Day Trading With Price Action Volume 2 - Market Bias.pdf

2 ND EDITION

Day Trading with Price Action Volume II: Market Bias Galen Woods Trading Setups Review Copyright © 2014-2016. Galen Woods. PDF eBook Edition Cover Design by Beverley S.

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Copyright © 2014-2016 by Galen Woods (Singapore Business Registration No. 53269377M). All rights reserved. First Edition, 1 September 2014. Second Edition, 5 April 2016. Published by Galen Woods (Singapore Business Registration No. 53269377M). All charts were created with NinjaTrader™. NinjaTrader™ is a Registered Trademark of NinjaTrader™, LLC. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, without written permission from the publisher, except as permitted by Singapore Copyright Laws.

Affiliate Program If you find this course to be valuable and wish to offer it for sale to your own customers or readers, please contact Galen Woods to be an affiliate and get a percentage of each sales as commission. Contact Information Galen Woods can be reached at:  

Website: http://www.tradingsetupsreview.com Email: [email protected]

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Disclaimer The information provided within the Day Trading with Price Action Course and any supporting documents, software, websites, and emails is only for the purposes of information and education. We don't know you so any information we provide does not take into account your individual circumstances, and should NOT be considered advice. Before investing or trading on the basis of this material, both the author and publisher encourage you to first seek professional advice with regard to whether or not it is appropriate to your own particular financial circumstances, needs and objectives. The author and publisher believe the information provided is correct. However we are not liable for any loss, claims, or damage incurred by any person, due to any errors or omissions, or as a consequence of the use or reliance on any information contained within the Day Trading with Price Action Course and any supporting documents, software, websites, and emails. Reference to any market, trading time frame, analysis style or trading technique is for the purpose of information and education only. They are not to be considered a recommendation as being appropriate to your circumstances or needs. All charting platforms and chart layouts (including time frames, indicators and parameters) used within this course are being used to demonstrate and explain a trading concept, for the purposes of information and education only. These charting platforms and chart layouts are in no way recommended as being suitable for your trading purposes. Charts, setups and trade examples shown throughout this product have been chosen in order to provide the best possible www.tradingsetupsreview.com

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demonstration of concept, for information and education purposes. They were not necessarily traded live by the author. U.S. Government Required Disclaimer: Commodity Futures Trading and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to Buy/Sell futures or options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this web site. The past performance of any trading system or methodology is not necessarily indicative of future results. CFTC RULE 4.41 - HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDEROR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.

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Contents Chapter 1 - Introduction ...................................................... 1 Chapter 2 – Finding a Tradable Time Frame............................ 3 2.1 - Price Action Time Frame Index (PATI) ......................... 6 2.2 - Finding Tradable Time Frames with PATI ..................... 9 2.3 - Minimum Tradable Time Frame (MTTF)...................... 12 2.4 - Useful Notes for Finding the Optimal Trading Time Frame and Market .................................................................... 14 2.4.1 - Optimal Trading Environment (OTE) Index ........... 14 2.4.2 - Insufficient Trading Opportunities ....................... 16 2.5 - Alternative Chart Types ........................................... 18 2.6 - Conclusion ............................................................. 21 Chapter 3 – Swings ........................................................... 23 3.1 - Defining Swings ..................................................... 24 3.1.1 - Exercises: Price Swings...................................... 34 3.1.2 - Solutions: Price Swings ...................................... 37 3.2 - Swing Pivots .......................................................... 39 3.3 - Pivot Types ............................................................ 43 3.3.1 - Basic Pivot ....................................................... 45 3.3.2 - Tested Pivot ..................................................... 46 3.3.3 - Valid Pivot ........................................................ 56 3.3.4 - Exercises: Pivot Types ....................................... 75 3.3.5 - Solutions: Pivot Types ....................................... 78 3.4 - Swinging It: Putting Them Together.......................... 80 3.5 - Conclusion ............................................................. 86 Chapter 4 – Trend Lines ..................................................... 88 www.tradingsetupsreview.com

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4.1 - Drawing Trend Lines ............................................... 90 4.1.1 - New Trend Lines ............................................... 90 4.1.2 - New Valid Pivots ............................................... 93 4.1.3 - Contains All Price Action Before The Trend Extreme ................................................................................. 95 4.1.4 - When to Stop Adjusting a Trend Line ................... 98 4.1.5 - Not Too Many Trend Lines ................................ 101 4.2 - Interpreting Trend Lines ........................................ 102 4.2.1 - 6E 60-Minute .................................................. 103 4.2.2 - ES 5-Minute ................................................... 107 4.2.3 - 6J 30-Minute .................................................. 112 4.3 - Conclusion ........................................................... 115 Chapter 5 – Evaluating Market Bias ................................... 117 5.1 - Our Thought Process ............................................. 118 5.2 - Step-by-Step Guide .............................................. 122 5.2.1 - Trend Line Break............................................. 124 5.2.2 - Multiple Trend Lines ........................................ 132 5.2.3 - Large Gap Between Price And Trend Line ........... 141 5.2.4 - Almost Flat Trend Lines ................................... 146 5.2.5 - Short-Lived Trend Lines ................................... 148 5.2.6 - A Struggling Trend .......................................... 151 5.3 - Conclusion ........................................................... 154

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Chapter 1 - Introduction In trading, the market bias is king. The market bias is simply the tendency of a market to move in a certain direction. Is the market more likely to move up or move down? Answering this question is the cornerstone of successful trading. After you master the art of interpreting the price action context and deciphering the market bias, you have a thousand and one ways to trade profitably. However, there is no easy answer to that question. This is because the market is lying constantly. Don’t blame it. You are part of it. Not to mention that the market has to lie. It has no choice. It has to deceive traders into thinking that it is moving down, in order to move up. It has to convince traders that it is rising up, in order to fall further. The logic is simple. Price rises until there is no one interested to buy at a higher price. Then, it falls. Price falls until nobody wants to sell at a lower price. Then, it rises. This story repeats and gives birth to the market swings we see on all trading time frames. It follows that for the market to trend either up or down, it must do so through a series of rising and falling. In bull trends, the total magnitude of the rising swings is larger than that of the falling swings. The opposite is true for bear trends – the total magnitude of downswings is larger than that of upswings.

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Chapter 1 - Introduction

In a bull trend, each time it falls, it is tricking some poor bearish traders into the market, before rising up again. In a bear trend, each pullback upwards represents the same trickery in reverse. Facing such a deceptive market, how do we determine its bias? The key is to focus and stay relevant. This is also where the difference between “market bias” and “trend” matters. In this series, I will use these two terms interchangeably. But, there is a subtle difference between them. Trend exists on many levels. Major trend, intermediate trend, minor trend, monthly trend, daily trend, hourly trend, and the list goes on. Trying to figure out the trend of all degrees is not only impossible, but impractical for trading. The secular trend lasting several years is not relevant for the day trader. Similarly, the 5-second trend is worthless to the pension fund investing with a long-term horizon. Think of market bias as the relevant trend. We need to figure out the degree of trend that is useful for our trading time frame. We must constantly try to interpret the trend that actually gives us an edge in our trading. The trend in the appropriate trading time frame dictates our market bias. Our job is to find the relevant trend (i.e. the market bias), and focus on it. In this volume, you will learn the essential tools for determining the market bias. Our approach uses pure price action that involves observing market swings and drawing trend lines. You will learn how to implement these basic concepts to the market objectively. Towards the end of this volume, you will integrate them to form your assessment of the market bias. (For clarification, the charts in this series are in the GMT +8 time zone.) www.tradingsetupsreview.com

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Chapter 2 – Finding a Tradable Time Frame Our main analysis tool is the price chart. It is a visual depiction of market prices over time. Our choice of trading time frame affects how many bars we have in our charts and how the bars look. Hence, the trading time frame has an important influence over our analysis context. Thus, deciding our trading time frame is Step Zero. An oft-repeated claim of price action traders is that price action works in all time frames. This claim is largely true. However, some trading time frames are not amenable to price action analysis. Price action involves pattern recognition. By claiming that price action works in all time frames, we are assuming that charts of all time frames are visually similar. Compare Figure 2-1 to Figure 2-2. Both charts show 6A futures. One chart shows 30-minute bars while the other shows 30second bars. Do they look the same? If not, how are they different?

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Chapter 2 – Finding a Tradable Time Frame

Figure 2-1 6A futures 30-minute chart

Figure 2-2 6A futures 30-second chart

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Chapter 2 – Finding a Tradable Time Frame

The 30-second chart in Figure 2-2 consists of mainly two types of bars:  

Dojis (bars that open and close at the same price) Marubozus (bars that open and close at opposite extremes)

This fast chart makes you doubt if “bar” or “candlestick” is the right label to use. Some “bars” are just dashes. On the other hand, the 30-minute chart looks “normal”. In fact, without the time and price axes, we cannot tell a 30-minute chart (Figure 2-1) apart from a 1-hour chart (Figure 2-3).

Figure 2-3 6A futures 1-hour chart

This simple visual examination shows that not all charts are created equal. When a chart consists of entirely Dojis and Marubozus, many price action patterns disappear. Good luck finding a decent pin bar from the 30-second chart.

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Chapter 2 – Finding a Tradable Time Frame

In conclusion, very fast charts are different from their slower counterparts. It is difficult to find meaningful price patterns on very fast charts. However, what do we mean by “very fast charts”? How do we know if a time frame is too fast for price action analysis? How do we know if a time frame is tradable? Many trading strategies prescribe the exact time frame to trade. The prescribed time frame might work for a certain market within a certain time-period given a certain market volatility. This is because the tradable time frame depends on the market volatility, which differs across markets and over time. When the market changes but the trading time frame stays constant, the trading strategy might not work well. To solve this issue, I have devised the Price Action Time Frame Index (PATI). The PATI is a robust concept for finding suitable trading time frames for price action trading.

2.1 - Price Action Time Frame Index (PATI) We observed that time frames that are not tradable are made up of mostly Dojis and Marubozus. Hence, the PATI seeks to find a time frame that is not overwhelmed by Dojis and Marubozus. In doing so, we verify that the time frame is tradable. The PATI measures the number of Dojis and Marubozus in the last 10 bars.

PATI Percentage of Dojis and Marubozus in the last 10 bars

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Chapter 2 – Finding a Tradable Time Frame

If the PATI value is 0.2, it means that only two bars out of the last 10 bars are Dojis or Marubozus. If the PATI value is 1, it means that all of the last 10 bars are either Dojis or Marubozus. The latter clearly describes a time frame that is not tradable. Why are we using a look-back period of 10 bars? Most price action patterns are two-bar patterns (inside bar, key reversal bar) or three-bar patterns (three-bar reversal, threebar pullback). This means on average, 10 bars will encompass around three price patterns which are adequate for ongoing price action analysis. Hence, 10 bars is a reasonable look-back period for ongoing analysis of recent price action. The PATI crystallises the idea that excessive frequency of Dojis and Marubozus in a time frame is not amenable for price action analysis. With this concept in mind, you are already armed with a perspective that alerts you to non-tradable time frames. If you need a tool to find tradable time frames objectively, in our Indicator Pack (available separately), you will find the PATI indicator. The PATI indicator value moves between 0 and 1. It represents the percentage of bars within the look-back period that are Dojis or Marubozus. If the value exceeds 0.5, it means that more than half of the bars in the look-back period are Dojis or Marubozus. It is a warning that the time frame is not tradable.

NOT TRADABLE A time frame is not amenable to price action analysis if the PATI exceeds 0.5

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Chapter 2 – Finding a Tradable Time Frame

In Figure 2-4, we applied the PATI indicator on a 5-minute chart of 6E futures (24-hour session). The parts highlighted in red are areas when the PATI value is higher than 0.5. These areas are warning us that this time frame is not great for price action trading, at least not for a full 24-hour session.

Figure 2-4 6E 5-minute chart in 24-hour session with the PATI indicator

According to the PATI indicator in Figure 2-4, from approximately 7:00 p.m. to 7:00 a.m. (GMT), the 5-minute chart is not tradable. Unsurprisingly, this unfriendly period contains the period when both the New York and London markets are closed. Like any other trading parameter, the look-back period of 10 bars is not set in stone. The PATI indicator allows you to choose the look-back period. Feel free to experiment with it. However, if you choose a lookback period that covers too few or too many bars, the PATI value is no longer meaningful. If you want to tinker with the setting, bear in mind that a good look-back period is more likely www.tradingsetupsreview.com

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Chapter 2 – Finding a Tradable Time Frame

to classify after-hours trading as non-tradable and the regular session as tradable.

2.2 - Finding Tradable Time Frames with PATI To assess if a time frame is tradable using the PATI indicator, follow these steps: 1. Load at least 30 days of recent market data in your preferred trading time frame. This is your sample period. 2. Make sure that you load the data within your trading session. (For instance, if you trade the New York session, load only the price bars within the regular session and exclude after hours data. On the other hand, if you trade the forex market round the clock, you must load all the price market data within your sample period.) 3. For a tradable time frame, the PATI value must be lower than 0.5 at any point in the sample period. 4. If the PATI value exceeds 0.5 at any point within the sample period, that time frame is deemed as nontradable. In that case, keep increasing your time frame until the PATI value is below 0.5 for the entire sample period. There is an exception to the rule mentioned in Step 4. If the PATI value exceeds 0.5 on (pre/post) holidays when market movements are expected to be muted, the time frame is still tradable. Of course, remember that you should not trade during these exceptional periods.

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Chapter 2 – Finding a Tradable Time Frame

You can check online for the trading holidays observed by different exchanges.1 You can also get the information from your broker. According to the PATI criteria, the 5-minute 6E chart shown in Figure 2-4 is not tradable as the PATI exceeded 0.5 for long periods. Take note that we used the 24-hour session on the chart. Hence, we were assessing the tradeability of the 5-minute time frame with the assumption that you will be trading the entire 24-hour session. As the underlying market of 6E futures is the EUR/USD currency pair, you might want to consider trading only during the London/New York overlap when the volatility is usually higher. In Figure 2-5, we constrained our trading session to that particular 4-hour period each day and reapplied the PATI indicator on the 5-minute time frame. The PATI indicator is below 0.5 for the entire chart. This confirms that the 5-minute time frame is tradable during the London/New York overlap.

1

Click here for more information.

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Chapter 2 – Finding a Tradable Time Frame

Figure 2-5 6E 5-minute chart showing only the London/New York overlap

If you are really bent on trading the full 24-hour session, you will need to increase your trading time frame. For instance, as shown in Figure 2-6, the 45-minute 6E chart is tradable as the maximum value of the PATI is 0.4.

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Chapter 2 – Finding a Tradable Time Frame

Figure 2-6 45-minute 6E chart is tradable.

With the PATI indicator, we can easily find out if a time frame is suited for price action analysis. Day traders have a knack of descending into lower and lower time frames to find more trading opportunities. However, as I have explained, some time frames do not produce meaningful price action patterns. Hence, applying the PATI indicator on your trading time frame is an important step that will keep you out of trouble.

