high probability trades

8/3/2019 High Probability Trades

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gH-probability trades

Timothy Morge

m m fu k

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High-probability Trades

edge

http://www.ytemagazine.com/




HigH-probability trad

Mar/apr 2011 yoUr TRADINGedge 39

n my opinion, price shows repeatablepatterns. You must pay close attention to spotthe patterns. Once you detect them, you cankeep track of them and use them to conductstatistical analysis. Study many charts ofmany instruments over many timeframes andmark the patterns when you see them. Afteryou have found one to two hundred, take acloser look to see if the pattern leads to a

repeatable outcome most of the time. Such apattern is potentially tradeable.

I have found that all I need are a feweasy-to-spot, repeatable patterns that I canconsistently trade profitably. Find a few thawork, use solid money management andthen get down to business. I work the samehandful of patterns over and over, and thinkof it as 'making the donuts'.

i

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http://slidepdf.com/reader/full/high-probability-trades 3/5 yoUr TRADINGedge Mar/apr 201140

gH-probability trades

Let me show you a simple trade in the

CME Australian Currency Futures market

(the Australian Dollar against the US Dollar

futures contract), built around a simple but

powerful pattern, which I call a 'failure'.

Failures are patterns that appear when

price has built up a good deal of energy and

then breaks above a major recent swing

high or an area of tested resistance; on the

down side, failures appear when price has

built up a good deal of energy and then

breaks below a major recent swing low oran area of tested support.

Why is the pattern called a failure? Let

me finish the description: after breaking

above or below major resistance or support,

when price is full of energy and ready to

make a huge run in the direction of the

breakout, it makes only a small breakout

and then congests – and heads right back

below the prior highs or above the prior

lows. Price ‘failed’ to use its stored energy

in the predictable manner.

Most traders get caught holding a position

based on the breakout. When the breakout

fails, they are left with a losing positionand must find a way to exit. Some of the

largest, most easy to spot moves come

after failures. I look for them, trade them

when the risk/reward is acceptable and find

them very profitable.

Figure 1 shows a chart setting up the

CME.

Green boxes on figure 1 show two failures.

I don't necessarily look for more than one

failure, but as I was doing my morning pre-

market chart work I spotted the first failure

and then noticed the second failure, which

looked remarkably similar.

In figure 1 price shows a nice uptrend,with a steep upward sloping line of force.

Then price levelled off as it ran low on

upside directional energy; it congested for

quite some time, leaving multiple highs,

before selling off a bit. You can see it wasn't

a deep pullback: as price sold off it made a

wide range bar spike lower, but the spike

bar closed back near its highs. This was

a sign that there were probably new limit

entry buy orders built up in that area, left

by traders anticipating a pullback. Price

rallied a bit and then sold off again, but it

stopped at the same area, leaving double

bottoms. There were now many limit buyentry orders, most likely left by the 'whales'

(very large traders) in this time zone, at this

level. I marked this area of limit buy orders

with a magenta multi-pivot line.

Once it was clear there were good limit

buy entry orders in that area, price began a

near vertical rally, easily breaking above the

multiple highs from its earlier rally. I marked

these highs with a black multi-pivot line.

Breaking above the black multi-pivot line,

price should be headed for a major rally. All

the pieces were in place:

• Price had congested and restored its

energy;• Price had sold off and had seemed to

find limit buy orders left by 'whales'.

The existence of these large buy orders

was confirmed with a nice retest of the

same area;

• When price broke above the overhead

resistance marked by the black multi-

pivot line, stop-loss buy orders left by

traders who had shorted this market

began to be executed and the stop-buy

entry orders left by the breakout traders

were also executed, adding more fue

to the fire.

This market had everything it needed foan explosive rally. Yet it was only able to

make a brief rally above the black multi

pivot line before price congested a bit, and

then sold back off. It is interesting to note

that the multi-pivot line gave no support as

price headed back lower – generally, tested

resistance, once broken, acts as support.

Quite a nice selloff came directly after the

first failure. It was fuelled by traders who

had gone long on the breakout to new highs

and who now had to exit their long positions

at a loss. Price approached but did not tes

the magenta multi-pivot line, where the

whales had been buying earlier. When pricerallied after the initial selloff, there were

good limit sell orders sitting in the market as

price approached the black multi-pivot line

from below – so the area was once again

acting as solid resistance. In my opinion

the whales had switched from buying to

selling and had no problem spotting the

likely overhead resistance, which was now

a good area in which to leave new limit sel

entry orders.

Price failed to rally enough to test the

FigUre 1: aUstralian dollar versUs Us dollar 20-Min casH Forex 24-sessioncH




overhead resistance and so a fresh selloff

began. Price congested a bit around the

magenta multi-pivot line, but once it was

clear the magenta multi-pivot line wasn't

going to act as solid support there was hard

selling, with price eventually breaking below

the prior lows that had spawned the initial

rally (the double bottoms on the far left of

the chart).

After this near-vertical fall, price ran out

of downside directional energy and a new

rally began. The rally was nearly vertical,testing the magenta multi-pivot line before

finding any willing sellers. Price pulled back,

restoring its energy, and then approached

the magenta multi-pivot line, this time

breaking through the overhead resistance.

Once again, all the conditions for a

significant rally were in place:

• Price was making higher highs and

higher lows, convincing traders a change

in behaviour may have occurred in the

form of a new trend higher;

• Price congested in a narrow trading

range, restoring its energy, so it should

have been full of upside directionalenergy;

• Price broke and held above the overhead

resistance, marked by the magenta

multi-pivot line;

• When price cleared the overhead

resistance, stop-loss and stop-entry

buyer orders were triggered, adding

additional fuel to the fire for an upside

rally from this area.

