It's the Pattern, Stupid!

[learner2007]

Hi learner2007,

Do you trade the breakout or the pullback? If you trade the pullback, can't you trade all three since they all pull back to the breakout point? Or am I missing something obvious?

Thanks.

You said 'all three'. F3 is not what I use as a trading set up. True, some traders do trade on failed patterns. But here, while the flag did fail, the trend has not changed. That would be an overly risky counter-trend trade because .......(what's your opinion of why?).

Given the extremely high success of the flag(provided it's read correctly) it is the only pattern with which I will trade on a breakout. In fact, though, if all the proper conditions are met, I usually enter on the 4th reversal point. Again though, as with entering on a breakout, this is the only pattern with which I would enter a trade before the pattern is completed.

 

[NoDoji]

Nodoji, what do you consider a small stop? Also, are you letting your trade ride when you trade that setup?

I like to see more conformation at E before I take a trade... I'm just trying to figure out your thought process..

I, too, prefer "confirmation", meaning I will trail a buy/sell stop using the chart with the shorter bar interval (1-min for me) to initiate a trade when price reaches a key level (such as E). If I perceive the risk to be too great, such as if the 1-min bar that closes with a high around price level E is so wide that it would exceed my max acceptable stop loss if I entered on a break of its low, I'll take an even more confirmed entry using a sell stop just below D and treat that as a breakout trade, meaning I expect bids to be pulled and price to drop quickly with conviction. If my sell stop is triggered at D and price just sits there or starts to tick back up, I'd scratch the trade for a break even or very small loss.

If I took an anticipatory entry by placing a limit order to sell a tick or two below price level B, I'd place the same small stop I use with a breakout trade, which is generally the equivalent of $50 per lot/contract.

With confirmed (stop order) entries, I like to keep my max stop between $60 and $150 per lot/contract. So if the technical at which a stop loss makes sense requires a greater risk, I will either skip that trade or place my max stop loss and cross my fingers.

As for letting a trade ride, I calculate my expected profit target in advance. In a setup like the one pictured, I'd be looking at a measured (equal) move target, which in the illustration is F.

 

[NoDoji]

This habit of cutting losses quickly - did it come by naturally or was it something you had to develop as a habit or reflex? ... yet one of your favourite pattern is a reversal pattern (which is kind of picking tops and bottoms and something you which do not recommend?). Can you help me understand the "apparent" contradiction between the two?

Cutting losses quickly can be an account killer when handled incorrectly. I believe it's very important to know in advance the price level at which a trade idea would be invalidated. If you're not comfortable with a stop loss placed at that price level, do not put on the trade because discomfort leads to cutting winners short (quickly moving stops to break even or to a smaller loss), while letting losers run.

It's very important to accept the risk on a trade and have an advance plan for how you respond to various scenarios. As I outlined in my previous post, if I enter a position at a break of a key level, I expect follow through. I know in advance that if the break of that level results in price going hardly any further, it's more likely than not to be a failed breakout and the opposite side will construe it as a trap and get aggressive. So my advance plan for any setup that should result in a strong break of a level is to use a small stop or scratch the trade near break even if the break of the level is no more than few ticks and stalls or reverses.

More importantly is a common habit of cutting winners short. It's very natural to want to move a stop closer or to break even as soon as a trade is moving favorably. The part of our brains that craves security and certainty says, "Hey, I'm profitable, quick, move the stop to break even and I'm free from worry! I can't lose now!"

This habit is awful and can turn a highly profitable trading method into consistently negative outcomes. It took me a long time to overcome this habit. End of the day, I'd see how much profit I would've made if I simply walked away and let my profit target stand.

So if you think you're cutting potential losses quickly by moving a stop loss to break even, you're probably a consistently break even or losing trader.

As for trends, I don't like to pick tops or bottoms in a strong well-defined trend because I've learned that even the first break of a well established trend line tends to fail and the easy money is in the direction of the trend.

I do however have a solid understanding of trend reversals and will start trading in the direction of a potentially new trend when indicated.

 

[romik]

It's all a bit of a gamble. Sometimes waiting for confirmation gets you in late and still reverse, not waiting for confirmation on the other hand can result in multiple losses. I have monthly/weekly/daily reaction levels marked on chart and look for weakening/strengthening PA near those levels, range expansion/volatility picks up around those levels.

 

[ubo]

it is the only pattern with which I will trade on a breakout.

I agree that if you are entering on a breakout, you are assuming that the flag or pennant is a trend continuation pattern and F3 would have been a failed trade. But what if you had waited for pullback to the breakout zone before trading it, not caring if it was a trend continuation or not. Then it doesn't matter if the breakout happened on the trendline side or the channel line side of the flag or pennant, as you will only enter when price revisits the breakout zone.

 

[learner2007]

you are assuming that the flag or pennant is a trend continuation pattern

Not assuming actually, as the pattern can only be a continuation pattern. Certain patterns, such as rectangles and triangles can be either continuation or reversal patterns, but not so with flags.

But what if you had waited for pullback to the breakout zone before trading it, not caring if it was a trend continuation or not. Then it doesn't matter if the breakout happened on the trendline side or the channel line side of the flag or pennant, as you will only enter when price revisits the breakout zone.

If I understand you correctly, you want to sell around 2495 as you consider that to be the breakout point of the failed pattern. If so, then, as I mentioned previously, you would be trading against a still existing trend which has not changed just due to the failure of a continuation pattern within it. Counter-trend trading is fine if you know what you're doing. I do so from time to time, but would not do so in the situation in F3.
Entering on a reaction is fine if it is a reaction to a breakout from a recognized continuation or reversal indication. Doing so on a failed pattern will not give you the high probability of success that you find with breakouts in the indicated direction of continuation and reversal patterns.
Sorry if I am misunderstanding your question.

 

[schizo]

If I took an anticipatory entry by placing a limit order to sell a tick or two below price level B, I'd place the same small stop I use with a breakout trade, which is generally the equivalent of $50 per lot/contract.

One of the biggest hurdles beginners find especially challenging is not knowing exactly where to place stops to control losses. A lot of traders tend to place their stops arbitrarily in the middle of nowhere, which invariably ends in losses. Would you mind elaborating where you see as important area to set your stop?

 

[ubo]

Tactic 2) Once D occurs, you wait for a retrace to B and if price doesn't run much further,

Tactic 3) Once D occurs, and price pulls back to B, if price turns back in the direction of the trend line break without running much further

Hi NoDoji,

Sorry to trouble you regarding the above.

I can understand tactic 2 but I'm lost for tactic 3. For example, when price pulls back to D and does not run any further up past D for both tactics, the actions are different? For tactic 2, you trail the low whereas for tactic 3, you put a sell stop at D? For tactic 3, which trendline are you referring to? I don't understand the phrase "price turns back in the direction of the trend line break without running much further" for tactic 3.

Thanks.

 

[ubo]

If I understand you correctly, you want to sell around 2495

That's correct. I'm assuming that the support has turned into resistance.

 

[learner2007]

That's correct. I'm assuming that the support has turned into resistance.

I would not call that 6th reversal point, within the pattern just before it failed, support, as it had not shown itself to be such. If the price had exceeded the 2647 high, you could then say it was support.
And, FWIW IMHO, I don't view various types of moves in uptrends that are commonly called resistance as being such. If you are interested, please see a post on the subject that I made in another thread.
http://www.elitetrader.com/et/index.php?threads/buying-at-support-or-buying-at-resistance.295563/