2.3 - Minimum Tradable Time Frame (MTTF) If you are trading a new market, you probably do not have a preferred trading time frame. In that case, the concept of the Minimum Tradable Time Frame (MTTF) is useful. The MTTF is the minimum time frame that is tradable for a given market. Time frames that are higher than the MTTF are tradable. Hence, the MTTF is a useful benchmark to remember. With the PATI indicator, you can find the MTTF quickly and easily by trial and error. Start with the 1-minute time frame and www.tradingsetupsreview.com

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Chapter 2 – Finding a Tradable Time Frame

see if it is tradable. If not, move up to the 5-minute time frame. Keep increasing the time frame until you find a time frame that is tradable according to the PATI. For your reference, I have listed the MTTF for some of the common futures contracts.      

CL 2-minute (regular session) ES 10-minute (regular session) 6E 20-minute (24-hour) 6A 25-minute (24-hour) 6J 45-minute (24-hour) FDAX 2-minute (XETRA session)

These MTTF values are not definitive. They will certainly change as the market volatility evolves.2 However, we do not need to worry as the PATI indicator will warn us if there are changes to the tradability of our time frames. Hence, it is essential that you review the MTTF for the markets you trade at regular intervals to make sure that your time frame is still tradable (i.e. above the MTTF). I perform a check at least once a month. This is especially important if your trading time frame borders the MTTF. Do not follow the MTTF blindly. Common sense should prevail. If the MTTF is so fast that it’s impossible for you to conduct your analysis. You should move your time frame up. For instance, even if the MTTF for a particular market is 1 second, you should not trade with the 1-second chart because it’s impossible to perform any meaningful analysis, at least not without some help from automated trading systems.

In fact, the example MTTF values above have been updated to reflect changes since the last edition of this book. 2

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Chapter 2 – Finding a Tradable Time Frame

2.4 - Useful Notes for Finding the Optimal Trading Time Frame and Market These are some useful notes for finding the sweet spot in day trading, in terms of your trading market and time frame. At this point, especially if you are new to trading, you can skim through this section. You will appreciate the ideas here better after you’ve tried trading with a variety of time frames and markets. Make a note to return to this section after you’ve gained more price action trading experience.

2.4.1 - Optimal Trading Environment (OTE) Index Trading in an environment that offers high reward-to-risk ratio is what most traders want. Hence, I’ve developed a useful index to help you find the best day trading markets. Traders profit from market movement. If the market does not move, we cannot make money. We need the market to move. In fact, we want the market to move as much as possible. We want to see high market volatility. This is why the volatility of the market is an indication of the potential reward size. A useful measure of volatility for day traders is the average daily range. The higher the daily range, the greater the potential reward for your trades. Now, let’s talk about risk. As a rule, smaller time frames give you the ability to select finer entries. Finer entries mean smaller trade risk. However, as discussed, the MTTF is the lower limit for us. Going below the MTTF might jeopardise the validity of our analysis. Hence, an indicator of potential trade risk is the average bar range, given the MTTF.

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Chapter 2 – Finding a Tradable Time Frame

Remember that we are looking for markets that offer high potential reward-to-risk opportunities. It follows that we want markets with a high average daily range and a low average bar range given the MTTF. From this, we get the Optimal Trading Environment (OTE) Index. OTE Index Formula Average Daily Range / Average Bar Range (given the MTTF)

OTE The higher the OTE of a market, the more ideal it is for day trading

Let’s apply this concept to the four futures markets below.3 Market 30-Period Average Daily Range ES 21.18

Average Bar Range of the MTTF4 3.11

OTE Index

CL

1.31

0.138

9.49

FDAX

214.12

8.59

24.93

FESX

70

7.68

9.11

6.81

Table 2-1 Optimal Trading Environment Index

According to the OTE Index, FDAX is more ideal for day trading compared to ES despite its popularity. CL and FESX are comparable.

Figures computed on 11 December 2015. The period of the average bar range is the number of bars in five trading sessions, given the MTTF. This is to account for any day of the week variations. 3 4

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Chapter 2 – Finding a Tradable Time Frame

It is possible to further refine the OTE, by adjusting the OTE inputs according to your actual trading parameters. For instance, you plan to trade the first two hours of each trading session. You can then find out the average range of the first two hours of each session and use that as the input for the OTE numerator. You can also work out a separate MTTF and the corresponding average bar range for the first two hours of each session. Then, use that number as your OTE denominator. While the OTE Index is useful when choosing your day trading market, do not use it as the sole criterion for choosing the market to trade. Your specific entry and exit method, liquidity, trading hours, trading costs, margin considerations and many other factors are also in play. For instance, despite having a scoring higher on the OTE Index, FDAX does not have the liquidity of ES so its potential for slippage is greater. I’ve tried to explain the inputs of OTE clearly so that you know when you can use it. It is most relevant when your risk is a function of the average bar range of your time frame. And that is largely true if you set your stop-losses using price patterns, as we will be doing.

2.4.2 - Insufficient Trading Opportunities Have you encountered markets that are moving with increased volatility? Prices running away from you as you struggle to find an entry point. When that happens, it might be wise to lower your time frame. Lower time frames will show the finer price action from which you can find more setups. But you must have a plan for lowering your time frame, rather than making it an ad-hoc decision.

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Chapter 2 – Finding a Tradable Time Frame

First, while you may lower your trading time frame, you must not go below the MTTF of the market you are trading. Second, define the conditions that will cause you to lower your trading time frame. Why do you need to define such conditions? This is to ensure that you are moving to a faster time frame because of increased market volatility, and not because of boredom and impatience. How do we define such conditions? What’s our basis? Bar range.5 When the market shows numerous consecutive narrow range bars, it is a sign that the market is congesting. Setups are unreliable under such conditions, and profit potential might be limited. When the market shows many consecutive wide range bars, it is a sign that the market is running amok and that volatility is growing. The market is running away without pausing for us to join it. Hence, there might be difficulty finding trading setups. These observations imply that in a healthy trading time frame, you will find a good mix of price bars with varying ranges, both wide range and narrow range. Thus, we can use this idea as a rule of thumb for lowering our trading time frame.

5

Bar Range = Bar high – Bar low

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Chapter 2 – Finding a Tradable Time Frame

When you get ten consecutive wide range bars, adjust your time frame lower. (Refer to Volume IV Chapter 2.2.3 for the definition of a wide range bar.) To avoid this problem of insufficient trades altogether, consider trading as close to the MTTF as possible, provided that you are confident of performing sound analysis within the time frame.

2.5 - Alternative Chart Types Chart types that do not use a time base are common among day traders. Some examples include:    

Tick charts Volume charts Range charts Renko charts

If you are not familiar with these chart types, you may skip this section and stick with time charts. However, for those wondering if our framework can be applied to these alternative chart types, read on. Any chart with price bars that look visually like a time chart (above the MTTF) works for our trading method. Both tick and volume charts fit the bill. They offer the same level of price detail as time charts. A volume (or tick) chart and a time chart are indistinguishable. The price bars in both charts look like normal candlesticks. Hence, it is possible to use them within our trading framework.

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Chapter 2 – Finding a Tradable Time Frame

Figure 2-7 A tick chart; Compare it to the time chart below

Figure 2-8 A time chart; Visually similar to a tick chart

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Chapter 2 – Finding a Tradable Time Frame

Figure 2-9 Range charts are very different from both time and tick charts

On the other hand, range charts and Renko charts look very different. They have price bars that always close at its extremes. For that reason, the appearance of the price bars has a distinctive blockish look. So, range and Renko charts are out. Ticks and volume charts are okay. It’s your choice. This is my experience with tick and volume charts. I have tried both tick and volume charts in my trading, before switching back to time charts again. The first reason is that I did not find any obvious advantage in using tick and volume charts. There is also no clear disadvantage in terms of price analysis. (Although, there are serious implications if you are using volume analysis on tick charts, but that’s beyond our scope.) The second reason is more important for my return to time charts. Different chart platforms/data feeds plot tick (volume) www.tradingsetupsreview.com

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Chapter 2 – Finding a Tradable Time Frame

charts differently, due to the difference in filtering the ticks and the start point of your charts. This is actually okay, as long as you are using one data feed consistently and are used to analysing the charts produced by that data feed. However, I feel more comfortable trading charts that are consistent across data feeds. This aspect is also important as I am trying to share my trading method here. By using time charts, I can be sure that if you open up your charts, you will be able to find the exact same chart as me. However, if I use tick charts, the chart produced from my data feed might differ from what you are seeing. The differences are not fatal and the methods are still applicable, but they do affect the exact entry timing and the exact patterns formed. Hence, to avoid confusion, let’s stay with time charts.

2.6 - Conclusion The trading time frame is our first consideration when we set up our charts. While most trading methods gloss over this important decision, we approached it directly. I introduced the PATI indicator and the concept of MTTF to find time frames that are meaningful for intraday price action analysis. However, remember that the PATI indicator is like any other indicator. You, as the trader, reserve the right to override the values and reinterpret it. In fact, I expect that after you understand the concept behind the PATI indicator (avoiding a high percentage of Dojis and Marubozus), eventually, you will www.tradingsetupsreview.com

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Chapter 2 – Finding a Tradable Time Frame

not need the indicator to find out if a time frame is tradable. You would have developed an intuition that can distinguish between tradable and non-tradable charts. The PATI method described in this chapter works only for intraday time frames. Do not use it on daily and weekly charts. These higher time frames are almost always tradable when evaluated with the PATI. There are other more appropriate methods to identify non-tradable periods on daily and weekly charts but they are beyond the scope of this book. As a final note, I must highlight that some price action methods require descending to extremely low time frames (seconds) that are well below the MTTF. Those strategies usually scalp for small profits. More importantly, they employ price patterns that are visually different from traditional bar and candlestick patterns. Hence, for those strategies, the concept of MTTF is not applicable. However, the price patterns in this series require a time frame above the MTTF to work.

TRADABLE TIME FRAME 

Avoid time frames with an overwhelming number of Dojis and Marubozus



Check if your time frame is tradable with the Price Action Time Frame Index (PATI)



Stay above the Minimum Tradable Time frame (MTTF)

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Chapter 3 – Swings Look at any price chart and you will agree that price does not move in a straight line. It does not move up or down vertically. It moves in waves, in what we call market swings.

Figure 3-1 Market swings in a bull market

Look at Figure 3-1. In a bull market, price rises with a series of up and downswings. Naturally, the upswings generally exceed the downswings in length. The reverse is true in a bear market. Hence, by observing market swings, we are able to glimpse into the structure of the market and get clues on whether the market will move up or down. Following market swings is our first step to deciphering the market bias. Another way to look at market swings is to think of them as a higher time frame perspective. Each swing is equivalent to a bar in a higher time frame. This is why some traders use a higher time frame to evaluate market bias. There are two challenges with the higher time frame approach. www.tradingsetupsreview.com

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Chapter 3 – Swings

First, the higher time frame is usually chosen arbitrarily. Common choices are multiples of three and five. For instance, if your trading time frame is 1-minute, using a multiple of five, you will use the 5-minute chart for determining the market bias. However, there is often no sound basis for the choice of the higher time frame. Next, by using a higher time frame, we must split our attention between two time frames (charts). While some traders might find that manageable, I prefer to keep my trading as simple as possible and focus on one chart. By analysing market swings, we are able to factor in the price action of a higher order into our analysis without a second chart showing a higher time frame. The advantage of this approach is that we are able to evaluate the ongoing price action within its larger context on the same chart. Furthermore, there is no need to decide on the periodicity of the higher time frame. Hence, we will focus on interpreting market swings to deduce the market bias using a single time frame.

3.1 - Defining Swings In the history of technical analysis, William Delbert Gann occupies a unique position. Gann was a trader who invented a myriad of trading tools using lines, angles, circles, hexagons, and squares. While he might have gone a little overboard with applying geometry to financial markets and attracted some detractors, Gann’s trading methods are still widely employed by traders all over the world today. We have no interest in the controversy surrounding Gann’s obscure methods. Our attention lies in his simple and elegant definition of market swings.

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Gann has an entire trading approach that uses market swings to trade trends. Gann’s approach contains three degrees of market swings: minor, intermediate, major. Our price action approach works by looking out for the small details to let them connect naturally to point out the larger picture. This is why we are only interested in the minor swings, the smallest meaningful market swings, the basic building blocks of the market’s wave-like structure. We are not employing Gann’s trading methods. 6 We are only borrowing his definition of a market swing. Gann’s definition of a market swing is perfect for price action analysis because he used bar-by-bar price movement to define market swings. It focuses on the relationship between bar highs and bar lows. The first step to defining market swings systematically is to classify every price bar into one of the four types shown in Figure 3-2.

If you are interested to pick up more from W.D. Gann, refer to The Trading Methodologies of W.D. Gann: A Guide to Building Your Technical Analysis Toolbox . Click here for more details. 6

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1. Up bars with higher high and higher low

2. Down bars with lower high and lower low

4. Outside bars with higher high and lower low

3. Inside bars with lower high and higher low

Figure 3-2 Examples of the four bar types (up, down, inside, outside)

Characteristics of the four bar types: 1. 2. 3. 4.

Up bars – Higher high, higher low Down bars – Lower high, lower low Inside bars – Lower high, higher low7 Outside bars – Higher high, lower low8

You should be able to classify every single price bar as an “up bar”, “down bar”, “inside bar”, or “outside bar”. These labels describe the relationship of each bar high/low relative to the previous bar. For practice, try classifying all the bars in Figure 3-2. 9

If the high or the low or both are equal to that of the previous bar, it is still an inside bar. 8 If either the high or the low are equal to that of the previous bar, it is still an outside bar. 9 Starting from the second bar on the chart – up, down, inside, inside, up, up, inside, down, down, up, up, inside, outside, inside, outside, up, down. 7

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Note that the closing price of a price bar does not matter in the classification. An up bar might close lower than it opened. A down bar might close higher than it opened. For a bar that closes higher, we will use the term “bullish bar”. For a bar that closes lower, we will use the term “bearish bar”. Once you have mastered the different bar types, you will be able to identify market swings with ease, with the four rules below. 1. An up bar starts an upswing and confirms the end of a downswing. 2. A down bar starts a downswing and confirms the end of an upswing. 3. Inside bars do not break the previous high and low. Hence, they do not affect the direction of the current swing. 4. Outside bars break both the previous high and low. It introduces uncertainty into the market structure. However, as each swing is a minor trend in itself and trends tend to continue, we give the benefit of the doubt to the current swing. Thus, outside bars in an upswing continues the upswing. Similarly, outside bars in a downswing continues the downswing.

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Figure 3-3 demonstrates how we apply these rules to define market swings. The blue lines mark out the swings.

4. Down bar

1. Up bar

5. Up bar

3. Up bar 2. Down bar

Figure 3-3 Bars that start and end market swings

In Figure 3-3, we marked out five bars that changed the direction of the market swings. The two circled bars are an inside bar and an outside bar. They do not affect the direction of the market swings. Gann minor swings provide a solid method for the price action trader to keep tabs on the ebbs and flows of the market. It focuses on every price bar and does not require any parameter. This is unlike percentage swings. Percentage swings ignore barto-bar price movement and use a parameter to filter small price fluctuations. For instance, if we use 1% as the filter threshold, an upswing ends when the price falls by more than 1%. A downswing ends when the price moves up by more than 1%. The obvious challenge lies with using the right percentage filter. Gann swings have eliminated this problem.

