مرکزی صفحہ Trading Price Action Trends: Technical Analysis of Price Charts Bar by Bar for the Serious Trader
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P1: OTA/XYZ P2: ABC JWBT576-fm JWBT576-Brooks October 18, 2011 1:8 Printer: Donnelly P1: OTA/XYZ P2: ABC JWBT576-fm JWBT576-Brooks October 18, 2011 1:8 Printer: Donnelly Trading Price Action TRENDS P1: OTA/XYZ P2: ABC JWBT576-fm JWBT576-Brooks October 18, 2011 1:8 Printer: Donnelly Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding. The Wiley Trading series features books by traders who have survived the market’s ever changing temperament and have prospered—some by reinventing systems, others by getting back to basics. Whether a novice trader, professional, or somewhere in-between, these books will provide the advice and strategies needed to prosper today and well into the future. For a list of available titles, please visit our Web site at www.WileyFinance.com. P1: OTA/XYZ P2: ABC JWBT576-fm JWBT576-Brooks October 18, 2011 1:8 Printer: Donnelly Trading Price Action TRENDS TECHNICAL ANALYSIS OF PRICE CHARTS BAR BY BAR FOR THE SERIOUS TRADER AL BR O O KS John Wiley & Sons, Inc. P1: OTA/XYZ P2: ABC JWBT576-fm JWBT576-Brooks October 18, 2011 1:8 Printer: Donnelly C 2012 by Al Brooks. All rights reserved. Copyright The first edition of this book, titled Reading Price Charts Bar by Bar: The Technical Analysis of Price Action for the Serious Trader, was published in 2009. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. C TradeStation Technologies, Inc. All rights reserved. All charts were created with TradeStation. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted ; under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data: Brooks, Al, 1952– Trading price action trends : technical analysis of price charts bar by bar for the serious trader / Al Brooks. p. cm. – (The Wiley trading series) “The first edition of this book titled, Reading price charts bar by bar : the technical analysis of price action for the serious trader, was published in 2009”–T.p. verso. Includes index. ISBN 978-1-118-06651-5 (cloth); ISBN 978-1-118-16623-9 (ebk); ISBN 978-1-118-16624-6 (ebk); ISBN 978-1-118-16625-3 (ebk) 1. Stocks–Prices–Charts, diagrams, etc. I. Brooks, Al, 1952– Reading price charts bar by bar. II. Title. HG4638.B765 2012 332.63 2042–dc23 2011029297 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 P1: OTA/XYZ P2: ABC JWBT576-fm JWBT576-Brooks October 18, 2011 1:8 Printer: Donnelly I would like to dedicate this book to my wonderfully kind daughter, Tess Brooks, who sees life as filled with opportunities and seeks them out around the world without hesitation. She is a bold, original thinker and a doer, and fills her life with the dreams that the rest of us have but are too afraid to pursue. P1: OTA/XYZ P2: ABC JWBT576-fm JWBT576-Brooks October 18, 2011 1:8 Printer: Donnelly P1: OTA/XYZ P2: ABC JWBT576-fm JWBT576-Brooks October 18, 2011 1:8 Printer: Donnelly Contents Acknowledgments List of Terms Used in This Book PART I xi xiii Introduction 1 Price Action 35 CHAPTER 1 The Spectrum of Price Action: Extreme Trends to Extreme Trading Ranges 55 CHAPTER 2 Trend Bars, Doji Bars, and Climaxes 59 CHAPTER 3 Breakouts, Trading Ranges, Tests, and Reversals 77 Bar Basics: Signal Bars, Entry Bars, Setups, and Candle Patterns 83 CHAPTER 5 Signal Bars: Reversal Bars 89 CHAPTER 6 Signal Bars: Other Types 101 CHAPTER 7 Outside Bars 155 CHAPTER 8 The Importance of the Close of the Bar 169 CHAPTER 9 Exchange-Traded Funds and Inverse Charts 173 CHAPTER 4 vii P1: OTA/XYZ P2: ABC JWBT576-fm JWBT576-Brooks viii October 18, 2011 1:8 Printer: Donnelly CONTENTS PART II PART III PART IV CHAPTER 10 Second Entries 177 CHAPTER 11 Late and Missed Entries 181 CHAPTER 12 Pattern Evolution 185 Trend Lines and Channels 191 CHAPTER 13 Trend Lines 195 CHAPTER 14 Trend Channel Lines 209 CHAPTER 15 Channels 219 CHAPTER 16 Micro Channels 249 CHAPTER 17 Horizontal Lines: Swing Points and Other Key Price Levels 269 Trends 275 CHAPTER 18 Example of How to Trade a Trend 289 CHAPTER 19 Signs of Strength in a Trend 307 CHAPTER 20 Two Legs 319 Common Trend Patterns 323 CHAPTER 21 Spike and Channel Trend 325 CHAPTER 22 Trending Trading Range Days 359 CHAPTER 23 Trend from the Open and Small Pullback Trends 383 P1: OTA/XYZ P2: ABC JWBT576-fm JWBT576-Brooks October 18, 2011 1:8 Printer: Donnelly CONTENTS ix CHAPTER 24 Reversal Day 415 CHAPTER 25 Trend Resumption Day 423 CHAPTER 26 Stairs: Broad Channel Trend 431 About the Author 437 About the Website 439 Index 441 P1: OTA/XYZ P2: ABC JWBT576-fm JWBT576-Brooks October 18, 2011 1:8 Printer: Donnelly P1: OTA/XYZ JWBT576-back P2: ABC JWBT576-Brooks October 12, 2011 2:38 Printer: Donnelly Acknowledgments My primary goal is to present a series of comprehensive books on price action that addresses the greatest concern among readers, which was how difficult my earlier book, Reading Price Charts Bar by Bar, was to read. I am deeply appreciative of all of the constructive comments that readers have provided and those from the participants in my daily live webinars. Many of these comments were incredibly insightful, and I have incorporated them in this current edition. I am also thankful to all of the traders who have been in my live trading room, because they have given me the opportunity to say things repeatedly until I could clearly articulate what I am seeing and doing. They have also asked many questions that have helped me find the words to communicate more effectively, and I have put those words into these books. I would like to give a special thank-you to Victor Brancale, who spent long hours proofreading the manuscripts and providing hundreds of very helpful edits and suggestions, and to Robert Gjerde, who built and administers my website and has given me candid feedback on the chat room and the website. Finally, I want to thank Ginger Szala, the Group Editorial Director of Futures magazine, for giving me ongoing opportunities to publish articles and speak in webinars, and for regularly giving me very helpful advice on how to become more involved with the trading community. xi P1: OTA/XYZ JWBT576-back P2: ABC JWBT576-Brooks October 12, 2011 2:38 Printer: Donnelly P1: OTA/XYZ JWBT576-LOT P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly List of Terms Used in This Book All of these terms are defined in a practical way to be helpful to traders and not necessarily in the theoretical way often described by technicians. always in If you have to be in the market at all times, either long or short, this is whatever your current position is (always in long or always in short). If at any time you are forced to decide between initiating a long or a short trade and are confident in your choice, then the market is in always-in mode at that moment. Almost all of these trades require a spike in the direction of the trend before traders will have confidence. barbwire A trading range of three or more bars that largely overlap and one or more is a doji. It is a type of tight trading range with prominent tails and often relatively large bars. bar pullback In an upswing, a bar pullback is a bar with a low below the low of the prior bar. In a downswing, it is a bar with a high above that of the prior bar. bear reversal A change in trend from up to down (a bear trend). blown account An account that your losses have reduced below the minimum margin requirements set by your broker, and you will not be allowed to place a trade unless you deposit more money. breakout The high or low of the current bar extends beyond some prior price of significance such as a swing high or low, the high or low of any prior bar, a trend line, or a trend channel. breakout bar (or bar breakout) strong trend bar. breakout mode through. A bar that creates a breakout. It is usually a A setup where a breakout in either direction should have follow- breakout pullback A small pullback of one to about five bars that occurs within a few bars after a breakout. Since you see it as a pullback, you are expecting the xiii P1: OTA/XYZ JWBT576-LOT xiv P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK breakout to resume and the pullback is a setup for that resumption. If instead you thought that the breakout would fail, you would not use the term pullback and instead would see the pullback as a failed breakout. For example, if there was a five-bar breakout above a bear trend line but you believed that the bear trend would continue, you would be considering shorting this bear flag and not looking to buy a pullback immediately after it broke out to the downside. breakout test A breakout pullback that comes close to the original entry price to test a breakeven stop. It may overshoot it or undershoot it by a few ticks. It can occur within a bar or two of entry or after an extended move or even 20 or more bars later. bull reversal A change in trend from a downtrend to an uptrend (a bull trend). buying pressure Strong bulls are asserting themselves and their buying is creating bull trend bars, bars with tails at the bottoms, and two-bar bull reversals. The effect is cumulative and usually is eventually followed by higher prices. candle A chart representation of price action in which the body is the area between the open and the close. If the close is above the open, it is a bull candle and is shown as white. If it is below, it is a bear candle and is black. The lines above and below are called tails (some technicians call them wicks or shadows). chart type A line, bar, candle, volume, tick, or other type of chart. climax A move that has gone too far too fast and has now reversed direction to either a trading range or an opposite trend. Most climaxes end with trend channel overshoots and reversals, but most of those reversals result in trading ranges and not an opposite trend. countertrend A trade or setup that is in the opposite direction from the current trend (the current always-in direction). This is a losing strategy for most traders since the risk is usually at least as large as the reward and the probability is rarely high enough to make the trader’s equation favorable. countertrend scalp A trade taken in the belief that there is more to go in the trend but that a small pullback is due; you enter countertrend to capture a small profit as that small pullback is forming. This is usually a mistake and should be avoided. day trade A trade where the intent is to exit on the day of entry. directional probability The probability that the market will move either up or down any number of ticks before it reaches a certain number of ticks in the opposite direction. If you are looking at an equidistant move up and down, it hovers around 50 percent most of the time, which means that there is a 50–50 chance that the market will move up by X ticks before it moves down X ticks, and a 50–50 chance that it will move down X ticks before it moves up X ticks. P1: OTA/XYZ JWBT576-LOT P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK xv doji A candle with a small body or no body at all. On a 5 minute chart, the body would be only one or two ticks; but on a daily chart, the body might be 10 or more ticks and still appear almost nonexistent. Neither the bulls nor the bears control the bar. All bars are either trend bars or nontrend bars, and those nontrend bars are called dojis. double bottom A chart formation in which the low of the current bar is about the same as the low of a prior swing low. That prior low can be just one bar earlier or 20 or more bars earlier. It does not have to be at the low of the day, and it commonly forms in bull flags (a double bottom bull flag). double bottom bull flag A pause or bull flag in a bull trend that has two spikes down to around the same price and then reverses back into a bull trend. double bottom pullback A buy setup composed of a double bottom followed by a deep pullback that forms a higher low. double top A chart formation in which the high of the current bar is about the same as the high of a prior swing high. That prior high can be just one bar earlier or 20 or more bars earlier. It does not have to be at the high of the day, and it commonly forms in bear flags (a double top bear flag). double top bear flag A pause or bear flag in a bear trend that has two spikes up to around the same price and