I received an email this week thanking me for the Advanced Candlestick Analysis articles and requesting some more analysis of this type.
If you haven’t seen these articles, check out part 1 and part 2 here:
I’d love to do more of these articles, but they take quite a while to put together. Probably video would be an easier format for me to present this type of material, but then you can’t print it out and study it.
Anyway, Ill be sure to do some more once the ebook is complete later this year. Actually, the ebook should present quite a few examples.
In the meantime, I went through my email archives to find a sequence of emails I recalled from earlier this year, which could be of interest to anyone who is into discretionary trading. It deals with whether or not it’s possible to trade a very narrow range sideways market, as occurred in the emini-futures on Jan 6th, 2010.
Please recognise that any hindsight based analysis should be treated with skepticism. As you’ll see in my response, it’s easy to trade with perfect hindsight. In reality (as I state in the email), standing aside was probably an excellent option.
Oh, and don’t get any thoughts that this is the usual amount of response I’ll provide to your email questions. This was a one-off. 🙂
Anyway, I hope you get something out of it…
Ok. I don’t want any freebies or for you to give away proprietary trading techniques. I am including three charts from today: 1 min, 5 min and 30 min of Russell 2000 futures. I’ve removed all my S/R lines and range markings so you see pure market. (NB. Charts not displayed – not relevant to this article)
Now, I know that it’s easy to see tops and bottoms in retrospect, but you’re experienced enough to be able to look at it from a more realistic perspective. The entire day’s range was only 6.3 points or 1% of the value of the index.
What I would like to know if someone like you can actually make money in this type of market. Just a yes or no. Don’t want to bother you with analysis.
Because I consider myself fortunate having taken no trades (call it fear, call it intuition or natural caution) and not losing any money. Generally, for me, this is a nightmare scenario day… no followthroughs, nothing but fakeouts, even a pump fake with that long tail.
IN RETROSPECT, a fade here and there, and a quick exit would have netted some cash. But even for someone who got in early on the fades, the retracement swings are so wide relative to the impulse moves, that who would have the stomach to hold on?
On the other hand, if my perspective is wrong, do tell me. I am going to be focusing so much on learning how to deal with sideways markets, [aside from scaling back like today], it’s like becoming an obsession.
Jan 6th was very tough to trade. You’re not the only one who found it difficult.
Sometimes it is best to pass. Tight ranges can be difficult. I like them wider than this one. Personally I think that if you somehow sensed a challenging market environment and stayed away, that’s maybe a positive. (Unless that same feeling starts to keep you away from good markets in future… then it needs to be addressed cause something’s not right).
I only had a short session (08:00 till 09:30ET) trading 6B, which was similarly in a tight little (approx 20 pip) range. I just wasn’t interested, so didn’t take any entries. There’s better days coming in future.
You ask whether or not I could profit from that session. Impossible to say with hindsight really. I look at the chart, and yes, there are setups. But whether or not I’d see them live is another matter altogether. Usually on these very tight ranges I’ll just stand aside, as I did with 6B.
Ok, before we look at where the entries are on this TF chart with the benefit of my hindsight let’s first go through some general principles of range trading, off the top of my head…
If you’re not feeling the flow of the market, don’t trade. Pass on the session… there’s better trades coming in the future.
Everyone is always focused on high probability setups – ie. a high win percentage. Remember though that your overall profitability is not only a function of your win %, but also your win/loss size ratio. So, it’s equally as important to focus on ensuring your wins are greater than your losses. This is even more important in range trading. Your risk has to be minimized as much as possible. The more confirmation you seek at turn points, the more risk you’re taking and the less profit potential you’ll have available. (ie. more confirmation = more risk). Confirmation is BAD for your results. This is hard for most people to get. If you can’t get an entry close to the extremes, with small risk and larger profit potential, don’t get in. With experience you can see this with price, but if you prefer an indicator to help quantify this, look at something like a Keltner Channel (2.5, 10) (or 1.5,10 in less volatile markets) and ensure that you get in within the wholesale side (closest to the range boundary). Or the wholesale third, or quarter would be even better. I love Keltner Channels by the way – my favourite indicator.
Although I’m usually happy to take scalp trades in-between support or resistance areas, they’re a much lower odds trade within a range bound environment, and generally best avoided. Stick to the areas of proven supply/demand imbalance, which are usually just previous extremes at the edge of the range. If this means less trades, don’t worry. That’s often a good thing anyway. (There may be some exceptions in wider ranging markets, for example if it develops a shorter timeframe range within the range, then the breakout point of the lower timeframe range can be a great setup area for an intra-range scalp trade (breakout pullback trade).
