During the overnight session on 02/20/2022 the following setup in Bitcoin presented itself. I decided to do this post because the setup is as textbook as they come! All comments in this post are referring to the hourly chart but these setups work on all timeframes.
First, price had experienced a sharp (impulsive) decline from 2/18-2/20. Price then rallied in the overnight hours on 2/20 but the rally looked corrective. A corrective looking rally consists of overlapping candles that don’t quickly retrace a significant amount of the previous move. When a corrective rally meets resistance it is very likely to reverse and move lower again. I use the 8 SMA bands to suggest what the current trend is. Since this post is referring strictly to the hourly chart then the current trend in Bitcoin on the hourly timeframe is lower. It’s possible that the trend on the longer-term charts such as daily and weekly could be in either an uptrend or a downtrend. You can’t tell from what I’m showing you here on the hourly chart. Since it doesn’t have any bearing on this particular hourly setup I won’t even show those longer term charts however, keep in mind, the potential for a strong directional move is greater if trades taken on the hourly chart are in the same trend direction as the daily chart is indicating!
On the chart below you can see that I was able to identify a potentially great location to initiate a short trade in Bitcoin while it was happening. The corrective looking rally had taken price back up into the declining upper band of the 8 SMA. That by itself is a good location for a short. The fact that price moved above the upper band and then reversed and dropped back below the upper band again is a good enough setup for me to take a short right then and there using the top of the spike high of that candle as the stop. That spike high was 39460 and at the time the upper band was 39315. That would’ve put me in a short trade with a 145 of risk. However, this post is about initiating a trade based on using the HB zone method. The HB zone is the 50%-61.8% retracement of a price range. At the close of the hourly candle (labeled #1) I placed a HB zone on that bearish reversal candle (long upper wick) and that set the range where a short trade could be initiated in the future. Again, on any short trade taken the 39460 high of the bearish reversal candle would be the stop level.
The chart below was from 7 hours later. The setup identified on the above chart in real-time had followed through as expected and a short trade would’ve been initiated in the 39325-39357 area. The actual high of the candle that triggered the short trade was 39335. The stop level of 39460 was 135 points away from the level that I would’ve entered the short trade so that was the total risk taken. The actual drawdown on the trade would’ve been just 10 points and the open profit at the time I’m writing this post would be 1,885. That’s 14 times of the risk taken!
All well and good on the trade entry but how do I manage that trade as price declines? It’s nice to have a profit but if I don’t have a strategy to protect that open profit I could give all of it (or more) back. 😬 I typically manage a trending trade by using the HB line (the white line with a dot). The dot is simply the Half-Back (midpoint) of the prior candle’s range. It’s a simple concept; in the case of this downtrend I’ll stay short as long as price is remaining below the prior candles midpoint. I allow for price to temporarily exceed the HB line as long as the candle closes below the line. If the line begins to flatten out then it’s generally indicating that the current trend is slowing or potentially reversing. That is an excellent time to consider DH’ing an open position. DH stands for Delta Hedge and it’s a strategy to reduce Delta (directional) risk as well as often offering the opportunity to take a position to a net $0 cost or even locking-in a profit while still maintaining the potential for future profits in the trade. So, as you can see in the above chart with the flattening HB line, now would be an excellent time to get to zero cost or lock-in that profit. Below is 2 ways to easily DH a position.
- If I bought a Put to initiate the short trade I could sell a further OTM (out of the money) Put for a Credit equaling or exceeding the Debit that I paid for the long Put. That would create a Put Vertical spread for $0 cost or a guaranteed profit.
- If I bought a Put Vertical Debit spread to initiate the short trade I could sell a further OTM Put Vertical spread for a Credit equaling or exceeding the Debit that I paid for the long Put spread. That would create a Put Condor spread for $0 cost or a guaranteed profit.
I’m back again and it’s a few hours later than the previous chart and Bitcoin just had a very strong bounce! If I had DH’d my position I’d still be in profit at this point but I’d now have to consider that the decline in Bitcoin has potentially ended and price is now transitioning into an uptrend. Why? Price has far exceeded the declining upper band and that’s typically indicative that the downtrend is over for now. However, I can add 2 new HB zones (one bullish and one bearish) to help me identify the motivation level of the buyer’s and seller’s at this point. That gives me very specific levels to trade against.
The chart below is from 4 hours later than the previous chart. Candle #1 was the original bearish reversal candle in this post and now we see two more bearish reversal candle’s forming and price making another leg down. Notice how the HB zone resistance from candle’s #2 and #3 line up (the 50% of one and the 61.8% of the other). Those reversal’s could have been used (in combination with being short if price is closing below the HB line) to initiate another short trade.
That’s going to end this post. There’s enough information here to help you see the various ways that you can gauge an instrument’s strength or weakness based on how it interacts with some important levels such as the 8 SMA bands, the HB zone support/resistance areas and the HB line. And just for fun, I’ve got one more chart for you to look at below. It’s one that you’d see on many trader’s monitors if you looked over their shoulder. It’s got a huge number of tiny candles and it’s got the ever popular RSI on there so they can see negative and positive “D”. 🙄 One question I like pose to traders who rely on RSI and MACD and whatever else is this; if RSI divergences really work as trading signals and probably 90% of traders have RSI on their charts, why do 90% of traders fail? Just asking for a friend.
