I’ll pass on many average setups to wait for a good setup. What’s a good setup? I have several tools that I use to identify good location for a trade; the upper or lower band of the 8 SMA is one, the High, Half-Back (HB), and Low of a prior period (hourly, day, week, month, year) is another, and the 50%-61.8% retracement (I refer to that as the HB or Fib zone) of a potential reversal candle is another important tool. It works on any time frame and on any instrument. That’s what I’ll address in this post.
Below is the daily chart of /BTC (Bitcoin futures). It was easy to identify 11/10/2021 as a potential bearish reversal. However, I look for some confirmation that it is indeed a reversal plus I don’t want to get short at the close of a potential reversal candle because in almost all cases that is not great location for a new trade. I placed a 50% – 61.8% retracement resistance zone on that potential reversal candle with the plan of initiating a short (bearish) trade between 64,768 and 65,515 at a future time. Maybe it’ll happen the next day. Maybe the next week. Maybe it won’t reach that zone at all and just move lower. Ok, then I miss a trade. It happens! Better to miss a good trade than to keep getting bad trade location in multiple trades! In this particular instance it took 3 days for the short trade to trigger. Once that trade is initiated I put a hard stop at 1 tick above the high of the reversal candle. No exceptions to that rule! That setup would’ve been a nice short trade. See the chart below.
Below is the daily chart where /BTC had a potential bullish reversal candle on 1/24/2022. Price did not come back to test the Fib retracement support zone in the following few days. It sure looked like I would’ve missed the rally! Patience was really needed here!!! It took 22 days for price to come back to test the support zone. There was an overthrow of that support area but the sell stop was never triggered. That’s why it’s important to leave the zone on the chart until it’s tested or invalidated. Looks like I wouldn’t have missed the rally after all! Again, mind your stop!
Finally, let’s take a look below at the current price action in /BTC. There was a potential bullish reversal candle on 5/12/2022 that has not been tested yet. That’s likely going to happen in the near future. No guarantees though, right? I just want to be prepared and know how I’d trade it IF that does happen. The support zone is 26,344-26,905 so that’s a target for price to reach. There will be buyer’s waiting in that zone! The question is; will they be strong enough to turn price higher or will they get run-over by the sellers? Here is my interpretation of the current price action. If buyer’s were strong then price should have rallied hard after the failed breakdown below last year’s low! Failed breakdowns are typically very bullish and often trigger a strong rally! Looking at the anemic ‘rally’ over the past couple of weeks hardly screams bullish, right? If price does drop down to test the support zone that means it will have fallen back below last year’s low again! To me that is a huge clue that buyer’s are not motivated at all. If they’re not interested in ‘loading the boat’ at last year’s low (a very important level) why should I expect that the support zone of the 5/12 candle will provide that motivation? The one other, less important, clue is from the reversal candle itself. That was a relatively uninspiring reversal as price didn’t even close in the green and the close remained below last year’s low. Putting all of those clues together, I’d expect to see price test the support zone soon but fail to find support there and likely head lower falling below the low of the 5/12 candle. That would completely invalidate it as a bullish reversal and open the door to more downside price action!
The lesson here is to draw the 50% and 61.% Fib levels of potential reversal days on the chart. If it’s a potential bullish reversal you start the Fib drawing at the bottom of the candle and draw to the top. If it’s a potential bearish reversal candle you start the Fib drawing at the top of the candle and draw to the bottom. Keep that support or resistance zone on the chart until price invalidates it by braking through the level and moving through the stop level of the reversal candle. That invalidates the setup. Be patient! Sometimes price can take days or even weeks before testing the Fib retracement zone. And above all, use the stop!!!!
Update #1: As I was looking at some other charts just after I made this post I noticed a good short setup on /CL (crude oil futures) from 5/31/2022. Or was it really a good short setup? There was clearly a potential bearish reversal candle with a very long upper wick but the 8 SMA bands were strongly sloping up which means price is in an uptrend. Do I take short setups in an uptrend? I do but I use a much shorter leash on them. A good target of a short taken in the 5/31 resistance zone would have been the rising lower band of the 8 SMA which was reached almost exactly at the low 2 day’s after the reversal! The close of the candle 2 day’s after the reversal brought price right back to within $.02 of the 61.8% retracement of the 5/31 reversal candle. Funny how that works, isn’t it? At that point, even though price hadn’t triggered the 119.98 high stop, I think we can agree it would not be advisable to be holding a short position!
Update #2: Here’s another good example from 10/21/2022. There was a ‘news’ reaction where the price of /ES (S&P 500 futures) rallied 56 points in less than 1 hour. Even after a huge rally like that price still pulled-back to exactly the 50% retracement level of the breakout on the following candle to offer great location for a bullish trade.
Here are 2 other posts you may find interesting if you like learning more about chart and price action analysis: Fib Levels or Patience is a Virtue and Understanding Price Action.
Questions or comments? Leave them down below. š