Learning to trade
the commodity markets with consistent gains is a difficult undertaking.
Most are originally lured to this endeavor by the promise of easy
profits. But there is little that could be further from the truth.
There are no consistently "easy" profits to be made
here. Oh, yes! We've all heard the stories about the lucky few
who have struck it rich overnight. And we've all read the magazine
adds that offer "systems" for sale that appear to be
as good as a money-printing machine. But when these stories and
advertisements are reviewed with any degree of scrutiny, they
just don't hold up to their original promise.
The Pattern Trapper takes an entirely different
approach. Rather than offering fantastic promises of easy profits,
it offers a way of approaching the markets that make their behavior
more easily understood. The path to learning successful trading
techniques starts with an understanding of price behavior. To
learn how to understand price behavior you first need to learn
how to create structure out of an inherently unstructured environment.
The whole focus of this service is to help subscribers learn how
to create that structure - to help them learn how to create "templates"
for interpreting market behavior and spotting opportunity. The
trading principles discussed throughout the report are applicable
to any freely traded, liquid market. For reasons explained in
the next section of this Guide, each issue of The Pattern Trapper
contains a detailed analysis of the 30 year US Treasury Bond futures
market. This daily commentary serves as an example of how creating
structure out of the markets can aid in their interpretation and
understanding. The analysis is a day-by-day exploration of the
way in which this can be accomplished, and the difference that
it can make in one's trading.
This Guide is composed of 15
sections:
Why T-Bonds?
Consider Mid-Am
When NOT To Trade
Cycle Indicators
Calculating Pivot System
S&R Levels
Pattern Signals
Making Note Of Recent
Intraday S&R
Reversal Patterns and
Others of Interest
The 3/10 Oscillator
Entry and Exit Execution
Techniques
Fib Retracements
Holy Grail Patterns
Practice! Practice!
Practice!
The Psychology Of Trading
Putting It All Together
Why T-Bonds?
For instructional purposes, each issue of The Pattern Trapper
includes extensive commentary on The 30 year US Treasury Bond
futures market. Learning Pattern Trapper Trading Techniques via
the T-Bond futures market has a number of distinct advantages,
especially for the beginner.
For one, T-Bond market behavior typically has a very "plodding"
nature about it. Provided that the trader avoids certain critical
times (discussed in the "When NOT to Trade" section),
T-Bond price activity is usually absent of the kind of volatility
spikes so often associated with many other futures markets. This
lends itself to a much more sane market atmosphere in which the
trader has sufficient time to make well planned decisions.
Secondly, armed with the tools detailed in this guide, Bond market
activity can have a surprising degree of predictability to it.
By looking at price behavior through the "templates"
described here, the trader is able to focus on high probability
set ups, and avoid those trading periods with less predictability.
Hence, the risk to reward ratio on every trade becomes much more
favorable.
And lastly, the T-Bond futures market has excellent liquidity.
This means that, under normal market conditions, the time in which
it takes your broker to fill your order is usually very fast.
Even more importantly, it also means that slippage, the degree
in which price will move from the time you place your order to
the time in which it is filled, is minimal - typically only one
or two ticks. In addition, due to this market's large trading
volume, it is much less prone to the kind of manipulation so often
associated with more thinly traded markets.
Consider Mid-Am
It is highly recommended that beginners start trading with the
Mid-American Exchange T-Bond contracts. There are a great many
advantages. The first being that they are half the value of the
larger contracts. Hence, if you're wrong (which can occur frequently
at first) it only hurts half as much as the big contract. Liquidity
is excellent, so you can expect fill times as fast or faster than
that of the big guy, especially with market orders. You can pretty
much trade the Mid-Am contract from a CBOT real-time chart. Just
realize that at times, the intraday peaks and troughs might not
develop quite as far as the big guy.
When NOT To
Trade
There are certain times, most often when economic reports are
released, that you just don't want to be holding short-term positions
in financial instruments. The potential for extreme volatility
is just too high. It is during these times that its best to just
sit back and let the market tell you which direction it wants
to take. You can usually get your bearings by waiting for 5-10
minutes after a report has been released before participating.
Market entry can then be made with a greater degree of confidence,
and you've reduced the chance of being whipsawed.
There are number of internet sources available to obtain calendars
of important release dates and times (detailed in the full version
of the guide). As release schedules often change, it is important
to update this calendar once a week. Each trading day should begin
with a reference to this calendar and a notation of the times
in which important economic reports are scheduled for release.
Each issue of The Pattern Trapper lists the important economic
releases for the trading day and a plan of action for dealing
with each.
