Yesterday, most of the potential setups from Sunday hit the support or resistance levels that were mentioned on the post. Thus, the question became, should I execute them or not?
I wanted to use to this post to discuss trade execution. As a result, not only will I review the price action of some setups, I will go in-depth into how I think about entering trades. This will be another long post, so get your coffee.
First, we need to discuss support and resistance. The better phrase would be “places where we expect a reversal“. These are levels where we expect buyers or sellers to a) overwhelm the market with bids or offers; and b) step in with more urgency.
The best support or resistance levels are the ones that are hit and the rebound is immediate and strong. Why? a) It means that the bids or offers are there with force; and b) It means that buyers or sellers (depending on whether we are at support or resistance) are also stepping in front of each other – with haste – to get in (meaning they’re also hitting the bid or lifting the offer). Price is getting away from the level fast because the “level of urgency” to get in is high.
In the world of support and resistance, below “the best support or resistance” level is the “great support or resistance” level. This is when the price lingers at the level before making a move. Why could this happen? Well, it means that the buyers could be absorbing supply at that level and vice-versa. If the level is good though, price will eventually start to move away. It’s still fact that the more aggressive the move from the level, the better the level.
Let’s use an example to convey this “great” support or resistance level. If you trade the futures market and use Market Delta, you can look at the trades going through in either the bid or the offer side of the market. Assume we’re at a support level for a market and a) the average trade in this market is 80-100 lots and b) big trades are 200-300 lots. You then start seeing 200-300 lots go through at the bid. You also see some 500 lot trades go through at the bid. Imagine if all of this is happening and the price is not moving lower. This means that there are some big buyers here. While price did not move immediately from the level, you better believe it that this level is probably good – at least for a period of time.
Brett Steenbarger of the TraderFeed blog (i.e. one of the best trading blogs on the internet, if not the best) wrote about this in 2006. (see his post explaining this example).
The point here is the following: if we specify a support or resistance level, price should at least hold there because there are solid bids or offers. The faster we move away from the level, the more trust we can have in that level.
So, this may seem obvious but I think it sometimes goes unnoticed: if we slice through a level, it means that we’re probably wrong!
Here is another obvious statement (which you’ve probably seen discussed in the trading world): the best trades will leave you behind if you don’t enter them immediately. When you think about the best type of support or resistance, it makes sense, right?
Great trades will give you a chance to get in. Price will either linger for a bit and possibly do a small retracement (probably in a smaller timeframe) somewhere close to that level again and you can jump on board.
Bad trades, as you might expect, will give you all the time in the world. Heck, if you’re looking to buy, it will probably give you a cheaper price! (i.e. you’re support level gets broken).
Okay, now that we got that out of the way, let’s look at some of the trade setups. Let’s start with Trade setup #2 (original post link) because this was almost a “best support level” setup.
As we can see on the 15-min chart of the EUR/USD, the pair hit the 1.1150s level, lingered for just a bit, and then took off for 100 pips. No pullbacks for those who didn’t just jump in. Thus, unless we had faith in the setup or got in as it started to go, we missed out.
Now let’s think about stop losses because people will usually ask me that question. Considering the discussion above about support and resistance and the fact that I was looking for 1.1150s to hold, where do you think my stop-loss would be? If the 1.1150s level is good, my stop-loss should not be below 1.1120/30 at best. You give 20-30 pips in case we get some type of spike due to a short-term imbalance or large trade that goes through.
Now let’s move to a setup that worked and kind of gave you a second chance to get in. I posted this GBP/AUD one on Twitter yesterday:
— Rafael Rosa (@RemixTrades) September 28, 2015
This is how it turned out:
We got a pullback (circled) to the 15-min block (or very close) that we would have expected to hold. This was a great trade but it was not a “best trade”. The best trade was long EUR/AUD! The EUR/GBP was flying to new highs and the Cable kind of fizzed out as the day went by (we’ll get to the Cable setup in just a bit).
Nevertheless, note that GBP/AUD a) immediately rejected the original order block I had + moved fast away from it; and b) went to break the market structure off that order block. This “b” factor is very important. Not only did price move away from the OB, the momentum was enough to take out the previous swing highs on the 15-min chart.
Note: the best order blocks are those where the price action is sharp and it breaks market structure.
Alright, now let’s move to a setup that worked at first but then didn’t. I was looking to buy Cable targeting 1.5220s and possibly 1.5280s. We got a high of 1.5212 before it gave back everything.
