On 3 February, I showed the large wedge pattern:
I noted that if the market could drop into the danger zone and break the lower wedge line, it would probably indicate a downtrend. In the interim, the market did indeed trade down to this zone. But then it staged a rally.
Here is the hourly chart showing a close-up of the recent action:
The rally only carried to the underside of the tramline in a kiss. As I write, the market is peeling away from this kiss. The normal action following a kiss is a ‘scalded cat bounce’ – a sharp move away from the wedge line.
So this is setting up the probability that the decline will resume. But are there any other clues that can help firm up my forecast?
Finding the ‘Chinese hat’
I have been searching for a good tramline pair using the 1.39 high as a touch point, but none made any sense. Then I asked what would happen if I ignored the spike move to this high and instead use the second high as a touch point. That would cut off the spike and leave it as an overshoot, which is within my tramline rules.
And this is the result:
I have three accurate touch points on the upper line, which is satisfactory. The lower line is a little problematic and I could have placed it slightly higher with just as good a result. But it is the upper line that is in play.
Now I have an area where two tramlines from different time-frames meet in a crossover. This area where my upper tramline crosses the up-sloping wedge line is very important. It’s an area of very high resistance, since both lines represent strong resistance. I call this crossover a ‘Chinese hat’ for obvious reasons.
This pattern reinforces my idea that the market should now trend lower. But is there any other clue that can shine more light on this question?
Will the market trend lower?
I have drawn in the Fibonacci retrace levels of the wave down from the 1.39 high and the recent low. And the market has just hit the Fibonacci 50% level on the nose. I am using the spike high (which I ignored when drawing my tramlines) because I always start with the most recent significant high and low as pivot points.
The 50% level is a common area for a reversal – if the rally up is a counter-trend move.
Putting all of these clues together I have this scenario:
• A recent kiss on the wedge line, indicating a down move
• A reversal at a Chinese hat (strong resistance) on the tramlines
• A Fibonacci 50% retrace of a strong down move from the 1.39 high
This is a strong case for the market to trend lower.
And the move up to the 50% level was the area to take the trade at low risk. Your protective stop could be placed just above the high. The confluence of the three resistance levels at 1.3680 gave a pin-point entry level for a trade. This provides an excellent example of how you could have managed the trade.
This is no place for ego
Of course, there is no guarantee that the trade will be successful. We are always dealing with probabilities. But the more evidence you can accumulate to build a case for a trade, the greater the number of winners you will have. Over time, your trading record should be profitable if you approach trading with this attitude.
One trade should not determine your long-term success. Having too much emotional stake in being ‘right’ on a market is a hindrance to your performance. So be even-handed in your trades. Some beautifully-researched trades will go wrong. That is a fact of life. And some will go spectacularly right. But don’t let them go to your head. There is no place for ego in the trading arena!
On Monday, I asked you a question. I had a long Dow trade working and it had reached an important Fibonacci retrace level. How should I handle this profitable trade? I shall discuss this on Friday because it goes to the heart of the management of your trades. It’s an aspect of trading that mostly determines your long-term performance. After all, it’s often said that the easiest part of trading is entering a trade, and the hardest part is exiting it.
If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:• The essentials of tramline trading
• Advanced tramline trading
• An introduction to Elliott wave theory
• Advanced trading with Elliott waves
• Trading with Fibonacci levels
• Trading with 'momentum'
• Putting it all together