Sometimes trading is like deep-sea fishing; it takes a strong hook to reel in a big fish.
“Safe profits: Trade an intraday stair” (Futures, June 2009) discusses one technique that relies on a strict definition of a trend. An uptrend is broken down as a series of consecutively higher lows (like an ascending staircase). Go long when you see higher lows. A downtrend is defined as a series of consecutively lower highs (like a descending staircase). Go short when you see lower highs. This trading strategy is best suited to swing and day-traders.
This strict definition and entry rules apply regardless of the bar charts you use to trade. All bar charts show lows and highs. Stairs can appear on any bar chart regardless of the duration of a price bar and the overall time period covered by a chart.
By adding the concept of an intraday hook, you can improve the success rate of this strict process.
If you review bar charts for this strict definition of trend, you may be surprised about how much action is skipped over. Some traders may chaff at being restricted this way. Why should you ignore what appear to be, even with hindsight, good trends? The answer is contained in another question. How many times have you entered what you thought was a strong trend only to see price unexpectedly reverse or begin churning for an extended period?
Selectivity is a tradeoff in making safe profits. By only going for price action that meets the strict definition of a trend, you gravitate toward the sharpest trends. You will only be in a position during the sharpest parts of a trend. You will avoid choppy price action. You will probably trade less, make more and keep more. You will also lower your stress level.
Exit rules that accompany this approach are equally strict.
If you are long and price undercuts the preceding low, take your profit (or loss) and go to cash. If you are short and price over cuts the preceding high, take your profit (or loss) and go to cash. An alternative is to loosen the entry/exit rules by degrees. You could define a trend using a tight moving average. Ignore price that undercuts a preceding low (or over cuts a preceding high), so long as price does not penetrate the tight moving average. Looser moving averages move you further from strict undercut and over cut rules. Trendlines also are effective. Trendlines tend to be less strict than moving averages. You see what is happening. Risk increases with each step away from the strict definition of a trend.
Part of the challenge of being a successful trader is to pick a strategy before you enter a market then stick with your strategy. Know the pluses and minuses of your strategy beforehand. One of the worst things you can do is start with a trading strategy then follow your
HOOKED ON ENTRIES
“Touch and go” is a six-month chart showing 30-year Treasury bonds represented by ZB, the Globex June 2009 futures contract. On this six-month chart, the strict definition of a trend was met during December 2008, January 2009 and early February 2009. As a swing trader or a day-trader you would have traded the sharpest parts of this six-month chart.
Look at April 2009. Even though price trended lower during April, the action was ragged. Now look at the far right price bar representing April 28. Even though April was difficult to trade using the strict definition of a trend, April 28 did provide a vital clue. Price rallied to the tight descending 10-period moving average then broke abruptly.
“Hooked” zooms in on the April 28 bond action. This 180-minute bar chart covers April 14 through April 28. For a day-trader, there were several times that the strict definition of a downtrend was met, including April 17, April 22 and April 28. By now you have seen one of the secrets of trading an intraday stair. A conspicuous part of a descending stair is the moment price undercuts (hooks lower off) the preceding low. The cleanest entry point in a stair is the hook.
Price may follow through after a hook or it may hook again in the opposite direction. There is no guarantee of a follow through. But by using more than one chart, by viewing price action at multiple levels of observation, you can reach a better idea of the likelihood of a follow through. The six-month chart implied that the break off the tight moving average presented a strong hook. The 180-minute chart reinforced that clue. On April 28, bonds hooked lower on the 9:30 a.m. New York Stock Exchange (NYSE) opening bell. Price ran lower right up to the 4 p.m. NYSE closing bell. April 28 presented a safe profit for bond bears.
As a trader, you are a detective. The more clues to your mystery, the better. “Really hooked” zooms in tightly on the April 28 bond action. This 10-minute bar chart covers the time between the 9:30 a.m. NYSE opening bell and the 4 p.m. NYSE closing bell. T-bonds can be strongly influenced by the direction of equities and vice versa on a minute-by-minute basis. The most liquid time to trade equities is during NYSE regular hours. Focusing on the behavior of bonds during NYSE regular hours can provide vital clues to the next move in bonds.
Notice how bonds trended lower below a descending five-period moving average. Toward the middle of the chart, price hooked sharply lower. This is a phenomenon of one-day trends. Price will tend to run, then move sideways, then run again. Watching for the second run can prepare you for the move. If you missed a day’s initial hook, you may be presented with a second.
Keep in mind that the clues on every trading day do not line up as neatly as these examples. Your job is to wait for the days when they do line up and then act. Don’t force it.
Strictness increases safety but decreases tradable opportunities. The success of the hook/stair trading strategy depends on discipline. Consider the amount of choppy action and the number of false hooks in the examples. A false hook quickly reverses. This is part of what makes the hook/stair strategy challenging. You have to pick out the good (strong hooks) from the bad (weak hooks). Strong hooks are corroborated by multiple clues.
“One down, one up” (above) is a 180-minute chart showing the euro currency represented by the Globex June 2009 futures contract. On April 28, as bonds hooked lower, the euro hooked higher. The inverse strength in the euro confirmed the weakness in bonds. The relationship between the euro and T-bonds is sometimes inverse and sometimes direct. In this case, it was inverse. On April 28, as the euro rallied, you were given one more clue that the hook lower in bonds was strong.
Using multiple charts on April 28 also would have saved you from taking a loss on the long side of bonds. Before the bell, bonds rallied: They showed higher lows. That rally was a bull trap. If you had been using multiple charts, you would have been warned. The six-month chart countered those higher lows by showing a descending 10-period moving average. Bonds broke off that tight moving average. In any case, if you had gone long bonds early on April 28, you would have exited when price hooked lower (undercut the preceding low).
Trading safely is not easy. While you spend a lot of time in cash, you are working all the time looking for
NO HOOK, NO TRADE
Risk increases with time. Even a good stair has a limited lifespan. Be careful about entering late. If you are slow to act, then by the time you do the stair may have exhausted itself. Price may hook in the opposite direction or begin to churn. Your money will be trapped in a pointless trade. If you suspect that price is about to reverse, do not jump in early. Instead, use a hook to time your entry.
Think: No hook, no trade. When you do see a hook and the general situation is favorable, then enter the hook, ride the stair. Be ready to exit when the hook/stair exit rules apply. Until then, enjoy the ride.
Richard L. Muehlberg uses linear regression channels and intermarket analysis to day-trade his own account. He publishes a day-trading diary on his website: www.DayTradingWithLinesInTheSky.com. E-mail: firstname.lastname@example.org.