Trapped traders are a simple concept you may wish to incorporate into your trading strategy, due to its potential to offer higher reliability trade setups.
These are price action based setups in which traders suddenly find themselves trapped in an undesirable situation, either:
- Stuck in a losing position, desperate to get out; or
- Stopped out of a position that then moves back in their direction, leaving them desperate to get back in.
The key in both cases is that the price action has placed traders in a position where their normal human emotional response will compel them to make a trade. We can then increase our odds by trading in the same direction as this new surge of order flow.
There are numerous ways this can present itself on a chart. We’ll look at one of my favorites today, and follow up with other trapped trader patterns in future articles.
Today’s pattern is called a 3-swing retrace.
You might also hear it referred to as an ABC correction, or an ABCD correction. It could also be considered in some cases a bull or bear flag.
We’ll start by examining a 3-swing retrace in an uptrend.
The 3 swings in the name refer to price swing AB, followed by BC and CD.
The price action is quite simple. An uptrend leading to:
- A higher high at pivot A, followed by
- A higher low at pivot B,
- A lower high at pivot C,
- A lower low at pivot D, and
- A price reversal back in the direction of the original trend.
The moving average is not essential – it’s just there to make it simpler to see the clear uptrend. And because you’re sure to be wondering, it’s a 20 period EMA. Nothing special about that, although it is a commonly used moving average. Anyway, back to the 3-swing retrace…
Why is this 3-swing retrace a powerful setup? Let’s consider the thought processes of two quite normal traders, trader A and trader B.
Trader A has been watching the uptrend rally from the sidelines, frustrated that he’s missed the move, and desperately seeking any sign of a reversal so he can get on board the next trend early. He’s not going to miss this next trade. Hope comes when he sees the price unable to breach the highs of pivot A, forming the lower high of pivot C. Trader A knows that the definition of an uptrend is a sequence of higher highs and higher lows, so the lower high is a warning sign of possible trend failure which will be confirmed by a break of the pivot low at B. He places an entry order to initiate a short position on a break of B, as is rewarded as a large red candle triggers his entry.
This is quite common thinking. Many traders will see this breakout as a quite reasonable entry point in the short direction. Others will wait for further confirmation such as a close below the pivot low at B, entering at an even worse price. The strong close below the EMA 20 is another bearish sign which should attract other traders seeking an early entry to a reversal.
In this case, the bearish order flow of the reversal traders was insufficient to overcome the force of the uptrend. Price immediately turned and smashed them, via a large green candle closing well above the pivot B breakout entry point and also above the entire red breakout candle.
No-one likes the pain of failure, especially when it comes so rapidly and decisively.
Stops will be triggered, in some cases above the red breakout candle which led to pivot D, or in other cases above the high of pivots C or A. These stop orders, which are a BUY, add to the uptrend bullish order flow, helping to propel price to new highs.
Now let’s consider Trader B. Trader B was lucky enough to catch the original trend and is sitting on a profitable long position. However, as is quite common, Trader B finds it difficult to let profits run. Recognizing the lower high at pivot C, and therefore the potential trend failure, she tightens up the trailing stop to a breakout of the last swing low, pivot B. Stopped out of her position as the red candle moved down to D she feels quite happy with herself and her brilliant tape-reading skills, until the next green candle reaffirms the dominance of the bulls and continues the uptrend without her.
Knowing that she was unfairly stopped out by those damn stop-running brokers who once again were obviously targeting her position, she now scrambles to reenter her position long, either on the close of the green candle, or the breakout above pivots C or A.
Once again, the reentry order, which is a BUY, adds to the bullish order flow helping to propel price to new highs.
All jokes about stop-running brokers aside, this is really quite common. A 3-swing retrace in an uptrend traps the bulls out of their long position, forcing them to have to get back in, and also traps the bears in a losing position, forcing them to get out. Both outcomes, trapped out of a trade, or trapped in a losing trade, lead to further bullish order flow.
Where is our entry?
As soon as we can after the large bullish green candle traps our friends Trader A and B.
Our stop loss of course should be below the pivot D, as price returning to new lows would confirm the failure of our 3-swing retrace setup. Yes, sometimes the trappers can get trapped!!!
Let’s look quickly at a second example, this time in a downtrend.
This example is not as technically beautiful as the previous one, but then price action patterns are rarely text-book perfect. If you look at the positioning of the labels A to D, you’ll clearly see the 3-swing retracement pattern. In this case we have a downtrend leading to…
- A lower low at pivot A, followed by
- A lower high at pivot B,
- A higher low at pivot C,
- A higher high at pivot D, and
- A price reversal back in the direction of the original trend.
The candle at pivot B offered an excellent rejection of higher prices, perhaps tempting many of the traders in a short position to tighten their stops above this candle. These positions were of course stopped out on the run up to D, trapping the bears out of their position as it then resumed its downward move.
Likewise, anyone entering long on the break above pivot B suffered through a 3 candle pause before being trapped in a drawdown situation.
