Trading techniques: the best strategies by John Person
Part 1: Breaking of the wedge pattern
This series of articles is intended to show different trading techniques that work on multiple time levels in liquid markets – especially in equities, stock indices, commodity markets such as gold and crude oil, and in Forex trading. In conjunction with the right indicators these methods have proven themselves well. You will get a set of rules that will help you to find a trade setup, in order to determine the right time to position opening, to place a meaningful Stop and to define the exit strategy.
Trading and emotions
There is a plethora of strategies. But the one that is constant and never changes is the emotional behavior of people. If you really want to dominate the trading, you need to have your emotions under absolute control. Many of us know that this is a difficult task for many traders. The markets are quite simply a mirror image of these emotions.
>> The principal concern of successful day traders is to catch a good part in the middle of a movement and to trade. <<
The fear of losing means that in the course of a wave of selling the price moves downwards while the Greed uses every opportunity to purchase and the willing to jump on the train, which drives the prices up. Therefore, it is imperative to understand when and how the market moves and what signals or patterns give us a clue for a directional change. There are patterns that occur again and again. These can help traders to cope with the emotions like fear and greed – and on the basis of the Entry, the Risk- and Trade-Management and the Profit-Target. It is important, for traders, to place entry orders, loss control orders and profit target orders. Note that we do not speak of "stop loss orders". This is intentional, because the "stop" order can be and should be used under certain circumstances as initial order. A buy stop is a buy order that is placed above the current price, while a sell stop is a sales order, which is set below the current price. Trader set Stops for "bundling" of orders, to enter the market. Especially those traders, who are looking for breakouts or falls from consolidation-patterns or trading-ranges. This technique is used by some traders who are not sure in which direction the market is developing, but want to be accordingly “stopped” after a breakout. Usually, the opposite order changes to ‘’stop-loss" order. The problem of this trading approach is that breakout-movements lead from time to time to failed breakouts.
The search for the advantage
Would it be not nice if there was a tool that would provide us an advantage and increase the probability to recognize the direction of the breakout and to reduce the risk factor for a false-Trade? The following strategy presents such a variant. Successful day traders, who trade with the trend, usually do not buy at the lowest rates and then sell at the highest. The principal concern of successful day traders is to catch a good part in the middle of a movement and to trade. Guessing tops and bottoms is more lucrative, but also has a lower probability of success. So we need to identify a trend, and look out by movements within this trend and set profit targets. One of the most reliable pattern, which is not traded by the most of the traders, is the wedge formation. Using a measurement procedure in this strategy, profit targets can be defined and risk-factors can be derived. It usually involves a pretty large risk factor that deters traders, so that they miss considerable profit opportunities. The wedge pattern is similar to a symmetrical triangle in shape and its time-scale. As the symmetrical triangle, the wedge is formed by two converging trend lines, which meet at a top. What the wedge from the triangles distinguish, is its unique, either upward or downward inclination. A falling wedge is bullish evaluated a rising wedge is bearish.
Example of a wedge-Trade
In Figure 1, is shown the 5-minute chart of crude oil on 07 / March 2016. The course was initially located in an uptrend and then formed a classic wedge pattern. Trader, which are based on this pattern, usually place a buy stop a few ticks or points above the primary high of the triangle, or wedge pattern (black line; point A). The corresponding sales stop was placed a few ticks or points below the primary low of the wedge (dotted black line). Once there is a breakout, the opposite Order changes to risk order or stop loss order. In the measure, as the price moves in the direction desired by the trader, it is then about managing the trade. The Stop is trailed from an initial accounting loss to a breakeven, whereupon the exit strategy is initiated. In this trade, the entry-level order was placed at 37.40 US dollar and then placed a stop-loss at 36.85 US dollars – that is 55 points or ticks, where each point corresponds to ten dollars. This is a risk per contract of $ 550. The beauty of the wedge pattern is the range or distance from the low to the high of the pattern. In this way, technical analysts have a measurable target price for Exit, by removing this range upwards from the Entry. Often, this level is even exceeded.
Technical Tools
As you can see, the trend had already been established, as the consolidation pattern has been recognized as a wedge formation. Some traders might forego the Trade, because the risk is too high for them. Here is the moment of technical tools. To confirm the movement, the author likes to use the volume indicator On Balance Volume (OBV). In breakout-trades the volume analysis helps if you want to determine whether a trade is really established so that it provides the necessary momentum to boost the price action. He also uses the Stochastic. This helps to find overbought or oversold markets and to identify divergences. If you look at the trade with these technical indicators, you will have a different perspective and the ability to reduce your risk as soon as the trade is initiated. As the price was gone over the swing-high and we have been long in the market (point A), it is clear that the volume increased. This shows the bullish momentum behind the movement. The OBV indicator (blue line in the sub-chart) had already moved higher before the price broke out. If the volume precedes the price, this is often a good indication that the trade is good. A positive thing in the OBV indicator is also that you can create a moving average over him, and so you can filter and smooth the trend. As you can see, the pink line is a simple moving average. The distance between swing high and swing low gives the trader a profit target, if you move upwards the distance from the entry price. You can set the stop below the channel as a stop-level emergency. It makes strategically sense to use a trailing stop-mechanism that ensures subsequently gains. In the chart it is possible to retighten stops below certain candles without hesitation or to adapt them. These are the last Conditional Change (LCC) Level.
Improving the setup
Now let's look more closely at Figure 2, so that we can take the risk component of the trades under the microscope. As you see, the candle (in the circle) had formed no lower shadow and resulted to an upward movement that led the traders in a long position. This is the basis for the Last Conditional Change and thus the low of this candle is used as a support where a trader can safely place the new stop-loss (upper dotted line). Now, instead of risking 550 US dollars per position (lower dashed line), the stop at 37.22 US dollars can be placed below the low of the bars (point A), which reduce your risk to just under US $ 200. The prerequisite for a bullish trend is higher highs and higher lows. So if a market has a bullish breakout, which is accompanied by an increase in volume, the low of the bars or of the candle should not to be touched. Therefore, the stop can be placed below this bar. The knowledge of which bar and what volumes are in the game give the better informed and better educated traders an advantage.
Outlook
We hope that you are also in the next issues when John Person will explain in his series of articles, how some of his methods and indicators work.
John Person.
John Person has worked for 36 years in the futures and options trading. In 1979 he started at the Chicago Mercantile Exchange and since then was an independent trader, broker, analyst and managing one of the largest companies in Chicago. He was the first, who combined the Candlesticks and Pivot analysis. Person is also author and respected speaker at events.