Monthly Archives: March 2011

Patterns vs Context

 

Patterns vs Context –

A Q&A Followup to the Better than Candlestick Series

This email Q&A is with a YTC Newsletter reader, regarding the following article series:

Please review these articles if you haven’t read them already, in order to understand the following Q&A.

 Email question:

In part two you’re explaining candlestick close positions and comparisons to determine sentiment. Are d and f patterns correct? High close is more bearish than a low close? I can’t understand that unless you’re taking prior candle sentiment into it somehow.

The diagram referenced in the question:

Response:

Yes the description of sentiment is correct.

Remember, at this stage of the analysis process we’re simply observing two consecutive candles. We have yet to take the bigger picture context into consideration. So the final assessment of market sentiment could well be very different.

But let’s examine each of the two pictures (d) and (f).

Firstly (d)

Let’s number the candles 1 and 2.

Considering candle 2 only (as a single candle), we see it is a high close candle, implying bullish sentiment.

However, let’s now take the previous candle into account, to get a feel for the sentiment over the last two candles. The previous candle (candle 1) was a low close candle with large range, (ie bearish) and the current candle was only able to retrace approximately 50% of the previous bearish range.

Overall… strong bearish (candle 1) followed by weaker bullish (candle 2) combines to equal a weak-bearish sentiment (or probably more correctly the bearish side of neutral).

Now… subsequent candles may change that assessment. The price could continue higher through a high close bull candle that breaks above all previous highs. But we don’t know that. We simply are looking at the current two-candle pattern sentiment, in this case weak-bearish. And then we go on to consider the meaning of that within the wider context of the current and previous price swings, and our S/R framework.

Another way to consider it is through the process of candlestick addition. (Click here to watch a video on candlestick addition: http://youtu.be/enPN5pIeGMo )

A single candle comprising the time period covered by both candles 1 and 2, would have a red body covering the upper half of the range, with a lower tail. Still bearish, but weak-bearish.

Now (f)

This works in exactly the same way. By itself, candle 2 is bearish, but when considered as a two-candle pattern, we have a strong bullish candle, followed by a weaker bearish candle. Overall sentiment is weak-bullish (when considering this as a two-candle pattern).

The candle addition process would show a single green candle, with body covering the lower half, and an upper tail comprising approximately half. It’s still bullish in sentiment, but once again weak due to the rejection of higher prices.

Subsequent candles may amend this… but for now it’s weak-bullish.

Is this clear? If not, please let me know and I’ll try to explain in another way.

In the end though, it all comes down to context. Where the patterns are occurring within the market is a great deal more important than the patterns themselves.

Question:

Ok, thanks lance. You’ve explained that well and I get it.

But… it does seem like fine lines. Candle 2 in (d) wouldn’t have to close much higher before the single candle addition starts to look like a hammer, usually a fairly bullish sign!

Very murky biz this!

Response:

You’re right – it can be a very fine line. But remember, we’re just talking about a VERY small part of the picture here. It’s just a quick assessment of the sentiment shown by the latest two candles.

More important is the current bias we have as a result of the bigger picture (context) – the positioning of price with respect to our S/R framework, the direction of the trend, and the nature of the trend movement (slowing down, speeding up, neutral).

In analysing a two-candle pattern in isolation, it’s easy to forget that in reality (while trading) this analysis is occurring within the context of the bigger picture bias. So the difference between a neutral (perhaps slightly bearish) pattern such as shown by (d) and a neutral (but potentially bullish) pattern such as would have occurred if the second candle closed higher forming a shooting star (or hammer)… is perhaps negligible.

Example: bearish bias; downtrend which has moved into an area of support. Both patterns (d) or the more bullish variation, indicate a presence of buying. Not yet enough to break the previous high. But they show a good sign of buying, so confirm the potential for support to hold. We wait for more information, and look for a place to buy.

Example: Uptrend, currently in a normal pullback, pattern occurring after 3 down candles, with price resting on the previous swing high. Both patterns are (again) evidence of buying, and possible signs that the pullback has come to an end. Look for an entry long for continuation of the trend.

Example: Downtrend, not at S/R. Green candle shows potential start of countertrend pullback. This is a sign to watch for strength / weakness of the pullback, remaining alert for an entry short on failure of the pullback.