Both groups of traders, those trapped in a losing long position and those trapped out of a profitable short position, will now contribute to the bearish order flow through their sell orders, as price plummets from pivot D.
We’ll look at more trapped trader patterns in future articles.
Till then, watch out for these patterns when the market is trending. Awareness of these setups can be difficult in real-time as it is quite common for traders to be searching for reversals. It’s important to remember though that trends will often continue a lot further than you can possibly expect. So don’t be too quick to change your bias. Watch counter-trend setups for possible failure opportunities, which often give a great entry back in the original trend direction.
Thanks Vagar! 🙂 I’m glad you enjoyed my blog post. 🙂
Nice post!! Only one doubt. What would be the right entrance in an uptrend? Once the green candle is completed after the red candle (D)? Once one or several candles close over point C? Once one or several candles close over point A?
Thanks a lot!!
It depends upon (a) your strategy and (b) market context.
For me, if the context suggests that this is a good trade then entry occurs on a lower timeframe, within the two candles comprising D, at the point at which the break below B fails.
That is, this kind of idea – https://yourtradingcoach.com/trading-process-and-strategy/buy-because-there-are-no-more-sellers-with-lower-timeframe/
I have read this blog recently and it is a great one.I just want to know who created the green candle at point D in the first example?Is it true that green candle and initial bulish order flow created by market makers via filling their significant orders? if it is not true then who trapped traders A and B?
Wow, we’re getting back to the old articles here. This was a long time ago.
I’m not sure what you mean by “Is it true that green candle and initial bulish order flow created by market makers via filling their significant orders? ”
I’ll just answer the question “who created the green candle at D?”.
You can’t EVER know who comprised the orderflow at any point. We have no insight into the other traders comprising the orderflow.
We can assume it’s professional traders of some type, simply due to the fact that this is not the kind of place that retail traders are taught to trade. But it is still an assumption.
The thing is though, it’s not important to know WHO comprises the orderflow. All we need to know is that SOMEONE is trapped.
Learn to recognise the places where people do get trapped (such as this 3-swing retrace against a trend), watch the break happen, watch it stall, and then join in with the winning side as they stop out.
Thank you for your response Lance,It was very helpful for me.
Merry Christmas! And best wishes for a healthy, happy, and peaceful New Year.
Thanks. Same to you. Best wishes for a Merry Christmas and a happy New Year.
Thanks for another wonderful article! I have few questions though:
1. What do you mean by ‘tape-reading (skills)’? Are you referring to the price action taking place?
2. The sentence – “In this case, the bearish order flow of the reversal traders was insufficient to overcome the force of the uptrend. Price immediately turned and smashed them” . In the example 1, the momentum was in the direction of the trend (its easy to spot it with the benefit of hindsight) and hence it can be said that those who tried to go against the up trend (trying to find the reversal) got trapped but what if there was enough bearish order flow which was just enough to overcome the uptrend? The exact same situation would have turned in favor of those who went short. Anything is possible due to the uncertainty in the market.
My question is how can one identify how the market is going to unfold and in which direction the order flow is going to come so that one can enter the position just before the order flow or with the order flow? Ideally you want people to buy or sell after you so that you benefit from the resultant order flow in your direction (up or down).
My apologies for the lengthy response with couple of questions. Please excuse me if my questions are silly as I am still trying to learn this craft.
1. Tape reading skills – price action, yes, but also this typically refers to looking at the actual order book as well such as through DOM and Time & Sales. It’s not relevant to the point of the article though. Feel free to replace the phrase with “skill in reading price action”.
2. Your question is asking “how can I be certain I’m going to get my analysis and trade decisions right, to avoid any losers?”. This is not possible. All trade decisions are made on a probabilistic basis. And so if we misread this situation, or subsequent information changed the picture after entry, and this break of swing D was indeed more bearish than we anticipated, then yes we certainly could be faced with a loss. Recognise this and scratch the position, or exit at the stop. Profits are made across a SERIES of trades, not in any one individual trade.
I’m not sure I fully answered your original question. In particular, “My question is how can one identify how the market is going to unfold and in which direction the order flow is going to come”
That is the aim of the analysis process in the YTC Price Action Trader – https://yourtradingcoach.com/ytc-price-action-trader/
We assess the strength/weakness within swings to identify potential edge. And then act upon this information to exploit this edge as best we can.
As mentioned before though, all trades are still made on a probabilistic basis. Hence the need for a trade management and risk management plan. And a longer-term perspective, in which we watch our edge play out over a larger series of trades.
Thank a lot for your blog. Really worthy to read it. I have been reading your blog from last month. I received so much understanding from your blog and recovered some of my loss.
Thank you Anand. I appreciate the feedback and am pleased you’ve been able to find value in my work. Best of luck with your trading.
Thank you very much for your blog. I feel it is really worthy to read. I have been reading your blog from last one year. It really helped to understand the chart pattern, important locations and psychology behinds the candles. I learned so many things from your blog and turning as a profitable trader.
Thank you Siddhu for your kind words and great feedback. I’m really pleased you found value in my work here. And I wish you all the best of luck with your trading.