I’ve written quite a bit lately on things that don’t work, and tried to point out some errors in common practical technical analysis. Yes, I’ll do more of that in the future (I suppose perhaps because I am a curmudgeonly soul (and, really, how often do we get to use that word?!)) But, today, I want to share with you a very simple, concise pattern that has a tremendous statistical edge. This pattern has been one of the mainstays of my trading techniques for many years. Daytrading, position trading, even looking at relative performance of sectors, trading options, trading spreads, outrights–this is a pattern that can inform all of your tactical/technical trading in the marketplace.
A pullback seeks to capitalize on the fundamental principle of trend movement: trends don’t move in straight lines. Rather, they move in periods of with-trend strength, interspersed with consolidations and pullbacks. Now, I think a lot of nonsense has been written about this–about patterns and types of pullbacks, and ratios, and different expectations based on these distinctions. (Maybe I’m wrong and it is not nonsense. I still continue to do research in this area.) I’m happy to tell you that you don’t need any of that stuff; all you need is to understand this fundamental pattern of the market, have some way to identify when a market makes a “strong thrust”, and then have some trade management skills with respect to stops and targets. (Well, you also need to be well capitalized, size positions correctly, and do everything with perfect discipline. This isn’t easy!)
The chart above is from the portion of my book I decided not to publish, and shows one way we can define pullbacks. In this case, once a market goes to a channel (any channel, within reason), you can look to enter around the moving average. Yes, there’s a lot of imprecision in that statement, because it all works. The concept here, of working within the fluctuations of the market, is solid and works across a wide range of markets.
The table above can be a little bit hard to read at first, but it’s worth a few minutes of your time. I’ll shortcut it for you: it shows a strong edge for both buys and sells across stocks, futures, and forex, and it’s one of the very few patterns that shows this kind of clear edge. No, it’s not a huge edge, but, as I’ve written before, markets are competitive; there are no huge edges. There are no statistical homeruns. There are, however, small, robust edges that we can apply, with perfect discipline, and pull superior risk-adjusted returns out of the market.
I also want to do something a little different today. Self-promotion really is foreign to me, as my long-time readers have seen. I suppose that’s because of my experience as a trader–seeing that every single time I have gotten overconfident the market has reminded me to be humble. I’m never going to be that guy telling you what “has to happen” with a stock or any market (because I think “that guy” is being intellectually dishonest, too.) However, in my published research, we are going through a period of really solid performance: we’re short the euro, short the pound, short soybeans, and have on a few other trades that are doing reasonably well. Clients get a lot of detail on the trades, specific entry levels, stop losses, profit targets, and ongoing trade management commentary. (Ahem, here’s my forced self-promotion note: if you’re interested, we do offer a free trial. Use this form to contact us. (Also, because I’m a cynic, I probably just nailed in the high or low on some of those markets by making this post!))
(Edit: my work is now available at Talon Advisors.)
The point here is that each of these trades was based on a pullback on the timeframe shown: the same simple, robust pattern over and over. I’m reproducing current charts with an arrow marking the entry so you can see how these patterns played out. (In all cases, the entry was on the next bar of the chart following the arrow.) Yes, there’s subtlety and an element of discretion here–some finesse even–and trade management is essential. Regardless, you can base an entire trading program on this simple, robust pattern that works.