then reverses back into a bear trend. double top pullback A sell setup composed of a double top followed by a deep pullback that forms a lower high. early longs Traders who buy as a bull signal bar is forming rather than waiting for it to close and then entering on a buy stop at one tick above its high. early shorts Traders who sell as a bear signal bar is forming rather than waiting for it to close and then entering on a sell stop at one tick below its low. edge A setup with a positive trader’s equation. The trader has a mathematical advantage if he trades the setup. Edges are always small and fleeting because they need someone on the other side, and the market is filled with smart traders who won’t allow an edge to be big and persistent. EMA See exponential moving average (EMA). entry bar The bar during which a trade is entered. exponential moving average (EMA) The charts in these books use a 20-bar exponential moving average, but any moving average can be useful. fade To place a trade in the opposite direction of the trend (for example, selling a bull breakout that you expect to fail and reverse downward). failed failure A failure that fails, resuming in the direction of the original breakout, and therefore a breakout pullback. Since it is a second signal, it is more P1: OTA/XYZ JWBT576-LOT xvi P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK reliable. For example, if there is a breakout above a trading range and the bar after the breakout is a bear reversal bar, if the market trades below that bar, the breakout has failed. If the market then trades above the high of a prior bar within the next few bars, the failed breakout has failed and now the breakout is resuming. This means that the failed breakout became a small bull flag and just a pullback from the breakout. failure (a failed move) A move where the protective stop is hit before a scalper’s profit is secured or before the trader’s objective is reached, usually leading to a move in the opposite direction as trapped traders are forced to exit at a loss. Currently, a scalper’s target in the Emini of four ticks usually requires a six-tick move, and a target in the QQQQ of 10 ticks usually requires a move of 12 cents. false Failed, failure. five-tick failure A trade in the Emini that reaches five ticks beyond the signal bar and then reverses. For example, a breakout of a bull flag runs five ticks, and once the bar closes, the next bar has a low that is lower. Most limit orders to take a one-point profit would fail to get filled since a move usually has to go one tick beyond the order before it is filled. It is often a setup for a trade in the opposite direction. flat Refers to a trader who is not currently holding any positions. follow-through After the initial move, like a breakout, it is one or more bars that extend the move. Traders like to see follow-through on the next bar and on the several bars after that, hoping for a trend where they stand to make more profit. follow-through bar A bar that creates follow-through after the entry bar; it is usually the next bar but sometimes forms a couple of bars later. fractal Every pattern is a fractal of a pattern on a higher time frame chart. This means that every pattern is a micro pattern on a higher time frame and every micro pattern is a standard pattern on a smaller time frame. gap A space between any two price bars on the chart. An opening gap is a common occurrence and is present if the open of the first bar of today is beyond the high or low of the prior bar (the last bar of yesterday) or of the entire day. A moving average gap is present when the low of a bar is above a flat or falling moving average, or the high of a bar is below a flat or rising moving average. Traditional gaps (breakout, measuring, and exhaustion) on daily charts have intraday equivalents in the form of various trend bars. gap bar See moving average gap bar. gap reversal A formation in which the current bar extends one tick beyond the prior bar back into the gap. For example, if there is a gap up open and the second bar of the day trades one tick below the low of the first bar, this is a gap reversal. P1: OTA/XYZ JWBT576-LOT P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK HFT xvii See high-frequency trading (HFT). higher high higher low A swing high that is higher than a previous swing high. A swing low that is higher than a previous swing low. higher time frame (HTF) A chart covering the same amount of time as the current chart, but having fewer bars. For example, compared to the day session 5 minute Emini chart on an average day, examples of higher time frame charts include a 15 minute chart, a tick chart with 25,000 ticks per bar, and a volume chart with 100,000 contracts per bar (each of these charts usually has fewer than 30 bars on an average day, compared to the 81 bars on the 5 minute chart). high-frequency trading (HFT) Also known as algorithmic trading or black box trading, it is a type of program trading where firms place millions of orders a day in thousands of stocks to scalp profits as small as a penny, and the trading is based on statistical analysis rather than fundamentals. high/low 1 or 2 Either a high 1 or 2 or a low 1 or 2. high 1, 2, 3, or 4 A high 1 is a bar with a high above the prior bar in a bull flag or near the bottom of a trading range. If there is then a bar with a lower high (it can occur one or several bars later), the next bar in this correction whose high is above the prior bar’s high is a high 2. Third and fourth occurrences are a high 3 and 4. A high 3 is a wedge bull flag variant. HTF See higher time frame (HTF). ii Consecutive inside bars, where the second is inside the first. At the end of a leg, it is a breakout mode setup and can become a flag or a reversal setup. A less reliable version is a “bodies-only ii,” where you ignore the tails. Here, the second body is inside the first body, which is inside the body before it. iii Three inside bars in a row, and a somewhat more reliable pattern than an ii. inside bar A bar with a high that is at or below the high of the prior bar and a low that is at or above the low of the prior bar. institution Also called the smart money, it can be a pension fund, hedge fund, insurance company, bank, broker, large individual trader, or any other entity that trades enough volume to impact the market. Market movement is the cumulative effect of many institutions placing trades, and a single institution alone usually cannot move a major market for very long. Traditional institutions place trades based on fundamentals, and they used to be the sole determinant of the market’s direction. However, HFT firms now have a significant influence on the day’s movement since their trading currently generates most of the day’s volume. HFT firms are a special type of institutional firm and their trading is based on statistics and not fundamentals. Traditional institutions determine the direction and target, but mathematicians determine the path that the market takes to get there. P1: OTA/XYZ JWBT576-LOT xviii P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK ioi Inside-outside-inside—three consecutive bars where the second bar is an outside bar, and the third bar is an inside bar. It is often a breakout mode setup where a trader looks to buy above the inside bar or sell below it. ledge A bull ledge is a small trading range with a bottom created by two or more bars with identical lows; a bear ledge is a small trading range with a top created by two or more bars with identical highs. leg A small trend that breaks a trend line of any size; the term is used only where there are at least two legs on the chart. It is any smaller trend that is part of a larger trend and it can be a pullback (a countertrend move), a swing in a trend or in a sideways market, or a with-trend move in a trend that occurs between any two pullbacks within the trend. likely long At least 60 percent certain. A person who buys a position in a market or the actual position itself. lot The smallest position size that can be traded in a market. It is a share when referring to stocks and a contract when referring to Eminis or other futures. lower high lower low A swing high that is lower than a previous swing high. A swing low that is lower than a previous swing low. low 1, 2, 3, or 4 A low 1 is a bar with a low below the prior bar in a bear flag or near the top of a trading range. If there is then a bar with a higher low (it can occur one or several bars later), the next bar in this correction whose low is below the prior bar’s low is a low 2. Third and fourth occurrences are a low 3 and 4. A low 3 is a wedge bear flag variant. major trend line Any trend line that contains most of the price action on the screen and is typically drawn using bars that are at least 10 bars apart. major trend reversal A reversal from a bull to a bear trend or from a bear trend to a bull trend. The setup must include a test of the old trend extreme after a break of the trend line. meltdown A sell-off in a bear spike or a tight bear channel without significant pullbacks and that extends further than the fundamentals would dictate. melt-up A rally in a bull spike or a tight bull channel without significant pullbacks and that extends further than the fundamentals would dictate. micro Any traditional pattern can form over one to about five bars and still be valid, although easily overlooked. When it forms, it is a micro version of the pattern. Every micro pattern is a traditional pattern on a smaller time frame chart, and every traditional pattern is a micro pattern on a higher time frame chart. micro channel A very tight channel where most of the bars have their highs and lows touching the trend line and, often, also the trend channel line. It is the most P1: OTA/XYZ JWBT576-LOT P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK xix extreme form of a tight channel, and it has no pullbacks or only one or two small pullbacks. micro double bottom near the same price. Consecutive or nearly consecutive bars with lows that are micro double top Consecutive or nearly consecutive bars with highs that are near the same price. micro measuring gap When the bar before and the bar after a strong trend bar do not overlap, this is a sign of strength and often leads to a measured move. For example, if there is a strong bull trend bar and the low of the bar after it is at or above the high of the bar before it, the midpoint between that low and that high is the micro measuring gap. micro trend channel line A trend channel line drawn across the highs or lows of three to five consecutive bars. micro trend line breakout A trend line on any time frame that is drawn across from two to about 10 bars where most of the bars touch or are close to the trend line, and then one of the bars has a false breakout through the trend line. This false breakout sets up a with-trend entry. If it fails within a bar or two, then there is usually a countertrend trade. money stop A stop based on a fixed dollar amount or number of points, like two points in the Eminis or a dollar in a stock. moving average The charts in this book use a 20-bar exponential moving average, but any moving average can be useful. moving average gap bar (gap bar) A bar that does not touch the moving average. The space between the bar and the moving average is the gap. The first pullback in a strong trend that results in a moving average gap bar is usually followed by a test of the trend’s extreme. For example, when there is a strong bull trend and there is a pullback that finally has a bar with a high below the moving average, this is often a buy setup for a test of the high of the trend. nesting Sometimes a pattern has a smaller version of a comparable pattern “nested” within it. For example, it is common for the right shoulder of a head and shoulders top to be either a small head and shoulders top or a double top. news Useless information generated by the media for the sole purpose of selling advertising and making money for the media company. It is unrelated to trading, is impossible to evaluate, and should always be ignored. oio Outside-inside-outside, an outside bar followed by an inside bar, followed by an outside bar. oo Outside-outside, an outside bar followed by a larger outside bar. opening reversal A