The Bear Growls – Waiting for Setups
The ability to be patient when waiting for trading opportunities/setups to present themselves is an acquired skill. It takes a calm temperament and ability to stick to one’s method and trading plan no matter how long it takes to find a clearly defined risk/reward trade and then pull the trigger. Cutting through the noise of the daily news, talking head chatter, and opinion-makers that influence all of us is the battle traders face. Focus and timing are needed to be successful. And when an opportunity arrives, one needs to be ready. As Louis Pasteur said, “Chance favors the prepared mind”. Case in point, this past Friday/ Monday an opportunity in WTI crude oil presented itself (and in the energy service stocks as a result). The setup was the first challenge in price of the 200-day moving average to the downside in WTI crude oil since price broke above the 200 dma back in November 2020. It is the first challenge/test of a key moving average such as the highly followed 200 dma that has a higher success rate than subsequent tests of that level, and experienced traders know it and trade on it.
In many moving average setups, a key moving average will not actually be touched but the price will come close enough for a trade. Algo traders have programs that do it automatically, but the individual trader can still compete. In one tactic in the case of a down-trending market, a countertrend trader, upon seeing a key moving average being tested for the first time to the downside, can place a buy stop limit order above the closing price of the previous day’s trading bar to go long (or if need be the high of that bar). Upon execution of the trade, a sell stop-loss order is placed under the low of the previous day’s trading bar. Thus the risk is defined. If the trader is wrong the loss is taken, and then the trader moves on to trade another day.
WTI Crude went from a high of $76.98 back on July 6th to its low of $61.74 near the 200 dma on Monday, August 23, a $15.24 drop (-19.8%). Then prices reversed up taking out to the upside the previous Friday’s close then the high of that Friday’s bar, leaving what is known as an “outside up day” which is a bullish pattern. So it is here that reversal traders look for potential retracement levels to see what price objective makes sense for the counter-trend trade. If the trader is clearly bullish and believes that price is overdone to the downside a retracement of a Fibonacci 61.8% of the $15.24 drop would be an objective. If less bullish for the countertrend trade, the levels would be a Fibonacci 38.2% to 50% of that $15.24 drop as an objective. (Note that a 23.6% Fibonacci retracement in WTI happened on Monday upon the reversal in price, a significant move on the day). To be sure, nothing is ever written in stone when it comes to trading and that is why successful traders have a plan, have an objective based on that plan, and limit losses with stop-loss orders for when they and the trade are proven wrong.
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