Cycle
Indicators
The Pattern Trapper regularly employs two Cycle Indicators as
an aid in determining short term cyclical positioning. These indicators
serve to identify those market periods in which short term tops
and bottoms are likely to develop. Their interpretation helps
determine any directional bias that might be assumed for a particular
day of trading. These indicators are the Double Stochastic (or
Double Stoch) and the 7 period %K.
The Double Stoch is a modification of Walter
Bressert's own Double Stochastic Oscillator. Referring to the
chart, both the 5 period Double Stoch (thin red line) and the
10 period Double Stoch (thick blue line) are used. The 10 period
Double Stoch gives us an idea of where we are in the larger 20
period cycle. Typically, there are two smaller cycles within the
larger 20 period cycle. The 5 period Double Stoch gives us an
idea of where we are in those sub-cycles.
If you're interested in a further discussion of these concepts,
visit Walter's site, he has much to offer there. If, on the other
hand, all of this just seems very confusing, and you're really
not that interested anyway, don't worry about it. For purposes
of the daily report, Double Stoch oscillator readings are one
of the components that go into determining any directional "bias"
discussed for that day's trading. That's all you really need to
know.
The 7 period %K is displayed directly beneath the Double Stoch.
Once this indicator turns from an overbought or oversold zone,
it is a fairly good indication that a new trend has begun and
at least several more bars of the new short term direction should
follow. But, as is true for ALL oscillator interpretation, when
a larger overall trend is dominant, the overbought and oversold
zones can mean very little.
Every issue of The Pattern Trapper includes Cycle Indicator charts
for each Highest Potential Setup, as well as for the T-Bond futures
market. Accompanying commentary contains an interpretation and
discussion of each market's cyclical positioning and what it means
in terms of directional bias as we enter each trading day.
Calculating Pivot
System S&R Levels
Floor traders and other professionals who do the actual buying
and selling of futures contracts in the trading pits of the exchanges,
generally employ very similar systems for valuing the price of
such contracts in the absence of significant outside influences.
These systems employ a method of calculating relative value based
on price activity of the prior day. An equilibrium point is determined
as well as support and resistance levels relative to that equilibrium
point. This method is called the Pivot System. The seven support
and resistance levels identified by this system are called, from
top to bottom, R3, R2, R1, DP (for Daily Pivot), S1, S2, and S3.
These levels act as potential support and resistance zones throughout
the day. They serve as focal points for floor professionals as
they adjust their bids and offers, especially when trading activity
is slow. The use of these levels, along with additional support
and resistance levels as explained later, help in determining
appropriate areas in which to initiate entry and place stops.
The full user's guide, issued to all subscribers, contains a complete
discussion of the construction, and use of these support and resistance
levels. Pivot levels for all of the futures markets covered by
The Pattern Trapper are included in each report. Details for the
construction of Pivot System levels, as well as for several other
indicators, for use in various charting platforms are available
to paid subscribers.
Pattern Signals
Before we enter each trading day, it is important to first identify
those markets which have either (1) the greatest potential for
a significant move or (2) the greatest likelihood of following
a specific price development. We accomplish this task through
an automated pattern recognition process which identifies, for
each futures market covered, today's most likely scenario based
on recent price behavior. The process screens each market for
a variety of setups of the type first identified by technical
analysis books such as "Day Trading With Short Term Price
Patterns And Opening Range Breakout" by Toby Crabel and "Street
Smarts" by Larry Connors and Linda Raschke. The process screens
each market for patterns such as Narrow Range Days, Wide Range
Upside & Downside Reversals, 2 Day ROC Buys & Sells, Momentum
PinBall Setups, Inside Days, Low Volatility Days, as well as a
variety of other patterns, many of which are unique to the Pattern
Trapper.
This process identifies those markets which have the greatest
potential to create a profitable move either during the next day's
trading session (intraday trades) or the next several trading
sessions (multi-day swing trades). Each Pattern Signal fired for
each market tells us something about the current price characteristics
of that market and suggests a game plan to be used in the attempt
to capture that profit.
Pattern Trapper subscribers have access to an extensive network
of web-based interactive learning tools providing detailed discussions
of each Pattern Signal fired, the conditions in place that triggered
them, and trading techniques to best take advantage of the market
information that they offer.
Making Note Of Recent
Intraday Support & Resistance
Prior to the beginning of each trading day, it is a good idea
to take a look at the prior few days of trading with an eye towards
spotting intraday highs and lows that are within a reasonable
range of current price. These often act as support and resistance
levels, especially when they form clusters. When a number of them
are grouped within the same general area, it is a strong indication
that the zone might be one of significance. In addition, any groupings
near Pivot System S&R levels serve to make that zone even
more credible.
