Trading the Strong Trend Day Down on Thursday

Jan 29, 2009: 10:12 PM CST

Thursday’s price action gave us yet another excellent example of a trend day, which offers us the opportunity to trade any retracement aggressively.  Let’s look at the structure and key high probability trade set-ups that formed.

DIA 5-min:

DIA 5 min chart

The day started just as Wednesday did with a large (greater than $1.00) overnight gap.  For the 100th time, it is generally not a good idea to try to fade a DIA gap greater than $1.00 as today’s (and yesterday’s) structure shows.

In such a situation, you should be waiting to sell the first pullback into key resistance for your first major trade of the day.  That occurred around 11:00am as price pulled back to confluence resistance via the falling 20 and 50 EMAs.

Price then went to new lows into noon and formed a Bear Flag into confluence resistance at the 20 EMA and 200 SMA - I labeled this the Highest Probability (or Best Setup) of the Day.  Note the risk-reward inherent in this trade.  If you expected a flag here (as it unfolded), you had a very tight stop (just above the confluence zone) to target a Measured Move of the prior swing from $82.80 to $82.20 (roughly $0.60) which unfolded perfectly as price moved to new lows on the day at 1:00 - this was also your exit as the measured move target was complete.

Price then staggered on the day’s lows and made one more flag-like retracement to the 50 EMA which set up another opportunity to enter short to target a test of the intraday lows.  The next swing took price down to new lows as the market closed very close to the absolute lows on the day - a bearish development that erased all the gains of yesterday’s bullish action.

If we break lower tomorrow, it will likely set-up yet another Bull Trap, meaning we would be almost certain to test our November lows.  Study the price action for more clues and use today’s example as a great reference for how an ideal trend day should unfold.

Corey Rosenbloom
Afraid to Trade.com

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  • DaveB
    I want to follow-up on the Dow-Mini's and profits from the measured move discussion.

    If you're not up to speed on futures trading another way to play this would be to do analysis on DIA but trade with DDM (which is like a 2x DIA), or trade one of the 3x ETFs. That could make the profit a little more worthwhile.

    I rarely day trade because I'm a rookie who is working with a small account size. (I don't dare put more money in until I can prove to myself that I know what the heck I'm doing!) I try to look for larger multi-day moves, because these smaller intraday moves aren't going to make enough money to bother with. Plus, if you make more than 4 day trades in a week you can be classified as a pattern day trader and that requires you to have a 25k account balance. So if you're working with a smaller account you have to keep your day trades to a minimum or else you could get a slap on the wrist.

    Does anyone have any recommendations as to where I can learn more about mini futures? Would I be able to trade those in my regular schwab brokerage account or do I need to set up an account with someone else? Thanks!
  • Don-Da-Mon
    Inverted Hammer can be a bullish pattern, can't it? As I look back at the S&P Weekly over the last year, after an inverted hammer there was a move upward. If retesting the bottom wasn't also in view, I'd think we were going to move upward.
  • Matthew C.
    Hi Corey.

    I set up a TOS account near the end of November. Since then I've been using their simulated trading feature to trade only trending days. The simulated account started with $100K, I just closed out January at $240K.

    I've been pretty aggressive and made some pretty bonehead stupid moves along the way. My best day was 60K, worst was -30K (don't ask how I managed to lose that much!)

    I'm actually using the maximum of 16 contracts once a trend day has proven itself for real. I'm even adding on SKF or SSO in $250K-300K size in addition to the futures contracts once I've maxed out TOS's 16 contracts.

    The key is, of course, that you have to have a maximum trade loss point and stick to it (my two 20-30K losses came from not respecting my hard final stop and moving it back when hoping for a reversal).

    Of course, this is extremely aggressive trading. But I only put any size on in trend days, so I need to take advantage of the trends that do happen. Maybe I'll tackle range bound trading later, but for now I have something that is working.

    I figure I'll wait a year or so to actually start trading real coin, once I make sure that I am profitable every month.
  • Anonymous
    Corey,

    Thanks. Yep, this is what I thought... makes perfect sense. Good luck in your trading.
  • Anon,

    I no longer trade using the DIA but I do analysis with it. I trade using the current Dow-Mini @YM futures contract. I'll take my positions in multiples of 2, because that translates into 1,000 shares of the DIA. 4 contracts is 2,000 shares, etc.

    Every point move in the @YM equals $5 in profit or loss. Every contract is the equivalent of 500 shares. The current margin required is around $7,000 per contract.

