RETRACEMENTS

One of the best ways to trade is simply wait for trends to develop, then enter in the direction of the trend on pullbacks. This is a what I like to call a conceptually correct approach. There are so many ways to trade that an individual can adapt his or her own style to what they are most comfortable with. However, the one guiding light in this process needs to be that just because you are comfortable with something does not mean it is a good approach. There is so much random activity that with some brain power along with computing power, you can data mine and make even the most obscure approaches appear to look good in back testing of data. What winds up happening often, and this has happened to me in the past, is that you zero in on something that has won 33 times in a row. You get so excited, you have found the grail. You are so proud of yourself you say out loud, I am not telling anyone about this, I found it. You cannot wait for the next occurence to show up to put all your chips on the table.

Sure enough, your trade setup shows up, you place your trade, and clank you get stopped out for a loss. You shrug that off knowing that there are always going to be some losses and this might be the only one. You take the next trade, wham another loss. At this point at least with me, I know something is wrong, you can just feel it. Sure enough the method just never works in a profitable fashion in real trading. You put your tail between your legs and go back to trying to figure out what went wrong. Chances are you had isolated a random event, data mined it and dressed it up, and it was never a causative event. Most often I would argue that was because it was not conceptually correct. This is not higher math, it just means that on a basic level it has to make some sense.

I love to hear things like "this market always makes it highs on Tuesday so I am shorting on Tuesday." That is an example of something that does not make conceptual sense yet, I know someone who trades like that. He has not done thorough enough research into this to discover that over large data sets, there are no tendencies in this area that are tradeable. Highs and lows are randomly made on different days of the week. This is something I have researched in detail, so I know what I am talking about here. There are some tendencies in the bond market specifically but they are few in number.

One conceptually correct approach is entering in the direction of larger trends on reactions against those trends.

In the chart at the top I have COPPER but it could be any market. I have marked off the trend retracement entries. You can see that in general the best entries are when price does not retrace very far. These are always difficult because we always want to feel like we are getting a good deal. When price declines ever so slightly we always feel that it has to go further, then wham it takes off again and we are left standing alone. There are some deeper retracements that would have caused losses had you entered when that retracement was shallow. Guess what, trading is hard, nothing works all the time. It is a probabilities game so losses occur trying to catch market moves. Deal with it. There is no approach I know of that can tell you when a retracement starts, how far it will go and whether it will be large or small. I am constantly trying to find something that can tell me that. If I find it you can be sure I will not post it here, that would be the greatest discovery of all time and I will hog it. I doubt very seriously I will ever discover that.

My advice would be to just establish some triggers that once a retracement begins and the market begins to resume it's trend direction, you enter a trade. This requires that the market prove itself before your dollars are at risk. This is in general why I buy above highs and sell below lows. I want to market moving in my desired direction to pull me into a trade. That is just my style and it is also from years of research. In almost every test I have done buying strength and selling weakness has shown superior results vs entering at the market. However, when I first started trading I just entered at the market and had very good results. There is no absolute answer on this. If you enter at the market you use a dollar stop, if you enter on High/low breaks, you use a prior high or low as a stop.

The overall point to be made is this. Entering on pullbacks in trends is a very good way to trade, but do not get caught up in hoping for large pullbacks. The best trend moves give small pullbacks then take off again. Sometimes you may enter once and get stopped out and might have to take a second entry if the pullback is deeper. That is life. Once you catch a few large launch moves on short pullbacks, it will get easier to take those trades going forward.