Reversal Patterns and
Others Of Interest
Reversal patterns are most often single and double bar patterns
that identify a likely turning point in market behavior. We use
reversal patterns primarily on an intraday timeframe, most often
on five minute bar charts. They will, however, work in just about
any timeframe, and can often be effectively applied on one minute
charts during fast market conditions.
Reversal patterns are oftentimes the trigger points used to enter
and exit a trade. Being able to spot these patterns and knowing
how to use them as they occur near important support and resistance
levels is of critical importance in this method of day trading.
They are the market's way of telling you "NOW!"
Some of the intraday price reversal patterns that the trader needs
to be able to quickly identify are the U-Turn, J-Hook, and Doji
(see the chart below for examples). The Pattern Trapper method
of day trading uses the occurrence of these reversal patterns
near support and resistance levels as a trigger into our trades.
As explained earlier, Pivot System S&R levels (as well as
the more "dynamic" S&R levels created by 20EMAs,
which will be discussed shortly) represent chart areas which have
the potential for creating significant shifts in market psychology.
But, not every level creates a significant market reaction. The
occurrence of price reversal patterns helps us distinguish those
levels which have a greater likelihood of creating a reaction
from those that don't.
Pivot System S&R Chart with Reversal Patterns
In addition to being able to identify very short-term
one and two bar reversal patterns, the trader should also be able
to identify a few intraday chart formations that might take a
bit longer to evolve. Patterns such as triangles, wedges, flags,
and channels develop on intraday charts in essentially the same
manner as they do on daily, weekly, and monthly charts. Oftentimes,
a break of these formations can be used as either a trigger into
a trade or as an aid in determining directional bias.
For example, oftentimes an intraday news-inspired spike move will
enter a short period of congestion as the market decides whether
to accept or reject newly acquired price levels. That period of
congestion often results in the creation of small flags or triangles
on intraday charts. The flag pattern created shortly after a spike
move higher is typically referred to as a bull flag, and the pattern
created after a thrust in the opposite direction is often referred
to as a bear flag. Many times, buying the topside break of a bull
flag is a good way of climbing on board a market that wants to
go higher, and selling the downside break of a bear flag is a
good way to participate in a market that is going lower. Another
productive intraday pattern is the wedge formation. Flat topped
wedges typically imply a topside breakout. Flat-bottomed wedges
suggest a breakout to the downside.
Intraday Chart Formations
  
The complete version of The Guide to The Pattern
Trapper, issued to all subscribers, contains a full description
of each Reversal Pattern along with diagrams. Also included in
the welcome package are two sheets of pattern descriptions and
diagrams that can be attached alongside your quote screen to help
in their identification. In addition, as an instructional aid,
the T-Bond Commentary in every issue of The Pattern Trapper identifies
the set-up patterns that come into play on each trading day.
The 3/10 Oscillator
Another very important way of identifying market turning points
is by comparing the degree of price momentum behind successive
market swings. Price momentum is a measure of the rate or speed
of price change. Normally, if we are to expect successive market
swings to continue creating new highs or new lows, we would expect
the rate of price change to increase along with the new highs
or new lows. If successive swings did not have an increase in
momentum, the validity of the new push higher or lower would be
called into question.
For the trading techniques advocated here, the 3/10 Oscillator
is used as our principal measure of price momentum. We look to
identify two principal conditions when using this indicator to
help interpret market activity. These two conditions are called
"Oscillator Divergence" and "Momentum Confirmation".
Typically, each successively greater swing pivot high or swing
pivot low will be accompanied by either one or the other.
In a market moving downwards, Oscillator Divergence is described
as a new low in price which is accompanied by a higher low in
the oscillator. In a market moving upwards, it is described as
a new high in price which is accompanied by a lower high in the
oscillator. Examples of both are shown in the chart below.
3/10 Oscillator Divergence and Momentum Confirmation
In essence, when Oscillator Divergence occurs,
the market is telling us that the current price movement is losing
momentum. It is at these times that a reversal is most likely.
If we had been considering a trade, this would be an opportune
time to initiate entry.
On the other hand, when Momentum Confirmation occurs, we know
that the current swing direction has some "oomph" left
to it, and it would be best to either stay with any currently
held positions or look for an opportunity to climb on board.
