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The Breakout Trap

July 5th, 2013
in contributors, syndication

Online Trading Academy Article of the Week

by Sam Seiden, Online Trading Academy

Last week, a classic bull trap had been developing that we were going over in some of our trading rooms at Online Trading Academy. It reminded me of an article I wrote a while back. Below are some parts of that article, explaining last week’s bull trap and this week’s opportunity.

Before you read on, let me make perfectly clear that I am a huge animal lover! The polar bear and the seal…the crocodile and the wildebeest…the professional trader and the novice trader… What do these three relationships have in common?

Follow up:

One is the hunter and the other is the hunted. Polar bears are white just like the icy snowy areas of the world they live in. Seals spend much of their time in water under a sheet of ice but have to come up for air at some point. When they come up for air, it is typically through a hole in that sheet of ice. Each breath however is potentially a life or death action because often, there is a polar bear waiting at that hole in the ice for his or her dinner, the seal. A seal has choices as there is always more than one hole to choose from but they better chose wisely for if they don’t, the hole they chose will be a “trap” set by the polar bear and that will be the last breath the seal takes. Wildebeest live on land but have to find water to drink in order to survive. They too have choices as to which bodies of water to drink from. One lake or river is clean, cool water, void of any danger. The other may very well have a crocodile waiting just below the surface, waiting for the wildebeest to come drink. One is opportunity to drink, the other is a trap that leads to a quick death for the wildebeest and a nice hardy meal for the croc. No, this is not some National Geographic article and again, I am a big animal lover.

When it comes to trading and investing, the hunter and hunted relationship is no different than in the wild only the end result typically does not lead to end of life. Make no mistake about it, there is a winner and a loser, nothing in between. There are many invitations to buy into a market. Some are opportunities that lead to low risk and high reward buying opportunities that end up being very profitable trades. Others are traps that lead to losses for the hunted and profits for the hunter. One of the most favorite and high probability trades we like to take in the Futures Extended Learning Track (XLT, our live trading rooms) is the Bull Trap or Bear Trap. For today’s piece, let’s take a look at classic Bull Trap that happened last week and one that can happen again this week.

The opportunity was to short the S&P into a supply level. The specific strategy is the Bull Trap as you can see on the chart below. Notice the two supply levels on the chart on the left, the yellow shaded areas and origin of supply zone lines (S&P 60 minute chart). This is a price level where willing supply exceeds willing demand. How do we know this? Simple, price could not stay at this level and had to decline away. Again, it declines because supply exceeds demand at that level. We wrap two lines around those levels and carry them forward because we want to remember where supply exceeds demand because that is where price is likely to stop rallying and turn lower in the future when it reaches that level.


Click to enlarge

This is a Bull Trap shorting opportunity for the following reason. Notice the chart on the right… This is a 15 minute chart of the S&P showing the price action inside the red circled area on the 60 minute. Notice the sideways trading followed by the breakout to the upside. Most novice/retail traders will buy this upside breakout because that is what they are taught to do and because as price is basing sideways, the assumption is that price will break higher which tends to get people thinking bullish.

A bit later, the breakout happens and a rush of buying came into the market as expected. However, that simply brought price up to larger time frame solid supply which is where the smart money is selling. Price then begins to decline and ends up falling fast because retail traders were caught on the wrong side of the market, a Bull Trap.

For this week, we would look for another shorting opportunity should the S&P trade up into that supply area. The same holds true for the NASDAQ. Just keep in mind that this would be the second time price would reach these levels of supply so the odds are not as strong as the first.

If you’re going to compete in the game of trading, make sure you have an edge or you will lose your money to someone who does. This game is a transfer of accounts from those who fall for professional “traps,” into the accounts of those who can identify “traps.” It’s the old hunter and the hunted. I do apologize if I have offended anyone with what may seem like harsh analogies but the truth is, I meant to send a strong message because the average person loses money trading and that’s not ok with me. They lose because they don’t have the edge the professional does and they don’t even know it. Learn to spot the difference between traps and opportunities.

Hope this was helpful, have a good day.

 









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