Figure 2 shows the results. Price had a

limited upside rally and then pulled back

to test the magenta multi-pivot line from

above. The multi-pivot line acted as support

and price began a new rally, but it fell shortof the recent swing high. Price then turned

lower, and the magenta multi-pivot line gave

no support this time, sending price lower in

a near-vertical selloff.

With price in a vertical selloff, I added a

modified Schiff median line, which generally

does a much better job than the traditional

median line in capturing the probable path

of price in this type of near-vertical move. I

used the highest high of the first failure, the

major swing low, and the right swing high

of the second failure, as my pivots for the

median line, and shifted the 'A' pivot 50 percent down towards the 'B' pivot and 50 per

cent to the right towards the 'B' pivot to form

a modified Schiff median line.

I always try to think ahead of all the

possibilities when I trade – I call this ‘using

the language of price'. I added the new

down-sloping median line to help me

anticipate the probable path of price: when

price sells off vertically, it often performs a

'pendulum pullback', giving traders who use

the 'language of price' an ideal opportunity

to attempt a short entry. If price pulls back to

test the down-sloping upper parallel, there

should be a good number of limit sell entryorders left by the whales at the magenta

multi-pivot line; if price rallies and fails to

break above the magenta multi-pivot line,

another leg lower should begin. This new leg

lower was coming after a second attempt to

form a significant rally, and in both cases,

the results were failure patterns.

Price did rally to test the upper parallel

of the modified Schiff and then congested

around the magenta multi-pivot line as the

limit entry sell orders were filled. When price

began to break below minor swing lows (in

the language of price, 'look left, be right!'), framed out my potential trade as follows.

I want to sell a re-test of the upper paralle

at 9812. My initial stop loss is above two

prior swing highs (look left, be right!) a

9836. My first quandary is that I can see

at least three logical areas to use as profi

targets. The first would be a test of the

modified Schiff median line. Dr. Andrews

original work at MIT and my own body o

statistical work show that price will reach

the median line 80 per cent of the time

This is the easiest choice and the leas

aggressive – I call it 'Andrews 101'. The

second potential profit target would be atest of the prior major swing low – many

traders leave limit buy orders to take profits

at prior major lows. But because price has

tried to rally twice, and both times the rallies

resulted in failure patterns, I expect price to

fall quite a bit further, to the lower paralle

Any of the three profit targets makes good

trading sense – it is from intuition and style

that I choose the lower parallel for my

potential profit target.

Mar/apr 2011 yoUr TRADINGedge 41

HigH-probability trad

FigUre 2: aUstralian dollar versUs Us dollar 20-Min casH Forex 24-sessioncHart – l




Fter tHe Flood

yoUr TRADINGedge Mar/apr 201142

As I frame out my potential trade, I

check to make sure the size of the initial

stop-loss order is within my risk tolerance:

I am initially risking 24 ticks and that's a

normal-sized risk for me in this market

and timeframe. It's important to note that I

hid my stop-loss order behind key market

structure, two prior swing highs, because

there should be additional limit sell orders

at these swing highs, and the orders should

slow any rally, helping to protect my stop-

loss orders.

If I run my chart cursor right below my

limit entry sell order, I see my potential profit

target is at 9622, so I am risking 24 ticks

to make a potential 190 ticks, giving me

a risk/reward ratio of 8 to 1, which is very

good. One of my earliest mentors, Amos

Hotstetter of Commodities Corporation

fame, taught me never to take trades with a

risk/reward ratio lower than 2 to 1, and that

advice has served me well over my more

than 40 years as a professional trader and

money manager.

This trade has all the things I look for

in a quality trade set up. I double-checkmy orders and then put both my limit sell

order and my initial stop-loss order into the

market at the same time. I always enter my

initial stop-loss order at the same time as

I enter my limit entry order, because if the

unexpected happens, I am protected (as

Amos would say, 'Keep the cheese, just let

me out!'). I won't enter my potential profit

order unless and until my limit entry sell

order is executed.

Price did rally (figure 4) to re-test the

upper parallel, and my limit sell entry order

was easily filled at 9812 – but my initial

stop-loss order was never in danger of

being executed. Price then began to dropquickly. After I had roughly 50 ticks of profit

in the position, I cancelled my initial stop-

loss order and began working a breakeven

stop order. Price easily broke through the

modified Schiff median line, but, as Dr

Andrews’ original work predicted, it soon

re-tested the median line from below (I call

this pattern a 'zoom and re-test'). Though

price broke briefly above the median line,

it soon turned lower and made a new low

for the move. This is important, because it

confirmed the high of that brief move back

above the median line as a new swing high.

I quickly cancelled my breakeven stop orde

and began working a profit stop order above

this new swing high (where there shouldnow be new limit sell entry orders sitting).

At the lower parallel, the chart shows tha

as each bar closed, I measured where price

would intersect with the lower parallel and

continually lowered my profit order. This

means that the more time passes, the more

profit I earn if price reaches my profit target

Any time you have an open position, you

are subject to unexpected events that migh

have a negative effect on your position, so

the longer you are in an open trade, the

more you need to be paid for taking this

risk.

FigUre 3: aUstralian dollar versUs Us dollar 20-Min casH Forex 24-sessioncHart – My trade plan



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