The same pattern can indicate potential opportunities long or short, depending on the context of where they’re occurring within the market.

Don’t get too caught up in the ‘two candle pattern’ sentiment. It’s a quick assessment, which is then used as confirmation or non-confirmation of your larger market bias. That’s all it is.

Happy trading,

Lance Beggs


Conflicting Trends on Different Timeframes – How I Read This Chart!

Here is some great email Q&A with a YTC Newsletter reader Thomas…

Question:

Hey Lance,

Hope you are well!

Got one question for you. Looking at the below 3-minute chart when would you say we went from uptrend to downtrend? I often have a hard time reading the market after a large move in one direction which then slowly starts grinding in the opposite direction. At first I look for pullback opportunities because the trend has not technically changed, but at some point in time it becomes obvious the sentiment has changed.

Your thought much appreciated.

Thomas

Chart:

(CLICK ON THE CHART TO OPEN A LARGER COPY IN YOUR BROWSER)

Reply:

(more…)

Self-deception – According to Kierkegaard – Part 2

I came across a great quote a week ago, which led to to part one of this short article series: http://yourtradingcoach.com/trading-process-and-strategy/self-deception-according-to-kierkegaard-part-1/

The quote:

“There are two ways to be fooled: One is to believe what isn’t so; the other is to refuse to believe what is so.”

…Søren Kierkegaard

There are countless ways these two forms of self-deception could play out in the markets.

In part one we looked at an example of the first – believing what isn’t so.

In this article… refusing to believe what is so.

There are just so many ways to demonstrate this. I was tempted to discuss the danger of continually fading a trend (something that catches me from time to time). But I’ve done that before.

For this example, we will look to something that doesn’t afflict me, but is incredibly important and does cause many people great concern. It’s also a topic I haven’t really discussed in much detail.

That is, failure to honor stops.

We can talk through any number of examples. They’re all over the charts. But let’s just go to the first that I can see as I write this evening.

It’s Monday, 21st March 2011. The Euro has broken a previous swing low with a number of very bearish looking candles. Let’s just assume for the sake of the article that you’ve entered short on breakout, via a stop entry order at 1.4128.

The chart is shown below intra-candle, as price pushes to new lows. The entry candle is shown as A. The stop will be placed above the previous swing high at B (that’s part of the reason I personally hate breakouts… how far away is that stop!!!)

Here’s the following price action.

 

D’oh! Our entry candle A closed back above the breakout level.

Let’s examine how the exit should have been managed, firstly if we use active trade management, and secondly if we prefer passive trade management.

Active trade managers will be aiming to minimise risk as much as possible, scratching the trade well before the stop if they perceive that the edge has gone, or is in doubt. These traders had three clear signals for exit.

  • On a break above candle A, which provides an immediate breakout failure signal (of course they would likely remain alert for reentry such as on subsequent break below the short term 123 pattern at D)

  • On a break above the candle following C, which indicates a second failure to push lower. Two failures to do something increase the likelihood of the opposite occurring.

  • On a break of the swing high at D. This is the absolute last resort. As an active trade manager, you’ve endured two failed pushes downwards and a break of an intermediate swing high. There is no way you should remain in the trade at this point.

Passive trade managers treat this game differently, preferring to set the stop and target and then walk away. While I disagree with this concept, provided your numbers work out and your trading gives you an edge, then who am I to argue. In that case, fine. Ignore all evidence otherwise and wait for your stop to hit as price exceeds the swing high from B. I would ask you passive trade managers though to consider one thing… assume you hadn’t entered at A, but did enter short at C. Where would your stop go then? Probably above D? If that’s the case, is there any reason that a stop for entry at A should not be moved from B to D after the second attempt at the breakout? Maybe you could consider a semi-passive strategy, moving the stop ONLY if a subsequent entry would actually offer a closer stop. Ok… I’m off topic, but it’s something to consider.

In both cases (active and passive exit), the trade has been aborted at the point at which they believe their edge is gone.

Exiting allows reassessment of the bias with a clear and objective mind. Something that’s more difficult to do with exposure to the market.