    You'd need around a $10,000 account to be safe trading 1 contract, and I'd recommend an even larger one, but in so doing, assume the following:

    If you captured the $0.60 move in the DIA, that would translate to around 50 to 60 points profit in the @YM. Let's just say 50 points profit to account for commissions/slippage (commissions are around $3 - $5 for a round-trip, btw).

    If you traded 1 contract, that 50 points would equal a profit of $250. That's 500 DIA shares x 0.50 = $250 or 50 x $5 (point move in the @YM) = $250.

    Of course, two contracts nets you $500. Four contracts (roughly 2,000 shares) nets you $1,000. Ten contracts (5,000 shares)nets you $2,500.

    You would need an account greater than $100k to trade 10 contracts efficiently - many would argue it should be much larger - at least $200k. Keep in mind with 10 contracts, you're trading the effect of 5,000 DIA shares which translates currently as a $400,000 position ($80 x 5,000). Clearly not for beginners.

    Please do not trade the @YM futures contracts until you are proficient at the DIA or other ETFs, as just as you can make money quicker, you can lose it quicker. The DIA is just a practice field for bigger and better things.
  • Don,

    A scary pattern. One could also call it a shooting star type pattern - both of which are bearish. Not good for bulls. I think we're set to test the lows.
  • Anonymous
    Corey,

    great educational blog, one of my favorites...

    However, I am struggling with the math of your suggested trades on DIA.

    Let's assume you initiate your short trade with $5000, which gets you about 61 shares @ ~$82 (5000/82= ~61). Then your measured move is $0.6, which produces a gain of about $37 (61*0.6= ~37). Subtract a buy/sell commission (2* $9.99 on average with an online account) and you get a whopping net profit of $17 for the trade.

    Is it this kind of scalping what makes the bulk of your monthly profits? Pls. advise/explain.
  • Don Da Mon
    Inverted Hammer on S&P 500 weekly. Still within Nov low to Jan high retracement to about 820. It bounced last time around 800. Will it do it again or finally retest the lows. I want either the rally that is expected or the retest. Just pulling my hair out wondering which way it'll go! Inverted Hammer mean anyhing significant to you?
  • NotAfraid,

    Agreed, but most people who use indicators can't step outside the classic rules they're taught which leads to some staggering losses on days like this. You'd have to filter out your signals at a minimum, but in the case of RSI, it could not get to 70 to give a sell signal at any point. It did give one buy signal which was worthless.

    I'm not saying kill indicators, but I'm saying for most people - particularly newer traders, they can't do it so it's just easier to remove them and look at moving averages.
  • Gawed,

    Trend Days are fun for me indeed. They make up the bulk of my monthly profits because I've learned to trade them aggressively.

    Today's post specifically addresses why NOT to use indicators on suspected trend days.
  • Anon,

    Do you mean EW count on the S&P; 500? Or Oil? I'll try to do so this weekend.
  • NotAfraidofTrend
    Corey, indicators are quite useful even on trend days, for entering the trend. Throwing them out out is like throwing the baby with the bath water. However, we must use them carefully, only for entering the trend, but definitely not for exiting or going against the trend.

    Gawed, I agree that it is not easy to switch the mind for different interpretations of indicators, depending upon whether it is a trending market or a trading range market.

    So, in a way, Corey is right about switching them off as it is very difficult to switch the interpretation of the indicators. In fact, I have personally had some of my worst losing trades because of that inability to switch the interpretation of the indicators. However, should we stop trying to improve?
  • it's soooo fun to see the trends, and i must say everyday reading you makes it easier to spot things in the moment! i can only thank you about that and hope to have you as a mentor some day! :D (more than you are now!)

    I think one of the best teachings I've gotten from you is that "don't use indicators on trend day" tag. we get so comfy and dependable on our indicators and graphics and stuff that we want to use them everytime, everyday, it's addictive! you're helping me out of an addiction.
  • Anonymous
    Hey Corey, can you revisit the EW counts again. Also, I've been looking at SUN, it's surprising running higher than alot of the other oil companies. Could you possible look at the EW on it. I've been studying this stock for a while.To me it looks like a good short setup since price has retraced 100 from the previous pivot point. I've been trying to figure out the EW on it.. maybe you can shed some light. Thanks.
  • That's true. These poor bulls get excited but then the market slams them down again. If they ever give up, it will be a quick move to new lows. Right now it's a battle as we forge this corrective period.
  • You have to wonder how many times we can test 800 on the S&P before we break through.

    New post - S&P still hitting the fib lines, GDP and Gold - http://chartsandcoffee.blogspot.com/2009/01/spy...
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