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Most swings are confirmed by an up bar or a down bar. However, under exceptional circumstances, it is possible for a swing to form without either an up bar or a down bar. An upswing can be formed when the market rises above the last swing high without forming an up bar. Similarly, a downswing can be formed when the market falls below the last swing low without forming a down bar. An outside bar is always involved in such cases. Figure 3-4 shows an example of the market forming a new upswing without an up bar.

2. Outside bar broke above last swing high, forming an upswing without an up bar Up bar

Down bar Up bar

1. Down bar Down bar Figure 3-4 Exceptional swings

1. The market has been forming regular swings with up bars and down bars. 2. This bullish outside bar broke above the last swing high. There was no up bar. However, as the last swing high has been broken, despite the lack of an up bar, we must recognise that a new upswing has been formed. www.tradingsetupsreview.com

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Such exceptional swings are uncommon and indicate erratic price action. Thus, when you encounter such swings, it is wise to hold back from entering the market and wait for further price action. Let’s take a look at another price swing example. Compare Figure 3-5 and Figure 3-6 on the next page. Which one shows the correct mark-up of price swings?

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Two upswings

Outside bar A

Figure 3-5 Two swings

One single upswing

A

Figure 3-6 One swing

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Figure 3-6 is the correct one. Although point A, given its protrusive appearance, might seem like a swing low, it is not. Typically, an outside bar does not end or start a price swing. Without a down bar or a break below the last swing low, an upswing will continue. (Nonetheless, from a generic price action perspective, the swings marked in Figure 3-5 are not wrong. In fact, point A is certainly a swing low on a lower time frame. However, it remains that Figure 3-5 is inconsistent with the price swing framework we’ve defined earlier. Stay consistent for now.) Let us look at one more example to drive home this concept. Look at the next page and compare Figure 3-7 with Figure 3-8. Which one is right?

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Chapter 3 – Swings None of these bars are up bars

Figure 3-7 Not the swings as we defined 2. First up bar since the downswing started

1. This bar started a downswing

Figure 3-8 The swings we want to find

Most of the time, you can mark out market swings easily by with up bars and down bars. The trickier situations have been covered above. If you’ve understood them, you are ready to move on. www.tradingsetupsreview.com

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To recap, in practice, when the market is in an upswing, look out for:  

A down bar; or A price break below the last swing low.

Either one of the conditions above will turn the market into a downswing. When the market is in a downswing, look out for:  

An up bar; or A price break above the last swing high.

Either one of the conditions above will turn the market into an upswing.

3.1.1 - Exercises: Price Swings In the next two pages, you will find four candlestick charts. Mark out the price swings according to the method we went through above. Some bar highs and lows are rather close and you need to zoom in with your PDF reader to examine them. You might also want to print them out for convenience of completing the exercises. In the pages following the four exercise charts, you will find the solution charts for them. You can then compare the swings that you drew with the answer charts. If there are any discrepancies, refer back to the rules above and figure out why.

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Figure 3-9 Price Swing Exercise 1

Figure 3-10 Price Swing Exercise 2

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Figure 3-11 Price Swing Exercise 3

Figure 3-12 Price Swing Exercise 4

The solutions to these exercises are in the following pages. Complete the exercises before you move on.

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3.1.2 - Solutions: Price Swings These are the solutions to the exercises above.

Figure 3-13 Price Swing Exercise 1 Solution

Figure 3-14 Price Swing Exercise 2 Solution

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Figure 3-15 Price Swing Exercise 3 Solution

Figure 3-16 Price Swing Exercise 4 Solution

If you understand how the swings above are marked, you have learned to identify market swings clearly.

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Congratulations, now you can follow the ebbs and flows of the market. You can confidently state the current direction of the market wave at any point in time. This is an important first step to uncovering the market bias.

3.2 - Swing Pivots Swing pivots are the turning points of each market swing. “Pivot” is an effective imagery as price does indeed pivot around each swing point. The point where an upswing turns down is a swing high. The point where a downswing turns up is a swing low.10 We’ve learned to tell when a market swing starts and ends. Hence, we can mark out swing pivots easily. Figure 3-17 shows the swing highs and swings lows in a CL 5-minute chart.

Swing Highs: Lines above the price bars

Swing Lows: Lines below the price bars

Figure 3-17 Swing highs and lows on a CL 5-minute chart

10

Throughout this book, we will distinguish between swing high/low and bar high/low.

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Why are swing pivots important? Swing pivots are price points that turned the tide of the market. These points are not random. They represent a momentary change in demand and supply forces. The bulls could not move the market above a swing high, not even for one tick. This means that at that point in time, no one was willing to offer a price higher than the swing high. Traders saw no value above the swing high. Traders did not want to buy above the swing high. Hence, subsequently, when prices move close to or above a swing high, we must remember that traders saw no value in buying above that point previously. Assuming that most traders have not changed their opinions, prices are unlikely to move above the swing high. Effectively, the swing high marks a price area that resists the market from moving up. This is what we call a resistance area. In the case of a swing low, the bears could not push prices below it. This occurrence implies that no trader was willing to sell below that price point. The reason was that traders perceived value below the swing low. They want to buy value and not sell it. Everyone wants to buy and no one wants to sell. Price goes up and we get a swing low. The logic we applied to analysing swing highs works for swing lows. When the market falls near a swing low, assuming that traders still see value in buying below the swing low, prices are unlikely to fall below it. The swing low supports the market and is a support area.

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Figure 3-18 shows a close-up of Figure 3-17 to illustrate how swing pivots act as support and resistance areas.

1. Swing highs project resistance areas. Price had difficulty closing above previous swing highs

3. Swing pivots do not always reject price

2. Swing lows project support areas Figure 3-18 Swing highs as resistance; swing lows as support

We deduced that swing pivots are support and resistance areas by assuming that traders hold the same view as before. That assumption is not always true. (Look at point 3 in Figure 3-18.) The failure of swing highs and lows to hold up at resistance and support respectively leads us into another concept – flipping. The concept of flipping refers to:  

Failed resistance turning into support Failure support turning into resistance

When a resistance level projected from a swing high fails to block a market from rising higher, it turns into a support area. This is because, despite its failure, the price point remains memorable to market participants. A price point that has failed decisively as a resistance will then serve as a reliable support. www.tradingsetupsreview.com

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You can apply the same logic to failed support. After failing to hold prices up, they flip and serve as potential resistance. An example of a failed resistance turning into support is shown in Figure 3-19 below.

1. Swing highs projected resistance

2. Price broke above the resistance decisively

3. Broken resistance then served as new support

Figure 3-19 Failed resistance flipping into support

1. We used swing highs to project possible resistance levels. 2. However, the market rose above with ease, crushing the resistance. 3. The failed resistance then became a powerful support zone. In a nutshell, there are two key skills in reading price action. 1. Evaluate how likely a swing pivot will hold up as support/resistance. 2. Understand the implication of a swing pivot not holding up as support/resistance.

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To hone these skills, first, we need to understand that not all swing pivots are created equal.

3.3 - Pivot Types This section will assume a solid understanding of price swings. You must be able to look at any chart and mark out all price swings correctly. If you are not able to, do not proceed with this section. Return to the start of this chapter and revise the concept of price swings. (Swing high and pivot high are used interchangeably. Swing low and pivot low are used interchangeably as well.) There are three types of swing pivots. 1. Basic Pivot 2. Tested Pivot 3. Valid Pivot In this hierarchy of pivots, the valid pivot reigns supreme. I’ll explain this in the context of an upwards trend. The market tried to move down. It stopped without reaching the previous pivot low. The bullish trend resumed. The price where it stopped at is a basic pivot low. The market tried to move down hard, so hard that it pushed below the previous pivot low. Then, it stopped. The price where it stopped at is a tested pivot low. Price tried to move down really hard. It pushed below the previous pivot low. Then, it stopped and the bullish trend www.tradingsetupsreview.com

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resumed. The market broke all resistance and made a new trend high. In other words, the market failed terribly in its attempt to move down. The lowest point it pushed to is a valid pivot low. Price action is varied. However, we have described three general scenarios above. All three scenarios started with prices moving down. According to the extent of the move down and the subsequent market reaction to the move, we are able to classify the different swing lows. Essentially, a valid pivot tells a greater story than a tested pivot. A tested pivot has a longer tale to tell than the basic pivot. Now, let’s move on from the stories and take a look at the technicalities of identifying these three types of pivots. To do so, we need to compare each swing pivot with the one before it. (Like what we did when we compared each bar to the one before it.)  

Is this pivot low higher, lower, or equal to the previous pivot low? Is this pivot high higher, lower, or equal to the last pivot high?

Type

Pivot High

Pivot Low

Basic

Lower/Equal

Higher/Equal

Tested

Higher

Lower

Valid

Higher, followed by a break below the last extreme low price of a bear trend

Lower, followed by a break above the last extreme high price of a bull trend

Table 3-1 Types of swing pivots

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Table 3-1 shows how to classify each pivot point as basic, tested, or valid. For instance, a pivot high that is higher than the previous pivot high is a tested pivot high. A higher pivot low is a basic pivot low. Basic and tested pivots are relatively simple to identify. A valid pivot is slightly trickier. A valid pivot is actually a special form of a tested pivot and is especially useful for determining the market bias. Fret not if you are still not sure of how to distinguish among the swing pivot types. Table 3-1 is just a cheat sheet for reference. We will be going through illustrated examples below for each pivot type. In the following sections, you will learn how to find the different pivots and their implications on your trading.

3.3.1 - Basic Pivot A basic pivot is either a higher low or a lower high. It provides basic support and resistance, and helps us track the direction of market movement.

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Lower pivot highs

Higher pivot lows

Figure 3-20 Arrows point to basic pivot highs and lows

We have marked out the basic pivot highs and lows in Figure 3-20. Keeping your eyes on the formation of basic pivots is the most direct way to follow the current market direction. These basic pivots also represent the weakest form of support/resistance in the market structure.

BASIC PIVOTS Follow the flow of basic pivots to know where the market is heading right now

3.3.2 - Tested Pivot A tested pivot is a higher pivot high or a lower pivot low. A basic pivot supports the market direction, but a tested pivot advances it.

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Figure 3-21 shows the tested pivots in the same CL 3-minute chart. Pivots A, B, and C are tested pivot highs. The arrow points out a tested pivot low, which later becomes a valid pivot low.

Higher pivot highs

A

B 2 1

C 32 1

Lower pivot lows

Figure 3-21 Tested pivots in CL 3-minute

Tested pivots are important because they represent a break-out of a support or resistance. Each tested pivot high marks the highest price the swing reached after breaking out of the previous pivot high. Each tested pivot low marks the lowest price a downswing reached after breaking below the previous pivot low. Depending on how successful the break-out is, we are able to judge the price momentum. Price momentum is typically defined as the rate of change of price. However, I use this term to refer generally to the strength of a price swing within the market structure. Momentum is an www.tradingsetupsreview.com

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important concept that will help us stay with the market’s path of least resistance. The most valuable piece of information a tested pivot can give is what it reveals about price momentum. To assess the momentum, pay attention to three aspects of each tested pivot. 1. How far did the break-out beyond the previous pivot go? 2. Did price close above or below the previous pivot? 3. Did price clear the previous pivot? The third question contains a new price action concept. It is the concept of clearing. To clear above a price level, the market must form a price bar that is completely above the price level. This means if a bar low is higher than a price level, the market has cleared above the price level. Similarly, to clear below a price level, the market must form a price bar that is completely below the price level. Figure 3-22 shows two attempts to push below the previous swing lows. The first attempt cleared the previous swing low, but the second attempt did not.

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3. Failure to clear below the support led to a strong bullish reaction

1. This bar was entirely below the previous swing low; cleared the swing low 2. These bars overlapped with the previous swing low; price level was not cleared Figure 3-22 When is a price level cleared?

Clearing a price level is an important concept that I will refer to repeatedly. Clearing above a resistance level and below a support level has different implications from merely touching them. Clearing a price level is a sign of decisive market strength. Look at Figure 3-22. The failure to clear below the previous swing low led to a strong bullish reaction.

CLEARING A PRICE LEVEL To clear above a price level, the market must form a price bar that is completely above the price level To clear below a price level, it must form a price bar that is completely below the price level

Now, let’s answer the three questions above for the three tested pivot highs shown earlier in Figure 3-21.

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1. Good break-out distance above previous swing high

A

2. Bar closed above

3. Price cleared above previous high (resistance)

Figure 3-23 First tested pivot high with strong bullish momentum

The first tested pivot high A is enlarged in Figure 3-23. It showed strong bullish momentum for the following reasons. 1. The break-out above the previous swing high went a good distance before a downswing took over. The greater the distance the market went beyond the last swing high, the stronger the bullish momentum. 2. The first bar that broke the resistance closed above it. This is a sign of bullishness. 3. Price cleared above the previous pivot high. When there is a gap between the price bars and the resistance level, we say that price has cleared the level. To clear a resistance level, the bar lows must be higher than the resistance. In all, the tested pivot high A showed strong bullish momentum.

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Figure 3-24 below shows the second tested pivot high B.

2. Bar closed above resistance

B 1. Decent breakout distance but shorter than the first

A

3. Did not clear resistance

Figure 3-24 Second tested pivot high with moderate momentum

Let’s take a closer look. 1. The break-out distance was shorter than the last tested high A, implying that the bullish momentum was weakening. 2. The break-out bar closed above the resistance - a bullish sign. 3. However, price was unable to clear above the previous swing high as the price bars drifted sideways. Although this tested pivot high B showed a decent break-out, the momentum was clearly less forceful than what was shown by the tested pivot high A.

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Look at the third tested pivot high C in Figure 3-25 below. It showed poor momentum in the bullish break-out. C 1. Similar break-out distance with the previous tested high

2. Bar closed below resistance

B 1

A 1

3. Did not clear resistance

Figure 3-25 Third tested pivot high with weak momentum

1. The break-out distance was similar to the tested swing high B. 2. However, the break-out bar could not close above the resistance. It was a strong hint that the bullish momentum was faltering. 3. Moreover, the break-out lasted only one bar before a downswing took over. Needless to say, it did not clear the previous pivot high (resistance). This confirmed the lack of bullish momentum. This tested pivot high C was the last one in this series. It was also the weakest.

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After looking at each tested high, let’s return to the big picture in Figure 3-26 below.

C

1. Weakening momentum A 1

B 2

2. Little bearish momentum

Figure 3-26 Interpreting tested pivots for momentum

1. Our earlier close-up analyses of each tested high revealed that the bullish momentum was fading. 2. Hence, it was not surprising when the market fell and made a tested low after tested high C. However, the bearish momentum of the tested low was muted, as the market did not clear below the previous pivot low. Shortly after, the market resumed the upwards trend. The point of this CL chart analysis is to show how we can interpret market momentum by examining tested pivots.

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Let’s look at the example in Figure 3-27 which shows a 6A chart in 25-minute bars. It demonstrates how observing tested pivots (momentum) can highlight potential trading opportunities.