The active trader is out at the very latest as price breaks above the swing high D, and able to clearly reassess. Analysis with an objective mind shows that there was actually very little in the way of bearish strength. Candle A rejected lower prices on high volume, indicating buying at and below the point of breakout. While C looks bearish when considering the low-close bearish nature of the candle, it’s on lower volume than the first push, was unable to break to new lows and was immediately rejected on the next candle. The break above D stalls, but is not able to fall. Reassessment with a clear mind, free of influence by open-position risk or confirmation bias, is able to perceive a higher likelihood of continuation higher, and prepare for entry long in the vicinity of either E or F (or maybe they’d prefer the break above B given that we’ve already established they’re breakout traders).

The passive trader is out as price breaks swing high B, and similarly able to reassess future bias and trade opportunity, maybe either entering immediately long on break above B (reversing the previous short), or entering long on the F pullback.

Price action and trading lesson over… let’s now consider the implications of not exiting at the pre-planned stop.

Failing to honor your stop in either case, means continued exposure to drawdown risk, increased potential for triggering of subconscious fear-induced patterns of behavior, clouded decision making, and quite likely zero potential for entry long at E or F.

Over the next few hours price moved about 50 pips higher. If you had the stomach to hold on this long, you were rewarded with a breakeven exit as price then crashed back down those 50 or so pips in less than 10 minutes.

Thankfully in this example it may not have destroyed your account. Most won’t. But one day… it will.

Why do people allow trades run past their stop?

Under no circumstances is it a subconscious decision to hurt themselves. Rather it’s a subconscious need to protect themselves from some deeper hurt that comes with trade loss. To the objective mind, this trade sequence offered numerous price action clues that there was little strength to the downside. However to the fearful short, the market offers endless signs that convince them that if they just hold a bit longer they’ll be rewarded as price moves back in their favor. Blinded by the fact that they desperately want this short to work, they seek out ANY information which supports their premise and keeps them in the trade (candle C for example, or the stall after break above D, or the dark cloud cover after the break through swing high B).

Exit and you take a guaranteed loss. Hold the trade just a little longer… and just maybe it’ll come back… after all, “look at all the clues the market is offering to support your short premise.”

What is the subconscious fear that we seek to avoid? There are as many variations of this fear as there are people on the planet – we all suffer through pain from some long forgotten trauma. This article is not about that subject. We can do that another time, or I can refer you to people who explain it much better than I ever will.

But from a “stop loss” perspective, the nature of the subconscious pattern is irrelevant. What is important is the fact that a potential trade loss has been allowed to trigger this pattern.

This is an indication of the following. Either:

  • You don’t completely trust your strategy; and/or

  • You don’t completely trust your ability to consistently implement your strategy.

If you did have trust in yourself and your strategy then taking a loss on any particular trade should not be of any concern. It’s part of the path to longer term profits.

The fact that you were unable to take that loss indicates trust issues.

If you have trouble taking losses from time to time… consider this… is it possible that you don’t believe in your ability to profit? Why? What can you do to develop trust?

We’ll talk more on trust in the future – a big topic.

For now… this article appears to have morphed from self-delusion to stop losses to psych issues. Ultimately they’re all related, so that’s cool.

Let’s tie it all up though, as it relates to self-delusion.

Whether continually fading a strong trend, stopping out time and time again, or holding a trade well past the original stop location, feeding on the hope offered by the never ending tempting trade patterns that convince you to hold just a bit longer, only to continually have your hopes dashed again and again, the issue is the same. You’re failing to see the signs the market is offering that show the opposite premise. You’re failing to believe what is so.

There are issues you need to work through – trust for one – and this will take time. But in the meantime, awareness of the potential for self-deception is a starting point in minimising its impact.

So, let’s wrap up with a reminder of the key points from the first article…

Always anticipate the potential for self-deception.

Always check your beliefs.

If you’re suffering a drawdown, is it possible that you’re actually suffering the second of Kierkegaard’s two ways to be fooled, and simply refusing to believe what is so?

Happy Trading,

Lance Beggs

 

Self-deception – According to Kierkegaard – Part 1

I came across a great quote during the week, which has led to an unplanned continuation of our recent theme on self-deception.