So, for setup areas, we’re basically looking to see how price reacts at the previous turn points near the top or bottom of the range.
The general principle for entry is to consider price from the perspective of the traders who are entering the market late – that is, buying late in the rally as it approaches the upper range resistance, or selling late in the decline as it approaches support. If our analysis is correct and this is a range bound market, then these people are taking very low odds trades. Where are these people going to exit for a loss? That’s where we want to get in – at the point of their exit. As they exit, their order flow pushes price further in our favor. Further price movement causes others to exit their position as well, as well as bringing in others trading in our direction but who are later to the party (waiting for more confirmation!!!). It’s kind of a cascade effect. The smaller order flow brings in more orderflow. The point of initiation is obviously the high or low of the move – that can be hard to see real-time, but the point at which the move can become self-sustaining is the point at which the late losers will exit. (NB. General principle only, not guaranteed!!!)
Ok, so what you’re looking for is price testing the previous extremes, preferably overextended in the short-term, and then failing. Where is the point at which the losers are getting out of their positions? (the losers are the late longs buying into resistance, or the late shorts selling into support)
Sometimes price will stall or turn before reaching the previous extreme. Other times it will breach it slightly before failing (breakout failure). Be prepared for either. With experience you’ll sometimes sense when a breakout is coming, but not always.
Please note, you’re not blindly assuming every test will fail. Always remain alert for any sign that the bias may have changed (or be changing) such that a test will lead to a successful breakout. However until you have this evidence, trust the range, watch for price to test the area and identify the area at which losers will exit.
Some of the absolutely best setups are those that make two attempts to breach the S/R. Enter on a fail of the second attempt. Most people won’t hold beyond a second failure, so they’ll exit and we’ll profit from their orderflow.
Even better when the first attempt had lots of volume. So, watch for large volume spikes at or approaching the S/R levels. A lot of people bought and sold at this area. If price then retreats and returns for a second test, those who spent the intervening period in drawdown will likely take the opportunity to exit close to breakeven, adding to the likelihood of of the S/R holding a second time.
Otherwise, I love the breakout failures (AKA prairie dog, pump fakes, turtle soup, trader vic 2B pattern, and any number of other names), where price moves beyond the S/R, preferably on low(ish) volume, and then fails quickly back into the range.
Ok, that being said, let’s look at the TF on Jan 6th and see what it shows, recognizing that any hindsight analysis is questionable. And the fact that it’s a bit tighter than I really like and would probably in reality just pass.
Please note that on my charts, the session runs from 00:30 to 07:15 local time
Previous days had shown little volume and largely range bound markets. There was little to suggest anything different would occur this day, unless one of the economic news releases gave a great surprise. Pre-session, the 23:15 ADP Nonfarm employment change had little impact. The ISM Non-manufacturing PMI was due at 01:00, Crude Oil Inventories at 01:30 (although that shouldn’t have significant impact), and the FOMC Meeting minutes at 05:00. Larger bias is to continue the range bound action, until proven otherwise. (Damn, this is easy with hindsight!!!!!! I’m really not sure what influence the hindsight is having – probably lots)
Looking firstly at the 30 min chart, this establishes the price midway between support in the vicinity of 633.0 and resistance in the vicinity of 640.0, which contained all of the action from the prior day and the bulk of the action from the day before. These will be areas to watch if price gets there (which it never did!!!!)
I’d normally use the five minute chart to establish the trend and define the bias, then the one minute chart to get finer detail. To reduce the size of this essay, let’s skip the 5 min chart and focus just on the one min. Any trend and bias discussion would have in reality come from the 5.
Refer to the one min chart above which shows the first couple of hours, till just after 1pm ET. The increase in volume shows the session open. I’ve attached the Keltner Channel (2.5,10) just to see what it looks like. Although in hindsight, this tighter range would probably be better with a 1.5,10.
I’ve used price bars rather than candles so it’s not so congested.
The horizontal blue line at 640 is the major resistance, never touched.
Initial bias is for continuation of pre-session uptrend, although expected to be weak. The size of the initial move though would have had me looking for a continuation and then possibly a trend day if we could break the higher major resistance. So, I’d be looking for a long entry from the pullback to C. To be honest, the pullback was a little deeper than I’d like, indicating some strength in the bears, so it’d be a cautious trade. Price then got choppy from C, offering lots of opportunity to scratch the trade. As it fell below to D, my bias would have changed to more neutral. I wouldn’t have got long off D – it rejected that level too quickly. But the fact that it did would probably be enough for me to tentatively change the bias to range bound between the support level shown in red, extending from the opening range congestion at A up to the resistance level in red extending from the congestion at B.
