. I don't place my Limit Exit orders [my profit orders] at this line - instead, I use Market Structure or run trailing stops under prior Swing Lows to box in profits; or I may use Euclid's Expansion series and measured moves or Median Line projections. But I keep this simple line on my charts whenever I can clearly see the Pendulum Pullbacks in a trend. I use it as a warning, much as the ancient Greeks had a servant standing behind them, whispering in their ear that 'Fame is fleeting'; in this case, it is a warning that the closer price approaches the Maximum Excursion Line, the more likely price is running low on directional energy. My first floor broker, and still one of my closest friend, used to say to me, 'Get in, get out, no one gets hurt', as a sort of mantra to me to frame my trade and get my money out before the rest of the crowd headed for the exits. This type of thinking has always served me well. I would rather have some money in my pocket and leave some money on the table for others to fight over then let slip away what was in my hands.

This is a simple line all of you can draw and if you practice, it can improve your profit taking decisions dramatically-literally from the first day you begin using it.

I wish you all good trading. Best,

Timothy Morge

Monday
Oct112010

Money Management Worksheets

At today's free Monday Mini-Mentoring Session Tim focused on several topics centering around money management.

Money management is a skill as important as the Market Maps trading methodology Tim and Shane teach. If you weren't able to attend this session it is strongly advised you review the recording before it is removed on Wednesday, October 13. The purpose and use of each of these spreadsheets as well as some real life examples of the benefits these worksheets bring to your trading business.

The Market Maps Trade Entry Worksheet is your tool for entering key details of a prospective trade. Recording this information before the trade allows you to layout your rules for managing the trade as it develops.

Download the Market Maps Trade Entry Worksheet here.

The Market Geometry Basic Monthly Statistics Worksheet is a business management tool for recording your end of month trading results. The statistical data recorded on these worksheets each month provides you with an alternative view of your trading track record.

Download the Market Geometry Basic Monthly Statistics Worksheet

The Market Geometry Manage Yourself Guideline Worksheet allows you to layout daily, weekly, monthly profit and loss limit rules. Establishing rules helps you take emotion out of trading and allows you to make choices based on sound business decisions.

Download the Market Geometry Manage Yourself Guideline Worksheet



Friday
Jul232010

Reading Gaps in Charts to Find Good Trades

One of the most rewarding and challenging things I have done in my 40-year trading career is teach elementary school students the basics of technical analysis and how to apply those basics in order to make money trading stocks. Each student comes to the trading class with a fairly clean slate: They don't know much, if anything, about the markets and they don't carry any of the emotional burdens of having to make “real” money to pay the rent or buy food. They soak up what I am willing to teach, which is a delight, but once they soak it up, they roll it around in their heads and then ask some of the most thought provoking questions!

When starting with an unmarked chart of a stock, I often point out market structure: Swing highs and lows,ranges, double or triple tops or bottoms, and gaps. On one particular afternoon, I started with a chart and began marking out simple market structure, and after a few minutes, the questions began. Why did I place any significance when price gapped higher or lower? Did it matter if the gaps remained unfilled or were all gaps the same? If gaps are important, how can you use them to make money?

This is the chart I started with:

Then I began to draw in what I considered to be the significant market structure, the “Don't Miss These” things that each of them should see when they first examine an unmarked bar chart.

On the unmarked chart, the first market structure that caught my eye was the unfilled gap that price left right as the downturn began in earnest, and of course, I may have noticed it first because we generally look left to right.

With the unfilled gap out, I added another easily spotted structure—“Three Drives to the Top”—and these were particularly easy to spot because each top was lower than the prior top. Once I marked the three drives to the top formation, its twin formation became evident:

This particular set of three drives to the top and three drives to the bottom are generally very reliable because the tops are forming lower and lower highs and the bottoms were forming a flat base. One of two outcomes flow from this set and the resulting move is generally explosive:

  • Either a fourth drive to the top breaks above the prior three highs (and remember, each of the three are swing highs so a break above this formation should indicate a change in behavior), or…
  • The third drive lower fails to hold at the test of the flat base (or a minor rally following the third drive runs through the flat base). While forming this flat base, price has been restoring energy, and when the bottom is violated, it generally moves a good amount to the downside.

Let's look at the interplay of the market structure I have marked so far:

When I view these formations, I like to take them apart in my mind and think in terms of the physics behind the market structure, which is how one of my earliest mentors, Dr. Alan Andrews, taught me to think about the markets.

The unfilled gap right at the beginning of this chart (and if you are like me, you view this entire chart as a whole) is like the winding of a spring in a clock. The unfilled gap shows you this market is rested and ready to move, and it also gives you the direction as clearly as the hands of a clock moving in one direction.

To flesh out the analogy, the three attempts price makes to rally are like the swinging of the pendulum in an old fashioned clock—and each time the pendulum swings back within a confined space or range, it's as if the clock spring is being rewound tighter and tighter. When price breaks below the flat base on the third drive lower, the pent up energy is expended quickly and in one direction: Down!

