Trade in the Best Zones

Online Trading Academy Article of the Week

Are You Getting In Too Far Out On The Curve?

by Rick Wright, Online Trading Academy

Hello traders! As I write this week’s article I am enjoying the late stages of a hot Texas summer. We are still having highs in the mid-90′s (Fahrenheit), with most of us wishing fall and winter would hurry up and get here. I have several friends and relatives who live out in Colorado, and so far parts of that beautiful state have skipped fall and have already had snow. Welcome to winter!

Looking at a few charts, I am drawn to a question that often comes up in our Online Trading Academy classes: Is it still too late to join this move?

An interesting analogy would be to look at buying clothing. Being late September as I write this, it wouldn’t make a lot of sense for me to go to clothing stores and shop for shorts and t-shirts for upcoming hot weather. It’s a bit late for that! Obviously, fall and/or winter clothing would be much more appropriate for this time of year. Buying shorts and t-shirts for the few remaining warm days would be similar to buying a currency pair after a long move to the upside-especially into a supply zone!

Take a look at the following chart.

At the point labeled “1,” I’m sure numerous traders bought on the breakout past the most recent high. Looking at the chart, are prices expensive or cheap there? Obviously, expensive! We call this buying retail prices. The chart had been moving up for weeks, yet some traders thought it was going to continue moving up to the moon! Now take a look at point labeled “2.” This is the same, but the opposite. Many traders sold short the break below the most recent low, expecting a continued move to the downside. Selling to enter a trade after a longer term move to the downside, especially into a previous demand zone, are two of the mistakes that many new traders make. Selling way down there is selling very cheap – we call that a wholesale price. You probably wouldn’t go shopping for a whole new summer wardrobe with only a week’s worth of warm weather left would you? Why would you buy (or sell) something that already had a huge move in that same direction?

Actually, I know why. By now you’ve heard of the two main driving emotions in trading – fear and greed. Many new traders will buy after a long move up because they are too greedy; “If I don’t get into this trade now, I’ll never have a chance and it will go on without me forever!” Some may also see the emotion of fear in this trade. “If I’m not on this move, I’ll never make it as a trader, I have to make money now, it’s been going up and I must be on board or I will fail as a trader!”

There are numerous problems with those thoughts. The main is that your career is not defined by being in one trade (unless you are an over-leveraged hedge fund manager who has one lucky trade and you hang your hat on that trade for years. Which is a funny conversation in class!)

So how can we fix the problem of entering a trade too far “out on the curve”? One simple way is to break the chart up into horizontal sections. What I’ve done in the following chart is to use the Fibonacci Retracement tool, but customized the percentage lines. Using the major swing high in early February and the lows formed in April the chart has been broken into thirds. The top third can be considered retail prices, the bottom would be wholesale prices, and the middle is where we don’t enter trades, but just manage them.

A few suggestions before you apply this to your charts. First, you must know what your time frame is to draw this breakdown on. If you are a short term daytrader, drawing in these sections on a daily chart would make no sense. In our classes we suggest watching at least two time frames if not three. I would draw this measurement on my highest time frame.

Second, it will take a little bit of practice to recognize the major swing highs and lows to draw from. It might be obvious to you by now that this technique is primarily designed for sideways markets. If you draw these sections on trending markets you will probably be waiting for many, many candles to happen before a trade presents itself!

Third, if you find yourself unhappy with breaking the chart into thirds, you could certainly try quarters. The bottom quarter would be wholesale, top quarter retails, and the middle half is only to manage a trade and not for entry.

Hopefully this technique will keep you from chasing too many trades, otherwise known as buying retail and selling wholesale!