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| April 19, 2005 Comments: Looking at the chart above, you can see that after a sharp sell off last week, S&Ps rallied yesterday, leaving multiple bottoms on the fifteen minute chart. The length and severity of the Energy Coil I showed on last week's 60 minute charts makes me believe this rally out of the hole will not be a major rally, and any crack that appears should then be exploited as a new selling opportunity. As I prepared for this morning's opening, I knew that price would likely gap open higher. The question was: Did price have enough up side energy left to test the blue Upper Median Line Parallel, it's "most probable" line? |
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You can see that price did indeed gap open higher above the blue up sloping Median Line and should now be headed to the blue up sloping Median Line Parallel. Price closed above the Median Line twice but after the third bar made a new high for the day, it could not hold above the blue up sloping Median Line and closed below it, near the low of its range. And although the next bar peeked back above the Median Line, it was unable to make a new high and then closed below the Median Line, unchanged, in the lower third of its range.
This looked like a price failure to me! Because price climbed above the blue Median Line and closed above it, it *should* make it to the Upper Median Line Parallel about 80 percent of the time. But after two closes above the Median Line, two closes back below the Median Line had me thinking of Hagopian's Rule: If price doesn't make it to its "most probable" line, it is likely due for an extended run in the opposite direction. I added a red down sloping Median Line Set, using the day's high as the last alternating pivot: |
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| Looking at the fifteen minute chart, price has three levels of overhead resistance: First, it must get back above the resistance formed by the blue up sloping Median Line. Second, it must climb above the resistance formed by the red down sloping Upper Median Line Parallel. And third, it will find its final resistance at the high made earlier this morning. As the last bar closed below the Median Line, I began forming a plan for a short set up in my mind. I'll diagram it for you: |
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I want to sell a re-test of the blue up sloping Median Line. If price intersected with the Median Line during the next bar, it would happen at 1154.25. With the additional overhead resistance of the red Upper Median Line Parallel and the high of the day, I am willing to get short three ticks below this intersection level, at 1153.50. I'll place my initial stop loss three ticks above the morning high of 1155, which is now a swing high, at 1155.75.
And because price failed to test the blue up sloping Median Line Parallel, I am looking for price to go further than its first possible target, which would be the blue up sloping Lower Median Line. Instead, I am looking for price to at least make it to the red down sloping Median Line, its "most probable" line. That makes my initial profit target 1148. That means I am risking 2 1/4 E*Mini S&P points to make at least 5 1/2 E*Mini S&P points.[Why do I say "at least?" Remember that the red Median Line is a down sloping line, so with the closing of each bar, its intersection level with price will move lower, and my potential profit will increase, as long as I move my profit target as that line moves lower with each bar's close.] This gives me a risk ratio of roughly 2.4, which is good. I enter my limit sell order at 1153.50 and my initial stop loss at 1155.75. Now let's see if price let's me get short: |
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| During the next bar, price opens unchanged and then spikes higher, just getting high enough to brush the blue up sloping Median Line and getting me short in the process. But price runs out of energy right where it *should* run out of energy and turns on a dime, quickly moving and closing below the lows of the day. |
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The next bar opens unchanged and then plunges lower, testing the blue up sloping Median Line, the first potential support level. Remember, I chose NOT to take profits here because I viewed the failure of price to test the blue Upper Median Line Parallel as a price failure, and thus expect a large magnitude move to the down side--at least to the red down sloping Median Line. Once price tests the blue Median Line, it rebounds and closes near its highs. At the moment, price ran out of energy *right* at the Lower Median Line Parallel. [Remember the most important tenet of Dr. Andrews' Original Action Reaction Course: Price will make it to the next line 80 percent of the time. It *did* miss making it to the Upper Median Line Parallel, but it *did* make it to the Lower Median Line Parallel, which is where it was headed once it closed back below the blue Median Line.]
The next bar is no help either: Price opens higher and closes higher. My only solace is that the ranges are narrowing as price moves back higher, so it's possible this is an Energy Coil forming. If that's the case, once price has re-stored its expended energy, it should move swiftly again. Now I start to play "What if..." And the problem is, price is so close to my original entry that I have no room to snug my stops without bringing them so close that I might simply be stopped out by the noise of this market. In fact, even moving my initial stop to break even looks too close to me at the moment. I don't feel comfortable, but I leave my initial stop loss order in the market and wait to see what price brings me next: |
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| Price spikes higher and suddenly, my position has gone from a nice three point profit to a loss. Although price doesn't hit my stop loss order at 1155.75, it *does* close above the red down sloping Upper Median Line Parallel. Now its last level of resistance is the morning's high at 1155. With the new found up side energy of this move, I invoke what I lovingly refer to as the "Two Bar Close" rule: If price closes twice above the red down sloping Upper Median Line, and I haven't yet been stopped out of my position, it is showing more up side energy than my initial observations predicted, and I will close out my position at the close of that bar. |
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The next bar opens a little lower and then trades lower in a narrow range, but it does close below the red Upper Median Line Parallel. Has price expended its up side energy with this single test of the red Upper Median Line Parallel?
The next bar again moves back above the red Upper Median Line Parallel and closes above it. And being true to my plan, I close out my short position as this bar closes, at 1154.50. Although price left a double top, it is showing *too* much strength [energy] for this trade to fit the profile I had drawn when I first envisioned the trade set up. Some of you may ask why I didn't simply wait to get stopped out at the initial stop loss level or why I wasn't heartened when price *didn't* make a new high, but instead left a double top. These are very valid questions and the answers come down to personal trading styles and preferences.
A long time ago, I learned that holding on to a losing trade keeps my mind occupied with managing *that* losing trade, which often left me too busy to see new and often better opportunities unfold right in front of me. When price doesn't act as I expected it to act when drawing up the trade parameters, it's telling me something important: Either I am not seeing the market clearly or the lines I am drawing are not the lines carrying price's frequency. Rather than hold on to a losing position, defending it, I would rather walk away from a losing trade, clear my mind and then have another look. I can always find a new entry if price makes a new sign of failure.
I have also discussed the cost of exposure here before, which means that the longer you have an open position, the greater the risk to your capital, and hence, to make equal returns, as a trade goes on longer and longer, it must yield greater and greater net profits. So to me, once it becomes clear to me I have misread a market, I am not shy about exiting. That's why I invoked the "Two Bar Close" stop. Now let's see what price did the rest of the session: |
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I lost one E*Mini S&P point on the trade per contract, which isn't important or expensive. You can see that after price tested the blue Lower Median Line Parallel, one bar after I got short, price action didn't fit the plan I had diagrammed. If I had struggled longer, trying to defend my short position and staying with my initial stop loss order, I would have eventually been stopped out for a larger loss. And as important, I would have spent quite a bit longer stuck in a losing trade, unable to think clearly about what the market was telling me. We will all have both winning and losing trades. It's how you manage both of them that makes the difference at the end of the day.
I hope you all find this trade example both interesting and informative. And of course, I wish you all good trading!
Act, don't Re-act! |
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