Yesterday the S&P500 (SPX) had a strong trend day offering good trade signals. Even though I don’t trade the SPX I think that a brief analysis helps to understand how these trade signals work. I know that “hindsight is exact science” but rule-based trading method wouldn’t fall too far from visionary trade examples.
Entry signals are provided by countertrend micro trendline breakouts with the trend indicated by the EMA20.
The bar breaking the pullback’s trendline is the signal bar. First entry is taken below the low of the signal bar. Second entry is taken at the low of the bar that has a higher low following the first entry bar. On the following charts I labelled first entries with 1 and second entries with 2.
Initial stop at the top of the signal bar but not smaller than 1.5 points which is roughly 1.5 times the average true range of the last 200 bars (5 minutes). The logic behind limiting how close you put the initial stop is that an intra-bar pullback followig the breakout may kick you out of the position just before the price would move into profit.
A short position is closed above the highest high of the last two bars prior the current bar.
1. The first signal came two hours after the open with an initial risk/reward of slightly better than 1:1 (measuring to the previous price extreme as a target). Exit signal came 11 bars later with a 4.60 pts profit. The second entry also offered a profitable trade with slightly less gain but the risk/reward was still close to 1:2 ex post after the price reached a new low. The small gap lower after the signal indicates that the entry was hard to execute without a few ticks slippage therefore the second entry was a safer trade to take.
2. The second trade offered an better risk/reward (nearly 1:3) while the second entry had a bit less profit. Should have been a pretty straight-forward trade to execute while two bars with long lower tail were giving an early warning for taking profit.
3. Trading the third signal would have been a bit tricky. While the first entry was not looking very decisive the the second entry was nearly at the same price level. Moreover the bullish bar after the first entry would have trapped out most of the traders entering short on the breakout so the second entry again had a better chance. I have to admit that after that long bullish trend bar against the setup taking out the high of the previous three bars I would have hesitated entering short.
4. The fourth trade had a nice signal with a bearish pin bar touching the EMA20 with a long bearish trend bar for the entry. One can argue that the pin didn’t break the micro trendline but the position and form of the setup bar was convincing enough in my view.
To sum it up, it was a study book example of a trend-from-the-open day with four trades with two of them require some discretionary judgement. I don’t think that there is problem with that. As long as there is a sound position management is place (i.e. stop loss) an experienced trader can trust his/her own gut feelings. As Al Brooks writes in his book, “close enough is good enough” when evaluating a pattern.