Market Threatens the Worst of Both Worlds with a Trap

Jun 21, 2010: 2:56 PM CST

What’s worse than getting trapped on the wrong side of a breakout move?

Easy – getting trapped on both sides of a false breakout – and that happened to some extremely frustrated traders today as the market threatens to form an outcome that marks the worst of both worlds for both bulls and bears.

Let’s see it:

I’ve been saying in a variety of recent posts how 1,120 was a major turning point between bulls and bears in terms of short-term structure and opportunities.

It’s a bull’s world above 1,120 and a bear’s world under it.

Thus, the best play for those holding short over the weekend was to go ahead and take a stop-loss on this morning’s large upside gap just to be safe.  You can always re-short on a break back under 1,120 – which has happened – but in the event the market formed a ‘popped stops’ breakout rally, it was safest to take a small loss instead of accepting the risk of that loss turning into a big loss (perhaps with a move up to 1,150).

So that’s not a big deal – but what happened if you got extremely upset at the breakout this morning and then flipped and reversed long to try to fight back at the market?

Again, that’s not necessarily a bad thing if your strategy – developed in calmer times – calls for that.  Indeed we could have seen a breakout to the upside.  Trading is a game of probabilities – not certainties (as Mark Douglas is famous for teaching).

I mentioned last week that the worst thing that could happen would be a sudden break above 1,120 to trigger stop-losses of the short-sellers and fresh breakout buys of the bulls… only to have the market suddenly collapse back under 1,120 then 1,100.  Such a move would trap both sides of the market with back-to-back losses.

And so far, that’s what’s happened on Monday.

Here’s the intraday action:

There are a couple of lessons to learn for the future in the event that you got trapped both ways.

First, Martin Pring and many other are famous for advocating a “two bar” close rule – meaning, don’t take a breakout trade unless the market can sustain TWO closes (two days) above the breakout level.

By today’s close, we won’t even have one close outside the level so that rule – so far – is out and would have certainly kept you safe.

Edwards and Magee – as well as others – advocate a 2% threshold closing level beyond a breakout zone.  A 2% move from Friday’s close would be roughly 22 index points higher, or up to the 1,140 level.  That may seem like a lot, but that’s the price you pay for safety in a breakout trade set-up.

Both of these ‘filters’ assume a swing or position trading style of trading, so intraday traders would need to use a lower threshold.

Monday’s action is a good reminder that sometimes it’s best to play it safe instead of acting aggressively or emotionally to a market at a key turning point level.

Corey Rosenbloom, CMT
Afraid to

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8 Responses to “Market Threatens the Worst of Both Worlds with a Trap”

  1. Stocks Rise But Fall As Currency Carry Trades Sell Off As China De-Pegs … US Treasuries Close Lower « EconomicReview Journal Says:

    […] Rosenbloom in article Market Threatens the Worst of Both Worlds with a Trap provides excellent coverage of today’s trading […]

  2. JeffreyLin Says:

    with the size of the recent moves, a 2 bar close could be a big chunk of the move already!

  3. JeffreyLin Says:

    with the size of the recent moves, a 2 bar close could be a big chunk of the move already!

  4. Corey Rosenbloom, CMT Says:

    I totally agree! Martin Pring & Edwards and Magee mostly teach swing or position trading tactics. I'm convinced that the current market is geared for intraday and very-short term swing trades, so 2-bar rules might not have the prominence they used to in the 1980s or even 1990s.

    Still, applying some sort of threshold/filter rule would have at least prevented losing trades short and long today from a swing trading perspective.

  5. Dan Omaha Says:

    30 minute charts are handy in this market oo

  6. Stoploss Says:

    Chart says 5 min, but looks like a 5 hour chart, right? Any way, i opted to go short as close to the high as i could, today. Yuan smuan, doesn't mean anything, same depeg different year. You didn't mention the death cross on the day chart. That is an important indication, on any time line. It caused me to stay short through to the close.

  7. john scola Says:

    Hi I have never heard of the 2% min breakout filter. I like that idea. I use a 5% max filter to eliminate the possibility of chasing a trade that has already happened. I just recently ordered Edwards and Magee. Hoping to gain some new insights

    John Scola

  8. Theyenguy Says:

    Given the bearishness of the S&P, one might to consider going short GAZ and UNG and GAZ, down 4% and 3% today; these have been quite bullish of late due to likely yen carry trade investing; and could reward those going short as published reports relate that there is plenty and plenty of natural gas, thus enabling a sell off from today's high prices.

    Perhaps one might enjoy my chart article: Stocks Rise But Fall As Currency Carry Trades Sell Off As China De-Pegs … US Treasuries Close Lower