What’s the difference between a Trend Day and a Rounded Reversal?  Today’s price action give you an excellent example.  Let’s see the intraday DIA and see how this structure played out and how you could have managed risk.

DIA 5-min chart:

The day started with a large-scale overnight gap of roughly $0.90.  That’s just at the threshold of “Do I fade the Gap or Not?”  Today’s gap did not fill, though there was a push into the gap shortly after 10:00am.

At 11:00am as price tested resistance, it was an ‘iffy’ position, but when price broke back down through the rising 20 EMA, odds then favored that we had a “Trend Day Down” on our hands.  Keep in mind that it’s relatively rare to get two back-to-back Trend Days and yesterday’s action was clearly a Trend Day Down.

That being said, one could have taken a short-sell as price tested the falling 50 EMA at 11:00 with a tight stop and tried to target new intraday lows.  Price ultimately challenged though not exceeded the lows of $86.60 at noon before forming an “ABC” or mini-bull flag that quickly met its target at the falling 50 EMA (I would not have suggested trading this bull flag, but merely to note its occurrence in the structure).

The second red arrow represents another high-probability, low risk short-sellt rade entry that met its target objective – a retest of the intraday lows.  Notice at this point that there was a triple-swing positive momentum divergence building under price, but even still it’s best to ignore all oscillators and focus only on the EMAs when we have a trend day unfolding, as all signs seemed to indicate as late as 2:00pm.

I highlighted and placed a “1″ to call your attention to the 2:00 structure.  That was a decent short-sell entry again, with a stop placed above the falling 50 EMA… however it was quickly stopped out, as were any core positions which was an early sign ’something might be up.’

The opponent or ‘rival’ structure of a “Trend Day” is a “Rounded Reversal” Day – and no, to my knowledge, there’s no magic formula or indicator that can tell you when the day will be a Rounded Reversal or a true Trend Day.

Unfortunately (for short-sellers), the day wound up being a Rounded Reversal.  Price broke EMA resistance just after 2:00pm then swung down to form a higher low… that was a signal to remain on the sidelines and let price prove itself in terms of which direction to go.

Price broke back above the EMAs and formed a higher high which officially reversed the chart’s trend to the upside.  At that point, you should have been looking for a pullback entry to ‘get long,’ which occurred around 3:15pm where I have the second highlight and the #2.  Notice this is the “Cradle Trade” or Confluence Support coming in from the 20 and 50 EMAs and a high probabiliy, low-risk (stop placed beneath the EMAs) long entry.

This is where the battle between “Loose Stops” and “Tight Stops” rages.  Traders taking this same trade who employed Loose Stops were able to hold their position and achieve a retest of the prior swing high into the close while those who employed a tight-stop strategy most likely were stopped out prematurely.  I’ll let you decide for yourself as to the trade-off in terms of overall system performance and your own money/risk mangement, but chalk this experience up to support the “Loose Stop” traders.

Today’s trading served as an example how we must let price action dictate our behavior, and not let our bias dictate our behavior (as in shorting any rally after 3:00).  Price gives clues from an edge standpoint in regards to the most probable direction, but we still deal in a probabilistic environment without certainties.

Let today’s trading day be a lesson and dig a little deeper into the action for additional insights.

Corey Rosenbloom
Afraid to Trade.com