2. Negligible bullish momentum

3. Shorting opportunity

1. Increasing bearish momentum

Figure 3-27 Trading with bearish momentum

1. After a tested low and a tested high, price broke down with six consecutive bearish bars. The momentum was pushing the market down. 2. Contrast the increasing bearish momentum with the negligible bullish momentum shown in the following tested high. The lack of bullish momentum confirmed that the market was heading down, at least for the next few bars. 3. The break below the bearish outside bar confirmed the weak upswing and was a potential short trade. This is just an illustration of the trading perspective given by an understanding of price momentum. In Volume III, you will learn the exact trading setups to enter such trades.

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Figure 3-28 shows an entire session of CL futures in 5-minute bars. This session went sideways. This is not a conclusion from looking at the chart after the session. If we apply our understanding of tested pivots and what they reveal about the market’s momentum, ongoing analysis during the session itself would have made it clear that the market was not committed to any direction for most of this trading session.

1. Tested highs that could not close above resistance

2. Similarly weak tested lows

3. Strongest tested low that cleared below the support

Figure 3-28 Lack of clear momentum in a sideways session

1. The tested highs in the earlier part of the day failed to close above their respective preceding pivots. There was only one exception which closed just a tick above the resistance - the bar that made the highest price of the session. In all, there was no sign of bullishness. 2. The tested lows were equally weak as none of them managed to clear their preceding pivots. However, if we must decide on a bias, the bears looked better. Both tested lows managed to close below their previous swing lows for two consecutive bars.

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Although it was not impressive, the bulls were not capable of a similar feat. 3. The first sign of solid momentum came towards the end of the session when a tested low formed after clearing a support level. Despite this downthrust, price stayed within the earlier trading range. Hence, it was better to wait for more price action to unfold before contemplating short positions. In this trading session, the lack of momentum in both directions informed us that a sideways market was underway.

TESTED PIVOTS Pay attention to the momentum revealed by tested pivots to find the path of least resistance

3.3.3 - Valid Pivot A valid pivot is a special type of tested pivot. It is the most significant pivot in the market structure as it shows the commitment of the market. Every major market trend has pullbacks. Some pullbacks are shallow and last for one swing. The point where such a shallow pullback stops is a basic pivot. However, some pullbacks go deeper and last for more than one swing, forming a tested pivot. Eventually, these deeper pullbacks terminate and the trend resumes. The price point where the multi-swing pullback stops is a valid pivot.

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As a valid pivot is the result of trend resumption after a substantial pullback, they are indicative of the market bias. Hence, valid pivots are among our best tools to decipher the market bias. Let’s learn how to identify valid pivots and use them to determine the market bias. A tested swing low becomes a valid swing low once price breaks out above the last extreme price high. Most tested pivot lows in a bullish market become valid pivot lows. Valid pivot lows make sense only from a bullish trend perspective. A tested swing high becomes a valid one when price falls below the last extreme price low. Most tested pivot highs in a bearish market become valid pivot highs. Valid pivot highs make sense only from a bearish trend perspective. Illustrated Examples As valid pivots are trickier to identify, let’s go through a few illustrations before looking at real chart examples.

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C B

A 2. A basic low will never become valid 1. This tested low became a valid low as the market rose above A

4. Became a valid low when the market rose above C 3. This swing low became a valid low when the market rose above B

Figure 3-29 Valid lows in an bull trend

The concept of pullback failure is the key to finding valid pivots. The explanation below revolves around this concept. 1. This tested low formed as part of a downwards pullback that started from A. Hence, this tested low failed and became a valid pivot low when the market rose above A. 2. This was a basic low that could never become a valid low. 3. This tested low formed as part of a downwards pullback that started from B. Hence, this tested low failed and became a valid pivot low when the market rose above B. 4. This tested low formed as part of a downwards pullback that started from C. Hence, this tested low failed and became a valid pivot low when the market rose above C. The swings in Figure 3-29 also showed a valid high. Did you spot it?

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Figure 3-30 below points it out.

1. These tested highs pushed the bull trend higher

C

B

D A 2. This tested high became a valid high when the market fell below D

Figure 3-30 A valid high and a short-lived bearish trend

1. These tested highs made new highs in the trend. From a bullish perspective, tested highs are advancing the trend. By definition, they cannot fail and hence cannot become valid highs. In a bullish trend, only valid lows make sense. 2. First, we note that this tested high did not manage to rise above C to continue the upwards trend. Then, we observe that this tested high formed as part of an upwards pullback that started from D. Hence, this tested high failed and became a valid high when the market fell below D. The formation of a valid high always points to a technical bear trend, which in this case was short-lived. Soon, the market rose above point C and resumed the bull trend. The extreme low of the short-lived bearish trend then became the latest valid pivot of the resumed bull trend.

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Figure 3-31 below shows a slightly tricky scenario of valid pivots.

A

2. When price rose above A, point B became a valid swing low C

D B

3. When price rose above C, point D became a valid swing low

1. These two pivots would never become valid as they were only basic lows Figure 3-31 Two valid lows in one complex pullback

1. These two swing lows were basic pivots. Hence, they would never become valid lows. 2. From a bullish perspective, tested low B was part of a pullback down that started from pivot A. Hence, the pullback down to pivot B would have failed if the market managed to rise above point A. Eventually, it did rise above point A. Hence, tested pivot B became a valid pivot. 3. Pivot D is the tricky part. It was formed as part of a downwards pullback that started from pivot C. Hence, when the market breached above pivot C, tested pivot D became a valid pivot low. With respect to pivot D, why do we consider pivot C (and not A) as the start point of the pullback?

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It was because pivot D did not go below pivot B. If it had gone below pivot B, it would be merely a continuation of the pullback down from pivot A. In that case, the market would have to break above pivot A to confirm pivot D as a valid low. To understand this concept, remember that we need to presume a bullish context when searching for valid lows. Valid low B existed within a larger bullish market which started earlier, in the price action on the left of what’s shown in Figure 3-31. In this larger bullish trend, the last extreme trend high was pivot A. Hence, pivot A must be exceeded for valid low B to be confirmed. Valid low D existed within a smaller bull trend which started from pivot B. For this smaller bull trend, the extreme high reached was pivot C. Hence, pivot C must be exceeded for valid low D to be confirmed. Let’s squeeze more value out of this example. How would our pivot analysis change if pivot D went below pivot B? This scenario is shown below in Figure 3-32.

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A

2. The market would then need to break above pivot A for pivot D to become a valid low C

B 1. When the market fell below pivot B, pivot C became a valid high

D

Figure 3-32 Adapting to different scenarios

1. The first difference is that we would get a valid high C. From a context of a downwards trend that started from pivot A, you could see pivot C as a pullback upwards which started from pivot B. Hence, when price broke below pivot B, tested high C11 became a valid high. This example shows that a trader who is always looking out for valid pivots (both valid high and low) is also constantly considering the possibility of new trends in both directions. A trader like that is painfully aware of the fact that “anything can happen in the market”. This is an attribute of a top trader. 2. The next difference was mentioned earlier. Pivot D, in this case, was a continuation of a pullback that started from pivot A. Thus, the market had to rise above pivot A to confirm pivot D as a valid low.

11

It was a tested high as it broke above the preceding swing high.

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Here is a tip for identifying valid pivot highs and lows. Always be clear of the trend action you are relying on to define a valid pivot. Valid pivots make sense only within trending price action. To find a valid low, you need to identify or presume a bull trend. You need to know the start point of the trend and the last extreme trend high. If any price action falls below the start point of the trend you are relying on, valid lows are impossible. If price rises above the last extreme trend high, the tested lows formed in the preceding pullback down become valid lows. To find a valid high, you need to identify a bear trend or at least a potential bear trend. You need to know the start point of the trend and the last extreme trend low. If price rises above the start point of the bear trend you are relying on, valid highs are impossible. If price falls below the last extreme low of the trend, the tested highs formed in the preceding pullback upwards become valid highs.

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Real Chart Examples Figure 3-33 below shows how a valid pivot low is formed with a real price chart.

3. Broke above the last extreme high before the retracement; tested pivot low becomes valid

1. Basic pivot 2. Fell below basic pivot and formed a tested pivot low Figure 3-33 Formation of a valid pivot low

1. Price descended for five consecutive bars. An up bar formed and we got a basic pivot low. A basic pivot will never become valid. 2. Price then swung down below the basic pivot low and made a lower low. A lower low is a tested pivot. This pivot could evolve into a valid pivot. 3. Price broke above the highest price point before the retracement downwards. This was the price action we needed to confirm that the tested pivot low was valid. The tested pivot became a valid swing low.

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Figure 3-34 below shows how a valid pivot high is formed.

2. Rose above the basic pivot and formed a tested pivot high

1. Basic pivot

3. Fell below last extreme low where the pullback upwards began; tested pivot high becomes valid Figure 3-34 Formation of a valid pivot high

1. From the market low, an up bar formed, followed by an inside bar. With the down bar that came after, a basic high was formed. Remember that a basic pivot high can never become valid. 2. Price then swung up above the basic pivot high and made a higher high. A higher high is a tested pivot. This tested high could evolve into a valid high. 3. Price then broke below the lowest price point before the retracement upwards. This confirmed that the tested pivot high was valid. At that point, the tested pivot became a valid swing high.

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Figure 3-35 below demonstrates the difference between valid pivots and basic pivots in a rising market.

1. Broke below the previous low before rising; valid low

2. No test of previous pivot low; basic lows

Figure 3-35 Basic pivots versus valid pivots

1. Price must have pushed below a previous pivot low before rising above the last extreme trend high to form a valid pivot low. 2. Although price broke the last extreme trend high in each of these instances, the retracement downwards did not test any pivot lows. Hence, they remained as basic lows. Basic lows do not become valid.

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Figure 3-36 shows more examples of valid pivots (circled) on a ES 5-minute chart. It shows how price must test a support before breaking a resistance to form a valid pivot low.

Valid pivot low

Tested below and broke above

Valid pivot low

Figure 3-36 Valid pivot lows in a bull trend

Valid pivots are extremely useful for determining the market bias. A valid pivot low is a sign of a bullish market while a valid pivot high is a sign of a bearish market.

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In Figure 3-37 below, we have marked out all the valid pivots with dotted lines. It shows an example of how a valid pivot high alerted us to the subsequent bearish trend on the 6E 30-minute chart. 2. The formation of a valid pivot high changes the market bias from bullish to bearish

3. A final burst of bullishness before the market plummeted 1. Valid pivot lows in a bullish market

Figure 3-37 Valid pivots point out the market bias

1. These valid pivot lows supported the bullish market in its ascent. 2. Then, a valid pivot high formed. That was a signal that the market bias has changed. 3. Indeed, after the failure of a strong upthrust, the market started its journey downhill.

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The 6J 60-minute chart in Figure 3-38 below shows another example of evaluating the market bias with valid pivots.

1. Valid pivot highs in a bearish market

4. Break-out confirmed valid pivot low; bullish market bias 2. Market rose above valid highs without much resistance

3. A tested pivot low which later became valid Figure 3-38 Change of market bias shown with valid pivots

1. Valid pivot highs are common when the market is moving down. 2. The market has been drifting upwards without much resistance. The ease with which the market rose above the two earlier valid highs suggested that a bullish market might come soon. 3. This was the first tested low in this bullish sequence. 4. This break-out confirmed the earlier tested low as a valid low and signalled that the market bias has turned bullish. In Figure 3-38, the valid low formed offered a late confirmation of the bullish bias. However, there were earlier signs of a new bullish trend. The earlier valid pivot highs acted as credible

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resistance. As the market broke above them with ease, we got a warning that a bull market was underway. Now, look at Figure 3-37 and Figure 3-38 again. If we had used basic pivots to perform similar analyses, our market bias would have changed very frequently. With our market bias changing at every other swing, a sustainable trading perspective is impossible. This is why valid pivots are effective for determining the market bias. The market bias indicated by valid pivots tolerates deeper pullbacks while still accounting for clear signs of reversal. In the examples above, you might have spotted the resemblance of the valid pivot to the 1-2-3 reversal (shown in Figure 3-39) that Vic Sperandeo has popularised in his book, “Trader Vic: Methods of a Wall Street Master”12. The 1-2-3 reversal is Vic Sperandeo’s method for determining a change of market bias. Indeed, a valid pivot that leads to a reversal of market bias is similar to a 1-2-3 reversal. However, there are two key differences. Discussing these differences will help you understand valid pivots, especially if you are familiar with the 12-3 reversal. If you are not and find the following discussion confusing, you may skim through it.

12

Trader Vic: Methods of a Wall Street Master – Click here for more details.

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1. Break of trend line 2. Lower high

3. Break of support

Figure 3-39 1-2-3 reversal turning a bullish bias to a bearish one

First, we have a specific method of identifying valid pivots and we are only interested in 1-2-3 reversals that occur with the formation of valid pivots. With reference to Figure 3-39, the “lower high” must be a tested high. In that case, when price breaks below the support, the tested high will become a valid high. The scenario we are looking for is shown in Figure 3-40 below.

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1. Tested high

2. Tested high becomes valid as price breaks below the support level

Figure 3-40 What we want to see before a trend change

Note that basic pivots can also form 1-2-3 reversals. However, in our trading framework, 1-2-3 reversals consisting of basic pivots are insufficient to constitute a change in market bias. Next, Vic Sperandeo’s 1-2-3 reversal comes after a trend line break. In the case of a valid pivot, a trend line break is not necessary and is not always present. This is largely because we are pickier about our trend lines. We’ll discuss more about trend lines in the next chapter. As I have mentioned, this book is not about promoting me as a trading guru with the Holy Grail. It is about helping you to trade better by sharing my trading perspective with you. This is why I am recommending Vic Sperandeo’s book. Read the entire book if you can. If not, you should at least read Chapter 7 on identifying a change of trend. It covers the 1-2-3 and 2B patterns together with trend line drawing.

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You will find both similarities and differences between Vic Sperandeo’s methods and what is covered here. I believe that it is from the differences that you find a trading method that is wholly yours. The utility of valid pivots is not limited to indicating market bias. Valid pivots often act as major support or resistance levels. Figure 3-41 below shows the only valid pivot low in this 6E 30minute chart. This valid pivot low provided support for the almost vertical market plunge. Price tested the valid pivot low’s price level repeatedly. This confirmed the effectiveness of a valid pivot low as a major support area.

Major support

Valid pivot low

Figure 3-41 Valid pivot low as a major support level

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Figure 3-42 shows the ES 10-minute chart across a few of its regular trading sessions. Areas of potential support and resistance indicated by valid pivots are always worth a closer look.

3. Price broke above resistance before falling to test it as a support area

1. A decisive break of the valid pivot high pointed to strong bullish momentum

2. Future support areas to pay attention to

Figure 3-42 A closer look at the price action around valid pivots

1. As the market surged up after a double bottom, it broke above a valid pivot high without hesitation, giving a clear sign that the market has turned bullish. 2. The market continued its ascent, forming several valid pivot lows along its way. If price starts to fall back down, these levels are potential support zones. 3. A valid pivot high from three sessions ago was still exerting its influence as a resistance zone. Price broke above it after some meandering. Then, it fell back down to test it as a support region. The broken resistance then became a support. This is the concept of flipping we’ve discussed earlier.

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If you want to evaluate the condition of a market with a simple look at the chart, valid pivots will do the job. Just mark out the valid pivots and you will get a sense of the market bias, and potential support and resistance zones.

