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| March 15, 2005 Comments: Let's take a look at another classic high probability trade set up in the E*Mini S&Ps. Looking at the chart above, it's clear price is in a strong down trend, after price traded above the up sloping Major Median Line but failed to test the Major Up Sloping Median Line Parallel. This failure to show any strength above the Median Line, which invokes Hagopian's Rule, is followed up by a gap lower in price and these led the way down. Let's take a closer look using fifteen minute bars and see if we can make more sense of the likeliest direction for today's action: |
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Looking at the next chart, you can see I added two new Median Line sets, one down sloping and one up sloping, and that has shown us a potential area of confluence that MAY serve as an Energy Point IF price tests it. What's an Energy Point? These are areas where the interaction of several lines of force interact and the confluence in that area of interaction usually means that price will either stall and change direction or hesitate and then accelerate in the same direction away from these areas. Note that I added an additional layer of confluence by calculating the 50 percent Fibonacci retracement from the last major high to this latest low. Here's the calculations, step by step, so you can see how to do it yourself without using a drawing tool or a fancy stand alone Fib calculator:
The High at Pivot A is 1229.75
The Low at Pivot B is 1202.50
Subtract 1202.50 from 1229.75 and you get 27.25 S&P Points, the distance between Pivot A and Pivot D.
One half of 27.25 is 13.625 S&P Points.
I take that distance and add it to Pivot "D" to give me the 50 Percent Fibonacci Retracement
1202.50 + 13.625 = 1216.125
You'll also notice that the red down sloping Median Line set has an additional line drawn to the right, the 1st Warning Line, which is nothing more than a projection forward in price and time of the distance between the Median Line and the Upper Median Line Parallel--This line carries the same frequency of price and time, so it projects the energy potential forward in the same way the Median Line and its Upper and Lower Parallels project where price is likely to run out of stored energy.
What does all this tell us? Looking at the chart, you can see a great deal is going on right at the 1216 area. This is the equivalent of "X Marks The Spot!" on a treasure map, I suppose. All lines lead us to believe that IF price gets to this area, it will either stall and change direction back towards its lower trend OR stall and then move dramatically higher.
Price closed just below 1208 yesterday [Monday]. Do we have any sign we can point to that a rally May take place, giving us a potential entry near the 1216 area of confluence? Price traded below the red down sloping Median Line on Friday, but ran out of energy to the down side before testing the red Lower Median Line Parallel. Using Hagopian's Rule, we now anticipate a move higher is in the making. And indeed, prices gapped higher Monday morning and then traded in a range [an Energy Coil] for the first half of the day, before trading lower and zooming down through the blue up sloping Lower Median Line Parallel to make a run at re-testing Friday's lows. But again, price ran out of energy before it was able to test Friday's lows or even test the red down sloping Median Line, which again invokes Hagopian's rule. And when price ran out of down side energy late Monday, it staged a nice rally, closing back above the blue up sloping Lower Median Line Parallel it had zoomed several hours earlier, and this is a nice sign of strength. So it's safe to say we see some signs that price MAY have some up side energy ready for today's [Tuesday's] market. Let's see how the market opens: |
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| Here's a zoomed in chart: Prices gap open higher, above the red down sloping Upper Median Line Parallel and fairly near our area of Major Confluence. Let's see if we can construct a trading plan to take advantage of this high probability trade set up. We have a great deal of confluence that SHOULD act as resistance at the 1216 area. We want to get short at or just a bit below that area. And we'll use that area and tuck our stops above it, far enough above it that the general noise inherent in the E*Mini S&Ps should be held in check by the confluence acting as resistance. Let's see how that would look: I'll diagram our orders out on the chart and see if they make sense: |
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Looking at this new chart, let's lay out the orders as I have them drawn in:
There is Major overhead resistance at the confluence of lines and the Fib retracement that all meet at 1216.
We want to get short this market as price approaches the area of confluence or resistance, so we'll work an order to get short at the area where price would intersect with the up sloping blue Major Lower Median Line Parallel that was zoomed [but never re-tested from below] on Friday. This is a classic zoom and re-test trade, and we know that if there is confluence above these areas, their probability of success approaches 80 percent. We'll work an order to sell E*Mini S&P futures at 1215.50, which is where we currently project price will meet the up sloping Major Median Line Parallel. And though this line has a slight up slope, we won't need to change the level of this order, because there is MAJOR resistance above it. We expect price will either test this area soon and we'll get short [and then be right or wrong in short order] OR price won't even rally enough to get to our order and we'll be looking for another trade idea. Why do I think the test will happen soon? Remember: These areas are where we project price SHOULD run out of their potential or stored energy, so it makes sense that this spike is near the end of its run.
We'll place our initial stop loss order two S&P points above the area of confluence--in fact, to stay away from the "even number" syndrome, we'll place our initial stop loss order at 1218.25. This should be far enough above the Major resistance that market noise won't cause our stops to be hit--if price gets up to this area, we're likely wrong about our estimation of the up side energy price is carrying [and we'll want out of the trade].