Whenever possible, we try to initiate market entry with an occurrence
of one of the single or double-bar reversal patterns as described
in the previous section. Sometimes, however, the formation of
these patterns are a little more vague than we would like, and
we are left wondering whether that particular U-Turn reversal
was truly thrusting in both directions, or perhaps the J-hook
just doesn't seem to hook as much as we would like. At times such
as these, it is often helpful to refer to 3/10 Oscillator behavior
to help make the decision as to whether or not to initiate trade
entries and exits.
The 3/10 Oscillator is an invaluable tool when daytrading. It
is a very good measure of market momentum and reveals much information
about the market's true intent. Become proficient in its use,
but also realize that it is not infallible. The more you use it,
the more familiar you will become with its idiosyncrasies.
Entry and Exit Execution
Techniques
By the time that we've identified a reversal pattern and/or oscillator
divergence sufficient to trigger us into the market, we've already
undergone quite a bit of analysis that puts the odds in our favor.
Therefore, we want the trade to start working for us right away.
If it doesn't, our analysis has failed somewhere along the line,
and we want OUT! We don't allow ourselves the luxury of hesitation.
We just want out! One of the keys to long term trading survival
is the ability to quickly admit our mistakes.
Once we've identified a good reason to enter a trade (most often
on a reversal pattern and/or Oscillator Divergence), the first
thing that we want to do before actually initiating the trade
is to consider stop placement. We want to identify a price level
which, if obtained, would represent a decisive market movement
against our position. Most often, for day trading purposes, this
level is best defined by a violation of the swing pivot extreme
which includes the reversal pattern and/or Oscillator Divergence
used to make the initial entry decision. Stops are typically placed
just beyond that level. If there happens to be an important support
or resistance line nearby (one that price has not yet breached)
we might want place the stop on the far side of that level so
as to give the trade a bit more room to work. Examples are shown
below.
Entry, Stop, and Exit Techniques
Once the stop level is determined, we then need
to make a quick decision as to whether the range between the stop
level and our likely entry point is within reasonable levels of
risk tolerance and in line with profit expectations (risk/reward
ratio). These considerations are largely dependent on such aspects
as the individual characteristics of the market being traded,
the type of order used to initiate entry (market, limit, etc.),
and our means of determining likely profit targets. If these factors
fall into place, we can then initiate entry with confidence.
Another important note concerning the use of stops is that we
don't always HAVE to stick around until our stop level gets hit.
The stop order is there only for protection - protection against
both quick market movements and ourselves. The best trades take
off in our favor right away. But it doesn't always happen that
way, and if the market starts getting sloppy, or a reasonable
period of time has passed and price hasn't started moving in our
direction, we need to decide whether its worth sticking around
or not. The old adage "When in doubt, get out!" certainly
applies here.
The rules for entering and stop placement are rather clear cut.
But the appropriate procedure for exiting with a profit can oftentimes
be more demanding. We use the same parameters for measuring market
movement in exiting with a profit as we do in entry and stop placement.
The only difference is that there is a little more latitude here
- a little more of the "art" of trading.
We look for the same primary conditions to set-up when making
exit decisions: price reversal patterns and/or Oscillator Divergence.
It's just that this time, we try to take in the larger picture
a bit more. We take into consideration such things as the "feel"
for the strength of the larger trend, cyclical positioning, and
pattern set-ups such as triangles, wedges, channels, or flags.
If our "feel" of the market is that the trend has quite
a bit more left in it, we might place less emphasis on other factors
and just go along for the ride, gradually moving the stop closer
as price moves, so as to lock in at least some portion of our
accrued profits. This is something for which one needs to develop
a feel - and that takes time and experience.
One tool that comes in very handy when making exit decisions is
Fib retracements.
Fib
Retracements
Simply put, Fib Retracements are used on an intra-day
basis to measure how far a market has retraced its primary move.
It helps determine, in large part, how much the market has taken
back, from that which it has already given. If the market "takes
back" only a small portion (.382) before continuing in the
primary direction, we know that the trend is strong and that it
will likely continue past the most recent intraday swing pivot.
If the market "takes back" a slightly larger piece (.5),
then we know that continuation of the previous trend is less likely.
And if it "takes back" a significant chunk (.618), we
know that the trend is much more poorly established than original
impressions might have left.
For instance, if we refer to the chart below, we see an initial
primary move in Microsoft quickly take price from the 94 3/4 early
morning swing pivot low, to the 97 3/16 swing pivot high. A short
while later, price has drifted back down towards the .382 Fib
retracement line. Initially, it appears as if this level might
hold, and, indeed, price is eventually able to work its way back
up towards the high of the day. But this zone is soon rejected
and the market begins a descent which eventually spikes through
the .382 Fib retracement level. This kind of action tells us that
the push behind the original move higher is not as strong as initial
impressions might have left. The .500 Fib level is able to contain
the action for a short while, but once the .618 level falls, the
flood gates open and the market begins a drop that continues on
into the next day of trading.