VALID PIVOTS Act as major support/resistance and are instrumental in determining the market bias

3.3.4 - Exercises: Pivot Types Let’s get some practice on labelling swing pivots. Mark out all the tested and valid pivots on the four charts that follow. For each valid pivot, mark out the price level the market broke to confirm it. Take your time and go through them slowly. You might not get them on your first try. But by working through these examples and understanding them, you will gain solid insights of the market structure. Marking out the prices swings first will make these exercises a lot easier.

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Figure 3-43 Pivot Type Exercise 1

Figure 3-44 Pivot Type Exercise 2

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Figure 3-45 Pivot Type Exercise 3

Figure 3-46 Pivot Type Exercise 4

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3.3.5 - Solutions: Pivot Types In the solutions below, the tested pivots are circled. The valid pivots are pointed out and explained. A

Valid high formed after market fell below B (trend context started from A) Valid high formed after market fell below D (trend context started from C)

C

D

B Figure 3-47 Pivot Type Exercise 1 Solution

Valid high formed after market fell below C (trend context started from B) B

C A

Valid low formed after the market rose above B (trend context started from A)

Figure 3-48 Pivot Type Exercise 2 Solution

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Valid high formed after market fell below B (trend context started from A)

D

A

B

C

Valid low formed after the market rose above D (trend context started from C)

Figure 3-49 Pivot Type Exercise 3 Solution Valid high formed after the market fell below B (trend context started from A)

A

B

Figure 3-50 Pivot Type Exercise 4 Solution

Note that the analyses in the solutions are based on the visible price action. Given more price action context, the analyses might differ.

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3.4 - Swinging It: Putting Them Together In this section, we will see how we can use our understanding of pivots to read price action. You have learned the pivot types in this sequence: basic, tested, valid. However, when you integrate them into your analysis, the sequence of analysis is the other way round. The process goes like this: 1. Focus on the valid pivots to understand the general market bias. 2. Examine the market momentum using tested pivots to find the path of least resistance. 3. Look at the basic pivots to follow the current direction of the market. The idea is to start with the bigger picture and drill down to the finer details. In trading, the larger picture always carries more weight than the details. We will apply this step-by-step analysis to the 6A 30-minute chart shown in Figure 3-51. Before we start, we must mark out all the pivots on the chart. This is an objective step that requires us to apply our definition of a market swing.

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Figure 3-51 6A 30-minute chart with all pivots marked

For clarity, we will explain each step of our analysis in a different figure. In Figure 3-52 below, we focus on the valid pivots to determine the general market direction. It shows that the chart started off with a bullish bias.

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3. Valid pivot highs

2. This bar completed the valid pivot high; the first sign of a bearish bias

1. Valid pivot low in a bullish market

Figure 3-52 Valid pivots showing the market bias

1. This valid pivot low showed that the market was bullish. 2. The bullish bias stayed intact until this bar completed the formation of a valid pivot high. This was the first sign of a bearish bias. 3. The valid pivot high held the market down, and a bear trend began. Shortly after, a second valid pivot high was formed. In all, the market has changed its bias from bullish to bearish in the middle of this chart. Now, let’s move on to examining the momentum in each tested pivot. Remember that valid pivots are special cases of tested pivots, and we need to include them in our momentum analysis.

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In Figure 3-53 below, we have marked out the noteworthy momentum moves. The solid lines mark out the most powerful moves that led to the formation of tested pivots. The price action in these swings cleared the previous pivots in each case. The broken solid lines mark the moderate tested pivots. These moves managed to close beyond the previous pivot but could not clear them.

1. Good bullish momentum in a bullish market

2. Turning point where bearish momentum took over

3. Tested lows with weak bearish momentum

Figure 3-53 Tested pivots for market momentum

1. The rising momentum in the earlier part of the chart supported our bullish market bias. 2. This was the turning point where bearish momentum took over the market. It also led to the formation of the valid pivot high mentioned earlier. With this strong bearish momentum and the valid pivot high, we were able to confirm that the market bias has turned down.

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3. However, after that downthrust, the tested lows did not carry on with the bearish momentum. Note that the tested highs did not exhibit much momentum as well. Hence, the market was moving sideways. Our assessment of the valid pivots and momentum has given us a clear bearish market bias. Hence, we might want to look for shorting opportunities within this sideways range. To do that, let’s drill down to the basic pivots for the most recent market moves.

Figure 3-54 All the basic pivots are pointed out

The arrows point out all the basic pivots in Figure 3-54. However, as basic pivots show the most insignificant swings, we should focus on those that are aligned with the market bias. Concentrate on basic lows in a bullish market and basic highs in a bearish market. This is why we left the analysis of basic pivots to the end. Now, we can make use of our earlier analysis to pick up the basic pivots we are interested in.

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Figure 3-55 shows the basic pivots that are aligned with the market bias. A vertical line separates the bullish phase from the bearish phase. In the bullish phase, we were interested in the basic lows. After the market turned bearish, our focus shifted to the basic highs.

4 3

2

1 1

Figure 3-55 Basic pivots aligned with the market bias

Each arrow on Figure 3-55 marks out a basic pivot that is aligned with our market bias. Coupled with momentum analysis, these points are potential trade entry points. 1. Good long signals. 2. Bad long signals as the market was about to change its bias. It is inevitable that we encounter bad signals just before a change of market bias. These are losses that must be taken with grace. It also highlights the advantage of entering a market during the preliminary stage of a trend. 3. Short signal suffered whipsaws before the market fell.

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4. Two excellent short signals. Note that if we trade these basic pivots indiscriminately, we are not taking the best trades. Even for the trades that turned out to be profitable, very often, we will need to place either wide stops or suffer whipsaws. This is why I do not advise trading based on basic pivots alone. Instead, you should use the price patterns in Volume III to find optimal trade entries. In that case, why should we bother with basic pivots? They are important because many of the best trade entries lead to or follow right after basic pivots. These basic pivots will provide a logical stop loss point for our trades. We will discuss trade entries and exits in detail later. For now, let’s leave it at this. This analysis exercise on the 6A 30-minute chart is not for demonstrating actual trading entries and exits. Its purpose is to show you how you can read the market with your understanding of market swings and the different types of pivots. Now, you can look at a chart to understand what the market did and what it is doing now. These skills lay the foundation for anticipating what the market will do, which is what trading is all about.

3.5 - Conclusion This chapter is one of the most important. Tracking market swings and understanding what they are telling us about the market are foundational price action trading skills. Many traders follow market swings in a haphazard manner and find them useful only from an ex-post perspective. They are unable to apply the concept of market swings in real-time. www.tradingsetupsreview.com

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The rules in this chapter are objective. You can objectively label each swing and its pivot type as it forms. You have learned the exact rules to interpret momentum. We have also gone through many examples to identify swings and pivot types. Yet, the application is not mechanical. I trust that the price swing framework in this chapter has given you the objective tools you need to conduct subjective, but insightful, analysis independently.

MARKET SWINGS 

Observe the market structure with price swings



Use swing pivots as support and/or resistance



Analyse pivots for market bias, momentum, and current direction

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Chapter 4 – Trend Lines A trend line is a line that connects pivot points to highlight a trend. For an upward trend, the trend line is drawn with pivot lows. For a downward trend, the trend line is drawn with pivot highs. It is the best tool to keep track of the market bias and a favoured tool of price action traders. Indeed, many traders uses it as their only trading tool. However, we have already gone through how valid pivots can point out the market bias. Why do we still need trend lines? Are they redundant? Trend lines are certainly not redundant. On the contrary, they integrate with and amplify the power of valid pivots in determining the market bias. Trend lines are our definitive tool in tracking the market bias.

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Figure 4-1 shows an example of how a trend line gave an earlier signal of a change in market bias.

1. Upwards sloping trend line broken here

2. 1st valid pivot high completed with this bar

Figure 4-1 Early signal of trend change from a trend line break

1. The upwards sloping trend line was broken, and we got a signal that the market might have turned bearish. 2. On the other hand, if we relied solely on the formation of a valid pivot high to indicate a change in market bias, we would have detected a change in bias later. Trend lines also make up for a shortcoming of using valid pivots to judge the market bias. Trends can reverse without forming any valid pivots in the opposing direction. For instance, a bull trend can turn bearish without forming a valid high. In such cases, the break of a bull trend line will alert us to the trend change. Other than indicating reversals, trend lines also act as support and resistance. Some of the best trades are bounces off trend lines. On top of that, the slope of a trend line tells us the www.tradingsetupsreview.com

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momentum of a trend. Very steep trend lines are very easily broken as they represent climatic trends. Trend lines that are almost flat might indicate congestion. Despite all the goodness of trend lines, many traders find it difficult to use them effectively. One main reason is the drawing of too many trend lines. You can draw trend lines with two bars or two hundred bars. But draw too many lines and you will only confuse yourself. Regardless of how powerful trend lines can be, they are useless in the hands of a confused trader. This is why we will focus on drawing trend lines that are effective in highlighting the market bias, and not every single possible trend line.

4.1 - Drawing Trend Lines Ground rules for drawing trend lines: 

  

Draw a new trend line by connecting the start of the trend with a valid pivot. This means that we cannot draw a new trend line without a valid pivot. Adjust trend lines along with new valid pivots. Adjust trend lines to accommodate all price action.13 Do not keep more than two pairs of trend lines on your charts.

4.1.1 - New Trend Lines If you can identify valid pivots, drawing trend lines is a simple affair. This is because you will be drawing new trend lines with valid pivots.

13

Similar to Trader Vic’s method

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Do not connect every single pivot indiscriminately. Focus on the pivots that are significant. Here, forget about basic pivots and tested pivots. After all, the aim of drawing a trend line is to highlight a trend and the best pivot type for that purpose is the valid pivot. Connect the start of a bull trend with the first valid pivot low to create a bull trend line. Connect the start of a bear trend with the first valid pivot high to create a bear trend line. Figure 4-2 below shows an illustrated example of a bull trend line.

2. Basic low; do not use basic pivots for drawing trend lines

B

Prior down trend

C

1. The starting point of the bull trend A

3. After the market rose above B, C became a valid low; use it to draw a bull trend line

Figure 4-2 Drawing a new trend line

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3. Pivot C became a valid low after the market rose above pivot B. Connect the start point of the trend to this valid low C, and extend the resulting line to the right. What you get is a bull trend line. Let’s take a look at a real chart example below in Figure 4-3. The price swings are marked out in blue.

1. Valid high A B

D

2. Valid low

C Figure 4-3 Two new trend lines

1. By connecting the start of this bear trend A to the first valid high B, we could draw a new bear trend line. This bear trend was extremely short-lived. 2. Connect the start of this bull trend C to the first valid low D to draw a new bull trend line. If you are not sure why pivots B and D are valid pivots, refer back to Figure 3-48.

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4.1.2 - New Valid Pivots After drawing a new trend line with the first valid pivot in the trend, keep a lookout for new valid pivots. New valid pivots require you to adjust your trend lines. The guiding rule here is that the trend line must cut through the most recent valid pivot.

2. Ignore basic pivots

C

B A

3. After valid pivot low C formed, we had to adjust the trend line to cut through it

1. The trend line was first drawn by connecting A to B

Figure 4-4 Trend line catching up with new valid pivots

1. The initial bull trend line was drawn by connecting the start of the bull trend to the first valid low. 2. Remember to ignore basic pivots when drawing or adjusting trend lines. 3. But do not ignore valid pivots. With the formation of this valid pivot C, we had to adjust the trend line to cut through it.

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The way to do so is to rotate the existing trend line around its more recent second touch point. In this case, rotate the trend line around pivot B until it touches the new valid pivot C. Figure 4-5 below shows a similar situation with actual market price action. However, unlike Figure 4-4, this example shows a bear trend line. A

1. This bear trend line was first drawn by connecting A to valid pivot B

B

2. After valid high C formed, we had to adjust the trend line

C

Figure 4-5 Shifting to a steeper bear trend line

1. The initial bear trend line was drawn by connecting the start of the bear trend A to the first valid high B. 2. After the formation of valid high C, we had to adjust the trend line to a steeper one that cuts through valid high C. The examples in this section cover valid pivots that do not break the existing trend line. The scenario of valid pivots that break the existing trend line is covered in the next section.

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4.1.3 - Contains All Price Action Before The Trend Extreme A trend line must always accommodate all price action prior to a new price extreme in its direction. This means that a bull trend line must be below all price action prior to the latest trend high. A bear trend line must be above all price action that took place before the most recent trend low. Hence, if price breaks your trend line before resuming the trend, you need to adjust the trend line after the trend resumes. This type of adjustment always results in a shallower trend line. 2. Adjust the bull trend line after a new trend high

C

B

3. Adjust the trend line to contain all prices before the new trend high

A

1. Initial trend line drawn with A and valid low B

Figure 4-6 Containing all price action

1. This was the initial bull trend line drawn with valid low B. 2. The market broke the trend line AB, before pushing to a new high to resume the upwards trend. That was the signal for us to adjust our trend line.

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3. The new shallower trend line AC was able to contain the price action before the new trend high. Note that for trend line adjustments of this nature, the new trend line will rotate around the first point (in this case pivot A) of the trend line. It does not matter if pivot C is a basic or valid low. Adjust the trend line in the same manner. Figure 4-7 below shows another example with actual market price action.

2. After the trend reached a new high, we had to adjust the trend line 1. This bull trend line was first drawn by connecting A to valid pivot B

B A

C 3. Adjusted trend line contained all price action

Figure 4-7 Adjusting a bull trend line after a slight break

1. This trend line AB was the initial trend line. 2. In the pullback before this new trend high, price pushed below the trend line AB. (Note the effectiveness of trend line AB as a support level.)

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3. The adjusted trend line AC contained all price action. Hence, it was shallower. There’s a point worth clarifying in the drawing of trend line AB. It will help to drive home the trend line adjustment we are talking about here. In Figure 4-8, the first half of Figure 4-7 is enlarged.

2. However, after a new trend high, the trend line must be below all prior price action

B A

1 This was the exact valid low we used to draw the trend line

3. Hence, the trend line was pushed lower to accommodate this break

Figure 4-8 Applying the rule of containing all price action

1. If we strictly connect the start of the bull trend with the valid pivot low, this would be the resulting trend line. 2. However, as the market pushed to a new high, we had to ensure that the trend line accommodated all prior price action. 3. Hence, the trend line was pushed lower to accommodate a slight break. The shallower trend line drawn with the circled price point is the trend line AB you saw back in Figure 4-7.

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Between cutting through a valid pivot and accommodating all price action before the trend extreme, the latter takes precedence.

4.1.4 - When to Stop Adjusting a Trend Line In the last two sections, we’ve gone through how to adjust existing trend lines. We adjust trend lines to keep them relevant to current price action. But no trend line is relevant forever. Hence, for trend lines that are out of step with the current price action, we can stop adjusting them. Each trend line has two pivots that we connect to form the trend line. If the market falls below the lower point (starting point) of a bull trend line, it is a clear sign that the trend line has lost its value. Stop adjusting it. If the market rises above the higher point (starting point) of a bear trend line, stop adjusting it as well.