reversal in the first hour or so of the day. P1: OTA/XYZ JWBT576-LOT xx P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK outside bar A bar with a high that is above or at the high of the prior bar and a low that is below the low of the prior bar, or a bar with a low that is below or at the low of the prior bar and a high that is above the high of the prior bar. outside down bar outside up bar An outside bar with a close below its open. An outside bar with a close above its open. overshoot The market surpasses a prior price of significance like a swing point or a trend line. pause bar A bar that does not extend the trend. In a bull trend, a pause bar has a high that is at or below the prior bar, or a small bar with a high that is only a tick or so higher than the previous bar when the previous bar is a strong bull trend bar. It is a type of pullback. pip A tick in the foreign exchange (forex) market. However, some data vendors provide quotes with an extra decimal place, which should be ignored. pressing their longs In a bull trend, bulls add to their longs as in a bull spike and as the market breaks out to a new high, because they expect another leg up to about a measured move. pressing their shorts In a bear trend, bears add to their shorts in a bear spike and as the market breaks out to a new low, because they expect another leg down to about a measured move. price action Any change in price on any chart type or time frame. probability The chance of success. For example, if a trader looks back at the most recent 100 times a certain setup led to a trade and finds that it led to a profitable trade 60 times, then that would indicate that the setup has about a 60 percent probability of success. There are many variables that can never be fully tested, so probabilities are only approximations and at times can be very misleading. probably At least 60 percent certain. pullback A temporary pause or countertrend move that is part of a trend, swing, or leg and does not retrace beyond the start of the trend, swing, or leg. It is a small trading range where traders expect the trend to resume soon. For example, a bear pullback is a sideways to upward move in a bear trend, swing, or leg that will be followed by at least a test of the prior low. It can be as small as a one-tick move above the high of the prior bar or it can even be a pause, like an inside bar. pullback bar A bar that reverses the prior bar by at least one tick. In an uptrend, it is a bar with a low below that of the prior bar. reasonable A setup with a favorable trader’s equation. reversal A change to an opposite type of behavior. Most technicians use the term to mean a change from a bull trend to a bear trend or from a bear trend to a bull P1: OTA/XYZ JWBT576-LOT P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK xxi trend. However, trading range behavior is opposite to trending behavior, so when a trend becomes a trading range, this is also a reversal. When a trading range becomes a trend, it is a reversal but is usually called a breakout. reversal bar A trend bar in the opposite direction of the trend. When a bear leg is reversing up, a bull reversal bar is a bull trend bar, and the classic description includes a tail at the bottom and a close above the open and near the top. A bear reversal bar is a bear trend bar in a bull leg, and the traditional description includes a tail at the top and a close below the open and near the bottom. reward The number of ticks that a trader expects to make from a trade. For example, if the trader exits with a limit order at a profit target, it is the number of ticks between the entry price and the profit target. risk The number of ticks from a trader’s entry price to a protective stop. It is the minimum that the trader will lose if a trade goes against him (slippage and other factors can make the actual risk greater than the theoretical risk). risk off When traders think that the stock market will fall, they become risk averse, sell out of volatile stocks and currencies, and transition into safe-haven investments, like Johnson & Johnson (JNJ), Altria Group (MO), Procter & Gamble (PG), the U.S. dollar, and the Swiss franc. risk on When traders think that the stock market is strong, they are willing to take more risks and invest in stocks that tend to rise faster than the overall market, and invest in more volatile currencies, like the Australian dollar or the Swedish krona. risky When the trader’s equation is unclear or barely favorable for a trade. It can also mean that the probability of success for a trade is 50 percent or less, regardless of the risk and potential reward. scalp A trade that is exited with a small profit, usually before there are any pullbacks. In the Emini, when the average range is about 10 to 15 points, a scalp trade is usually any trade where the goal is less than four points. For the SPY or stocks, it might be 10 to 30 cents. For more expensive stocks, it can be $1 to $2. Since the profit is often smaller than the risk, a trader has to win at least 70 percent of the time, which is an unrealistic goal for most traders. Traders should take trades only where the potential reward is at least as great as the risk unless they are extremely skilled. scalper A trader who primarily scalps for small profits, usually using a tight stop. scalper’s profit scratch A typical amount of profit that a scalper would be targeting. A trade that is close to breakeven with either a small profit or a loss. second entry The second time within a few bars of the first entry where there is an entry bar based on the same logic as the first entry. For example, if a P1: OTA/XYZ JWBT576-LOT xxii P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK breakout above a wedge bull flag fails and pulls back to a double bottom bull flag, this pullback sets up a second buy signal for the wedge bull flag. second moving average gap bar setup If there is a first moving average gap bar and a reversal toward the moving average does not reach the moving average, and instead the move away from the moving average continues, it is the next reversal in the direction of the moving average. second signal The second time within a few bars of the first signal where there is a setup based on the same logic as the first signal. selling pressure Strong bears are asserting themselves and their selling is creating bear trend bars, bars with tails at the tops, and two-bar bear reversals. The effect is cumulative and usually is eventually followed by lower prices. setup A pattern of one or more bars used by traders as the basis to place entry orders. If an entry order is filled, the last bar of the setup becomes the signal bar. Most setups are just a single bar. shaved body A candle with no tail at one or both ends. A shaved top has no tail at the top and a shaved bottom has no tail at the bottom. short As a verb, to sell a stock or futures contract to initiate a new position (not to exit a prior purchase). As a noun, a person who sells something short, or the actual position itself. shrinking stairs A stairs pattern where the most recent breakout is smaller than the previous one. It is a series of three or more trending highs in a bull trend or lows in a bear trend where each breakout to a new extreme is by fewer ticks than the prior breakout, indicating waning momentum. It can be a three-push pattern, but it does not have to resemble a wedge and can be any series of broad swings in a trend. signal bar The bar immediately before the bar in which an entry order is filled (the entry bar). It is the final bar of a setup. smaller time frame (STF) A chart covering the same amount of time as the current chart, but having more bars. For example, compared to the day session 5 minute Emini chart on an average day, examples of smaller time frame charts include a 1 minute chart, a tick chart with 500 ticks per bar, and a volume chart with 1,000 contracts per bar (each of these charts usually has more than 200 bars on an average day, compared to the 81 bars on the 5 minute chart). smart traders Consistently profitable traders who are usually trading large positions and are generally on the right side of the market. spike and channel A breakout into a trend in which the follow-through is in the form of a channel where the momentum is less and there is two-sided trading taking place. P1: OTA/XYZ JWBT576-LOT P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK xxiii stair A push to a new extreme in a trending trading range trend or a broad channel trend where there is a series of three or more trending swings that resembles a sloping trading range and is roughly contained in a channel. After the breakout, there is a breakout pullback that retraces at least slightly into the prior trading range, which is not a requirement of other trending trading ranges. Twoway trading is taking place but one side is in slightly more control, accounting for the slope. STF See smaller time frame (STF). strong bulls and bears Institutional traders and their cumulative buying and selling determine the direction of the market. success Refers to traders achieving their objective. Their profit target was reached before their protective stop was hit. swing A smaller trend that breaks a trend line of any size; the term is used only when there are at least two on the chart. They can occur within a larger trend or in a sideways market. swing high A bar that looks like a spike up on the chart and extends up beyond the neighboring bars. Its high is at or above that of the bar before it and that of the bar after it. swing high/low Either a swing high or a swing low. swing low A bar that looks like a spike down on the chart and extends down beyond the neighboring bars. Its low is at or below that of the bar before it and that of the bar after it. swing point Either a swing high or a swing low. swing trade For a day trader using a short-term intraday chart like the 5 minute, it is any trade that lasts longer than a scalp and that the trader will hold through one or more pullbacks. For a trader using higher time frame charts, it is a trade that lasts for hours to several days. Typically, at least part of the trade is held without a profit target, since the trader is hoping for an extended move. The potential reward is usually at least as large as the risk. Small swing trades are called scalps by many traders. In the Emini, when the average range is about 10 to 15 points, a swing trade is usually any trade where the goal is four or more points. test When the market approaches a prior price of significance and can overshoot or undershoot the target. The term failed test is used to mean opposite things by different traders. Most traders believe that if the market then reverses, the test was successful, and if it does not and the move continues beyond the test area, the test failed and a breakout has occurred. three pushes Three swing highs where each swing high is usually higher or three swing lows where each swing low is usually lower. It trades the same as a wedge P1: OTA/XYZ JWBT576-LOT xxiv P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK and should be considered a variant. When it is part of a flag, the move can be mostly horizontal and each push does not have to extend beyond the prior one. For example, in a wedge bull flag or any other type of triangle, the second push down can be at, above, or below the first, and the third push down can be at, above, or below either the second or the first, or both. tick The smallest unit of price movement. For most stocks, it is one penny; for 10-Year U.S. Treasury Note Futures, it is 1/64th of a point; and for Eminis, it is 0.25 points. On tick charts and on time and sales tables, a tick is every trade that takes place no matter the size and even if there is no price change. If you look at a time and sales table, every trade is counted as one tick when TradeStation charting software creates a tick chart. tight channel A channel where the trend line and trend channel line are close together, and the pullbacks are small and last for only one to three bars. tight trading range A trading range of two or more bars with lots of overlap in the bars and in which most reversals are too small to trade profitably with stop entries. The bulls and bears are in balance. time frame