While many modern traders prefer high-tech solutions, some of us have found simplicity to be the answer to profitable trading. So-called “sophisticated” technicians with their multi-screened computers, crammed with all the latest software often scoff at the more basic approaches, but time has a habit of proving that the simpler something is, the longer it will prevail. One of the most reliable of the simple trading solutions is the pivot break continuation (PBC) formation.
This is a high-probability pattern. As long as one market attribute is present — an established trend — the PBC usually works. The beauty of the PBC is that entry signals are easy to spot even when just eyeballing a price chart.
Moreover, typically reliable stop-loss and profit targets are easily calculated and set by the price moves, rather than any sort of fixed dollar amount or some complex formula based on account size rather than market action. This means the levels adjust with price moves, making the pattern itself much more dynamic.
There are four steps to using the PBC correctly:
1. Confirm the market is trending either up or down.
2. Wait for a pivot break continuation pattern to appear.
3. Enter in the direction of the trend, on a break of the pivot high/low.
4. Let the market tell you where your stop loss and profit targets should be.
These examples use only 50- and 200-period moving averages and basic trendlines to find a confirmed trend.
TAKING ACTION
There is nothing unexpected about the PBC. It is a basic continuation pattern that works in most instances when it is correctly identified. As a continuation, as opposed to a reversal, pattern, the PBC identifies times when we can expect prices to continue breaking in the direction of the overall trend.
In short, when we have a confirmed uptrend, we are looking for pivot high patterns, and when we have a confirmed downtrend we are looking for pivot low patterns. The PBC pattern is a three-bar (minimum) retracement from a high or low pivot.
As you can see in “Going with the flow” (below), we have pivot bars starting at “A” on both charts. The trend continuation pattern is confirmed once we have at least three bars to the right that have lower highs to confirm a high pattern, or three higher lows to confirm a low pattern.
Looking at “Long-term break” (above), the Japanese yen is in a downtrend. The 50-period average is below the 200-period average, the market is trading below both averages and a down trendline can be drawn. These attributes easily meet our first qualification for an established trend.
Because this is a downtrend, we are looking for low PCBs. The low PCBs can be identified by the red lines that begin at completion of the PCB pattern. Even though we are looking for low PCBs at this point, high PCBs also are shown on the chart with green dots.
Our goal is to enter in the direction of the downtrend when the market breaks through a low PCB — in other words, when the market breaks the red PCB line. In the example “A” we want to enter on a break of the low PCB, minus three ticks (the red lines on the chart). Three ticks is not a cast-in-stone figure, any number of ticks can be used. While the more ticks used, the more sure you are price will continue in that direction, however, the trade-off is you are giving up one tick in potential profit for each extra tick you add before entry.
Once we are filled, we use the recent market action to help define the stop loss. In this case, we place the stop loss three ticks above the last occurring PCB in the opposite direction of the prevailing trend. Next, we calculate the number of points from the entry price to the stop-loss price, and this number is used as our initial profit target. These prices are shown by the magenta (stop loss) and yellow (profit target) lines on the chart.
NOW, REACTION
When you hit a stop loss, the response is simple: Get out of the trade. However, you have two options when you reach the first profit target.
1. You could exit half of your position at the initial profit target and
leave your stop loss for a reduced number of contracts at the same price, thus creating a breakeven position and giving the market more room to breathe.
2. You could exit half of your position at the initial profit target and then move the stop on your reduced number of contracts down to the price where you entered the trade to lock in a profit on this position.
“Long-term break” shows three opportunities to enter the market. Whether you open a new position at every PCB depends on your risk tolerance and account size. One reasonable option is to add to your position if all previous positions have already hit their profit targets. This way, you only have one position with the full entry to stop-loss risk open at any time.
In any case, once the market ceases to continue its current trend, you should exit all of your positions and wait until a new trend is confirmed. There are several ways to look for the end of a trend just using this type of chart. For example, the market could trade above the 50-period moving average, the 50-period moving average could move above the 200-period average or price action could break above a downward sloping trendline.
An uptrend example in silver is shown in “Shining performance” (below). In this case, we are looking for a break of a high PCB to get long. The stop loss that was put in place for the first trade was almost hit; however, the trade survived to make money. This shows the importance of using stops that are generated based on market action rather than fixed-dollar stops, which seem to be hit more often than not.
You don’t have to make things complicated to make money in the markets. Indeed, the simpler techniques often have the most universal application. Further, they are easy to apply — a key benefit that should not be overlooked in a vocation where proper application is at least a third of the battle.
Don Wright runs Which Trading System, an independent testing, monitoring and ranking service for futures, options, stock and forex trading systems. Contact him through www.whichtradingsystem.com.
