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April 27, 2005 Comments: The E*Mini S&P 500 futures have been following a blue up sloping longer-term Median Line set on the fifteen minute chart quite well in the past four or five sessions. After a nice run higher, they turned lower on Monday and continued lower Tuesday as well. Looking at the first chart, you can see that I added a red down sloping Median Line set after Monday's high was in and since I added the red Median Line set, it, too, has done a good job containing price. Note that BOTH the blue up sloping Median Line set and the red down sloping Median Line set have been tested and done a good job "describing" the path Price would likely take--that is, both clearly gave you areas where Price SHOULD run out of Energy, and Price DID run out of Energy in those areas.
So going into Wednesday's pre-opening routine, what's a trader to do? Looking at the pre-opening market levels, price is likely to make a nice gap lower on the opening. I note with mild interest that the blue up sloping Lower Median Line Parallel and the red down sloping Median Line intersect in the general area where "time" will be on the opening, give or take a few fifteen minute bars. The intersection of these two can be a powerful area of confluence. Let's watch how the market opens and see if we get any clues about the day's direction: |
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Price gaps open lower, and while I am watching the first fifteen minute bar unfold, I do a quick Fib Expansion calculation, from the last swing lower:
The High at A is 1163.75
The Low at B is 1143.75
By subtracting the High from the Low, I get the distance or directional Energy expended in this swing, and that's 20 points.
The High at C is 1166.25
I subtract that same distance, 100 percent of the directional energy expended on the prior swing, from the 1166.25 high made on Monday and that gives me the 1:1 Expansion Target of 1146.25.
That means that if Price expends the same amount of directional energy, it will run out of energy at 1146.25. A quick glance at the chart tells me this is very close to the confluence formed by the intersection of the blue up sloping Lower Median Line Parallel and the red down sloping Median Line. I'm intrigued but I'd like to see a little more price action unfold before I jump in, because at the moment, it looks like an awfully big gap lower and if price runs into this area of confluence, it may just zoom through it hard, which is one of the three things possible: 1) Price will turn or 2) Price will form an Energy Coil or 3) Price will accelerate and Zoom through.
If price Zooms through this area, I want to be a seller on the re-test of the confluence if price rallies back to test it.
If price turns higher from this area or appears to be stalling at this area, I want to try to identify a long entry set up that gives me a good risk reward ratio.
If it looks like an Energy Coil is forming, I may not be interested in a trade at all!
Let's watch a bit more: |
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Two bars later, I see what I want to see to get some ideas: Price tests the area of confluence, actually peeking below the blue up sloping Median Line Parallel before closing back above it. Now this single bar test, in and of itself, DOES NOT tell me price is going higher from here. In fact, both Median Line sets are still doing a good job predicting where price will likely run out of its directional energy.
But what I DO have is this: I have a solid set of confluence just below where this current bar is closing. I also have a general 1:1 Expansion Projection that tells me price should run out of directional energy at this area. And I have one thing even better: Now I have a trade set up that easily identifies a low risk stop loss, so that if I my intuition to try a long entry here is wrong, the risk reward ratio of the potential trade is well within my parameters. Let me diagram the trade out for you: |
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I want to buy a re-test of the blue up sloping Lower Median Line Parallel and this intersection comes in right at 1146 for the next bar. I'll set my initial stop loss order at three ticks below the 1145.25 low of the day that was just made, so it will be at 1144.50. So I'll be risking 1 1/2 points on this trade IF price allows me to get long at a re-test of the blue Lower Median Line Parallel.
And for those that have asked, my secondary entry order [in case price doesn't re-test the Lower Median Line Parallel] is three ticks above the 1147.25 high of the probe bar that just closed. And if that is how I end up getting long, I'll be risking 3 1/2 points, which is just about as much as I risk on a trade. Let's look at potential profit targets to see if they justify a risk of 3 1/2 points!
The most likely profit target is a test of the blue up sloping Median Line, and doing that fuzzy bar spacing technique I showed here on 4/22/05, I calculate price should intersect with the blue Median Line at just about 1158. This means that if I get filled on the secondary entry order, my risk reward ratio is nearly 2.9 and that's fine. And if I get filled on my preferred entry order, which would come with a test of the blue Lower Median Line Parallel, I'd be looking at a risk reward ratio of...well, 8, which is wonderful. So I like these orders and I'll take this trade set up.