The length of time contained in one bar on the chart (a 5 minute time frame is made of bars that close every five minutes). It can also refer to bars not based on time, such as those based on volume or the number of ticks traded. tradable A setup that you believe has a reasonable chance of leading to at least a scalper’s profit. trader’s equation To take a trade, you must believe that the probability of success times the potential reward is greater than the probability of failure times the risk. You set the reward and risk because the potential reward is the distance to your profit target and the risk is the distance to your stop. The difficulty in solving the equation is assigning a value to the probability, which can never be known with certainty. As a guideline, if you are uncertain, assume that you have a 50 percent chance of winning or losing, and if you are confident, assume that you have a 60 percent chance of winning and a 40 percent chance of losing. trading range The minimum requirement is a single bar with a range that is largely overlapped by the bar before it. It is sideways movement and neither the bull nor the bears are in control, although one side is often stronger. It is often a pullback in a trend where the pullback has lasted long enough to lose most of its certainty. In other words, traders have become uncertain about the direction of the breakout in the short term, and the market will have repeated breakout attempts up and down that will fail. It will usually ultimately break out in the direction of the trend, and is a pullback on a higher time frame chart. P1: OTA/XYZ JWBT576-LOT P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK xxv trailing a stop As the trade becomes increasingly profitable, traders will often move, or trail, the protective stop to protect more of their open profit. For example, if they are long in a bull trend, every time the market moves to a new high, they might raise the protective stop to just below the most recent higher low. trap An entry that immediately reverses to the opposite direction before a scalper’s profit target is reached, trapping traders in their new position and ultimately forcing them to cover at a loss. It can also scare traders out of a good trade. trapped in a trade A trader with an open loss on a trade that did not result in a scalper’s profit, and if there is a pullback beyond the entry or signal bars, the trader will likely exit with a loss. trapped out of a trade A pullback that scares a trader into exiting a trade, but then the pullback fails. The move quickly resumes in the direction of the trade, making it difficult emotionally for the trader to get back in at the worse price that is now available. The trader will have to chase the market. trend A series of price changes that are either mostly up (a bull trend) or down (a bear trend). There are three loosely defined smaller versions: swings, legs, and pullbacks. A chart will show only one or two major trends. If there are more, one of the other terms is more appropriate. trend bar A bar with a body, which means that the close was above or below the open, indicating that there is at least a minor price movement. trend channel line A line in the direction of the trend but drawn on the opposite side of the bars compared to a trend line. A bull trend channel line is above the highs and rising to the right, and a bear trend channel line is below the lows and falling to the right. trend channel line overshoot line. One or more bars penetrating a trend channel trend channel line undershoot A bar approaches a trend channel line but the market reverses away from the line without reaching or penetrating it. trend from the open A trend that begins at the first or one of the first bars of the day and extends for many bars without a pullback, and the start of the trend remains as one of the extremes of the day for much if not all of the day. trending closes Three or more bars where the closes are trending. In a bull trend, each close is above the prior close, and in a bear trend, each close is lower. If the pattern extends for many bars, there can be one or two bars where the closes are not trending. trending highs or lows The same as trending closes except based on the highs or lows of the bars. P1: OTA/XYZ JWBT576-LOT xxvi P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK trending swings Three or more swings where the swing highs and lows are both higher than the prior swing highs and lows (trending bull swings), or both lower (trending bear swings). trending trading ranges Two or more trading ranges separated by a breakout. trend line A line drawn in the direction of the trend; it is sloped up and is below the bars in a bull trend, and it is sloped down and is above the bars in a bear trend. Most often, it is constructed from either swing highs or swing lows but can be based on linear regression or just a best fit (eyeballing). trend reversal A trend change from up to down or down to up, or from a trend to a trading range. 20 moving average gap bars Twenty or more consecutive bars that have not touched the moving average. Once the market finally touches the moving average, it usually creates a setup for a test of the trend’s extreme. undershoot The market approaches but does not reach a prior price of significance like a swing point or a trend line. unlikely At most 40 percent certain. unreasonable usually A setup with an unfavorable trader’s equation. At least 60 percent certain. vacuum A buy vacuum occurs when the strong bears believe that the price will soon be higher so they wait to short until it reaches some magnet above the market. The result is that there is a vacuum that sucks the market quickly up to the magnet in the form of one or more bull trend bars. Once there, the strong bears sell aggressively and turn the market down. A sell vacuum occurs when the strong bulls believe that the market will soon be lower so they wait to buy until it falls to some magnet below the market. The result is that there is a vacuum that sucks the market down quickly to the magnet in the form of one or more bear trend bars. Once there, strong bulls buy aggressively and turn the market back up. wedge Traditionally, a three-push move with each push extending further and the trend line and trend channel line at least minimally convergent, creating a rising or descending triangle with a wedge shape. For a trader, the wedge shape increases the chances of a successful trade, but any three-push pattern trades like a wedge and can be considered one. A wedge can be a reversal pattern or a pullback in a trend (a bull or bear flag). wedge flag A wedge-shaped or three-push pullback in a trend, such as a high 3 in a bull trend (a type of bull flag) or a low 3 in a bear trend (a type of bear flag). Since it is a with-trend setup, enter on the first signal. wedge reversal A wedge that is reversing a bull trend into a bear trend or a bear trend into a bull trend. Since it is countertrend, unless it is very strong, it is better P1: OTA/XYZ JWBT576-LOT P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly LIST OF TERMS USED IN THIS BOOK xxvii to take a second signal. For example, if there is a bear trend and then a descending wedge, wait for a breakout above this potential wedge bottom and then try to buy a pullback to a higher low. with trend Refers to a trade or a setup that is in the direction of the prevailing trend. In general, the direction of the most recent 5 minute chart signal should be assumed to be the trend’s direction. Also, if most of the past 10 or 20 bars are above the moving average, trend setups and trades are likely on the buy side. P1: OTA/XYZ JWBT576-LOT P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly P1: OTA/XYZ JWBT576-LOT P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly Trading Price Action TRENDS P1: OTA/XYZ JWBT576-LOT P2: ABC JWBT576-Brooks October 18, 2011 2:13 Printer: Donnelly P1: OTA JWBT576-cintro JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly Introduction here is a reason why there is no other comprehensive book about price action written by a trader. It takes thousands of hours, and the financial reward is meager compared to that from trading. However, with my three girls now away in grad school, I have a void to fill and this has been a very satisfying project. I originally planned on updating the first edition of Reading Price Charts Bar by Bar (John Wiley & Sons, 2009), but as I got into it, I decided instead to go into great detail about how I view and trade the markets. I am metaphorically teaching you how to play the violin. Everything you need to know to make a living at it is in these books, but it is up to you to spend the countless hours learning your trade. After a year of answering thousands of questions from traders on my website at www.brookspriceaction.com, I think that I have found ways to express my ideas much more clearly, and these books should be easier to read than that one. The earlier book focused on reading price action, and this series of books is instead centered on how to use price action to trade the markets. Since the book grew to more than four times as many words as the first book, John Wiley & Sons decided to divide it into three separate books. This first book covers price action basics and trends. The second book is on trading ranges, order management, and the mathematics of trading, and the final book is about trend reversals, day trading, daily charts, options, and the best setups for all time frames. Many of the charts are also in Reading Price Charts Bar by Bar, but most have been updated and the discussion about the charts has also been largely rewritten. Only about 5 percent of the 120,000 words from that book are present in the 570,000 words in this new series, so readers will find little duplication. My goals in writing this series of three books are to describe my understanding of why the carefully selected trades offer great risk/reward ratios, and to present ways to profit from the setups. I am presenting material that I hope will be interesting to professional traders and students in business school, but I also hope that even traders starting out will find some useful ideas. Everyone looks at price charts but usually just briefly and with a specific or limited goal. However, every chart has an incredible amount of information that can be used to make profitable trades, but T 1 P1: OTA JWBT576-cintro 2 JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION much of it can be used effectively only if traders spend time to carefully understand what each bar on the chart is telling them about what institutional money is doing. Ninety percent or more of all trading in large markets is done by institutions, which means that the market is simply a collection of institutions. Almost all are profitable over time, and the few that are not soon go out of business. Since institutions are profitable and they are the market, every trade that you take has a profitable trader (a part of the collection of institutions) taking the other side of your trade. No trade can take place without one institution willing to take one side and another willing to take the other. The small-volume trades made by individuals can only take place if an institution is willing to take the same trade. If you want to buy at a certain price, the market will not get to that price unless one or more institutions also want to buy at that price. You cannot sell at any price unless one or more institutions are willing to sell there, because the market can only go to a price where there are institutions willing to buy and others willing to sell. If the Emini is at 1,264 and you are long with a protective sell stop at 1,262, your stop cannot get hit unless there is an institution who is also willing to sell at 1,262. This is true for virtually all trades. If you trade 200 Emini contracts, then you are trading institutional volume and are effectively an institution, and you will sometimes be able to move the market a tick or two. Most individual traders, however, have no ability to move the market, no matter how stupidly they are willing to trade. The market will not run your stops. The market might test the price where your protective stop is, but it has nothing to do with your