So, we hit the order block (went pretty deep into it), rebounded, and broke minor structure. All in all, this looked good. It went a few pips from the primary target.
I’m using this example and the next to underline the following: while we may be right about a level, the bigger picture doesn’t always help us – and should we stick around if we see that? European markets were selling off hard yesterday and the general sentiment was risk-off. The Pound has been under-performing in risk-off environments.
Thus, at that point where the Pound is back to the critical level again, the best option is to get out. Sometimes I’ll jump out of trades and people don’t quite get it. Why not stick around? The pair rebounded off the original level, did it not?
Well, it did, but the follow through was weak. The S&P mini also broke key support (1900). We also had lower highs on the Cable chart. Had we taken out the day’s high off the first rebound of 1.5160s, then the story might have been different.
Now let’s look at a setup that also failed but I stuck around. The USD/CAD did almost everything I wanted at first – it jumped above 1.3350, hit the 1.3370s order block, and then went as low as 1.3330.
What did it not do? It never broke the market structure by taking out that swing low (15-min chart; dotted line shown below) at 1.3319.
So why did I stick around? I was thinking that oil would do the trick. I shared this chart of WTI with a colleague yesterday.
My thesis was: as long as oil holds that order block, I’ll give this USD/CAD a chance. Guess what happened? Oil held the order block and is up 2% today!!! However, that didn’t help me and I still lost out on the trade. The correlation didn’t hold.
There are a few points on this trade: first, I’ll sometimes stick around if the inter-market analysis is compelling. Of course, it doesn’t always work.
Second, we can see that USD/CAD could not break the market structure (and if you look closely, it held a bullish order block on the 15-min timeframe). If you look at both the GBP/AUD and EUR/USD examples, they both managed to break structure off the order block. Additionally, and this can be important, they managed to make new highs for the day on that push. That’s another thing to look at – when we break structure and make new highs for the day – that’s a good sign. That’s another tally for “this may work” column.
Now let’s look at a setup that just completely failed – CAD/JPY. This was also my “favorite” setup on Sunday.
I was expecting the beige order block to hold. Did I buy?
Well, price sliced through the thing as if it was hot butter. If we go back to the whole support discussion, you would know that I was dead wrong on the level. No buyers whatsoever and we immediately sold off on the re-test from the bottom. This is when you immediately crumble up the paper you wrote the setup on and try to do a swoosh on the closest garbage can.
This applies to most of the setups on the JPY crosses. It didn’t even stop for a water break at the specified level. Look at NZDJPY – straight butter.
Now that we went from top to bottom quality in terms of setups, let’s take it back to the middle again. The Cable setup situation was also seen in a few other pairs. Aussie rebounded off .6990s for 40 pips and EUR/CHF rebounded nicely off the specified support.
I wanted to bring it back to these setups because these are the hardest ones to deal with (at least for me). I think this is also the place where most people get screwed. It’s as if the market is evil and wants to really stick the knife to you.
What happens is that your setup starts out perfectly – you get the reaction you want. You’re in the money just long enough so you get attached. Then, instead of either getting out or letting your stop-loss get hit when things turn sour, people move their stop-loss or something along those lines. The fact that it worked at first messes up the mind – you still want the trade to be a winner. It worked at first, so it has to be right, right? We know the true answer to that one. Even if you don’t change a stop-loss, these losses are the hardest. The “why didn’t I get out earlier” ghost hunts you with great enthusiasm.
At the end of the day, I think it’s always important to keep in mind what trade you’re in: is it the best trade, the great trade, or potentially the bad trade? I’ll finish it off with an example from today because it’s common for the “great trade” to become the bad trade (that’s where the Cable, Aussie, and EUR/CHF fit if you ask me).
During the European session, the AUD/JPY, the NZD/JPY, and the CAD/JPY crosses moved up sharply. Thus, all the commodity currency JPY crosses caught a bid. The AUD and NZD crosses never came back to the original order block. The CAD/JPY though, came back to the hourly block and gave you a “second chance” to get in. It then rallied 80 pips.
Of course, if you didn’t book those gains, they were completely wiped out. Maybe the CAD/JPY rallies from here, maybe it doesn’t. However, I know one thing for sure, the CAD/JPY was not the “best” trade out of the three. That pullback was a good opportunity for a day trade, yes it was. However, that pullback tells you something about the type of trade it is: It was a great trade (at best) that may potentially become a bad trade pretty fast.
I hope this post is helpful and adds some clarity on how I do things. And maybe this will give an additional way to think about trade entries.