Is there anything else we can learn from physics about this chart before we move on?

Let's examine this chart and keep in mind the analogy of price being a large clock with a wound spring driving price's movements. First, I measure where the wound spring of the clock was originally released and measure how far it powered price lower before it slowed and then restored its energy, in this case by trading within a tightening range that was marked with a flat bottom. Then I project that same distance from the area where the newly rewound spring was released (where price broke below the flat bottom of its trading range). As a student of physics, it is not surprising to me when the lengths of the two distances are very nearly the same, and in this case, price runs out of downside directional energy at almost exactly the same distance.

Now I am focused on the lowest low on the chart and the bars that follow it. Specifically, I am looking at the very last bar, which is a wide range bar. Does this bar have any significance? Or is this bar just a wide range bar in a cascading downtrend? Let's look at it closer.

I zoomed in so you could see the bars after the lowest low much more clearly. My eyes are drawn to the very last bar on the chart. Price had begun to climb out of the hole after meeting its projected low and had a nice little rally going. It may even have broken above a minor swing high or two. And then something—news, a very large sell order, an overall breakdown of the prices in the stock market—made price open up much lower than the close of the prior day. But even though it gapped open much lower, it found nothing but buyers at the lower levels.

How do I know there were buyers at the lower levels? Price closed near its high. In fact, it closed higher than it did the prior day. There is a trading term that was started in the currency markets in the mid-1980s: When this type of action was seen, large, knowledgeable traders would say that there were “whales feeding there!” In this case, when price gapped open much lower, the average retail trader either sold out or was stopped out of their long position, or worse, they may have even gone short when price gapped open, expecting the prior low to be broken. But a few large traders, the whales, bought all the shares being dumped and then began to buy more,pushing prices higher. Soon those traders who had gone short on the lower opening were buying, covering their losing short positions. And at some point, the retail traders who had been long but had dumped their long positions began to realize price wasn't going lower—not today, at least—and they also began buying,establishing new long positions at higher prices. And so the gap was filled and price closed higher on theday—quite a remarkable recovery!

But does one bar like this mean the sell off is finished? Of course not. Price action must be observed these levels. Price will tell us when the downtrend is over: If we continue to see buying activity, there will  come a point where a change in behavior is obvious.

This particular bar is interesting because of the failure of the large gap lower to hold, but at the moment, it is just something interesting to file away in the back of your mind as you watch price unfold from this point. Let's watch price unfold a bit and see what we notice.

First, let's find that wide range bar that gapped lower but closed higher—and you can see I marked it on this chart. You can see that bar did not signal price was about to skyrocket higher; instead, it was indeed something to file away in the back of your mind. There were “whales,” or large traders, willing to buy this stock as it traded towards it prior low.

Depending on the length of your holding period and how much risk you are willing to place upon your account, you can do different things with this information:

  • If you are a long-term investor looking to add long-term positions to your portfolio, there may be a price down near the prior low where you are willing to buy some of this stock (it is a major company and has a very large daily volume, by the way) with a stop loss 30 to 50 cents below the prior low.
  • If you are a trader who uses daily bars when trading stocks and has a holding period of days or a few weeks, you may be willing to watch price action before deciding where this stock is heading. You maybe willing to trade time and price to get more information before you make a trading decision. Since I am a trader, not an investor, I am always willing to make this tradeoff.

So I watched patiently. As it traded lower from the wide range bar that gapped lower and closed higher and headed towards the prior lows, I had no sign from price that a change in behavior had occurred. I was willing to watch as price declined to see if the whales were still buying at lower levels, and to get me interested in getting long this stock, I would need to see some signs of strength.

Price traded lower but was unable to approach its prior low. Then price began to stair step higher. As I watched patiently, I began marking swing highs and swing lows. Price eventually climbed above two swing highs that I had marked from the prior move lower (marked in dashed red lines), a measurement I generally use to tell me to pay attention, a change in behavior may in the making.

But let's go back to the clock spring analogy again: Price has climbed higher and it has taken out two prior swing highs. But it stopped right where the clock spring should have run out of directional energy if price was still vibrating with the same frequency. Price has now retraced 50% of its sell off, the amount of potential energy price found each time in the clock spring on the way down. To get me interested in buying this stock, I need a sign of strength, and I need to know there are buyers at higher levels.

Or perhaps I will be a seller as price retests the 50% retracement area.

Or perhaps I will continue to wait.

My actions at this point will depend on what price shows me next.

Price rallied even further, breaking above the halfway point marked by the blue multi-pivot line. It also left several unfilled gaps on the way up. Now price may have topped out. It has broken below several swing lows made during this current rally, a sign that generally makes me pay attention in case a change in behavior has taken place.