The Logical Profit Target is a test of the blue up sloping Lower Median Line. We have to "project" an area where price is likely to intersect with this line, to give us an initial profit target level. That allows to calculate the risk/reward ratio. In this case, our initial Profit Target order will be placed at 1208.50 and that gives us a potential profit of 7 E*Mini S&P points. So we are risking 2.75 E*Mini S&P stops and our initial potential gain is 7 E*Mini S&P points, giving us a risk reward ratio of 7 divided by 2.75 = 2.54, and since the probability of success associated with this trade set up approaches 80 percent, that is a very acceptable risk reward ratio.
Before we move on, remember that our Profit Target will move up slightly with the close of each bar, since the Lower Median Line Parallel has a positive slope. We actually put this order at a level that is where price will intersect with the Lower Median Line Parallel several bars from now, because we assume it will take price a few bars to test the overhead resistance and then a few more bars to make any significant down move once the overhead resistance is tested. But as the day goes on, we'll have to monitor where price intersects with this line and eventually, we'll have to snug our profit order a bit higher as each bar closes, IF we manage to get short. Now let's see what the market does next: |
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Price does follow through enough to the upside to get us short at 1215.50 and in fact, it touches the 50 percent Fibonacci retracement area exactly. The bar then closes just below the up sloping Major Lower Median Line Parallel. Remember that we ALWAYS put our entry and stop loss orders in the market at the same time, to protect our capital. If our broker allows it, we enter contingency orders and enter our profit order at the same time--if not, we enter our profit order once we confirm that we are filled on our entry order. If we are using an electronic platform, we check the audit trail once we see price touch our level and we look for the confirmation from the exchange that our order is indeed filled. Then we double check that our stop loss order is in the market and working. We can then place our profit order. If possible, we make the stop loss order and profit order OCO [One Cancels the Other].
Now that we are short this market, let's see how it plays out: |
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| Three bars after our entry, price has come down nicely from our entry level and the Lower Median Line Parallel, as well as the confleunce area of resistance. As this bar closes, we have a couple of E*Mini S&P points of profit in the trade, but there is no logical way that I see to lower our initial stops yet, because price just hasn't moved far enough away from our initial entry point. Let's see what happens next: |
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Price makes a new low for the day, down to 1211.75 and then the bars get smaller and we see three matching tops form, each with higher lows. The narrowing of the ranges of each succeeding bar tells us price is re-storing energy. The higher lows tell us price may take a run to the up side, so putting those two thoughts together, I again take a look at the chart and wonder, can the initial stop be snugged up?
This comes down to personal preference. At this point, you could take partial profits on the trade and look to sell that portion of the position back out IF price re-tests the original entry area, just below the resistance formed by the area of confluence at 1216. Or you could snug the initial stop to break even, but I still feel that the overhead resistance is strong enough to protect our stops and that moving the stops any closer subjects them to the whims of the market noise that the S&Ps are famous for. I elect to leave the stops at their current level. And looking at the profit target we are working, it is just about at the level where price would intersect the Lower Median Line Parallel, so there's no need to move it just yet, though we do need to monitor it at the close of each bar. Let's see if there's any significant rally after this narrowing range: |
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Price rallies a bit after the narrow range triple tops are formed and broken, but not enough to test the down sloping red Upper Median Line Parallel or get anywhere near our stops. As price comes back down again, I re-check where price would intersect with the up sloping blue Lower Median Line Parallel and move up our profit target just a touch, to 1209.00. I still like our stop loss levels, so I make no change there. Let's see what price has in store for us now:
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Price spikes lower, hitting our profit target as it runs through the Lower Median Line Parallel. I confirm that our profit target was filled, and then I check to make certain that our stop loss order has been cancelled. As I've said a hundred times before, I make my broker repeat: "You're flat and working nothing." If you are using an electronic entry platform, check your own orders and the audit trail to make sure you are flat and that the exchanges have given you confirmation that your stop loss order is now cancelled. Then get in the habit of saying out loud: "I'm flat and working nothing." It's ok to talk to yourself if it will save you money in the long run...
We're flat and we had a nice 6 1/2 point gain in the E*Mini S&Ps for the day by taking advantage of a classic trade set up with a high winning percentage and solid money management. Let's look at how the rest of the day played out: |
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It's clear there was more downside energy to this market than that measured by the Lower Median Line Parallel. Was there a clue that could have led us to chose a different profit target? I never second guess a trade, especially a winning trade. But looking at the final chart, you can see that although price tested the area of confluence at 1216, it never approached it's "most probable line," the red 1st Warning Line, so it would also have been a valid assumption to use the associated red Upper Median Line as a down side profit target, either for all or some of the position. But this comes down to personal trading styles and truthfully, what you saw when you initially made the trade plan. I did not figure the 1st Warning line and the failure to test it into my initial plan, so I won't second guess my original profit target. If you are a fluid enough trader, you could have certainly adapted your orders to reflect this as the day unfolded, but doing that here in these step by step trade commentaries would only lend confusion, so I mention this possibility as a thought exercise to those of you that want to take your trading a step further. I wish you all good trading!
Act, don't Re-act! |
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