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Buying bottoms and selling tops carefully applies countertrend traging strategiesCOUNTERTREND TRADING Constricted ranges dictate countertrend plays. This classic swing strategy uses clearly marked boundaries to buy weakness and sell strength. When S/R draws strong congestion, sell short as price tests resistance and go long when it falls into support. Use the charting landscape to guide low-risk execution levels. Keep in mind that the first thrust into S/R usually offers the best fade position and that odds will deteriorate on repeated tests. And remember that swing entry is always very pricesensitive. Focus the intended execution near a single price level and stick to it. Never chase entry and always maintain a tight stop loss. Countertrend trades must execute with minimum slippage right at or close to known S/R. The swing trader should stand aside if conditions don’t allow for this narrow entry. These setups manage risk through small losses taken when positions violate specific S/R zones. A series of larger losses due to poor execution will eliminate a very good profit. Target reward through examination of the local features. If possible, carry the position until price approaches the other extreme of the range. Broad congestion likely mirrors intermediate S/R that inhibits a quick price thrust across the pattern. Many swing traders find that single direct price moves without retracement provide the best conditions for a profitable exit. Consider getting out as price jumps into that first boundary. If this is the chosen style, the original reward:risk evaluation should confirm that this price target carries enough profit to make the trade worthwhile. Buying bottoms and selling tops carefully applies countertrend strategies. Major highs and lows attract interest more than any other charting landscape feature. This ensures a large supply of participants but also invites more whipsaws and unexpected outcomes. Apply this primary rule at tests of prior highs and lows: fade the first test after a significant pullback but trade in the direction of the extreme on subsequent tests. Price tends to break out of ranges on the third try (second test of a high or low). Use small reversal patterns in the chart below the holding period to fade entry near S/R extremes. Adam and Eve patterns and double tops/bottoms present simple formations that apply this 3D technique. Short sales depend on price violating the bottom of the smaller top pattern, while long positions signal when price surges through the top of the smaller bottom pattern. This original method allows low-risk execution close to the larger high or low in anticipation of a favorable price move. Victor Sperandeo’s 2B trade in Methods of a Wall Street Master and Raschke and Connor’s Turtle Soup in Street Smarts both trap the crowd as it leans the wrong way right after price violates a high or low but reverses immediately. As smart traders adopt these contrary tactics, many price extremes face increased danger of a swift reversal after the initial breakout or breakdown. The safest 2B fade strategy lags the crowd before position entry. Let the price action break through key levels but don’t execute in the opposite direction until it pops back across support or resistance. Trade 2B setups defensively. The market may still want to break through the barrier. Ride the subsequent pullback to the first natural swing level and then exit. After a good reaction the trend can reassert itself quickly and take out the old extreme. This follows the wisdom to fade the first test of an old high or low but follow the trend on the second test. Apparent triple bottoms and tops often yield to significant breakouts or breakdowns. Watch out when a new high or low retraces and forms congestion close to the price extreme. Simple continuation patterns can quickly ignite into new trend thrusts. Stay away from small pennants and short pullbacks when planning 2B entry. The best reversals for this pattern come when a sharp retracement occurs after the first high or low. The subsequent test should then print more price bars than the decline that precedes it. Also pay close attention to lower-pane indicators as the event approaches. The trade cross-verifies when oscillators diverge from price direction just as the old high or low breaks. Pullback entry into a strongly trending market represents a major category of swing tactics. This classic setup buys the first sharp decline into support or sells the first bear rally into resistance. Exit depends on many factors, including personal trading style, holding period, and available capital. Subsequent swings also offer safe entry, but risk increases as trends evolve and reach overboughtoversold conditions. In other words, each pullback after the first one has higher odds of being a reversal rather than a continuation pattern. Chapter 8 examines this bread-and-butter swing trade in greater detail. Central tendency presents high reward: high risk opportunities at the extremes of price action. These tactics work best in congested markets or in the extreme volatility near climax events. The strategy fades price when a long bar thrusts out of a Bollinger Band extreme more than 50% of its entire length. In rangebound markets, odds for success improve substantially when the top or bottom band aligns horizontally just before the violation and price thrusts into known resistance (other than the band itself). Consider this trade at the end of parabolic rallies and selloffs. The bands will turn close to vertical as these events progress. Look for an intense burst of energy that forces the bar to break halfway or more through the band. This signals the possible climax and invites countertrend entry. But successful execution requires both a skilled hand and excellent timing. Some blowoffs can issue a series of these bars before a violent reversal. Use cross-verification and tight stop loss to manage risk. And master other setups before attempting this dangerous trade. TRADING TACTICS Narrow range tactics enter positions in low volatility near the edge of S/R in anticipation of a breakout. Both range-based coiled springs and simple, well-placed congestion generate excellent reward:risk profiles. These unique opportunities may signal through the pattern alone, but look for volatility and price rate of change indicators to verify narrow conditions. Both plots should move toward flatline before a breakout occurs. This indicates that the pattern has a supportive environment but does not flag an impending move. Review coiled spring tactics in Chapter 9 to manage positions with this important contraction event. Trends advance through major highs and lows after repeated attempts. When congested price tries to break S/R and subsequent bars narrow, they often signal impending breakouts and breakdowns. This tight congestion offers a very narrow execution window before price explodes through the barrier. These interfaces also signal low-risk failure when price rolls and expands slowly in the wrong direction. Focus sharp attention