stop. It will only test that price if one or more institutions believe that it is financially sound to sell there and other institutions believe that it is profitable to buy there. At every tick, there are institutions buying and other institutions selling, and all have proven systems that will make money by placing those trades. You should always be trading in the direction of the majority of institutional dollars because they control where the market is heading. At the end of the day when you look at a printout of the day’s chart, how can you tell what the institutions did during the day? The answer is simple: whenever the market went up, the bulk of institutional money was buying, and whenever the market went down, more money went into selling. Just look at any segment of the chart where the market went up or down and study every bar, and you will soon notice many repeatable patterns. With time, you will begin to see those patterns unfold in real time, and that will give you confidence to place your trades. Some of the price action is subtle, so be open to every possibility. For example, sometimes when the market is working higher, a bar will trade below the low of the prior bar, yet the trend continues higher. You have to assume that the big money was buying at and below the low of that prior bar, and that is also what many experienced traders were doing. They bought exactly where weak traders let themselves get stopped out with a loss or where other weak traders shorted, believing that the P1: OTA JWBT576-cintro JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION 3 market was beginning to sell off. Once you get comfortable with the idea that strong trends often have pullbacks and big money is buying them rather than selling them, you will be in a position to make some great trades that you previously thought were exactly the wrong thing to do. Don’t think too hard about it. If the market is going up, institutions are buying constantly, even at times when you think that you should stop yourself out of your long with a loss. Your job is to follow their behavior and not use too much logic to deny what is happening right in front of you. It does not matter if it seems counterintuitive. All that matters is that the market is going up and therefore institutions are predominantly buying and so should you. Institutions are generally considered to be smart money, meaning that they are smart enough to make a living by trading and they trade a large volume every day. Television still uses the term institution to refer to traditional institutions like mutual funds, banks, brokerage houses, insurance companies, pension funds, and hedge funds; these companies used to account for most of the volume, and they mostly trade on fundamentals. Their trading controls the direction of the market on daily and weekly charts and a lot of the big intraday swings. Until a decade or so ago, most of the trade decisions were made and most trading was done by very smart traders, but it is now increasingly being done by computers. They have programs that can instantly analyze economic data and immediately place trades based on that analysis, without a person ever being involved in the trade. In addition, other firms trade huge volumes by using computer programs that place trades based on the statistical analysis of price action. Computer-generated trading now accounts for as much as 70 percent of the day’s volume. Computers are very good at making decisions, and playing chess and winning at Jeopardy! are more difficult than trading stocks. Gary Kasparov for years made the best chess decisions in the world, yet a computer made better decisions in 1997 and beat him. Ken Jennings was heralded as the greatest Jeopardy! player of all time, yet a computer destroyed him in 2011. It is only a matter of time before computers are widely accepted as the best decision makers for institutional trading. Since programs use objective mathematical analysis, there should be a tendency for support and resistance areas to become more clearly defined. For example, measured move projections should become more precise as more of the volume is traded based on precise mathematical logic. Also, there might be a tendency toward more protracted tight channels as programs buy small pullbacks on the daily chart. However, if enough programs exit longs or go short at the same key levels, sell-offs might become larger and faster. Will the changes be dramatic? Probably not, since the same general forces were operating when everything was done manually, but nonetheless there should be some move toward mathematical perfection as more of the emotion is removed from trading. As these other firms contribute more and more to the movement of the market and as traditional institutions increasingly use computers to analyze and place their trades, the term P1: OTA JWBT576-cintro 4 JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION institution is becoming vague. It is better for an individual trader to think of an institution as any of the different entities that trade enough volume to be a significant contributor to the price action. Since these buy and sell programs generate most of the volume, they are the most important contributor to the appearance of every chart and they create most of the trading opportunities for individual investors. Yes, it’s nice to know that Cisco Systems (CSCO) had a strong earnings report and is moving up, and if you are an investor who wants to hold stock for many months, then do what the traditional institutions are doing and buy CSCO. However, if you are a day trader, ignore the news and look at the chart, because the programs will create patterns that are purely statistically based and have nothing to do with fundamentals, yet offer great trading opportunities. The traditional institutions placing trades based on fundamentals determine the direction and the approximate target of a stock over the next several months, but, increasingly, firms using statistical analysis to make day trades and other short-term trades determine the path to that target and the ultimate high or low of the move. Even on a macro level, fundamentals are only approximate at best. Look at the crashes in 1987 and 2009. Both had violent selloffs and rallies, yet the fundamentals did not change violently in the same short period of time. In both cases, the market got sucked slightly below the monthly trend line and reversed sharply up from it. The market fell because of perceived fundamentals, but the extent of the fall was determined by the charts. There are some large patterns that repeat over and over on all time frames and in all markets, like trends, trading ranges, climaxes, and channels. There are also lots of smaller tradable patterns that are based on just the most recent few bars. These books are a comprehensive guide to help traders understand everything they see on a chart, giving them more opportunities to make profitable trades and to avoid losers. The most important message that I can deliver is to focus on the absolute best trades, avoid the absolute worst setups, use a profit objective (reward) that is at least as large as your protective stop (risk), and work on increasing the number of shares that you are trading. I freely recognize that every one of my reasons behind each setup is just my opinion, and my reasoning about why a trade works might be completely wrong. However, that is irrelevant. What is important is that reading price action is a very effective way to trade, and I have thought a lot about why certain things happen the way they do. I am comfortable with my explanations and they give me confidence when I place a trade; however, they are irrelevant to my placing trades, so it is not important to me that they are right. Just as I can reverse my opinion about the direction of the market in an instant, I can also reverse my opinion about why a particular pattern works if I come across a reason that is more logical or if I discover a flaw in my logic. I am providing the opinions because they appear to make sense, they might help readers become more comfortable trading P1: OTA JWBT576-cintro JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION 5 certain setups, and they might be intellectually stimulating, but they are not needed for any price action trades. The books are very detailed and difficult to read and are directed toward serious traders who want to learn as much as they can about reading price charts. However, the concepts are useful to traders at all levels. The books cover many of the standard techniques described by Robert D. Edwards and John Magee (Technical Analysis of Stock Trends, AMACOM, 9th ed., 2007) and others, but focus more on individual bars to demonstrate how the information they provide can significantly enhance the risk/reward ratio of trading. Most books point out three or four trades on a chart, which implies that everything else on the chart is incomprehensible, meaningless, or risky. I believe that there is something to be learned from every tick that takes place during the day and that there are far more great trades on every chart than just the few obvious ones; but to see them, you have to understand price action and you cannot dismiss any bars as unimportant. I learned from performing thousands of operations through a microscope that some of the most important things can be very small. I read charts bar by bar and look for any information that each bar is telling me. They are all important. At the end of every bar, most traders ask themselves, “What just took place?” With most bars, they conclude that there is nothing worth trading at the moment so it is just not worth the effort to try to understand. Instead, they choose to wait for some clearer and usually larger pattern. It is as if they believe that the bar did not exist, or they dismiss it as just institutional program activity that is not tradable by an individual trader. They do not feel like they are part of the market at these times, but these times constitute the vast majority of the day. Yet, if they look at the volume, all of those bars that they are ignoring have as much volume as the bars they are using for the bases for their trades. Clearly, a lot of trading is taking place, but they don’t understand how that can be and essentially pretend that it does not exist. But that is denying reality. There is always trading taking place, and as a trader, you owe it to yourself to understand why it’s taking place and to figure out a way to make money off of it. Learning what the market is telling you is very time-consuming and difficult, but it gives you the foundation that you need to be a successful trader. Unlike most books on candle charts where the majority of readers feel compelled to memorize patterns, these three books of mine provide a rationale for why particular patterns are reliable setups for traders. Some of the terms used have specific meaning to market technicians but different meanings to traders, and I am writing this entirely from a trader’s perspective. I am certain that many traders already understand everything in these books, but likely wouldn’t describe price action in the same way that I do. There are no secrets among successful traders; they all know common setups, and many have their own names for each one. All of them are buying and selling pretty much at the same time, catching the same P1: OTA JWBT576-cintro 6 JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION swings, and they all have their own reasons for getting into a trade. Many trade price action intuitively without ever feeling a need to articulate why a certain setup works. I hope that they enjoy reading my understanding of and perspective on price action and that this gives them some insights that will improve their already successful trading. The goal for most traders is to maximize trading profits through a style that is compatible with their personalities. Without that compatibility, I believe that it is virtually impossible to trade profitably for the long term. Many traders wonder how long it will take them to be successful and are willing to lose money for some period of time, even a few years. However, it took me over 10 years to be able to trade successfully. Each of us