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B

A

When the market breaks below A, the bull trend line AB is no longer useful

Figure 4-9 No more meaningful adjustments possible

The rules stated above and illustrated in Figure 4-9 are absolute. They are easy to apply when you encounter such scenarios. However, very often, a trend line becomes irrelevant even before it satisfies the condition above. The guideline is to stop adjusting a trend line when it is no longer relevant. For a trend line to be irrelevant, it must first be broken. However, a broken trend line is a necessary condition, and not a sufficient one. Do not deem a trend line as irrelevant simply because it is broken. Refer Figure 4-6 and Figure 4-7. The trend lines in these figures were broken. But when the trend resumed, the trend lines could be adjusted to maintain relevance. Hence, to determine if a broken trend line is still helpful for price analysis, as a trader, you need to exercise some discretion. To help you with exercising this discretion, consider the following. www.tradingsetupsreview.com

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First, consider the proportion of the trend that has been retraced by the market. In fact, the situation in Figure 4-9 shows a 100% retracement of a trend. The entire trend was gone. The greater the retracement, the more likely the trend line is no longer relevant. Compare Figure 4-10 and Figure 4-11. Which trend line is more likely to be still useful and worth adjusting?

B

Shallow break

A Figure 4-10 Trend line more likely to be relevant

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B

Deep break and retracement A

Figure 4-11 Trend line more likely to be irrelevant

Second, watch out for formation of new trend lines in the opposite direction. For instance, if a bear trend line forms after a bull trend line is broken, it is more likely that the broken bull trend line is no longer useful, except as a potential resistance (having flipped from being a support). As you practise drawing trend lines and observing how they interact with price action, you will be able to choose the right trend lines to adjust and to give up. The key here is to stay with a consistent trend line drawing method. If you draw trend lines haphazardly without regard to the rules we covered, you will find it hard to develop this market intuition.

4.1.5 - Not Too Many Trend Lines Over time, you might start to accumulate a number of trend lines on your chart. If you do not clean up your trend lines frequently, Figure 4-12 is the disaster you will get.

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Figure 4-12 A disaster of lines

This example shows how price action traders, like indicator overdosed traders, can get their charts cluttered. To avoid a useless mess of diagonal lines, do not keep more than two pairs of trend lines on your chart. By a pair of trend lines, I refer to a set of one bull trend line and one bear trend line. I usually retain only the most recent pair of trend lines. Depending on the market circumstances, I might keep the second most recent pair for reference.

4.2 - Interpreting Trend Lines Basic rules for interpreting trend lines:    

An upwards sloping trend line points to a bullish bias. A downwards sloping trend line points to a bearish bias. Trend lines act as support and resistance. Trend line breaks do not always point to a reversal.

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I will explain these rules in greater detail in the following examples. I will also be reinforcing the trend line drawing techniques along the way.

4.2.1 - 6E 60-Minute Figure 4-13 shows the formation of a valid pivot low in an original downwards trend in a 6E 60-minute chart. By connecting the lowest point of the bear trend with this new valid pivot low, we produced a shallow bull trend line. The market bias has turned bullish. I’ve marked out the swing lines in Figure 4-13 for a clearer picture.

This bar completed the valid pivot low, allowing us to draw the bull trend line

Valid pivot low Figure 4-13 6E 60-minute: Drawing a bull trend line with a valid pivot low

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As mentioned, there are two scenarios that require us to adjust a trend line. Let’s recap. We adjust a trend line when: 1. Another valid pivot low forms; or 2. Price breaks the trend line before resuming the trend. The first scenario is shown in Figure 4-14, which shows the price action following Figure 4-13. A new valid pivot low formed. A bull trend line must always catch up with the latest valid pivot low.

This price bar confirmed the valid low

New trend line

Latest valid low

Figure 4-14 6E 60-minute: Catching up with the latest valid pivot low

From the second point of the existing trend line, we projected a new line through the latest valid pivot low to obtain the new bull trend line. The old trend line was then redundant and could be erased from the chart.

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ADJUSTING A TREND LINE When a new valid pivot appears, adjust the trend line to catch up with it

3. After the trend resumed, we had to adjust the trend line to the one shown in Figure 4-16

2. Trend line acted as support

1. The same trend line added in Figure 4-14 Figure 4-15 6E 60-minute: Trend line acting as support

In Figure 4-15, the trend line was tested. 1. This was the trend line we added earlier in Figure 4-14. As no more valid pivot lows formed, the trend line remained without further adjustment. 2. The bull trend line acted as a solid support for any long setup. 3. With this price bar, we had to adjust the trend line again to accommodate all price action. This is an example of the second scenario that requires a trend line adjustment - price breaking the trend line before resuming the trend. The adjusted trend line is shown in Figure 4-16 below.

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1. This price bar resumed the trend

A

2. And we adjusted the trend line to a shallower one to accommodate all price action

Figure 4-16 6E 60-minute: Adjusting the trend line to contain all price action

1. This price bar made a new trend high and resumed the trend. 2. After the trend resumed, we adjusted the trend line to accommodate all price action before the resumption. This resulted in a shallower trend line. The previous trend lines are shown as light blue dashed lines for comparison.

ADJUSTING A TREND LINE When a trend resumes after a trend line break, we need to adjust the trend line to contain all price action

There’s more to learn from this example if we look just a bit further. To provide a visual anchor, the swing pivot A in Figure 4-16 and Figure 4-17 is the same one.

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1. New bear trend line

3. Broken bull trend line flipped and became resistance

2. Violent break of bull trend line with a bearish outside bar A

Figure 4-17 6E 60-minute: Violent break of trend line and exact re-test

1. This new bear trend line formed as the market fell to test the bull trend line. 2. The bull trend line held the market for a short period before it failed. However, it did not break without a fight. It took a powerful bearish outside bar to break it. 3. The broken bull trend line flipped and offered a reliable resistance for a subsequent bullish reprisal. Broken bull trend lines flip from support to resistance. Broken bear trend lines flip from resistance to support. Trend lines offer value even after they are broken. This is why I recommend keeping the last two sets of trend lines on your chart.

4.2.2 - ES 5-Minute This 5-minute ES chart example shows how to adjust a trend line after a trend line break.

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Figure 4-18 shows a bull trend line drawn with a valid pivot low.

Bull trend line

Valid pivot low Figure 4-18 ES 5-minute: Drawing a bull trend line with a valid low

Price continued to move upwards in the ES 5-minute chart and formed another valid low as shown in Figure 4-19 below. Hence, we had to adjust the trend line to catch up with the new valid low. From the second pivot of the original trend line, we rotated the line upwards until the line hit price.

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Latest valid low

Rotate trend line upwards Figure 4-19 ES 5-minute: First step to adjusting the trend line

However, this adjustment was insufficient to catch up with the newly-formed valid pivot low. We could do better. And so we did in Figure 4-20.

Latest valid low

Rotate trend line upwards again

Figure 4-20 ES 5-minute: Second step to adjusting the trend line

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From the second pivot of the trend line, we rotated the trend line upwards again until we hit price. This trend line is the closest one we could draw to the latest valid low given that the trend line must accommodate all price action. This example highlights that although valid pivots guide the drawing of a trend line, the trend line may not always be in contact with the valid pivot. This is due to the need for a trend line to accommodate all price action. Following the adjustments in Figure 4-19 and Figure 4-20, we also noticed that the trend lines got steeper and steeper. This phenomenon reflects the increasing momentum of the trend. The trend was accelerating. Accelerating trends will slow down. They either slow down before resuming, or they reverse into the opposite trend. Let’s see how this ES 5-minute chart unfolded in Figure 4-21 below.

Price broke the trend line

Figure 4-21 ES 5-minute chart: A change in bias?

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Price broke the trend line. However, we should not adjust the trend line, not until the trend has resumed. (A bull trend resumes only when the market rises above the last extreme trend high.) If we adjust the trend line before the trend resumes, the trend line will only become shallower, both in its slope and its meaning. Premature adjustments render the trend line useless for tracking trends and serving as effective support and resistance. Figure 4-22 shows the trend resuming. That was our cue to adjust the trend line.

1. Price broke above the last extreme high

2. Adjust the trend line to contain all prices

Figure 4-22 ES 5-minute chart: Adjusting the broken trend line

1. Price broke above the last extreme high and continued the upwards trend. 2. As the bullish trend continued, we adjusted the trend line to ensure that all prices were above the trend line. www.tradingsetupsreview.com

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4.2.3 - 6J 30-Minute Let’s go through one more example. This example will also highlight the effectiveness of trend lines as support and resistance. Figure 4-23 shows the 30-minute bars of 6J futures.

1. Trend line drawn with a valid high

2. Resistance from the trend line

Figure 4-23 6J 30-minute bars: Trend line as resistance

1. We drew the bear trend line using this valid high. 2. Price moved horizontally and hit the trend line. The bearish pin bar was a sign that the trend line was providing resistance. It was a potential short setup.

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Figure 4-24 below shows the adjusted trend line after the trend resumed.

1. Adjusted trend line

2. Resistance from the trend line

Figure 4-24 6J 30-minute bars: Adjusted trend line as resistance

1. We adjusted the trend line to accommodate the price action. 2. Similarly, the adjusted trend line resisted the pullback upwards. The market plummeted after meeting the trend line.

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Look at Figure 4-25 below. After the powerful bearish bar, the market got interesting, and the market bias changed.

1. Final bear trend line

3. Congestion between two trend lines

2. Trend line support Figure 4-25 6J 30-minute bars: New bull trend line as support

1. We adjusted the trend line again to accommodate the entire downtrend. There was no more valid pivot high after the plunge. Hence, this trend line was the final bear trend line in this downwards trend. 2. On the other hand, a valid pivot low formed (as circled), and we drew a bullish trend line with it. This trend line acted as support for a potential long trade. 3. However, the downwards sloping trend line was still effective. Hence, we expected price to stall if it rose against the bear trend line. With two effective trend lines surrounding price, it was likely that the market would bounce in between them. This example illustrates that trend lines must be adjusted properly to keep them relevant to ongoing price action. Properly

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adjusted trend lines play a significant role as support and resistance.

4.3 - Conclusion Trend lines are extremely useful tools for tracking the market’s bias. They factor in the effect of valid pivots and double up as support and resistance. However, we are not interested in drawing every single trend line. We are interested in drawing useful trend lines, using a consistent method. If you look at a chart ex-post, you can draw many trend lines that seem like the perfect support or resistance. However, these trend lines lack consistency. Moreover, in real-time, you will find it a lot harder to draw such perfect trend lines. In trading, consistency trumps perfection. Drawing trend lines with valid pivots takes some practice. However, once you get the hang of it, it will become second nature. In fact, many experienced traders are able to visualise trend lines and are aware of trend line breaks without actually drawing trend lines on the charts. Trend lines have another useful extension. You can draw parallel lines to form channels. These channels are powerful tools for profit taking. We will return to the topic of price channels and how to draw them in Volume 4 where we discuss different methods for taking profit.

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TREND LINES 

Draw trend lines with valid pivots



Adjust trend lines as price action unfolds



Use trend lines to track market bias and as support and resistance

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Chapter 5 – Evaluating Market Bias Identifying swing pivots and drawing trend lines are technical and straightforward skills. However, evaluating market bias can get tricky. When it comes to evaluating market bias, there are no rules. There are only guidelines and principles. One trader might see more bullishness where another sees selling pressure. Nothing is cast in stone and everything is in gray. Brace yourself. Do not expect textbook examples in this chapter because the aim of what follows is to show you how to handle non-textbook examples - the real market. Let’s recap what we have learned so far about tracking market bias with trend lines.

TREND LINE - BIAS Upwards sloping – Bullish bias Downwards sloping – Bearish bias But what happens when a trend line breaks? The greatest value of a trend line break is not that it confirms a reversal. Its value is that it alerts us to pay more attention to the market. It highlights a hotspot that requires further analysis. It raises the possibility of a change in market bias. The further analysis we conduct as the trend line is tested might reveal that the market bias has changed, or the trend is offering a solid retracement trade.

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This is an example of the typical analysis cycle. 1. 2. 3. 4.

You draw an upwards sloping trend line in a bull market. The trend line breaks, and we look at price. We decide to change to a bearish view. As the bearish trend develops, valid pivot highs form, and we draw a downwards sloping trend line to track the bearish market. 5. When the bearish trend line is broken, we study the surrounding price action again. 6. Then, we reverse to a bullish bias. Back to the first stage. This chapter is about reinforcing this analysis cycle and how to respond when the market deviates from these clear-cut stages. But before that, let’s clarify our thought process on market bias.

5.1 - Our Thought Process I’ve briefly discussed the way I look at market bias in Volume I. Here, let’s recap and go further to look at its practical implications. The market is commonly described as bullish, bearish, or neutral. Bullish refers to the tendency to rise, and bearish refers to the tendency to fall. A neutral state reigns when the market is not heading anywhere. Most market observers try to classify the market into one of these three phases. In one form or another, the usual trading tenets are: 1. Buy in a bullish market (trend trading) 2. Sell in a bearish market (trend trading) 3. Buy weakness and sell strength in a neutral market (range trading)

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These tenets sound great in theory. Figure out the market context and take the trades accordingly. However, in practice, the third tenet is problematic. It is in the supposed neutral market that traders get into trouble. When traders have the mandate to both buy and sell, they tend to lose focus and overtrade. If they get stopped out of a long trade, they reverse immediately, thinking that the market will now fall. If that short trade fails as well, they try to find buying opportunities again. In a neutral market, it’s easy to disguise a lack of focus and discipline as flexibility. I am against trading without a directional focus. I am not rejecting the idea that the market has three phases. I am not rejecting the idea that the market might be neutral. I am rejecting the idea that the market, at times, gives us the equal mandate to buy and sell. This idea of equal mandate to buy and sell is built on an overconfident mentality that traders can catch every ebb and flow of the market. Buy and sell at the exact turning points of each market swing. Be the best trader in the world. Since these traders want to and think that they can catch every move in the market, they refuse to be fixated on one direction. They claim that they must be flexible to maximise their trading performance. Hence, they are constantly looking for opportunities to both buy and sell. The thinking of these optimistic traders sounds great. Unfortunately, they mostly end up abusing this flexibility and ruin their trading account. This is because it is simply impossible for anyone to catch every single market swing. Traders who are obsessed with catching every swing are so caught up with small

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market movements that they miss the real underlying market bias. Do not miss the forest for the trees. Find the forest, and you will have plenty of trees. To prevent this lack of focus, use this two-step thought process. The first step requires that we decide on a bias. Don’t say that the market bias is neutral. Say that the market is bullish. Or say that it is bearish. Commit to a direction.

MARKET BIAS - STEP ONE Commit to a bias, and decide if the market is bullish or bearish now

Why only focus on one market bias? This is so that you stay clear-headed and are not confused. You might not make the most money by focusing on one market bias. But you will certainly lose money if you feel like buying and selling at the same time, all the time. The resulting confusion damages a trader’s performance far more than a wrong assessment of the market. The second step involves a question. How sure are you?

MARKET BIAS - STEP TWO How sure are you that the market is bullish? Or how sure are you that the market bias is bearish?

