December 5th 2016 Lesson

Last week I received a support ticket from an aspiring trader interested in OFA.  He was looking for guidance on how to pick trade opportunities – which swings and ranges to target.  One piece of the answer I gave was to always focus on the immediate potential reward as a product of the initial risk.  Huh?  I know.  It’s not the answer you’re looking for.  You’d probably rather get an answer outlining the perfect combination of moving averages and ATR indicators so you can run a backtest and see how awesome you are going to be…  Well good luck with that.  I deal in reality here.

The simple truth is that each swing, range or reversal is unique.  Maybe not completely unique in every possible way – but let’s face it, each event in the market is made up of volume.  Those participants and their objectives are unique to the situation.  You can’t call every trader who was long yesterday and ask them to do the same thing so you can make a better trade today.  Yesterday was a unique event and today will be also.

Perhaps yesterday there was a swing made up of 10 periods and your 7 period moving average did a great job of alerting you to the trend before it was over…  What if today’s trend is more like 50 periods?  How will that 7 period MA work?  Why can’t it just know that it should track 50 periods today instead of 7 yesterday?  Get the point?  Unless you are willing to treat each market move as it’s own story – you’re going to be lost in the black hole of backtesting.  Better to get some simple rules that you can put into practice right away – and then start to drill down your own process for trade selection based on the feedback (PnL) of your practice.

The key points you should take away from today’s class:

1. In a range, sharp reversals provide great turning points if you can trade them early enough.  But it’s hard to fade a range high or low unless it is the extreme high or low of the data set.  As subsequent reversals build, they often stair-step up (lows) or down (highs).  This makes it very hard to use a small stop on the outside of the range.
2. Slow consolidation reversals (often known as an “Eve” top/bottom instead of an “Adam”) provide a better way to time an entry.  The back and forth fighting of buyers and sellers indicate a stronger move is likely to follow.
3. It’s imperative to find an entry with a small enough stop to allow for a target within the range equal to a multiple of the initial risk.  Trading inside a range with the expectation that the range “must” break is foolish.  Make sure you can get paid even if no breakout happens.

Enjoy the video:

 

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