has many considerations and distractions, so the time will vary, but a trader has to work though most obstacles before becoming consistently profitable. I had several major problems that had to be corrected, including raising three wonderful daughters who always filled my mind with thoughts of them and what I needed to be doing as their father. That was solved as they got older and more independent. Then it took me a long time to accept many personality traits as real and unchangeable (or at least I concluded that I was unwilling to change them). And finally there was the issue of confidence. I have always been confident to the point of arrogance in so many things that those who know me would be surprised that this was difficult for me. However, deep inside I believed that I really would never come up with a consistently profitable approach that I would enjoy employing for many years. Instead, I bought many systems, wrote and tested countless indicators and systems, read many books and magazines, went to seminars, hired tutors, and joined chat rooms. I talked with people who presented themselves as successful traders, but I never saw their account statements and suspect that most could teach but few, if any, could trade. Usually in trading, those who know don’t talk and those who talk don’t know. This was all extremely helpful because it showed all of the things that I needed to avoid before becoming successful. Any nontrader who looks at a chart will invariably conclude that trading has to be extremely easy, and that is part of the appeal. At the end of the day, anyone can look at any chart and see very clear entry and exit points. However, it is much more difficult to do it in real time. There is a natural tendency to want to buy the exact low and never have the trade come back. If it does, a novice will take the loss to avoid a bigger loss, resulting in a series of losing trades that will ultimately bust the trader’s account. Using wide stops solves that to some extent, but invariably traders will soon hit a few big losses that will put them into the red and make them too scared to continue using that approach. Should you be concerned that making the information in these books available will create lots of great price action traders, all doing the same thing at the same time, thereby removing the late entrants needed to drive the market to your price target? No, because the institutions control the market and they already have the P1: OTA JWBT576-cintro JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION 7 smartest traders in the world and those traders already know everything in these books, at least intuitively. At every moment, there is an extremely smart institutional bull taking the opposite side of the trade being placed by an extremely smart institutional bear. Since the most important players already know price action, having more players know it will not tip the balance one way or the other. I therefore have no concern that what I am writing will stop price action from working. Because of that balance, any edge that anyone has is always going to be extremely small, and any small mistake will result in a loss, no matter how well a person reads a chart. Although it is very difficult to make money as a trader without understanding price action, that knowledge alone is not enough. It takes a long time to learn how to trade after a trader learns to read charts, and trading is just as difficult as chart reading. I wrote these books to help people learn to read charts better and to trade better, and if you can do both well, you deserve to be able to take money from the accounts of others and put it into yours. The reason why the patterns that we all see do unfold as they do is because that is the appearance that occurs in an efficient market with countless traders placing orders for thousands of different reasons, but with the controlling volume being traded based on sound logic. That is just what it looks like, and it has been that way forever. The same patterns unfold in all time frames in all markets around the world, and it would simply be impossible for all of it to be manipulated instantaneously on so many different levels. Price action is a manifestation of human behavior and therefore actually has a genetic basis. Until we evolve, it will likely remain largely unchanged, just as it has been unchanged for the 80 years of charts that I have reviewed. Program trading might have changed the appearance slightly, although I can find no evidence to support that theory. If anything, it would make the charts smoother because it is unemotional and it has greatly increased the volume. Now that most of the volume is being traded automatically by computers and the volume is so huge, irrational and emotional behavior is an insignificant component of the markets and the charts are a purer expression of human tendencies. Since price action comes from our DNA, it will not change until we evolve. When you look at the two charts in Figure I.1, your first reaction is that they are just a couple of ordinary charts, but look at the dates at the bottom. These weekly Dow Jones Industrial Average charts from the Depression era and from World War II have the same patterns that we see today on all charts, despite most of today’s volume being traded by computers. If everyone suddenly became a price action scalper, the smaller patterns might change a little for a while, but over time, the efficient market will win out and the votes by all traders will get distilled into standard price action patterns because that is the inescapable result of countless people behaving logically. Also, the reality is that it is very difficult to trade well, and although basing trades on price action is a sound approach, it is still very difficult to do successfully in real time. P1: OTA JWBT576-cintro 8 JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION FIGURE I.1 Price Action Has Not Changed over Time There just won’t be enough traders doing it well enough, all at the same time, to have any significant influence over time on the patterns. Just look at Edwards and Magee. The best traders in the world have been using those ideas for decades and they continue to work, again for the same reason—charts look the way they do because that is the unchangeable fingerprint of an efficient market filled with a huge number of smart people using a huge number of approaches and time frames, all trying to make the most money that they can. For example, Tiger Woods is not hiding anything that he does in golf, and anyone is free to copy him. However, very few people can play golf well enough to make a living at it. The same is true of trading. A trader can know just about everything there is to know and still lose money because applying all that knowledge in a way that consistently makes money is very difficult to do. Why do so many business schools continue to recommend Edwards and Magee when their book is essentially simplistic, largely using trend lines, breakouts, and pullbacks as the basis for trading? It is because it works and it always has and it always will. Now that just about all traders have computers with access to intraday data, many of those techniques can be adapted to day trading. Also, candle charts give additional information about who is controlling the market, which results in a more timely entry with smaller risk. Edwards and Magee’s focus is on the overall P1: OTA JWBT576-cintro JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION 9 trend. I use those same basic techniques but pay much closer attention to the individual bars on the chart to improve the risk/reward ratio, and I devote considerable attention to intraday charts. It seemed obvious to me that if one could simply read the charts well enough to be able to enter at the exact times when the move would take off and not come back, then that trader would have a huge advantage. The trader would have a high winning percentage, and the few losses would be small. I decided that this would be my starting point, and what I discovered was that nothing had to be added. In fact, any additions are distractions that result in lower profitability. This sounds so obvious and easy that it is difficult for most people to believe. I am a day trader who relies entirely on price action on the intraday Emini S&P 500 Futures charts, and I believe that reading price action well is an invaluable skill for all traders. Beginners often instead have a deep-seated belief that something more is required, that maybe some complex mathematical formula that very few use would give them just the edge that they need. Goldman Sachs is so rich and sophisticated that its traders must have a supercomputer and high-powered software that gives them an advantage that ensures that all the individual traders are doomed to failure. They start looking at all kinds of indicators and playing with the inputs to customize the indicators to make them just right. Every indicator works some of the time, but for me, they obfuscate instead of elucidate. In fact, without even looking at a chart, you can place a buy order and have a 50 percent chance of being right! I am not dismissing indicators and systems out of ignorance of their subtleties. I have spent over 10,000 hours writing and testing indicators and systems over the years, and that probably is far more experience than most have. This extensive experience with indicators and systems was an essential part of my becoming a successful trader. Indicators work well for many traders, but the best success comes once a trader finds an approach that is compatible with his or her personality. My single biggest problem with indicators and systems was that I never fully trusted them. At every setup, I saw exceptions that needed to be tested. I always wanted every last penny out of the market and was never satisfied with a return from a system if I could incorporate a new twist that would make it better. You can optimize constantly, but, since the market is always changing from strong trends to tight trading ranges and then back again and your optimizations are based on what has recently happened, they will soon fail as the market transitions into a new phase. I am simply too controlling, compulsive, restless, observant, and untrusting to make money in the long term off indicators or automated systems, but I am at the extreme in many ways and most people don’t have these same issues. Many traders, especially beginners, are drawn to indicators (or any other higher power, guru, TV pundit, or newsletter that they want to believe will protect them and show their love and approval of them as human beings by giving them lots P1: OTA JWBT576-cintro 10 JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION of money), hoping that an indicator will show them when to enter a trade. What they don’t realize is that the vast majority of indicators are based on simple price action, and when I am placing trades, I simply cannot think fast enough to process what several indicators might be telling me. If there is a bull trend, a pullback, and then a rally to a new high, but the rally has lots of overlapping bars, many bear bodies, a couple of small pullbacks, and prominent tails on the tops of the bars, any experienced trader would see that it is a weak test of the trend high and that this should not be happening if the bull trend was still strong. The market is almost certainly transitioning into a trading range and possibly into a bear trend. Traders don’t need an oscillator to tell them this. Also, oscillators tend to make traders look for reversals and focus less on price charts. These can be effective tools on most days when the market has two or three reversals lasting an hour or more. The problem comes when the market is trending strongly. If you focus too much on your indicators, you will see that they are forming divergences all day long and you might find yourself repeatedly entering countertrend and losing money. By the time you come to accept that the market is trending, you will not have enough time left in the day to recoup your losses. Instead, if you were simply looking at a bar or candle chart, you would see that the market is clearly trending and you would not be tempted by indicators to look for