Over the course of the next week of blog entries here at the Daily Trading Edge I am going to be outlining the different entry strategies I use to trade chart patterns.
One of my favorite tools is the IBFX PRS (Pattern Recognition Scanner) because it scans across multiple time frames and pairs and alerts me when patterns have 1) formed and 2) been broken. The determining factor in my opinion, for any entry is the market cycle and when you can use both the 34EMA Wave and the PRS Initial Trend reading, and I believe you can begin to put together a solid trading plan for the current market environment.
Consider for a moment that many traders will for the most part identify very similar levels on a chart as support and resistance. In fact many popular tools such as pivot points, Fibonacci levels, and whole, round numbers will overlap with one another to confirm that a particular price level is indeed a decision level. I call any support, resistance, or trendline “decision levels” because it is at that point on the chart that traders are making a decision to either buy or sell. If you can consistently identify these levels correctly using whatever method at your disposal, you will find that prices will commonly accelerate, stall, or reverse from that level and then you know you have identified a level that the market as a whole is reacting to.
The reason chart patterns “work” when they do is that the lines and levels of the pattern are at decision levels. In my experience, the best way to capitalize on this is to understand whether the market will accelerate, stall, or reverse at the pattern’s support or resistance. Making educated decisions about what price action may do and then prioritizing the different entry scenarios can be done by first determining whether the market is trending or moving sideways.
There are five possible scenarios for entering any market. A market can continue the trend, reverse the trend, retrace or correct the trend, breakout or breakdown from a sideways market, and finally exhaust at the floor or ceiling of a sideways range; notice there are three trending and two non-trending entry scenarios. Each has a market cycle that they are most likely to occur in.
There are four market cycles. This is mainly straight from Charles Dow and what is now known as “Dow Theory”. A market can trend higher (mark up), trend lower (mark down), move in a quiet, sideways range (accumulation), or move sideways in a more volatile sideways range (distribution). Each is characterized by specific price action and therefore has an entry strategy that is ideally suited to the underlying market psychology it is reflecting.
For example, a trending market will have the potential to continue the trend, reverse the trend, or correct the trend. A continuation means that prices will typically travel higher through resistance in an uptrend or lower through support in a downtrend with little to no correction. A trend reversal is when prices break through correction support or resistance levels and move in the opposite direction of the prior market direction.
I have to mention here that many traders have a very difficult time differentiating between corrections and reversals. For me a trending pattern break can often be an aggressive trend correction, but I personally do not confirm a trend reversal until prices break the 34 period EMA low of a 12 to 2 o’clock Wave or the 34 period EMA high of a 4 to 6 o’clock Wave. The Wave is the “line in the sand” for me to look at any pullback and determine at-a-glance, if it represents a correction or a reversal.
Therefore the third trending entry scenario, a trend correction, is dependent upon the trend staying intact and also staying on above the 34 period EMA low in an uptrend and the 34 period EMA high in a downtrend.
Now that we’ve outlined some of the entries and details, in the next update we’ll begin combining different and current chart pattern results from the PRS and choosing the entry strategy based upon the market direction.
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