Point E is the first real opportunity. A second test failure (first test at D rapidly rejected, second test stalled). Anyone entering late on either thrust down to D or E is likely to bail on failure of E, so if I didn’t get in earlier I’d be looking for an entry on a break above the small candle at E.
F hasn’t really extended close enough to the resistance for me. I wouldn’t have traded here. However the larger red candle at F would get my interest. G provides a second test of the F level (after that larger red candle. I’d love to say I’d get this short signal, but probably wouldn’t in reality. I hate the crappy grinding action that occurs between E and F, so likely would have just switched off until price got closer to the S/R.
H is not quite at the resistance zone, although very close. What interests me here is the 3 candles in a row with equal low. I know I hate breakout style trades, but that’s probably how I’d enter a short here – first target the area of the swing low between G & H (which it got), second target the vicinity of E (resulting in a b/e exit).
‘I’ offers a great setup having just touched the zone (note: both H & I are pump fake style breakout failures as well)
J offers a second failure entry (if you’d missed ‘I’). Anyone who was still bullish, and held after I’s failure, would probably exit after the attempt at J failed again. (REALITY CHECK – just a reminder this is all in hindsight, as so far it’s working out beautifully, apart from C, the reality is never this good – I probably would have got out of ‘I’ at breakeven, on the J retracement, and then missed the J reentry)
K is nice – slow momentum move into support. Low risk trade for a long.
No entry at L, unless an anticipation style entry was taken – unlikely though in this case – I can’t see any reason for one. The rejection was too quick.
M is the entry of the day (or at least up there with E). This is a beautiful breakout failure / upthrust style entry at resistance, also second test failure after the higher volume test of L. Beautiful.
Anyway, this has probably set a new record for length of email response, so lets stop here instead of continuing onto a second chart.
I know you weren’t after this much response, but hopefully it helps show a little about my thought processes, accepting that the reality is probably quite different. As I said, this one is probably too tight for me to bother risking money. Best to wait for another day. But when analyzed in hindsight, there are clear entries all over the place. The challenge is in finding a couple of them live. Easier said than done. More likely, if I was to trade this, it’d be a bunch of scratched trades, small wins and small losses.
This was just awesome analysis. This is the sort of thing that will plug holes in my trading technique. If I could integrate this with my trending/breakout/large range reversal techniques, I think I would feel complete. Man! you don’t know it, but you’re ready to mentor. I love the detail of this essay. I have read it and will be rereading it over and over, since this is the best sideways market tutorial I’ve ever come across. lol.
Thanks so much! what can I say! Your generosity in time and sharing your knowledge is astounding.
I am determined to work on my trading harder than ever.
I really appreciate, in particular, this email and yes, the length and thoroughness of it. There is much to digest. I think you gave me quite a few great principles.
One quick question to clarify. You’re saying confirmation is always bad??? or only bad at turning points/range bound markets. Sometimes on breakouts, when I think it might trend, but I have some reservations (for instance, counter general trend breakout), I wait for confirmation in the form of “retracement” that fails to turn into reversal. Then it it turns around and breaks new lows (on a short) and I see momentum, I get in later, than I would otherwise have gotten in, BUT my stop is usually tighter, because that retracement created a lower high. Another time I seek confirmation is when I see no reasonable hard stop, for instance if opening range is wide, so from risk/reward perspective it sucks, even though it’s a clear breakout, and might even look good. But I am not willing to give up 5 points. So often I miss it, or I wait for confirmation in the form of digestion, sideways movement before further breakout, or the retracement I mentioned.
‘Confirmation is bad’ is a poor choice of words. The types of confirmation that you referred to are great, as they minimize risk.
I was referring to seeking confirmation through price moving further and further from the optimal entry point, in particular within a ranging market.
Think of a sliding scale of increasing risk/decreasing potential reward. The best entry (in terms of R:R) is an anticipatory entry right at the S/R zone which provides minimal risk and maximum potential reward. The worst entry would be after allowing price to move all the way to the opposite S/R where there is maximum risk and almost nil reward potential.
Most traders are not comfortable with an anticipatory entry. It’s tough to go short at the top of a series of green candles. Instead, most traders wait for a stall and some degree of reversal, whether via a candlestick pattern breakout, or MA cross, or oscillator cross or whatever. All I was getting at is that the more confirmation you seek, the worse your R:R. So, time needs to be spent in working out ways to get entries as close to the start of the move as possible. (wholesale prices rather than retail prices, to use Don Miller terms).