Students who follow the Discussion Forums might have noticed I recently posted “the market seems to be out to mug us at the moment! ”This reflected my frustration at some false breaks of first lower and higher swings.
Both the September low and October high on Commonwealth Bank (ASX:CBA) were strong turns in the market I was trading and I was planning to add to my position (perhaps too aggressively) on the first higher swing bottom after the September low and first lower swing top after the October high. Each of these was taken out by a more defined swing on the 2-day chart before running on strongly in the expected direction, as illustrated in Chart 1:
Chart 1: CBA with Swing Overlay
click chart to enlarge
After back-testing, I found that a 1-day first higher/lower swing will often (but not always) be taken out by the 2 day swing, which gives a better entry. I also found that sometimes a 1-day swing gives the only entry. The key is in the percentage retracement and I look for a retracement of 50-75% of that first swing before a strong move as highlighted in Chart 2. Having said that, I will still take a 1-day first higher/lower swing entry as sometimes this will be the only entry, but the difference is that in the future I will be ready to jump back in if I am kicked out.
Chart 2: CBA with 2-day SwingOverlay and % Retracement
click chart to enlarge
The next step is to go back to my written Trading Plan for CBA and edit it to include such a scenario. It would be nice to be able say I had back-tested this entry method well enough to have expected such a result. This is the benefit of back-testing in advance of trading. You won’t have every scenario covered but you will have more confidence in what you have seen and it’s cheaper than learning by experience!
Since these two turns we have seen a strong rally out of the 25 November low. This lined up nicely with a pressure date I was watching and was, perhaps, the start of a Christmas rally. You might like to read my article from late last year “All I Want for Christmas is a Piece of the Rally”. We are now sitting just above 50% of the yearly range and yet we have lower tops and lower bottoms on the swing chart. It could go either way! If the market pulls back into the gap to say 50% of the recent weekly range, then we might have a continuation of the Christmas rally into late December or early January, but I would be surprised if it took out the recent swing tops.
The market isn’t really out to mug us – it doesn’t even know who we are. But if we do our homework we will find the answer can almost always be found (with apologies to Dickens) in the ghosts of markets past.
It’s the Journey