trend reversals. The most common successful reversals first break a trend line with strong momentum and then pull back to test the extreme, and if traders focus too much on divergences, they will often overlook this fundamental fact. Placing a trade because of a divergence in the absence of a prior countertrend momentum surge that breaks a trend line is a losing strategy. Wait for the trend line break and then see if the test of the old extreme reverses or if the old trend resumes. You do not need an indicator to tell you that a strong reversal here is a high-probability trade, at least for a scalp, and there will almost certainly be a divergence, so why complicate your thinking by adding the indicator to your calculus? Some pundits recommend a combination of time frames, indicators, wave counting, and Fibonacci retracements and extensions, but when it comes time to place the trade, they will do it only if there is a good price action setup. Also, when they see a good price action setup, they start looking for indicators that show divergences, different time frames for moving average tests, wave counts, or Fibonacci setups to confirm what is in front of them. In reality, they are price action traders who are trading exclusively off price action on only one chart but don’t feel comfortable admitting it. They are complicating their trading to the point that they certainly are missing many, many trades because their overanalysis takes too much time for them to place their orders and they are forced to wait for the next setup. The logic just isn’t there for making the simple so complicated. Obviously, adding any information can lead to better decision making and many people might be able to process lots of inputs when deciding whether to place a trade. Ignoring data P1: OTA JWBT576-cintro JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION 11 because of a simplistic ideology alone is foolish. The goal is to make money, and traders should do everything they can to maximize their profits. I simply cannot process multiple indicators and time frames well in the time needed to place my orders accurately, and I find that carefully reading a single chart is far more profitable for me. Also, if I rely on indicators, I find that I get lazy in my price action reading and often miss the obvious. Price action is far more important than any other information, and if you sacrifice some of what it is telling you to gain information from something else, you are likely making a bad decision. One of the most frustrating things for traders when they are starting out is that everything is so subjective. They want to find a clear set of rules that guarantee a profit, and they hate how a pattern works on one day but fails on another. Markets are very efficient because you have countless very smart people playing a zero-sum game. For a trader to make money, he has to be consistently better than about half of the other traders out there. Since most of the competitors are profitable institutions, a trader has to be very good. Whenever an edge exists, it is quickly discovered and it disappears. Remember, someone has to be taking the opposite side of your trade. It won’t take them long to figure out your magical system, and once they do, they will stop giving you money. Part of the appeal of trading is that it is a zerosum game with very small edges, and it is intellectually satisfying and financially rewarding to be able to spot and capitalize on these small, fleeting opportunities. It can be done, but it is very hard work and it requires relentless discipline. Discipline simply means doing what you do not want to do. We are all intellectually curious and we have a natural tendency to try new or different things, but the very best traders resist the temptation. You have to stick to your rules and avoid emotion, and you have to patiently wait to take only the best trades. This all appears easy to do when you look at a printed chart at the end of the day, but it is very difficult in real time as you wait bar by bar, and sometimes hour by hour. Once a great setup appears, if you are distracted or lulled into complacency, you will miss it and you will then be forced to wait even longer. But if you can develop the patience and the discipline to follow a sound system, the profit potential is huge. There are countless ways to make money trading stocks and Eminis, but all require movement (well, except for shorting options). If you learn to read the charts, you will catch a great number of these profitable trades every day without ever knowing why some institution started the trend and without ever knowing what any indicator is showing. You don’t need these institutions’ software or analysts because they will show you what they are doing. All you have to do is piggyback onto their trades and you will make a profit. Price action will tell you what they are doing and allow you an early entry with a tight stop. I have found that I consistently make far more money by minimizing what I have to consider when placing a trade. All I need is a single chart on my laptop computer with no indicators except a 20-bar exponential moving average (EMA), P1: OTA JWBT576-cintro 12 JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION which does not require too much analysis and clarifies many good setups each day. Some traders might also look at volume because an unusually large volume spike sometimes comes near the end of a bear trend, and the next new swing low or two often provide profitable long scalps. Volume spikes also sometimes occur on daily charts when a sell-off is overdone. However, it is not reliable enough to warrant my attention. Many traders consider price action only when trading divergences and trend pullbacks. In fact, most traders using indicators won’t take a trade unless there is a strong signal bar, and many would enter on a strong signal bar if the context was right, even if there was no divergence. They like to see a strong close on a large reversal bar, but in reality this is a fairly rare occurrence. The most useful tools for understanding price action are trend lines and trend channel lines, prior highs and lows, breakouts and failed breakouts, the sizes of bodies and tails on candles, and relationships between the current bar to the prior several bars. In particular, how the open, high, low, and close of the current bar compare to the action of the prior several bars tells a lot about what will happen next. Charts provide far more information about who is in control of the market than most traders realize. Almost every bar offers important clues as to where the market is going, and a trader who dismisses any activity as noise is passing up many profitable trades each day. Most of the observations in these books are directly related to placing trades, but a few have to do with simple curious price action tendencies without sufficient dependability to be the basis for a trade. I personally rely mainly on candle charts for my Emini, futures, and stock trading, but most signals are also visible on any type of chart and many are even evident on simple line charts. I focus primarily on 5 minute candle charts to illustrate basic principles but also discuss daily and weekly charts as well. Since I also trade stocks, forex, Treasury note futures, and options, I discuss how price action can be used as the basis for this type of trading. As a trader, I see everything in shades of gray and am constantly thinking in terms of probabilities. If a pattern is setting up and is not perfect but is reasonably similar to a reliable setup, it will likely behave similarly as well. Close is usually close enough. If something resembles a textbook setup, the trade will likely unfold in a way that is similar to the trade from the textbook setup. This is the art of trading and it takes years to become good at trading in the gray zone. Everyone wants concrete, clear rules or indicators, and chat rooms, newsletters, hotlines, or tutors that will tell them when exactly to get in to minimize risk and maximize profit, but none of it works in the long run. You have to take responsibility for your decisions, but you first have to learn how to make them and that means that you have to get used to operating in the gray fog. Nothing is ever as clear as black and white, and I have been doing this long enough to appreciate that anything, no matter how unlikely, can and will happen. It’s like quantum physics. Every conceivable P1: OTA JWBT576-cintro JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION 13 event has a probability, and so do events that you have yet to consider. It is not emotional, and the reasons why something happens are irrelevant. Watching to see if the Federal Reserve cuts rates today is a waste of time because there is both a bullish and bearish interpretation of anything that the Fed does. What is key is to see what the market does, not what the Fed does. If you think about it, trading is a zero-sum game and it is impossible to have a zero-sum game where rules consistently work. If they worked, everyone would use them and then there would be no one on the other side of the trade. Therefore, the trade could not exist. Guidelines are very helpful but reliable rules cannot exist, and this is usually very troubling to a trader starting out who wants to believe that trading is a game that can be very profitable if only you can come up with just the right set of rules. All rules work some of the time, and usually just often enough to fool you into believing that you just need to tweak them a little to get them to work all of the time. You are trying to create a trading god who will protect you, but you are fooling yourself and looking for an easy solution to a game where only hard solutions work. You are competing against the smartest people in the world, and if you are smart enough to come up with a foolproof rule set, so are they, and then everyone is faced with the zero-sum game dilemma. You cannot make money trading unless you are flexible, because you need to go where the market is going, and the market is extremely flexible. It can bend in every direction and for much longer than most would ever imagine. It can also reverse repeatedly every few bars for a long, long time. Finally, it can and will do everything in between. Never get upset by this, and just accept it as reality and admire it as part of the beauty of the game. The market gravitates toward uncertainty. During most of the day, every market has a directional probability of 50–50 of an equidistant move up or down. By that I mean that if you don’t even look at a chart and you buy any stock and then place a one cancels the other (OCO) order to exit on a profit-taking limit order X cents above your entry or on a protective stop at X cents below your entry, you have about a 50 percent chance of being right. Likewise, if you sell any stock at any point in the day without looking at a chart and then place a profit-taking limit order X cents lower and a protective stop X cents higher, you have about a 50 percent chance of winning and about a 50 percent chance of losing. There is the obvious exception of X being too large relative the price of the stock. You can’t have X be $60 in a $50 stock, because you would have a 0 percent chance of losing $60. You also can’t have X be $49, because the odds of losing $49 would also be minuscule. But if you pick a value for X that is within reasonable reach on your time frame, this is generally true. When the market is 50–50, it is uncertain and you cannot rationally have an opinion about its direction. This is the hallmark of a trading range, so whenever you are uncertain, assume that the market is in a trading range. There are brief times on a chart when the directional probability is higher. During a strong trend, P1: OTA JWBT576-cintro 14 JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION it might be 60 or even 70 percent, but that cannot last long because it will gravitate toward uncertainty and a 50–50 market where both the bulls and bears feel there is value. When there is a trend and some level of directional certainty, the market will also gravitate toward areas of support and resistance, which are usually some type of measured move away, and those areas are invariably