The “Sweet Spot” in the Data: Trend Beginnings and Playing for Large Targets

Mar 4, 2007: 5:05 PM CST

Would you like to know the true, statistically tested spot of a new trend in development? Is this the secret to riches?!

No, there is no secret, unfortunately, but with this objective model of quantifying trend birth, you’ll be more “in the know” than those who miss this key “Sweet Spot” in the market structure.

We know that trends have higher odds for continuation than reversal, and that it takes considerable power and money to shift a trend, but is it possible to spot the EXACT price that a trend changes? Studies have identified a sweet spot where odds are highest for a confirmed trend change, stops (if incorrect) are closest to the zone, AND profit potential is substantially higher than your risk target. This truly is a rare find but it can lead to high profits, if you are patient enough to identify these spots and hold your position with leverage (or higher than normal) position size.

While this may be intuitive to some, it was a major revelation for me. We know that uptrends are characterized by Higher Highs and Higher Lows on a swing chart (don’t try to be exact, just look for recent swing highs and lows). Downtrends are the opposite (in trend structure). Here are a few questions regarding trends:

  1. If price makes a higher high after a sustained downtrend, is this the signal for a new uptrend? Answer = NO.
  2. If price makes a higher high AND a higher low following a sustained downtrend, is this the signal for a new uptrend? Answer = NOT YET. (Reason = price may continue to roll lower and invalidate the recent higher high and lure you in to buy when really the price is still rolling over in a confirmed downtrend)
  3. If price makes a higher high, then makes a higher low, THEN takes out the most recent higher high, is this a new uptrend? Answer = YES!

Not only is this the statistical trend beginning confirmation zone, but it is a zone for you to establish and hold a core position and utilize swing trading tactics (retracement entries) with confidence following this point. It answers the question: “When do I play for a Small or a Large Target?” Finding these areas provide one of the only locations to play for a large target (this is true across any timeframe, for that matter – targets are relative to time-frames).

I am providing a Weekly chart example of Boeing in 2003 as it changed its trend with a technical confirmation pattern (Chart from TradeStation).

Of note, the “Trend Confirmation Point” came just above $36 when price took out the new higher high. Two strategies arise here:

1. Enter at the market at the trend confirmation zone and hold until a price extreme occurs OR price takes out the most recent (new) swing low. The stop would be placed just above $30 – the most recent (higher) swing low.

2. Wait for the market to PULLBACK following this point and then enter with a very tight stop.

Waiting for the pullback is almost always the best strategy as your risk is so low. Price pulled back to $34, which happened to occur as the 20 period and 50 period Moving Averages provided a strong support floor for the trade. It is times like this that you place a larger than average position on and hold for a large target.

Not only are the odds stacked so strongly in your favor, but your risk (stop-loss) is so close to entry that the trade becomes almost irresistible. A conservative stop would be $33.50 while an aggressive (proper, in this case) stop would be $31 (below recent swing low).

Please realize that these “Sweet Spots in the Data” occur on 5-minute charts, 30 minute charts, daily, and weekly charts. You simple identify confirmed turning points in the market.

A question always is: “Why not buy at $26, or the absolute low?” The simple answer is that you cannot do this consistently over various time frames and through hundreds of trades. The risk is too high and odds are strongly stacked against you based on core trend structure. Yes, you will surrender potential profits by waiting for confirmation, but at the point of confirmation, odds are so strong for a successful trade that it creates a strongly positive edge which can be played out over hundreds of trades and new trend confirmation zones.

Never try to be perfect; only try to make money. Making money is done by putting the odds (edge) in your favor consistently and knowing when to get out when simple probability goes against you.

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Comments
  • Harjit

    refer my above post. it is actually a continuation of of the bull trend.

  • Harjit

    hi corey,
    refer to my post of Apr 16(above).
    after about 5 year bull run, reliance.ns had nosdived
    by >25% and gone below 20 dma,
    today, reliance.ns has given SweetSpot (trend begin)
    ahead of the broad index(^NSEI). it has also moved
    above the 20 sma.
    thx for the insight into a safe strategy.

  • Harjit

    hi corey,
    excellent article.
    i've backtested indices across usa, euriope and asia.
    1. in india,reliance.ns is reversing ahead of the index. how to decide when to reverse a stock when the index has not reversed?
    2. how to differentiate between normal short term reversals from change of trend?
    thanx.

  • Jeff,

    Thank you for reading and for the comment.

    I have edited the text - slight error on my part. The chart is correct and the concept is correct. Thank you for letting me know!

    All the best!

  • Jeff

    Hi Corey, great blog!
    i'm a bit confused: you write "If price makes a higher high, then makes a lower low, THEN takes out the most recent higher high, is this a new uptrend? Answer = YES!"
    but tha chart shows higher high - *higher* low - hier high.
    So which one is it?

    thanks,\Jeff

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