But let me add one more thing, since some traders have asked if I ever trail stops and "just let things run," or if I take partial profits and then trail stops on the balance, to try to capture more of the move if I get a pleasant surprise. Since I *still* can't tell which of the Median Line sets is "in charge," I can also make the case that the profit target *should* be where price is likely to intersect with the red down sloping Upper Median Line Parallel. So I've added this to the entry order possibilities as well, and labeled it as the "Secondary Profit Objective." Now let's see if price get's me long at the re-test of the Lower Median Line Parallel or at the break above the prior bar's high...Or if I get long and quickly stopped out for a loss as price zooms lower: |
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| Price DOES re-test the blue Lower Median Line Parallel, getting me long at 1146. I check the audit trail on my electronic platform and once I see the exchange confirmation that I am long, I cancel the secondary order to get long at 1148. And I double check that my initial stop loss order is in place. Price doesn't make a new low, but instead leaves double bottoms and after getting me long, price moves above the high of the previous bar and closes near its highs. I enter my profit order at 1158 as the bar closes. |
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| Price spikes higher and makes a new high for the day, but just as quick as it rallied, it comes back down. Price still hasn't filled the morning gap, but this bar closes higher, so perhaps that was some over-eager short term traders trying to fill the gap and then exiting their long positions when it didn't look likely. The next two bars are narrower in range and have about the same range--I call these "mirror bars," because they also have alternating closes, meaning the first bar closed higher and the second bar closed lower and they left double bottoms. As the second "mirror bar" closes, I move my initial stop loss order up to break even. The inability to fill the gap and the mirror bars with double bottoms are a sign it's time to be a little cautious. I'm always trying to play, "What if..." |
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Just as I turn cautious, price spikes higher again, making another new high for the day, and this time, price easily fills the morning opening gap. Note that the low of this spike bar matches the double bottoms of the mirror bars. As soon as this bar closes, I cancel and replace my break even stop and snug it up to three ticks below the 1148 triple bottoms, to 1147.25.
The next bar makes another new high but then closes near its lows. This is followed by a bar with about the same range, and this bar closes near its highs! These two are essentially "mirror bars" as well, but I've already snugged my stop order up, so there's nothing for me to do but wait for further input from price. |
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| Price again spikes higher, quickly filling my Logical Profit Order at 1158. I check my electronic audit trail and once I see the exchange confirmation, I cancel my stop loss order at 1147.25. This trade quickly netted me twelve E*Mini S&P points and that's always a good day's work. Let's follow the action a bit more, since I put a Secondary Profit Target on the chart for those of you that want to try to either let trades run with trailing stops or want to try taking off half a position at one target and let the rest run, with trailing stops. |
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| The spike bar is followed by a very narrow range bar that closes lower--which isn't unusual, since price *should* have expended its directional energy at the blue up sloping Median Line. Even if it goes higher from here, it needs to re-store energy after that powerful spike higher. The next two bars both close a little higher, but they leave double bottoms. It's still not clear if price expended ALL its directional energy at the test of the blue Median Line, so it's possible that was all the rally we'll see for the day. So playing, "What if..." If I was still long either the entire position or a portion of the original position, I would now snug my stop profit order from the 1147.25 level to three ticks below the 1155.25 double bottoms, to 1154.50. Now no matter what happens, I'd be out of the market with a tidy profit. |
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And once again, as soon as I get cautious, price spikes higher, this time hitting the Secondary Profit Target at 1161. If I was still long, I'd check my audit trail and once I saw the exchange confirmation, I'd cancel my stop profit order. I'll have to start keeping track of when I get cautious...maybe it's a new indicator I can plot?
It's actually this: Any time price expends a great deal of energy and then pauses, I get cautious, because there is always the danger that that heavy expenditure has "emptied the fuel tank." The key is the narrower range bars that follow the spikes, which always point to price resting, re-storing energy. And though they aren't *true* Energy Coils, they act very much like them, meaning price could come out of these mini-formations on either side, so I always try to play "What if..." and make sure I have my stop order protection at a level I am comfortable with. Let's see how the day finishes up: |
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Price leaves a double top and then turns lower. Though it does eventually re-test the red down sloping Upper Median Line one more time, it finally breaks back below the blue Median Line and closes below it as well. Now comes the philosophical question: I began the day asking which of these two Median Line sets was in control. And honestly, I now end the day admitting that even after the day's nice trading action, it's not clear which is in control. Maybe it's correct to say that both contained price, though I clearly keyed my own trading off of the blue up sloping Median Line set. Maybe tomorrow will tell us which one is in control...
Once again, I tried to show a couple different twists in this example, showing multiple entry techniques and multiple profit levels. Also note that this trade was really a simple "buy at the test of the up sloping Lower Median Line Parallel" vanilla type trade, with one exception: The key to limiting the risk on this trade AND making it a higher probability trade was watching price test the confluence area once and then putting in place a solid entry order set that had good risk reward ratios.
Can you simply buy or sell at the test of every Median or its Upper and Lower Parallels and use stops or stop and reverse orders? Certainly! Will it work? Yes. Each trade won't carry the rate of success of the trades I show here, and I think that's where people get confused. At these lines, one of three things will happen: 1) Price will turn or 2) Price will form an Energy Coil or 3) Price will accelerate and Zoom through.
DR. Andrews said price will reach these lines 80 percent of the time, and as I have stated many times and showed in my first book, after doing statistical research, that statement is correct. But reaching the line and turning at the line is NOT the same thing.I have found that by being more selective--in this case, waiting for the test of the area and then laying out the orders once I can measure risk--I miss most of those "buying or selling in front of the zooming train" trades now. Do I miss some entries that would have been very profitable? Absolutely. But my winning percentage is much higher and I find it much less wear and tear on *me*, which is very important, at least to me.
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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