where uncertainty returns and a trading range develops, at least briefly. Never watch the news during the trading day. If you want to know what a news event means, the chart in front of you will tell you. Reporters believe that the news is the most important thing in the world, and that everything that happens has to be caused by their biggest news story of the day. Since reporters are in the news business, news must be the center of the universe and the cause of everything that happens in the financial markets. When the stock market sold off in mid-March 2011, they attributed it to the earthquake in Japan. It did not matter to them that the market began to sell off three weeks earlier, after a buy climax. I told the members of my chat room in late February that the odds were good that the market was going to have a significant correction when I saw 15 consecutive bull trend bars on the daily chart after a protracted bull run. This was an unusually strong buy climax, and an important statement by the market. I had no idea that an earthquake was going to happen in a few weeks, and did not need to know that, anyway. The chart was telling me what traders were doing; they were getting ready to exit their longs and initiate shorts. Television experts are also useless. Invariably when the market makes a huge move, the reporter will find some confident, convincing expert who predicted it and interview him or her, leading the viewers to believe that this pundit has an uncanny ability to predict the market, despite the untold reality that this same pundit has been wrong in his last 10 predictions. The pundit then makes some future prediction and naı̈ve viewers will attach significance to it and let it affect their trading. What the viewers may not realize is that some pundits are bullish 100 percent of the time and others are bearish 100 percent of the time, and still others just swing for the fences all the time and make outrageous predictions. The reporter just rushes to the one who is consistent with the day’s news, which is totally useless to traders and in fact it is destructive because it can influence their trading and make them question and deviate from their own methods. No one is ever consistently right more than 60 percent of the time on these major predictions, and just because pundits are convincing does not make them reliable. There are equally smart and convincing people who believe the opposite but are not being heard. This is the same as watching a trial and listening to only the defense side of the argument. Hearing only one side is always convincing and always misleading, and rarely better than 50 percent reliable. Institutional bulls and bears are placing trades all the time, and that is why there is constant uncertainty about the direction of the market. Even in the P1: OTA JWBT576-cintro JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION 15 absence of breaking news, the business channels air interviews all day long and each reporter gets to pick one pundit for her report. What you have to realize is that she has a 50–50 chance of picking the right one in terms of the market’s direction over the next hour or so. If you decide to rely on the pundit to make a trading decision and he says that the market will sell off after midday and instead it just keeps going up, are you going to look to short? Should you believe this very convincing head trader at one of Wall Street’s top firms? He obviously is making over a million dollars a year and they would not pay him that much unless he was able to correctly and consistently predict the market’s direction. In fact, he probably can and he is probably a good stock picker, but he almost certainly is not a day trader. It is foolish to believe that just because he can make 15 percent annually managing money he can correctly predict the market’s direction over the next hour or two. Do the math. If he had that ability, he would be making 1 percent two or three times a day and maybe 1,000 percent a year. Since he is not, you know that he does not have that ability. His time frame is months and yours is minutes. Since he is unable to make money by day trading, why would you ever want to make a trade based on someone who is a proven failure as a day trader? He has shown you that he cannot make money by day trading by the simple fact that he is not a successful day trader. That immediately tells you that if he day trades, he loses money because if he was successful at it, that is what he would choose to do and he would make far more than he is currently making. Even if you are holding trades for months at a time in an attempt to duplicate the results of his fund, it is still foolish to take his advice, because he might change his mind next week and you would never know it. Managing a trade once you are in is just as important as placing the trade. If you are following the pundit and hope to make 15 percent a year like he does, you need to follow his management, but you have no ability to do so and you will lose over time employing this strategy. Yes, you will make an occasional great trade, but you can simply do that by randomly buying any stock. The key is whether the approach makes money over 100 trades, not over the first one or two. Follow the advice that you give your kids: don’t fool yourself into believing that what you see on television is real, no matter how polished and convincing it appears to be. As I said, there will be pundits who will see the news as bullish and others who will see it as bearish, and the reporter gets to pick one for her report. Are you going to let a reporter make trading decisions for you? That’s insane! If that reporter could trade, she would be a trader and make hundreds of times more money than she is making as a reporter. Why would you ever allow her to influence your decision making? You might do so only out of a lack of confidence in your ability, or perhaps you are searching for a father figure who will love and protect you. If you are prone to be influenced by a reporter’s decision, you should not take the trade. The pundit she chooses is not your father, and he will not protect you or your money. Even if P1: OTA JWBT576-cintro 16 JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION the reporter picks a pundit who is correct on the direction, that pundit will not stay with you to manage your trade, and you will likely be stopped out with a loss on a pullback. Financial news stations do not exist to provide public service. They are in business to make money, and that means they need as large an audience as possible to maximize their advertising income. Yes, they want to be accurate in their reporting, but their primary objective is to make money. They are fully aware that they can maximize their audience size only if they are pleasing to watch. That means that they have to have interesting guests, including some who will make outrageous predictions, others who are professorial and reassuring, and some who are just physically attractive; most of them have to have some entertainment value. Although some guests are great traders, they cannot help you. For example, if they interview one of the world’s most successful bond traders, he will usually only speak in general terms about the trend over the next several months, and he will do so only weeks after he has already placed his trades. If you are a day trader, this does not help you, because every bull or bear market on the monthly chart has just about as many up moves on the intraday chart as down moves, and there will be long and short trades every day. His time frame is very different from yours, and his trading has nothing to do with what you are doing. They will also often interview a chartist from a major Wall Street firm, who, while his credentials are good, will be basing his opinion on a weekly chart, but the viewers are looking to take profits within a few days. To the chartist, that bull trend that he is recommending buying will still be intact, even if the market falls 10 percent over the next couple of months. The viewers, however, will take their losses long before that, and will never benefit from the new high that comes three months later. Unless the chartist is addressing your specific goals and time frame, whatever he says is useless. When television interviews a day trader instead, he will talk about the trades that he already took, and the information is too late to help you make money. By the time he is on television, the market might already be going in the opposite direction. If he is talking while still in his day trade, he will continue to manage his trade long after his two-minute interview is over, and he will not manage it while on the air. Even if you enter the trade that he is in, he will not be there when you invariably will have to make an important decision about getting out as the market turns against you, or as the market goes in your direction and you are thinking about taking profits. Watching television for trading advice under any circumstances, even after a very important report, is a sure way to lose money and you should never do it. Only look at the chart and it will tell you what you need to know. The chart is what will give you money or take money from you, so it is the only thing that you should ever consider when trading. If you are on the floor, you can’t even trust what your best friend is doing. He might be offering a lot of orange juice calls but P1: OTA JWBT576-cintro JWBT576-Brooks October 18, 2011 1:30 Printer: Donnelly INTRODUCTION 17 secretly having a broker looking to buy 10 times as many below the market. Your friend is just trying to create a panic to drive the market down so he can load up through a surrogate at a much better price. Friends and colleagues freely offer opinions for you to ignore. Occasionally traders will tell me that they have a great setup and want to discuss it with me. I invariably get them angry with me when I tell them that I am not interested. They immediately perceive me as selfish, stubborn, and close-minded, and when it comes to trading, I am all of that and probably much more. The skills that make you money are generally seen as flaws to the layperson. Why do I no longer read books or articles about trading, or talk to other traders about their ideas? As I said, the chart tells me all that I need to know and any other information is a distraction. Several people have been offended by my attitude, but I think in part it comes from me turning down what they are presenting as something helpful to me when in reality they are making an offering, hoping that I will reciprocate with some tutoring. They become frustrated and angry when I tell them that I don’t want to hear about anyone else’s trading techniques. I tell them that I haven’t even mastered my own and probably never will, but I am confident that I will make far more money perfecting what I already know than trying to incorporate non-price-action approaches into my trading. I ask them if James Galway offered a beautiful flute to Yo-Yo Ma and insisted that Ma start learning to play the flute because Galway makes so much money by playing his flute, should Ma accept the offer? Clearly not. Ma should continue to play the cello and by doing so he will make far more money than if he also started playing the flute. I am no Galway or Ma, but the concept is the same. Price action is the only instrument that I want to play, and I strongly believe that I will make far more money by mastering it than by incorporating ideas from other successful traders. The charts, not the experts on television, will tell you exactly how the institutions are interpreting the news. Yesterday, Costco’s earnings were up 32 percent on the quarter and above analysts’ expectations (see Figure I.2). COST gapped up on the open, tested the gap on the first bar, and then ran up over a dollar in 20 minutes. It then drifted down to test yesterday’s close. It had two rallies that broke bear trend lines, and both failed. This created a double top (bars 2 and 3) bear flag or triple top (bars 1, 2, and 3), and the market then plunged $3, below the prior day’s low. If you were unaware of the report, you would have shorted at the failed bear trend line breaks at bars 2 and 3 and you would have sold mo