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For example, your stance is bullish. How sure are you that the market is bullish? If you are absolutely certain, go ahead and trade all the bullish setups you can find. If you are somewhat convinced, be more selective of your trading opportunities. If you are not sure, the market is probably in the neutral state we mentioned. Simply don’t trade when you are not sure. This two-step process forces us to stay focused and hold on to a hypothesis regarding the market’s bias. When we are not sure of our hypothesis, we do not trade. Do not ask: Is the market bullish, bearish, or neutral? Ask: How sure are you? The market is bullish. How sure are you? Or the market is bearish. How sure are you? At times, the answer is clear. For instance, the market is clearly rising, and we have a bullish trend line supporting it. There is not a single valid pivot high on the chart. There’s no significant overhanging resistance. We are very sure that the market is bullish. The problem arises when the answer is not so clear-cut. These gray areas occur in the following situations:      

The trend line is broken. There is more than one effective trend line. Price is too far removed from the trend line. The trend line is too shallow. The trend line is broken right after it’s drawn. There’s a trend line, but the price action is stalling.

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In the following sections, we will go through a variety of examples covering the scenarios above and try to make sense of the murky market bias. At times, we will find a clear answer. At times, we might give up finding the answer. And of course, we might get it wrong occasionally. However, generally, the market bias will give us the trading edge we need to trade successfully. The examples in this chapter will revolve around the gray scenarios mentioned above.

5.2 - Step-by-Step Guide It’s time to consolidate what we have learned into a step-bystep process for assessing the market bias. 1. 2. 3. 4. 5.

Mark out all swing pivots Identify the valid pivots Draw trend lines using the valid pivots Observe price in relation to the most recent trend line Observe the momentum shown by the recent tested pivots

When you open up a chart, the first thing you do is to mark out all the swing pivots. Recognising market swings is an essential skill. If you are unsure about this, return to Chapter 3. Reread it and practise marking out swing highs and lows on your charts. How far back do you need to go when marking out swing pivots? Go as far back as you need to figure out the market bias. This means at least marking sufficient swings to find the most recent valid high and low. As a rule, the high the trading time frame you are using, the further back in time you have to go. www.tradingsetupsreview.com

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Once the swing pivots are marked out, identify the valid pivots. Watch out for both valid highs and valid lows. Then, draw the most recent bull and bear trend lines using the valid pivots. These trend lines will highlight the most recent market structure. While the trend lines set the backdrop for our analysis, we need to zoom in on price itself to know what’s really going on in the market. Specifically, we are interested in the interaction between the current market price and the trend lines. When we examine the current price and the most recent trend line, there are three possible scenarios. 1. The trend line is still effective. (i.e. not broken) 2. The trend line has been broken decisively with strong momentum. 3. Not sure what is going on. Table 5-1 shows the implication of each scenario on market bias.

Bull Trend Line

Effective Bullish bias

Broken Bearish bias

Bear Trend Line

Bearish bias

Bullish bias

Unsure Wait for more price action Wait for more price action

Table 5-1 Deriving the market bias from price and trend lines

For example, the most recent trend line is downwards sloping (bear trend line), and the market has risen above it with strong bullish momentum. This means that the bear trend line has been broken. Our market bias is bullish even if the market has not formed a new bull trend line.

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When are we unsure? The situations with higher uncertainty are those we mentioned earlier in this chapter.      

Trend line breaks without clear momentum Multiple trend lines Large gap between price and trend line Almost flat trend lines Short-lived trend lines Stalling price action

What do we do in these situations? A useful tool is the concept of momentum/tested pivots. By focusing on tested pivots, you can observe the strength of bullish or bearish momentum. The momentum serves as a guide to the path of least market resistance. Deciphering the market bias is one of the toughest but most critical steps in your trading process. It is full of variations and often requires your subjective interpretation. To deal with such a tricky topic, it’s better to look at examples covering different scenarios than to prescribe further guidelines.

5.2.1 - Trend Line Break A trend line break is not a sign of market bias reversal. Most trend line breaks do not reverse our market bias. Instead, most trend line breaks fail, and the trend continues in the same direction. Very often, a trend line break merely represents deeper pullbacks before the trend resumes.

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The ES 10-minute chart in Figure 5-1 presents such an example.

3. Trend resumed

2. Support again

1. Bottom tails showed buying pressure

Figure 5-1 Trend line break with bullish bias intact

1. Buying pressure at the bull trend line was evident from the long bottom tails. The three bars with long lower tails formed a Pressure Zone, a price pattern we will discuss in Volume III. 2. The tested low closed below the previous swing low for only one bar before it got rejected upwards. Furthermore, the tested low did not clear the previous swing low. Thus, the bearish momentum was clearly muted as the previous swing low prevented the market from falling further. Due to this lack of bearish momentum, despite the break of the bull trend line, we did not conclude that the market bias has turned bearish. 3. Indeed, the trend resumed its way up.

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The 6A 30-minute chart in Figure 5-2 below shows another typical trend line break.

1. Bearish outside bar broke the trend line

3. Price continued to rise

2. The bar could not close below the trend line Figure 5-2 Trend line breaks do not usually reverse the trend

1. The market reversed violently from the top of the trend in the form of a bearish outside bar that broke the trend line. This might have spooked some bulls. 2. However, the bar could not close below the trend line. Hence, it was in fact a bullish hint. 3. That explained why the market’s subsequent bullish action was not a surprise. These examples demonstrate why we do not rely solely on trend line breaks to confirm a change in market bias. Instead, we wait for a trend line break and observe the price action surrounding the break. The momentum of the market swing that breaks the trend line is the key in most cases. If price momentum against the current www.tradingsetupsreview.com

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trend is evident as the market breaks the trend line, a change of market bias is likely. In both cases above, we did not see any serious bearish moves with good follow-through despite the trend line breaks. Hence, we managed to persist with the correct market bias. However, we should not take the scenarios above for granted. Some trend line breaks do lead to a change in market bias. Or, in some instances, the breaks are strong enough to make us doubt our bias. It is common to feel uncertain about the market bias. Remember that it is this uncertainty that traps more traders into the market to fuel the trend. Hence, if you are confused by the market, do not trade. The following charts show examples of trend line breaks that led to a reversal of market bias.

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Figure 5-3 shows a 30-minute 6J chart with a trend line break that warrants a closer look.

1. Powerful bearish thrust from top of the trend

2. Strong support

3. Equally strong resistance

4. These bars cleared below the last swing low

Figure 5-3 Support and resistance that were equally strong

1. The fact that four consecutive strong bearish bars led to a trend line break caught our attention. Did the market bias turn bearish already? We should not be too quick to decide on a change in market bias, so we waited for more price action to unfold. 2. This bar with a long lower tail (bullish pin bar) showed extreme buying pressure. Obviously, after this development, we hesitated to adopt a bearish bias. 3. After the bullish pin bar, we expected the market to move up. However, price met with strong resistance from the trend line which has already flipped from a support level to a resistance area.

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Clearly, both bulls and bears were making their presence felt. We maintained a technical bullish bias. But we were unsure. So we stepped aside and waited for more price action to unfold. 4. These bars formed entirely below the last swing low, showing clear bearish momentum. Bearish momentum below a bull trend line is a reliable sign that the market bias has turned bearish. Hence, we assumed a bearish bias. Again, Figure 5-4 and Figure 5-5 below demonstrate how examining price momentum can help us to interpret the market bias.

Trend line break gave the first sign of reversal

Figure 5-4 A trend line break that led to a change in bias

This trend line break led to a bullish reversal. If we had persisted with our bearish perspective, we would have ended up on the wrong side of the market. Let’s zoom in to the boxed area above for a closer analysis in Figure 5-5.

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3. Price continued to move above the trend line with a strong thrust

2. Resistance from the trend line

1. Break-out to a new low was rejected immediately Figure 5-5 Close-up analysis reveals bullish momentum

1. Price broke below the trading range (double bottom) but was rejected immediately. That strongly suggested a lack of bearish momentum. 2. However, the next bar had an extremely long upper tail which signified resistance from the trend line. 3. Yet, price did not follow-through with the selling pressure. Instead, it broke the trend line with a strong bullish thrust. This thrust led to a tested high that cleared above the previous swing high for four bars. It showed undeniable bullish momentum. As you can see from the two examples above, momentum is extremely useful to determine if a trend line break has the power to change the market bias. Recall how we judge momentum.

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(Hint: Distance, bar closes, and clearing. Refer to 3.3.2 - Tested Pivot if you are unsure.) Other than strong momentum against the existing market bias, there is another similarity between the 6J and 6E examples above. As the trend line was broken, there were clear signs of both the bulls and the bears. A change in market bias involves emotional turmoil in the minds of both bullish and bearish traders. Usually, it is not a swift process. Hence, it is typical to get mixed signals before a change of market bias. Figure 5-6 shows another example with the 10-minute chart of ES futures.

Price closed above, and cleared the previous pivot high

Figure 5-6 Trend line break with sustained bullish momentum

The swing that broke the trend line formed a tested swing high. It rose above the previous pivot high, closed above it, and cleared it. The bullish momentum was evident.

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The next upswing persisted with the same strong bullish momentum. These momentum signals confirmed that the trend line break was serious business. The bullish price action would mostly likely go beyond a deep retracement and lead to a trend change. The key takeaway of this section is that we should observe the price action and momentum when the trend line is broken. If momentum goes strongly against our current bias, it is likely that the market bias has already changed.

TREND LINE BREAK Observe the price momentum that accompanies a trend line break to determine if there is a change in bias

5.2.2 - Multiple Trend Lines Most of the time, a trend line is broken before a trend line in the opposite direction forms. However, occasionally, we get an opposing trend line before the current trend line is broken. In such instances, the market bias might have changed without a trend line break. For instance, before the break of a bull trend line, a valid pivot high forms, and hence we add a bear trend line on our chart. Now, we have two effective trend lines – a bull and a bear trend line. How do we assess the market bias in such scenarios? Generally, the more mature trend line is more significant and holds more sway as a support or resistance level. However, the more recent trend line is more relevant to current ongoing price action. Hence, while we can trade in the direction of the recent trend line, we must bear in mind that the older trend line is still

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significant. It remains as an area of major support and/or resistance until it is broken decisively. Trend lines offer natural support and resistance. Having two effective trend lines pointing in opposing directions implies that price might bounce between the two trend lines. Remember the dual trend line chart in the last chapter? It is reproduced in Figure 5-7 as an example.

1. Mature bear trend line

3. Congestion between the two trend lines

Trend line bounce 2. Recent bull trend line Figure 5-7 Wrestling with two opposing trend lines

1. The bear trend line was effective. 2. A bull trend line formed as price rose up towards the bear trend line. As this bull trend line was the more recent trend line, we assumed a bullish bias. 3. Price found resistance as it hit the bear trend line and started moving sideways. With the formation of the bull trend line, we could take long setups. However, we must make sure that there was reasonable www.tradingsetupsreview.com

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profit potential even with the bear trend line as an overhanging resistance. Take the trend line bounce for instance. (Small vertical arrow in Figure 5-7) That setup was reasonable as there was a decent price range between that price bar and the bear trend line. Figure 5-8 and Figure 5-9 below are more examples of dual trend lines. In both cases, the mature trend line was broken with good momentum. In such cases, once you are convinced that the market bias has changed for good, you can remove the mature trend line from the chart or keep it under observation as potential support/resistance. However, in both cases, by the time we drew the recent trend line and confirm our new bearish bias, price was too close to the mature trend line for us to consider taking trades along with the new-found market bias. We could only consider trades after the mature trend line had been cleared.

Recent bear trend line

2. Negligible momentum breaking the bear trend line

Mature bull trend line 1. Strong momentum breaking the bull trend line

Figure 5-8 Breaking a bull trend line with strong momentum

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1. The market broke the bull trend line with strong bearish momentum. 2. On the other hand, the break of the bear trend line had weaker momentum, confirming that the market bias was indeed pointing down. (The retest of the bull trend line as a resistance offered a shorting opportunity.) In Figure 5-9 below, the market gapped down past the last pivot low and continued falling for several bars, punching right through the bull trend line. That was enough for us to call out a bearish bias.

Recent bear trend line

Strong momentum breaking the bull trend line

Mature bull trend line

Figure 5-9 Pushing past the bull trend line

A similar situation is shown in Figure 5-10. However, the outcome was different.

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Recent bear trend line

Mature bull trend line

2. But price rose up instead

1. Strong momentum breaking the bull trend line

Figure 5-10 Strong break of trend line did not lead to reversal

1. Together with the formation of a new bear trend line, price broke the bull trend line with strong momentum. As this situation looked similar to the two examples above (Figure 5-8 and Figure 5-9), we deduced that the market had turned bearish. 2. However, instead of shifting into a bearish gear, the market defied gravity and shot up with a long terrible bar. What happened? Why were we wrong? How could we be wrong? Is this method flawed? What did we miss? These are all the wrong questions. The right question is: Did you expect our analysis to be correct every time? If you did, you need to rethink.

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There is no trading method that tracks the market with 100% accuracy. Having a solid timing technique (Volume III) and an exit plan (Volume IV) will protect you when things are not going your way. If I wanted to, I could have chosen the perfect example to convince you that I am a trading guru and my method works all the time. However, instead of presenting textbook examples, I chose to include realistic examples. I want to show you not only how to trade, but also what trading is really about. More than assessing the market bias, allow me to digress and take this example as a chance to persuade you to stop your search for the Holy Grail, in the event that you are still looking for it. When a trading method fails like the example above, we can react in a few ways. We could start doubting the method and immediately move on to the next trading strategy that promises us eternal wealth. However, in that case, we will never gain competence in one strategy, and we will have a higher than average chance of falling for scams. On the other hand, we might decide to stick with the method, thinking that once our skills get better, we can avoid these losses. Sticking with the method is correct. But no method is perfect. Regardless of how well you trade, losses are inevitable. Prepare to accept losses, or you will never respect the value of risk management in trading. It is also possible that we understand that no method is perfect. But we know of this powerful indicator analysis that would have helped us avoid that losing trade. So we add that indicator in as a filter. This is acceptable, as long as we do not fall into what I www.tradingsetupsreview.com

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call the escalation of analysis. That term refers to the phenomenon of adding more and more indicators onto more and more charts to attempt to avoid all losses. That is no different from the trader who is constantly moving from one method to another. Both are searching for the same thing - the supposed Holy Grail. In summary, no trading approach is perfect. Some fail in areas where others excel. And using multiple trading approaches is not the answer because you will sacrifice consistency. Without consistency, sustainable profits are impossible. Hence, instead of reacting to each losing trade with your mind set on vengeance, take a step back. Look at a larger sample of your trades. Are you profitable? If you are, why are you tweaking the method? Mind more about the consistency of your trading methods than its performance. Please excuse this digression about reactions to losing trades. If I wrote this under the section “Trading Psychology” (which I will in Volume IV), I know that traders trapped in the cycle of searching for the invincible Holy Grail will ignore it, as they always do. By inserting it here, I hope I’ve managed to reach out to a wider audience. Now, let’s return to the same example (reproduced in Figure 5-11). Because we are looking at the chart ex-post, I could easily focus on the bullish signals and tell you how I could have anticipated the bullish break above the trend line. But the fact is that I could not have done that in real-time. The strong bearish momentum was undeniable. The three consecutive bearish bars that broke the bull trend line were especially striking. Now, I know that the downthrust was actually an exhaustion move. However, I could not have

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deciphered that in real-time, not without sacrificing the consistency of my analysis. Realistically, we could have stepped aside because of the wild swings marked out in Figure 5-11. Wild swings in both directions make us unsure. We maintained a bearish bias, but were uncertain. Hence, we waited for more price action to unfold. However, it was perfectly reasonable to look for short setups at the retest of the bull trend line, despite the negative outcome.

