Yesterday, I traded the SPY off of its LOD and it was a perfect example of one of the lesson PDF's that I provide my students on wave trading. I thought other readers would benefit from some of that lesson material so I will insert a portion of that material followed by the example from Wednesday
One of the things most Day Traders do is try and catch the big reversal trade … that is usually because they missed the bigger trade into that possible low. However, most traders get chopped up at these bottoms and end up losing money … those traders would buy or go long at point “A”. Other Day Traders wait for a break higher of a previous high (point B) and finally you will get the last group of Day Traders that like to catch knives that will enter on the making of a higher low (point C).
Again, on any given trade, purchasing at these points on the chart may work. They are not high-odds entry points but they may work. Let me point out the problems with purchasing at these levels and why I generally pass on getting involved at these levels.
For Point A buyers … where do you place your stops? Below the LOD? If you do, you must realize that stocks often will make double bottoms that actually push through the prior low by a few cents. This happens as market makers and algorithm computer trading programs are designed to take out these obvious stops before reversing higher. Ok … no problem, just move your stop lower than just a few pennies below the LOD. That may work on some occasions, but on some of these trades, this will not be the bottom and when price breaks the LOD the down trend will be resuming and then take out your lower stops causing you more financial pain than if you had a tighter stop. Bottom line, this is not a good place to try and get long.
For Point B buyers, you are buying on the first break above a temporary swing high in a confirmed down trend. Even if price is now starting a new trend in your direction, the break is almost always going to be tested as it is the first one of this “new” trend. Many traders will try and short the bounce as they believe that the trend lower still is going to hold. In any case, price will pull back and if this is a normal pull-back of a new trend, it is liable to pull all the way back to the 78.6% level on a retracement grid. That is an awfully big stop to use for a long trade that hasn’t “proved” itself yet. What if you are wrong and price takes out the low and keeps on going lower … you are going to get stopped out and not likely be in the mind set to get short for the easier “continuation” trade lower.
For Point C buyers, you at least waited until you had further evidence that price wasn’t going to quickly turn lower and resume the trend lower. Price made a higher-high and a higher-low, so the odds are definitely better that you are picking a potentially winning trade. Are you sure though? Let me show you something …
Corrections off of bigger moves will almost always have more than one leg, and will form some kind of an “ABC” pattern. Here in our example, the Point C buyers are profitable for a while in this trade, but it eventually turns against them and they are likely stopped out. If conservative, Point C buyers would have most likely raised their stop to at least break-even when price took out the prior high. That is not what we as traders are looking for though … small winners or scratched-out trades.
Consistently profitable traders are looking to get involved (for the most part) once price has proven that it is likely to move higher. All we can do as traders is to pick good set-ups and then let price do its thing. Occasionally, even the best looking set-ups are going to fail. If traders take good fundamental spots to enter trades, in the long run, he or she will be profitable.
So where is the best risk/reward spot to get long on this reversal of the 10-minute chart?
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I think I will stop leaking the student notes at this point … I will show you the first 1/2 of the example from Wednesday though.
SPY 1-Minute Charts
Point A buyers are the heros … they are willing to be the first buyers of "the final bottom".
Damn … this game is rigged. Time to go help out the 99%ers!!
Point B Buyers are the "smart" ones waiting for price to prove it wants to go higher …
Point B survived (his underwear didn't though) and the smartest little piggy (Point C buyers) went long at just the right spot after a higher-high and a higher-low was put in. Price continued on to make another higher-high and so Point B and C buyers added on to their longs and lookie here, Point A dug up enough courage to wade back into the market and went long as price gave him the "all-clear" signal.
Enough said … classic ABC corrective move before the dominate trend reasserted itself.
Students, find the remainder of the blog posting under the educational material tab … for other readers I will post the remainder of this posting next week sometime.
Cheers … Leaf_West (visit my blog)
