The holy grail of trading the markets

Finding a way to identify high-probability positions that can be taken at low risk is the holy grail of trading.

I will therefore continue with this week’s theme – the FTSE – because it has been providing some great examples of how useful my methods are in forecasting market turning points. And this is what enables high-probability positions to be taken at a low risk.

They also allow for exit targets for your live trades to be forecast well in advance. No more fumbling around in indecision!

The method that can help identify these trades is measured by the reward/risk ratio. In my swing trading, I want to search out trades that carry a reward/risk ratio of at least three-to-one.

You should monitor several indexes

As we know, for the most part, global stock markets trade in synch. What is bullish for the Dow is likely to be bullish for the FTSE, and vice versa.

But they all have their distinctive chart patterns, and what may be a clear Elliott wave pattern in one index may be a muddy picture in another. That is why I monitor movements in several stock indexes.

On Wednesday, I showed this chart:

13-10-11-MWT01

The market had declined right into my hat where tramlines crossed in a clear five-wave pattern. This hat pattern is a powerful area of support and usually leads to a reversal.

How to set your downside target area

Note that I was able to set this as a downside target area several days before the low was in place on Tuesday.

I had all of the touch points available for my tramlines by Wednesday 2 October, when the last minor low was set.

The only one to be put in later was the Friday 4 October high for the upper tramline, but I already had the two major upper touch points from previous trading.

Let’s see if this target was indeed the low for the move. Here is the chart updated:

13-10-11-MWT02

That was spot on – and the target was derived solely from applying my tramline technique.

Traders then could have taken profits on short trades and even taken long positions, relying on the hat support to hold.

Now we have a post-crisis rally as there appears to be some kissing and making up in Washington. The sharp rally has broken above my upper tramline and has carried to the Fibonacci 38% retrace of the entire move off the 19 September high.

And it is now eating into a zone of overhead resistance:

13-10-11-MWT03

And momentum is overcooked (yellow highlight). The rally off the Tuesday low has an A-B-C feel to it, leading me to believe the rally should at least pause here, if not entirely reverse. The C wave is extended – a not uncommon event.

And since the rally has broken above the upper tramline, I would expect the market to drop down to test the line again anyway.

Verify your forecast using more than one stock index

The prognosis this morning is that a decline to the upper tramline is likely.

But what can another stock index tell me to verify this forecast?

Let’s look at the Nasdaq, which has held up well in the face of the sharp decline in the Dow off the 19 September high:

13-10-11-MWT04

It was as late as yesterday when then Nasdaq finally broke – and plunged below the short-term support of my centre tramline.

Note that the decline reversed very close to my lower tramline (with an overshoot, which is typical after a sharp move). Once again, my tramline method predicted this area after the centre tramline had been broken.

Now that the market has taken part in the relief rally, it has carried back to the centre tramline – and a Fibonacci 62% retrace of the move off the high – and into overhead chart resistance.

This is the moment of truth for both the FTSE and the Nasdaq – they have reached their respective critical points.

What is quite remarkable here is that these two disparate indexes (FTSE is full of UK-based mining and financial companies, while Nasdaq has many US high tech firms) have arrived at their own lines in the sand together – even though they show totally different chart patterns.

Last time, I wrote about market psychology and this morning, there is palpable relief at the news from Washington that Armageddon in markets seems to have been avoided (or is that postponed?). This is the news – and it followed the market!

So, will the markets now sell off in a ‘buy the rumour, sell the news’ move, and resume the downtrends?