Powerful bull swing

Strong downthrust

Retest of the broken trend line

Figure 5-11 Strong swings in both directions followed by a trend line retest

Let’s move on to the next dual trend line example. With the ES 10-minute chart in Figure 5-12, we will get down to detailed step-by-step analysis.

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5. Possible short setup

1. Solid bullish momentum

2. Bull trend line drawn with this valid low

4. Trend line break with strong bearish momentum

Figure 5-12 Break of a recent trend line

1. The session opened with a down gap. However, the bulls quickly asserted themselves with a strong upwards thrust to test the low of the previous session. Although we were technically bearish, the bullish momentum made us think twice about looking for short setups. 2. With the formation of this valid low, we drew a bull trend line. That was our signal to start looking for long setups. 3. However, the market was too near to the overhanging resistance projected by the bear trend line. Hence, we held back from looking for long setups. 4. Price fell with strong momentum to form a tested low below the bull trend line. Such price action, coupled with the fact that the bear trend line was still effective, pointed to a bearish bias. This bull trend line is also an example of a short-lived trend line, which we will be covering in greater detail later.

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5. This bearish reversal bar offered a shorting opportunity. In fact, it was a Trend Bar Failure setup which is a simple price action pattern you will learn in the next volume. Overall, this is a classic example of a deep bull pullback within a larger bear trend.

5.2.3 - Large Gap Between Price And Trend Line When price is playing with the trend line, we know that we should look closer at the market to see if a reversal is looming on the horizon. The scenario at the other end of the spectrum also warrants a closer look. That is when price is too far away from the trend line. The problem with price that is too far removed from the trend line is that the market bias can change without a trend line break. Hence, when the price is too far away from the trend line, we must keep our eyes open and look out for signs of changes in the market bias. In some cases, a trend line would form in the opposing direction to confirm a change in market bias, like the dual trend lines examples we went through in the last section. However, in other instances, the market might reverse its bias without forming a new trend line. Price usually gets too far away from the trend line when a strong trend develops, or when a trading session opens with a significant gap. If a trend forms valid pivots along the way, we would have adjusted our trend line to catch up with the market movement. However, a strong trend might move quickly without forming any valid pivots. When that happens, we are unable to draw or adjust trend lines. Hence, it is possible for a strongly trending market to move far away from the most recent trend line. www.tradingsetupsreview.com

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An example is shown in Figure 5-13.

3. First strong downthrust

2. Tested highs showed strong bullish momentum

1. No new valid lows; no adjustment of trend line

Figure 5-13 A rising market without valid lows

1. As the market rose without deep pullbacks, there were no new valid pivot lows. Hence, we did not adjust the trend line, and the gap between price and the trend line widened. 2. An analysis of the tested pivots showed that price had been pushing higher with solid momentum. There was no reason to consider a bearish outlook. 3. This held true until the first strong downthrust set off by the bearish outside bar at the top of the chart. This downswing cleared the last swing low. Moreover, the market’s effort to rise again was minimal, as shown by the three small bullish bars following the downswing. This downthrust made us doubt our bullish bias. Hence, we stepped aside and held back our trading activities.

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The above example in Figure 5-13 shows the 6A futures in 24hour trading. Hence, there were no obvious gaps in the chart. However, if you are not trading 24-hour charts, you will encounter gaps between trading sessions that will also cause price to move far away from the trend line. Figure 5-14 shows a CL 4-minute chart with a gap between its regular trading sessions. This example shows how price momentum can help us confirm the market bias in times of uncertainty.

3. Bullish momentum fading 1. Large down gap that caused price to move away from the trend line

2. First tested high had strong bullish momentum

4. Bearish momentum returning Figure 5-14 Using momentum as a compass

1. The large gap down from the previous session was an extreme exhibit of bearish prowess. It also pushed the market a great distance away from the bear trend line. The greater the distance between the market and the trend line, the more sensitive we need to be to signs of market reversal. 2. The first tested high of the session showed strong momentum, clearing above the preceding swing high. It was a www.tradingsetupsreview.com

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bullish sign. Hence, despite the bear trend line and our technical bearish outlook, it was unwise to take any bearish setups. 3. However, the next tested high showed that the bullish momentum was faltering. Instead of clearing above the preceding swing high, the market merely closed above it for one bar before being rejected down. That was the first hint that the bears might have returned. 4. The rejection from the session’s high pushed right below the preceding swing low, clearing it and closing below it for four bars. It was a clear sign of bearish momentum. Coupled with the earlier fading bullish momentum, we could confirm that the market bias was still bearish. It was then time to look for short setups. Figure 5-15 shows another example of the market moving far below the bear trend line.

2. Resistance from the bear trend line 1. Both bullish thrusts showed good momentum

3. Limited upside due to the bear trend line

Figure 5-15 Going up against a bear trend line

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1. After plummeting far below the bear trend line, the marketed rebounded sharply. The bullish momentum was undeniable. As the market was far below the bear trend line, we were more sensitive to bullish signs. Hence, it was acceptable to turn our bias bullish at that point. 2. As price tested the bear trend line, the long top tail showed clear resistance. 3. While this pullback down offered an opportunity to go long, we must bear in mind that our profit potential was limited. We could target the bear trend line, or the last swing high. If we were able to find a trading setup with small risk, we might be able to take it. However, more conservative traders would have skipped this opportunity. You can compare Figure 5-12 in the last section with Figure 5-15 here. They are similar in terms of our market bias assessment. Technically, we were in bullish mode for both despite the overhanging bear trend line. However, we were more likely to consider a trade in Figure 5-15. This is not because we knew that the market in Figure 5-15 was going to break-out and continue rising. It is because of rewardto-risk considerations. There were two clear resistance areas in each case. They were the last pivot high and the bear trend line. In Figure 5-12, the first pullback after we formed our bullish bias was shallow. Hence, there was not enough room for profit even if the market rose back to test the last pivot high. On the other hand, in Figure 5-15, the pullback down went deeper and hence the profit potential was higher.

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The point is that our assessment of the market bias guides us to focus on setups in the right direction. Then, our knowledge of pivots and trend lines acting as support or resistance helps us to evaluate if the setups are worth taking, given their potential reward and risk. We will focus more on the latter aspect in the final volume where we consider the concept of positive trade expectancy.

5.2.4 - Almost Flat Trend Lines Technically, it is possible to encounter very shallow trend lines. These almost flat trend lines occur when the two points of the trend line are found within a tight price range. For instance, if the start point of a bull trend and the first valid low formed are near to each other in price terms, the resulting bull trend line will be relatively flat. The closer in price and further in time the two pivots of the trend line are, the shallower the resulting trend line is. You would wonder if such lines still deserve the word “trend” in their description. Flat trend lines might indicate a lack of trend. However, the more common scenario is that it indicates a trend that has yet to pick up momentum. This is because by requiring a valid pivot before drawing a trend line, we are looking for a high threshold to confirm our market bias. Valid pivots seldom form unless the market has a certain degree of trend conviction. Often, price moves quickly away from a flat trend line to present situations we went through in the last section (Chapter 5.2.3 Large Gap Between Price And Trend Line).

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Otherwise, the flat trend line quickly evolves into a steeper trend line with the formation of new valid pivots. Figure 5-16 below shows such an example in the 6A (AUD/USD) futures market.

A

B

2. Shallow trend line drawn

1. Price broke below and confirmed the valid high

Figure 5-16 A flat trend line – cause for concern?

This market was initially in a bullish bias. In fact, you could see the current bull trend line at the bottom right hand corner of Figure 5-16. 1. This price bar pushed to a new low and confirmed pivot B as a valid high. 2. Hence, we drew a bear trend line by connecting the start of this possible new bear trend A with the valid high B. This bear trend line was hardly assuring. It was so flat that it did not look like it was highlighting a bear trend.

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Since we could not be sure of the bearish bias, it was wise to wait and see. The market gave us an answer pretty soon after, as you can see in Figure 5-17 below.

A B

C

1. Trend line grew steeper with a new valid high

2. Together with this clear and strong break of the bull trend line, the bearish bias was clear

Figure 5-17 Bear trend line grew steeper and more convincing

1. A steeper bear trend line was possible with the new valid high C. 2. Together with the decisive break of the bull trend line, the bearish bias was clear. The lesson here is not to fear flat trend lines or over-analyse them. Just be patient with them. Eventually, they will show you the market bias.

5.2.5 - Short-Lived Trend Lines As you keep up with your trend line practice on actual markets, you will come across trend lines that fail almost right after you draw them.

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These short-lived trend lines often point to a market bias in the opposite direction. A short-lived bull trend line hints at a bearish market; a short-lived bear trend line hints at a bullish bias. Figure 5-18 below shows a bull trend line that failed quickly in the FDAX futures market.

1. The market broke this bear trend line with solid bullishness

2. This bar confirmed a valid low for the new bull trend line

3. The bull trend line failed right after it was drawn

5. Especially when the market failed to clear above this resistance

4. Be careful of the bullish bias this bull trend line implied

Figure 5-18 Immediate failure of a new trend line is ominous

1. The market was in a bearish bias before it broke the effective bear trend line decisively. However, the strong upthrust was followed by an equally strong downthrust. (Look at the threebar and six-bar consecutive bearish bars that followed.) Given such conflicting price action, we were hoping for some clarification. 2. This bar confirmed a new valid low for us to add the first bull trend line to the chart. It offered fresh bullish hope. 3. However, this new bull trend line failed as quickly as it formed. This immediate failure of a bull trend line had bearish www.tradingsetupsreview.com

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implications. It made us more wary of subsequent bullish attempts. 4. This was why we were more sceptical when we got this second bull trend line. 5. When price struggled to push beyond the high of the last bullish drift, it confirmed that the bulls were not ready to turn the market tide. Indeed, this bull trend line failed again, without offering the falling market much support. Figure 5-19 below shows another example of a quick failure of a trend line, this time from the 6A currency futures market. Due to the scale of the chart, the valid lows might not be apparent. Hence, I’ve highlighted the swings that formed the valid lows.

1. Broke above the extreme high by just one tick to confirm the valid low

3. The market was rejected down right after confirming the valid low

2. Trend line drawn with this valid low

4. Trend line drawn with this valid low

Figure 5-19 Quick failure of bull trend lines in a bearish market

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1. This price bar broke above the resistance by just one tick to confirm the valid low. 2. With the valid low, we drew a bull trend line. However, right after the trend line was added to the chart, the market started falling and swiftly broke below the trend line. 3. Despite an impressive five-bar bullish thrust, the rise above the resistance was rejected quickly. 4. This instance was similar to the first bull trend line. Just after we drew the bull trend line, the market fell and broke the trend line. In this case, the failed bull trend lines not only confirmed the bearish bias, they were also potential trend line break setups. Go back and look at the examples again. You will notice that trend lines that fail quickly usually represent a pullback on a higher time frame. This is why there’s no need to complicate our analysis with a higher time frame. If you learn how to interpret what you see on your active time frame well enough, you are not missing out anything critical.

5.2.6 - A Struggling Trend Trends pause and look like they are going to reverse. They keep doing that. But usually, they resume after a few tries. A bull trend resumes by making a new trend high. A bear trend resumes by pushing to a new trend low. When a trend does not resume after a few tries, it is a struggling trend. Struggling trends are usually a prelude to a

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prolonged sideways market or even a reversal. It pays to trade carefully when you observe a struggling trend. Use four attempts as a rule of thumb. If a market tries to resume the existing trend for four swings and fails, it is struggling. Figure 5-20 below shows an example. It shows the later part of a session in the CL futures market.

1. Existing bearish bias

3. The blue lines mark out eight swings, of which four swings tried to resume the trend, but failed

2. Push to new low rejected (early warning) Figure 5-20 A struggling bear trend ended with an upwards drift

1. The market bias was bearish as shown by this bear trend line. 2. This push to a new trend low was rejected clearly by the market. It was an early warning that this downwards trend might be over. However, it was in no way conclusive of a bullish takeover. 3. Compare this price action (blue lines) to the earlier pullbacks in this downwards trend. The earlier pullbacks resumed the

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trend with two downswings. At this point, the bear trend failed to resume even after four downswings. It was struggling. Combined with the bullish rejection mentioned in point 2, it was reasonable to hold back our search for bearish setups. If you were short, it’s a good time to cover your position. However, it was premature to adopt a bullish bias with confidence. The market drifted upwards until the end of the session. Of course, not all struggling trends reverse nicely like Figure 5-20. Let’s take a look at another example of a struggling trend in Figure 5-21.

1. The market was bearish

2. Bull trend line that failed fast; bearish

3. The bearish trend resumed only with the fifth downswing

Figure 5-21 Struggling, or not?

1. The market was in a bearish trend. 2. This pullback took four downswings to resume the bearish trend. The pullback upwards was strong enough to form a bull trend line. But it was a bull trend line that failed almost

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immediately after forming. Recall from the last section that this was a bearish sign. 3. Soon after resuming the bearish trend, the market lapsed into another multi-swing pullback. The fourth downswing in the pullback could not resume the trend. Technically, according to the rule of thumb I mentioned, it was a struggling trend. But trading is not about rules of thumb. It is about what is really happening in the market. There were good reasons to downplay this supposed struggle of the bear trend. First, remember that we just saw a short-lived bull trend line. It pushed our market bias towards the bearish side, and made us more sceptical of the bullish price action that followed. Second, the broken bull trend line has clearly flipped into a resistance. Look at how price bounced off the bull trend line. Given such a bearish context, the inability to resume the trend by the fourth downswing was not a deal-breaker for traders who were looking to short.

5.3 - Conclusion This is a tough chapter to digest. But this is the closest you get to assessing the market bias in real trading, without actually trading. Getting the market bias right is the key to our trading edge. As you will see, price patterns only help to limit our risk. Our trading edge comes chiefly from getting the market bias right. If you get the market bias right, you can pretty much enter along with the bias with any setup. www.tradingsetupsreview.com

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A few useful tips for deciphering the market bias: Do not be too quick to decide that the market bias has changed. When you cannot decide if the market bias has changed, it is always safer to assume that it has not and that the current bias is still intact. Of course, nothing is safer than just stepping aside and waiting for more price action to unfold. Regardless of the market bias, do not trade against the most recent strong momentum. By strong momentum, I am referring to tested pivots that manage to clear their preceding swing pivot. If the most recent tested high showed strong bullish momentum, do not take any short trades until there are signs of bullish momentum fading or bearish momentum returning. (Like the example in Figure 5-14.) Watch out for the first tested pivot of each session. This is especially applicable for sessions that open with a gap away from the previous session. Wait for the first tested pivot of the session and see what it shows you about the momentum of the session. If the first tested pivot of the session shows strong bullish momentum, you should consider that in your market bias assessment.

MARKET BIAS 

Always have a directional bias in the market but be prepared to change it



Trend lines are our best tool for mapping the market structure



Don’t be afraid to step aside when the market bias is unclear

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