 Original articles:

The quote:

“There are two ways to be fooled: One is to believe what isn’t so; the other is to refuse to believe what is so.”

…Søren Kierkegaard

There are countless ways these two forms of self-deception could play out in the markets.

But let’s look at one example of each.

First… believing what isn’t so.

As an example of this form of self-deception we will consider the novice belief that a market gapping down should be sold (or gapping up should be bought) in order to profit from the continuation of overnight momentum.

A look at yesterdays emini S&P should suffice…   (Tuesday 15th Mar 2011)

(more…)

A New Market Model – The Market As A Self-Deception Mechanism – Part 2 of 2

“Will you walk into my parlor?” said the spider to the fly;
‘Tis the prettiest little parlor that ever you may spy.”
… Mary Howitt

Last week, we discussed a market model based upon the fact that the market is a mechanism that promotes self-deception. If you missed the article, read it first here: http://yourtradingcoach.com/trading-process-and-strategy/a-new-market-model-the-market-is-a-self-deception-mechanism-part-1-of-2/

The end result of the article was an understanding that the basis for trading in accordance with this model, is one of recognising deception in the market.

We trade with three main objectives:

  1. Be aware of the potential for self-deception, especially when faced with a “certainty”.
  2. Aim to maximise your profits through recognising when others are being deceived, and trading against their position.
  3. Aim to minimise your losses through recognising when you have been caught in a trap, allowing prompt action to exit before suffering catastrophic damage.

Self deception applies in all timeframes, at both a macro and micro level.

Let’s look at some chart examples though, from short timeframe Euro charts.

(1) Be aware of the potential for self-deception, especially when faced with a “certainty”.

“Do not bite at the bait of pleasure, till you know there is no hook beneath it.”

…Thomas Jefferson

Where do we find self-deception?

While it can occur anywhere on the chart, the obvious place to look are whenever you see a move on the charts that tempts you to jump in, which on further examination is:

  • Against an existing strong trend, with price not yet having broken your trend definition and shown price acceptance in the new direction.

  • Rallying right into an area of resistance, or declining right into an area of support.

  • Any price move which, upon examining the higher timeframe, will simply look to the higher timeframe participants as an opportunity to enter against your planned position. In particular, lower timeframe breakouts against higher timeframe orderflow.

(more…)

A New Market Model – The Market Is A Self-Deception Mechanism – Part 1 of 2

Here’s a different way of viewing the markets and the game of trading, which I particularly like – the market is a mechanism for self-deception.

This idea comes in part from the world of military strategy. Deception is a key principle of warfare, as stated by Sun Tzu in one of his most famous quotations:

“All warfare is based on deception. Hence, when able to attack, we must seem unable; when using our forces, we must seem inactive; when we are near, we must make the enemy believe we are far away; when far away, we must make him believe we are near.”

… Sun Tzu

If we can show the enemy something that he wants to see, and that he perceives to be certain, then his decision making processes will become predictable and we can position our forces to successfully inflict defeat.

Can we apply this idea to the markets, and to the game of trading? Absolutely.

Before we discuss how to apply this concept to the markets, let us first consider which role we play in this game of deception.

I’ll repeat the above key statement, “If we can show the enemy something that he wants to see, and that he perceives to be certain, then his decision making processes will become predictable and we can position our forces to successfully inflict defeat.”

Are we the deceiver… attempting to move the market and tempt other traders to position themselves incorrectly against the true market bias? I wish I was… but I don’t have sufficient capital for that, and I don’t imagine you do either.

No… we are the deceived… we are the one being tempted to position ourselves incorrectly, or to make poor management decisions once in a trade.

So who then is the deceiver?

The market exists as a result of net orderflow, created as a result of the net sentiment of all market participants. It is not capable of individual thought, and does not exist with a sole strategic objective to wipe out your account (as much as it appears that way at times). The market simply exists.

It is us who decides how we will perceive and understand market movement. If market movement shows us something that we want to see, and that we perceive to be certain, it is because we alone have decided to perceive it this way.

In the market environment, we are both the deceiver, and the deceived.

“We are never deceived; we deceive ourselves.”

…Johann Wolfgang von Goethe

The market is an environment that promotes self-deception.

So, how can we use this model to trade the markets?

(more…)