Fib Retracements
The use of Fibonacci retracement can be a very
valuable aid. It is definitely worth adding to your arsenal of
trading tools. A full discussion, with additional examples, is
included in the complete Guide to Using The Pattern Trapper, available
to all paid subscribers.
Holy Grail Patterns
Holy Grail setups were originally introduced in the "Street
Smarts" book by Linda Raschke and Larry Connors. The method
uses ADX to determine a trend, and an exponential moving average
to decide the appropriate time within a pullback from that trend
in which to enter.
Five different time timeframes are monitored for Holy Grail setups:
5, 15, 30, 60, and 120. If the trend in any one of those time
periods is strong enough to register an ADX reading greater than
30, we want to watch for any retracement to the 20 period Exponential
Moving Average in that timeframe. Consider the 20EMA as a "dynamic"
support or resistance line - one which moves with the market.
Treat it as you would any other static support or resistance line.
Any price reversal pattern that develops along that line is cause
to consider entering the trade.
Holy Grail Setups
You will often find opportune use of the 5 minute
Holy Grail pattern after a strong initial impulse move, especially
those caused by the release of significant economic reports or
other news driven price thrusts. Oftentimes, the first retracement
level will be that of the 5 minute 20EMA. Keep a close eye on
retracements to this moving average line when the market seems
to "take off".
The intent of the Holy Grail setup is to catch the first retracement
on an initial trend move. Trend moves imply that there is more
to come. Therefore, when basing a trade in part on Holy Grail
patterns, you can typically set your minimum profit target to
be that of the last swing pivot extreme in your direction. But,
many times that trend move has much further to go. So give the
trade room to breathe. Here again, single and two bar reversal
patterns and/or Oscillator Divergence/Momentum Confirmation are
good tools to use when deciding whether or not to exit near the
level of the last swing pivot extreme. Keep in mind, however,
that if the move is particularly strong, a trend force of a larger
timeframe can be in effect which can easily overshadow oscillator
behavior on the smaller timeframes. Again, experience is the best
teacher. Start off trading small until these techniques have become
more fully integrated with your daily routine. Only then will
you start to appreciate many of the idiosyncrasies that only familiarity
can reveal.
A full discussion of entry and exit techniques based on Holy Grail
patterns is included in the complete Guide to Using The Pattern
Trapper, which is available to all paid subscribers.
Practice!
Practice! Practice!
In order to make the most effective use of the techniques described
in this guide and throughout the daily report, it is important
that you develop a feel for them on a very visceral or "gut"
level. It is best that they become an automatic reaction . . .
instinctively integrated with the way in which you approach the
market. The goal is to get to the level where you can look at
a chart and be able to instantly zero in on the pockets of opportunity.
The complete Guide to Using The Pattern Trapper includes specific
methods for practicing the techniques discussed here. With a thorough
understanding and repetitive practice, the goal is to attain enough
confidence to take advantage of these profit opportunities on
a consistent basis.
The
Psychology Of Trading
The psychological aspects of trading are of paramount importance.
This guide has given you some of the basics for understanding
the technical aspects, but of equal or even greater importance
is an understanding of how your mind works, especially in regards
to the way in which you handle fear and greed.
You will find reference to the psychological aspects of trading
peppered throughout the commentary. Maintaining the proper attitude
throughout the trading day can mean the difference between failure
. . . and long term success.
Putting
It All Together
Although this condensed guide is offered as an overview of the
service, the complete Guide to Using The Pattern Trapper is designed
so that it may stand on its own as a day trading technique. The
daily reports can be considered as a constant re-enforcement and
consistent reminder of the concepts covered in the complete guide,
as well as a helping hand and note of encouragement as you enter
each trading day.
The intent is to give the subscriber a framework for evaluating
market conditions and the best way to exploit them. The path to
understanding successful trading techniques starts with an understanding
of price behavior. You cannot understand price behavior until
you learn to create structure out of an inherently unstructured
environment. The whole point of The Pattern Trapper is to help
the subscriber create that structure - to help them create "templates"
for interpreting market behavior and spotting opportunity.
It is my hope that the practitioner of these techniques will save
a great deal effort and money lost, by not having to go down a
GREAT many dead-ends before becoming successful. But it is still
going to take a great deal of practice, unflinching execution,
and some deep levels of personal soul-searching.
The Pattern Trapper offers an experienced trader as a partner
on that journey. |
