Wednesday, August 15, 2012

Trend analysis using pivots.

I've been trading for so many years and I still can't find the winning setup without some risk of losing the amount of money I'm willing to risk or being stopped out.
The only 100% certainty is that even the best looking setup could and will fail at times. Any price affecting event can happen at any time. Don't believe it? 

You need to always risk the same amount of money on every trade, combined with the need to find trades that will reward you three times to one the risk amount that you are willing to lose, because you can have two trades being stopped out and if the third one hits three times reward target, you end up making one risk amount of money, even with two losing trades.
Basically always try to find the higher odds trade 3 to 1 or greater R/R. And protect yourself with a solid stop underneath in case your trade/ investment moves in the opposite direction that was intended.

Disclaimer: if you like to use these strategies, paper trade them first until you feel extremely comfortable risking your hard earned money. Specially when shorting stocks as they have inherently higher risk.

First, understanding that the monthly and weekly charts have total control of the daily chart is a must. 

Or just skip all them lessons, read the time frame cycles lesson to get the general idea of how the larger time frames control price.

Read this four links about the monthly chart: 

After that read how all time frames interact with and influence each other:

After reading the lessons above you are ready to put your hard earned money on the markets right? You checked the monthly chart and looks green and not too extended, even better if it has been resting for a couple of months. Now lets check the weekly chart to look for clues about direction for the next four weeks.

Read how the weekly chart controls the daily and 60 minute chart and vice versa:

Crazy!! I know, you thought taking money from the sharpest minds on Wall street could be easier.

Now that the monthly and weekly chart line up with your direction bias, it's time to find the early signs that the daily chart will begin forming an uptrend

The very first lesson on the blog showed us how trend pivots form.
Now after multiple pivots have formed, if the buyers have control over the sellers a new trend will emerge, this trend will dictate my trading bias.
I have a trading plan that helps me narrow my trading choices, simply because inside the markets (auctions) there are no rules by design, to protect us from everybody else that is trying to take our money away from us. (this isn't even a zero sum game, when you enter the trade you are negative considering the trade's commission) Said plan also protects me from my own mistakes, so I had to create a plan to protect me from myself first. One of the rules on said trading plan dictates that I only trade on the long side or that I only buy up trending stocks on their daily charts provided their weekly charts are in an uptrend and have room to move higher after a controlled pullback.
Some times the weekly chart is in an uptrend but having a needed pullback as explained on time frame cycles lesson or reviewed in detail throughout this blog.
The pullback on the weekly chart will put the daily chart in a downtrend for the duration of said pullback, this is the only time one can look for signs that the downtrend is about to end to anticipate the bounce with good R/R Odds aggressive entry, that signal for entry will be as soon as the first HL Forms stopping the DT As showed on the chart above, because for the pullback to end and to bounce on the weekly chart, the daily chart will re-establish its uptrend first, thus reversing direction on the weekly chart.

I absolutely avoid buying down trending stocks on their daily charts when their weekly charts are in a downtrend or their monthly candle is forming a giant red bar on the monthly chart, unless they become climactic or in capitulation stage but that will be another lesson you'll find here:
On the chart below we can tell that the daily chart is in an uptrend just by looking at price above its 20 Moving average (MA) which is above the 40 MA. Also above the 200MA.
One of the simplest money making strategies in a trending market is to buy near the rising R20 MA. As it acts as support (Is not solid support but some buy side computer programs buy as soon as price touches this MA.) As long as price is clearly up trending as shown on the chart below. This strategy does not work on flat markets.
What defines a trend? Better yet how can one easily identify a trend? I will not bore you with technicalities, An uptrend is described as two higher lows HLs and two higher highs HHs, at some point trends do come to an end and the easiest way to visually see them ending is through a blow off top or climax top process, for the most part they end when sellers overwhelm buyers forming a noticeable lower high (LH) if in an uptrend, and even then the LH only puts the uptrend in question as shown on the first chart below, it formed a LH, price even closed below the last higher low (HL) formed another LH, and now having two LHs and one LL this area I call the critical point in the trend that usually gets buyers motivated to salvage the trend and creates a very profitable trade with good risk reward when I can find them, because price needs to close and complete the second lower low (LL) Remember two lower highs and two lower lows establish a downtrend, but some times buyers are not ready let the stock begin the D/T and will push price back to the top or even new highs before the downtrend gets established as was the case. 
This battles for the trend happen every day in all time frames in some stocks and ETFs.
The second chart shows you how an old trend changes and a new one emerges, price was clearly in a D/T forming LHs and LLs, all of the sudden it forms a higher low signaling sellers exhausted and putting the D/T in question, after that buyers showed up pushing price above a LH Pivot putting  the trend less stock in a transition stage from downtrend to sideways to uptrend? Well, to turn it into an uptrend the next pullback needed to be controlled and form a higher low and it did, after that buyers pushed price higher enough to close above the previous higher high forming the now second higher high thus establishing the new uptrend.
The red arrows show the best entry points for the high probability beginning of the new trend

On the third chart the buyers were overwhelmed by the sellers at the critical area judging by the biggest red bar closing below the first LL, after that price was under its decline 20 MA. With the D/T established. 
On this new chart below we can see the LH Pivots forming when price bounced and touched its declining 20 MA. Another good way to visually measure the selling intensity is to measured the drop from top to bottom versus the technical bounce (dead cat bounce) higher to be no more than 50% of the previous drop only to begin the next wave lower to match the last drop, sort of in a measured move, an 80- 100% retracement of the last drop signals a possible surge in buying to stop the D/T.
Remember a downtrend has two lower highs and two lower lows.

Lesson #3 Anatomy of the setup bar:

Don't take my word for it, print some charts from the monthly to the 5 minute time frame of trending stocks on both directions and analyze the pivot formation around the 20 MA. And the way price behaves when the trend becomes questionable? 

I hope you learned something valuable. 

Feel free to leave a comment. 

All charts are source

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