How do you become a better trader? Probably for most of us, it can be as simple as looking at our prior trades in retrospect to see if they made sense?
I had a reader e-mail a little while ago and asked about a short trade he tried in the SPY which he covered for a small loss, to see what I thought about the trade … he already knew the answer in retrospect by looking at the trade. He was caught up in the small time frame chart (1-minute) and didn't realize he was swimming against the current.
In my site's Elliott Wave Theory lesson module I talk about how most day traders never make money and that the biggest reason is as simple as they often trade counter-trend. The sad thing is that almost all of these traders don't even realize that they are trading against the bigger trend.
That is why I am always looking at where we are in terms of the wave structure on multiple time frames … I want to avoid the simple mistake of getting long at the top of a wave structure (or short at the bottom of one), and I definitely want to know what the direction of the bigger trends are. That is what my Morning Outlook and Afternoon Trading Plan try to do … assess where the market is going and then trade based on that bigger directional bias.
Again, I only want to swing trade in the direction of the 60-min/daily charts using the 10-min chart for my entry/exit timing.
For intra-day trading, I want to trade in the direction of the 60-min/10-min charts and use the 3-min chart for exit/entry decisions.
With that as a preamble, I will use my reader's short trade as an example of what I mean … I'm not trying to pick on any one or the trading mistakes that they make. I make enough to keep me busy if that is what I am trying to do. I just thought that we could all benefit from looking at this common mistake a little closer.
Since my reader was trading off of the 1-min chart, let's start there …
SPY 1-Minute Chart
So when looking back at a chart that is complete, it is easy to see right from wrong … let's try and think for a moment what the trader's mind set must have been in real time. Again, I haven't really talked to this guy other than read his comments on the trade after he looked back at it (he knew he missed the bigger trend in retrospect).
On Dec 20th the market had just finished trading lower for almost two straight weeks, so the talking heads on CNBC were probably bringing out all of the doomsayers and talking about why the market was heading lower.
Here is what the 1-min chart looked like that morning before the market gapped higher on Dec 20th …
SPY 1-Minute Chart
Most traders get caught up in the emotion of what the market is doing right at that time … that is why price patterns repeat. Traders typically react the same way time and time again.
What do a large percentage of traders do when they have just sat on the sidelines and watched price trade lower for 2 weeks? They sit there on their hands just waiting for a big bounce so that they can short the market to get themselves some of that free easy money on the short side.
So without having asked that question of my reader, my bet is that is exactly what he was thinking when the market gapped higher on Dec 20th by about $1.80/share for the SPY. He was probably saying to himself …. "great … I can't wait to short this pig!!"
So let's stop there and call this lesson #1 … traders need to check their biases pre-market every day and look at the bigger picture. A prepared trader will almost always have both sides to potential trades thought out ahead of time, so that he is not "surprised" by the price action that any one day may bring him.
I can almost guarantee you that my reader did not think about whether or not the gap higher made any sense … he was most likely hell bent on shorting this "weak" market. Again, I'm not trying to pick on him. There are 1000's of other traders doing the exact same thing everyday.
If the any trader bothered to look at the bigger price action to see what the deal was, they would have seen the following …
SPY 130-Minute Charts
It was a simple as looking at the bigger time frame chart to see that price was most likely still in an upward structure. Price had busted prior highs in late October, thereby busting the prior downward price structure, and then had corrected to a normal 61.8% support level before bouncing higher.
Since the price high in early Dec was a lower high, it has to be considered a "minor" wave high until proven otherwise. The pull-back should be monitored with the thought that the bigger trend was still in control until proven otherwise … where did price correct to by the end of Dec 19th?
Lookie lookie … price pulled right back to the 61.8% level. What is that called? Oh yeah … SYMMETRY people!!!!
So a trader who is looking at the market on the morning of Dec 20th "could" have been able to see that the bigger trend for price was still higher and that the minor pull-back found support right at the level that made perfect sense (61.8%).
There are no guarantees that this meant price was going to behave itself and go straight higher, but it greatly increases the odds of price going higher on Dec 20th.
Ok … so I think I have made my point about watching the bigger picture so you don't step in the cow dung. But as we know price moves in waves up and down, and there are smaller waves inside of bigger waves. So one could argue that you don't need to know the bigger picture to intra-day trade since you will be flat overnight and you need to only concern yourself with the day's action.
While that is correct and that traders can trade profitably counter-trend, I would argue that trading counter-trend for intra-day traders only makes sense for 10-minute waves and not 3-min waves. Ten minute waves, even if counter trend do provide enough time and price potential to allow normal trading. Trading 3-minute counter trend requires catching the waves almost perfectly at their highs/lows to make it worth while, and as we all know, that is impossible on a consistent basis. Therefore, I think people should avoid trading counter-trend on the 3-minute chart.
So if you agree with this, then you still don't need to look at the bigger time-frame charts to intra-day trade. You just have to "know" which way the 3-min chart is heading. What is the easiest way to do that?
SPY 3-Minute Chart
Here is the 3-minute chart from Dec 20th and the following day … if you were smart enough to have bought the Leaf_West Trend Tracking software, you could have seen very easily which way the 3-minute trend was (shameless plug for the software LOL).
The light blue candles reversing a 2-week move lower is your warning of a "kick-off" of a strong move … this is your warning to "expect" higher prices yet to come.
The dark blue candles warn traders that the trend has extended to unsustainable levels (historically). I have some videos up on the site now, so I encourage readers to watch these to better understand how to handle dark blue and light blue candles.
Suffice to say, that you shouldn't be selling longs at the first sight of the dark blue candles. The fool proof method is to wait for the moving average to be broken. This way you can allow a super strong move to burn itself out, without undo risk.
If you don't have the software yet, you can rely on the tried and true method of how to define trends … higher lows and higher highs. I marked with green solid lines the higher lows … so it was obvious even using pretty primitive methods that the trend was upward on the 3-minute chart.
So trying to short the 3-minute chart was definitely counter-trend, and offering little margin in terms of profit and time potential. My reader didn't stand much of a chance. Even if he knew that he was trading counter-ternd, he would have had to been perfect to make any real money.
He would have had an easier time trading the pull-backs in the 3-minute trend … that meant going long on the flipping of the LWTT candles from red to green …
You can see visually how much easier it is for traders to enter and exit for intra-day profits when trading with the trend on the 3-minute chart versus trading counter-trend. You can do quite well even if you fail to get the best entry and exit price for long trades with trend … get less than perfect entries when trading counter-trend and you are guaranteed to lose money.
One final chart from a bigger time perspective as a source of encouragement for traders to pay attention to the bigger time frames …
SPY 10-Minute Chart
Light blue and dark blue candles warn of an extreme … wait for the pull-back to get long. Best spot to get long is after completion of a recognizable corrective pattern (here it was an "ABC" move) that terminates in the SLOT area (50% – 78.6% retracement).
This should also show traders that it is easier/less stressful if they swing trade versus trading the more emotional smaller-time frame charts inrta-day.
Again, I did not mean to slight or crap on the reader that asked me about this short he tried … I just thought it was a good example of what most intra-day traders do wrong.
Cheers … Leaf_West (visit me at http://blog.tradingwithleafwest.com)