after a first test fades and retraces. The next attempt faces fewer whipsaws because most participants took their shot on the last try. Many swing traders freeze at breakout interfaces and fail to execute these profitable positions. Because most opportunity relies on crowd participation, they wait too long for confirmation rather than accepting the pattern signal that flags the impending move. The narrow-range setup depends on execution ahead of the crowd and lets their fuel carry the position into a fast profit. Reprogram trading rhythm and watch these unique formations to capture trends just before they appear. Setups work best when executions align with market conditions. Shorting rallies in hot markets or chasing trends in dull ones both empty trading accounts. It takes considerable skill to recognize the interface that separates a momentum market from a countertrend one. But this also allows a tactical shift that beats the crowd to the new dynamics. Changing conditions may not offer good setups right at the interface. A developing market trend may just shake up confidence and tell the swing trader to stand aside until opportunity shows up. Learn to read market cycles before the crowd. Cycle analysis uncovers trends ready to tighten into congestion and offers another tool to locate impending breakouts into new trends. Apply a 14-day slow Stochastic or RSI and measure the longer-term swing between buyers and sellers. Or plot a five-bar slow Stochastic under a 5-minute chart and look for the 90-minute S&P alternation cycle. At potential turning points, watch for reversals at trendlines, channels, and other natural break levels. Align executions to these underlying cycles and place trades in tune with the market. Study volatility through range bar expansion-contraction. Look for the range-bound NR7 and trending wide bars that reflect shifting crowd conditions. Apply Bollinger Bands to bar range study. Watch for constricting bands around price as volatility decreases and signals an imminent swing back into bar expansion. Measure how quickly they turn out and twist as price momentum builds. Or plot classic lower-pane volatility indicators that track the central tendency aspects of price change. Volatility routinely increases through the early phases of a trend, decreases in the middle, and peaks as it climaxes into a sideways range. Friction and intense bull-bear battles characterize new breakouts and lead to wide range bars. The conflict eases as price ejects and the dominant crowd assumes control. Heavy crosscurrents return near climaxes and participation surges again. Volatility decreases gradually through the congestion zone as volume dries up and price bar range narrows. These peaks and valleys define points of swing trade opportunity. Frequent pullbacks after new breakouts offer low-risk countertrend entry. The dynamic third-wave trend environment favors momentum tactics as prices ramp bar after bar. Climax tops and bottoms invite central tendency trades at the extremes of overbought-oversold readings. Sideways congestion presents fade setups until the empty zone signals the start of a new trend. MORE ON CROSS-VERIFICATION Market participants have difficulty understanding the nature of opportunity. The pundits teach that a few well-marked patterns have secret triggers that lead to profit. In their logic, participants must find these quickly and take a seat before the blessed event. But effective strategy requires far more careful planning. Price emits continuous data about future direction. Each new piece of chart information can alter the likelihood that any specific outcome will occur. Execute the right bar and mediocre patterns may yield profits. Execute the wrong one and no textbook will save the position. Directional probability falls through negative feedback and rises through positive feedback. But odds don’t matter until setups appear. When they do, the charting landscape will filter opportunities with the highest odds for success. Predictive force peaks at certain crossroads on price charts. Odds for a specific outcome increase when discontinuous forms of S/R converge at a single price level. Apply this cross-verification (CV) mechanism to measure the setup’s potency. Each position generates a probability for success or failure. Enter a trade only when highly favorable odds support the setup. Measure probability by the actual number of converging S/R points. This simple analysis dictates that the more CV, the higher the likelihood that the position will produce a profit. When four or more levels intersect (CV4), entry into that setup at the low-risk execution target (ET) has the highest odds for profit. Keep in mind that trade probability must also align with favorable reward:risk. A move in the profitable direction does little when the potential gain remains small. Understand the nature of the ET and its relationship to cross-verification. This important swing trade concept represents the price, time, and risk that trade entry must be considered. The best ET naturally occurs right at the strongest S/R. But the most promising CV4 setup offers no trade if it lacks an appropriate ET. The market’s cruel nature generates many promising price expansion events with highly unfavorable entry points. Skilled participants must always manage execution as aggressively as opportunity to stay in the game. Discontinuous information requires that different features exist independently of each other. Many types of S/R data actually derive from other calculations. For example, MACD Histograms arise from moving average data. Therefore, a setup does not cross-verify when MACD and MAs say the same thing. On the other hand, a hammer candle that strikes an old double top at the bottom of a horizontal Bollinger Band constitutes three unrelated elements that converge at a single point and suggest a major reversal. Take great care before accepting each CV point. Accidental combination of derivative measurements may carry substantial risk. The trade will inaccurately cross-verify and give false confidence to the position. Cross-verification supports standard price convergence-divergence analysis. This method parallels the momentum cycle and confirms new trends. Multiple convergence improves the odds that the trend will continue. For example, when the Stochastics indicator moves sharply off a bottom, try to verify that observation with trendlines and pattern breakouts. Or when MA ribbons spread out, analyze the recent price bars to locate narrow range or wide range signals such as the NR7. Fibonacci ratios offer excellent CV analysis. Stocks faithfully retrace certain percentages of prior movement before finally reversing or continuing the prevailing trend. These stair step levels identify significant setups when bottom pane indicators and landscape features converge to offer support. Apply a Fib grid to trend extremes and look for activity at the 38%, 50%, and 62% retracement levels. Price often bounces like a pool ball back and forth across this marvel of crowd mathematics. |
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