A Lesson Inside the Failed Bear Flag Feb 5

Feb 6, 2010: 2:00 PM CST

It’s true that failed trades sometimes can teach us more than successful trades, especially if we take the time to learn what went wrong – as in “Did I make a trading error” or “Did the market do something unexpected?”

There was a particularly high probability trade set-up that triggered late Friday afternoon that failed due to the afternoon surge, but there were a few hints and lessons we can learn from this experience, so let’s take a look!

First, we’ll start with the @ES (SP-mini futures) contract 5-min chart:

This is a simplified chart of the @ES with the 3/10 Oscillator and NYSE TICK as lower panel indicators.

The main idea of this trade set-up is a type of Bear Flag intraday where the goal is to get short on a move into overhead resistance (such as the 20 EMA) and trigger entry when a reversal candle forms (like the doji that peaked at 1,048 at 1:30 CST).

This retracement rally came after a new momentum (3/10) and TICK intraday low, both of which forecast lower prices are expected due to the increase in downside momentum and selling pressure.

For reference, this trade set-up was similar in structure to the 11:30am ‘bear flag’ rally into the declining 20 period EMA that also formed a doji reversal candle at resistance after a flag-like retracement to the 1,056 level.

Aggressive trade entries are taken at the upper resistance line while conservative entries are taken – with confirmation – when price breaks under the lower trendline.

As such, at 1:30, a short-sell is triggered with an entry as close to 1,048 as possible while placing a stop one to two points (depending on your strategy) higher than your entry.

The minimum target was a retest of the intraday low at 1,040 or – preferably – a new swing low that would end under 1,040.

So we enter the trade and wait…10 minutes later, we are already in the profit zone by 3 points ($50 per contract)… but something unexpected happened!

Price rallied slightly higher, paused, and then took off suddenly and stopped us out with a small loss.

Of course, I want to know if there was any way I could have foreseen this trade failure, or any lessons to be learned.

It turns out, there were!

Let’s see the 1-min chart and learn a valuable lesson about bias, neutrality, and reading market internals.

The Red “S” and arrow at 1:40 represent an ideal entry when the 1-min trendline was broken after the 5-min ‘doji’ formed (reference both charts).

We also saw a slight negative TICK divergence leading into the 1,048 high – that’s often only seen on the 1-min frame.

So as price rallied off the 1,044 level, it was no big deal because our stop was safe at 1,049/1,050 (depending if you prefer tight stops or not… remember we are playing for at least an 8 point target to the downside).

At 2:02 CST, something powerful and interesting happened that was either ignored by traders with a “The Market HAS to Go Down” bias or not seen by those not watching internals closely.

Price formed a New TICK high on the session which corresponded with a 20,000 print in @ES Volume – interesting.

These are “Hidden” Signs of Strength (new TICK highs when price is far from making an intraday TICK high) which forecasts reversals and bullish strength yet to come.

I have little green dots on my TICK charts to clue me in when we are making new intraday TICK highs – that’s very important to know.

Why?

Because we can’t let our bias (that “This trade HAS to work!”) cloud the reality of the growing bullish/buying power coming into the market.

Exactly 5 minutes after this “Shot Across the Bow” (which should have triggered you out with a stop-loss), price surged in an impressive power buying (short-squeeze/covering) rally.

This was forecast in part by the New TICK high and failed high-probability Bear Flag set-up.

Very aggressive traders could have flipped their position long and bought, taking advantage of the buying power and short-covering rally… but that’s another story.

Here are a few helpful lessons we can learn from this failed set-up:

1. Remain Flexible – do not let your bias (“The Market MUST Go Down”) cloud the reality of what’s happening

2. Seek High Probability, Low Risk Set-ups
(In this case, we had the trend, resistance, and a doji working in our favor, and were risking 2 points to play for 8 points)

3. Take Your Stop-Loss when the Trade Fails
(You would have been in a worse situation if you stubbornly held short into the sudden 10-point rally)
(In fact, some of the largest swings occur AFTER a high-probability set-ups has failed … I call this “Popped Stops”)

4.  “Anything Can Happen” in the Market (Mark Douglas)
Even the best set-ups can … and sometimes do… fail and that’s perfectly fine as long as you control risk.
Don’t blame JP Morgan’s Buy Desk or Goldman Sachs – trading is a game of probabilities instead of certainties.

Study each day to learn more concepts and do your own end-of-day analysis of the charts to make yourselves even better traders!

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

10 Comments

10 Responses to “A Lesson Inside the Failed Bear Flag Feb 5”

  1. terlyn Says:

    Thanks, Corey.

  2. terlyn Says:

    I was looking at yesterday's chart of SPY and inverse (2X) SPY and FAZ. I think it is possible to count a 5-wave pattern on the impulse up. It is clearer in reverse on the inverse, especially FAZ, which has a clear double top on the one and 3-minute charts.

  3. Craig Says:

    Corey,

    I enjoy your work. It is always insightful. I've had you on my blogroll for some time. Addition to your blogroll would be much appreciated.

    Craig

  4. Jason B. Gordon Says:

    Great post Corey. Thanks for the thorough analysis and explanations.

    keep up the good work!

  5. tradingdonk Says:

    Cory, great post. One thing I'd like to point out in this failed trade is the 3/10 oscillator. It did not give a sell signal. In fact, it gave a buy signal at 11:50 (PT). If you were to take the aggressive entry that you mentioned, this would have signaled a failed break down from the bear flag and opportunity to exit with a scratch. The conservative entry you mention, in fact, never set up due to the 3/10 oscillator.

    For comparison, the 3/10 gave a sell signal at 9:45 (PT).

  6. uempel Says:

    Corey, this is really a good post, congrats. Instead of observing the market closely and looking at the facts, some people prefer to accuse dark forces.

  7. Diggy | Forexhabits.com Says:

    Very Interesting Corey!
    I don't like the 1,5 and 10 minute charts, it's all a little too much too fast. I prefer finding a trend on daily and an entry point on a 4 hour chart. Sometimes it means a position needs to be held for a few weeks, other times a day or two.

    I find that the patterns on smaller time frames are more often mis-leading than on the larger ones?

  8. Diggy | Forexhabits.com Says:

    Very Interesting Corey!
    I don't like the 1,5 and 10 minute charts, it's all a little too much too fast. I prefer finding a trend on daily and an entry point on a 4 hour chart. Sometimes it means a position needs to be held for a few weeks, other times a day or two.

    I find that the patterns on smaller time frames are more often mis-leading than on the larger ones?

  9. Three Day in a Row SPY Pattern Yields Profit or Peril | Afraid to Trade.com Blog Says:

    […] “A Lesson Inside the Failed Bear Flag” […]

  10. Three Day in a Row SPY Pattern Yields Profit or Peril | Penny Stock Trading System Blog Says:

    […] “A Lesson Inside the Failed Bear Flag” […]