But look carefully at the last bar on this chart. Price has sold off below two prior swing lows, and these are signs of weakness. It tried to enter and fill an unfilled gap, but it failed to fill that gap. It gapped lower inside the unfilled gap, but closed near its highs. This is a sign of strength. Is this a sign that whales are interested in buying at these higher levels?

In my mind, the next bar should give me key information:

  • If price turns lower and fills the currently unfilled gap, price is likely headed lower.
  • If price heads higher, leaving this gap unfilled, it is a sign of strength, a sign that the whales missed this move higher (I certainly chose to sit on the sidelines while this stock rallied quite a bit) and have an interest to buy at this unfilled gap.
  • If price trades quietly for a bar or two, which is always possible, I'll simply wait for price to show its hand. I believe price is now at a level where the next move will give me a clear direction.

Price gives me an indication that the whales have left limit buy entry orders at the unfilled gap area. I cannot overstate how much of an edge you have as a trader when you have the ability to read where the large buy or sell orders are sitting in the market by the price action on a simple bar chart. I learned this ability because I was one of the five or six cash forex traders who spawned the original term “whales” in the mid-1980's. It was easy for me to see my own “tracks” on a bar chart because I knew what orders I was working in the market and how these orders showed up in the price action. And I quickly learned what the “tracks” of the other whales looked like that traded in my active time zone. Eventually, the similarities of the whale tracks became apparent and it became second nature to me to be able to see these signs on a bar chart. 

Now that I know there are whales feeding at the unfilled gap area and price has shown its hand by gapping and closing higher, what I am going to do with this information?

I add a simple trend line drawn from the low of the prior swing low below the multi-pivot line and connect it to the low of the bar that failed to fill the unfilled gap (where the whales have left large limit buy orders). Are there other things to consider?

I pull back for perspective and simply connect the major highs and lows with simple lines. I add a blue, up-sloping line connecting the major low and the low of the unfilled gap, where I know the whales have left limit buy entry orders.

Price has broken above two major swing highs from the long move lower, a sign that a change in behavior may have occurred, although I have mentioned this several times at various places that this is the first time price action has confirmed this potential change in behavior.

Now that both price and market structure have given me what I was looking for, let me show you my orders:

I want to buy a retest of the green, up-sloping simple trend line at 4.83. My initial stop loss order will be at 4.53, and if my limit buy order is filled, my profit target will be just below the last swing high, at 6.48.

Note that I placed my stop loss order below the low of the bar that failed to fill the unfilled gap, where I know whales have left large limit entry buy orders. If price begins to run through their orders, or if they pull their orders and the gap gets filled, I no longer have the market structure in place that spawned this trade idea.

Sometimes, you must be patient and diligent and stick with your plan until price decides to let your limit orders get filled. As each bar closed (especially because these are daily bars), I move my cursor to see where pricewill intersect with the green, up-sloping line. In this case, I got filled on the fifth bar. Because I am tradingagainst an up-sloping line and the intersection price climbs higher with the close of each bar, there is a pricewhere the risk/reward has eroded too much or the initial stop loss has gotten too large for me to continue towork the orders associated with this trading idea.

After moving my order higher four times, I am risking 63 cents to make a potential $1.32, which gives me arisk/reward of just over two to one. I rarely take trades with risk/rewards under two to one, so if I had not gottenfilled on this bar, I probably would have pulled the order. I also like my retests to be between three and fivebars after the initial test; once it takes more than five or six bars, I will generally pull my orders and watch priceagain, waiting for another clear sign that there are buyers or sellers in the market.

But I do get filled on the fifth bar at $5.16. I immediately check to make sure my initial stop loss is in the marketand then I enter my limit sell order (my profit order) at $6.48. Then I check again to make sure I bought theamount of shares I wanted to buy, and at the price I wanted to buy them. Now is the time to find any problems,not after price has moved far away from this level. Once I am sure I have the position I want, and at the price Iexpected, I double check the orders I am working in the market. Now I have to watch price and execute the plan I made before entering the position.

Once I am long at $5.16, the next several bars are uneventful; then price begins to creep higher. When price gaps open higher and closes quite a bit higher, I cancel my initial stop and enter a break even stop loss order. Remember, the original risk/reward on this trade was barely acceptable to me, so this unfilled gap gives me anopportunity to “collapse” my risk. If price is not heading higher from here after leaving another higher unfilledgap, I don't want to lose money on this trade.

Once I moved my initial stop loss order to a break even stop loss order, price made an orderly climb higher and my limit sell order was filled at $6.48 four bars later, giving me a net profit (before brokerage) of $1.32. You can see the unfilled gaps played a major part in my thought process and decision making. Many traders don't understand the significance of gaps, and this article has just scratched the surface of their meaning and how to use them to your advantage. But understanding and using unfilled gaps, as I have in this example, is something you can practice and ultimately add to your trading tool kit.

I hope you found this example interesting and informative.

I wish you all good trading!