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dashed line on the chart. We have once again locked in a greater level of profit for the trade.

Nearing the end of the session, the market finds support at its previous low and manages to rally enough finally to break through overhead resistance and stop us out of the trade, as marked on the chart.

Refer to this trading example often, because it quite effectively demonstrates the classical use of the four-step method of major and minor trend identification, trade execution, and exit using a trailing stop. Quite important also here is the graphic illustration of the importance of fading prices indicated by support and resistance points.

For our next trade illustration we will be analyzing the activity of the four-step process on an chart, this time using a one-minute time frame (Figure 12.6).

The first step analysis, using the Directional Day Filter, shows us that there is some activity on both sides of our filter line prior to the time used to make our final analysis, in this case 90 minutes into the session for Amazon. Although the activity advantage is only slightly

Figure 12.6 Two buy signals are generated in The first is a breakout trade using the early range from the Directional Day Filter, while the second is generated by the four-step method.

in favor of a rally, the close on the timing bar near the top of the daily range at this point gives the day an upward bias. Also, the strength of the market at this point, combined with the signal from the filter lines, is telling us that the trend for the rest of the day is sideways to higher. With this in mind, we will be primarily looking for buying opportunities from this point on. Keep in mind that the picture is not 100 percent for a strong rally since our primary trend designation is sideways to higher. We must understand that significant setbacks along the way are a definite possibility.

With the prospect of a rally in this market, we are free to enter an early-morning breakout trade by once again placing a buy stop above the intraday high identified one hour into the market. The first solid horizontal line on Figure 12.7 details the placement of this buy stop, showing that it was filled as the market traded through the designated price 13 minutes after the order was placed. As the market moves in our favor, we are able to place a trailing stop slightly below the Category 3 support point that appears just after 10:00 . on the

AMZN LAST-1 min 04 000 ~3«( «1

Breakout Trade Entry.

0x26.000 H=26.1B8 lrf4.B25 V=1639300

- Category 3 Resistance

uptrend Predicted

Stopped out Category 3 Support ! -Directional Day Filter 1 -......-----

uni flr I Q-m qir - a-4fi ltl:01 10:16 10:31 10.46 11:01 11:16 "llT

Figure 12.7 Theinitialbreakouttradeis stopped out by Category 3 SUppOtt

with a modest profit.

Chart created with TradeStation® 2000i by Omega Research,Inc.

chart. Our position is liquidated by this sell stop a few bars later for a modest profit.

Looking then primarily for additional buying opportunities, we can observe the first buying window opening shortly after 11:00 A.M. as we get an exhaustion reading from our dual settings on the RSI indicator (Figure 12.8). A fairly lengthy market correction has lasted for over an hour; thus this market is ripe for a rally, With the recognition of this new buy window step two is completed; we have now identified the exhaustion phase of the corrective move against the dominant trend for the day

Going on to step three, we are able to identify the nearest overhead resistance at the Category 3 point identified just a few bars prior to the opening of the buy window by the RSI oscillator. This point is marked by the short, horizontal solid line above the RSI buy window dot. The actual Category 3 levels are represented by the small black squares above and below the price bars on the chart.

Shortly after 11:00 we are presented with a second Category 3 resistance point, which allows us to lower the placement of our buy stop

Figure 12.8 The next long position is initiated with a buy window opened by dual RSI and the violation of Category 3 support. Trailing stops, placed courtesy of Category 3 support, eventually stopthetrade out with a profit. Chart created with TradeStation® 2000i by Omega Research, Inc.

to this level. Remember, each resistance level placed by a given chart pattern carries with it equal probability of success. Therefore one should not hesitate to move stops to a lower level, thereby allowing the system to buy at a more profitable level. A few minutes after low- ering the buy stop, our position is established as the market trades I through our price level.

Our emphasis now shifts to step four where we actively manage I an appropriate exit strategy for our trade. Our immediate attention therefore is directed to the most recent Category 3 support level, which appears at about the same time as the long position is actually established. The dashed line labeled 1 on the chart further defines the exact placement of the protective stop, again placed slightly below the actual generated support point to avoid being inadvertently stopped out during the formation of a double bottom.

As the market moves higher we then experience another slight correction, which forms a new, higher Category 3 support point, labeled as 2 on the chart. The protective sell stop is now moved to this level, locking in a significant profit for this trade.

After making another new high for the day and subsequently creating a double top on the chart, the market pulls back into another correction, again providing a new support point, labeled 3. Shortly after moving the stop to this new, higher level the market trades down through our sell stop, exiting the trade at a profit.

Within a few minutes of being stopped out of the first long position of the day, the dual RSI combination opens up a second buying window, as illustrated in Figure 12.9. Note that multiple signals are generated by the dual RSI pattern when this buy window is being activated. This is actually nothing more than a passing curiosity; the faster average can turn higher multiple times below the oversold area in a short period of time. This activity creates the multiple signals generated here. Keep in mind that signals such as these carry no greater significance than the buy window that was created earlier with only a single occurrence of the required pattern. Multiple signals generated in a short period of time, from this or any of our tools used to measure exhaustion of a market correction, have no greater weight in the general scheme of our trading system than a single occurrence of the same nature. Since step one has already been completed by defining the uptrend for the day much earlier in the session, it is acceptable to move immediately to step two of the process, which is accomplished by the appearance of the dual RSI signal.

,ll :, Exit ............... .......Exit:........

X : / .V V * Buy

Support -.J-J-r""~ " ........................:...........:..................j :

Buy Windows Opened by Dual RSI ""

-37.500 37.000 36.50G

- .

35.500 -35.000 -34.500 -34.000 33.50D -33.000 j -32.500

Directional Day Filter

: RS[faS(7J0.O)4e:6 30.00 7000 RSI S0W(12.70.1) 40.51 30.00 70.00-!-!---

100.00 80.00

eooo .

4000 20.00

---if IV.41 12 46 ,1B I,.,, i.,JB 0, 4 f

figure 12.9 The last buy of the day is entered and exited using Category 3 support and resistance.

Chart created with TradeStation® 2000iby Omega Research, Inc.

Again we move on to step three, establishing a high-probability entry point. Note that in this case the appropriate resistance point as defined by our Category 3 chart formation rests a considerable distance from the point at which the actual buy window was opened in this case. This is of no immediate concern. As noted in previous examples, it is not uncommon for these entry points to be reestablished at lower levels prior to actually being activated. Again, as with the placements of the protective stops earlier, we are careful to fade the placement of entry stops by placing these orders slightly above the price designated by the actual resistance formula. The same theory applies here: We wish to enter the market only after resistance has been broken, not as it is reinforced by a double top. The effectiveness of our fading strategy is demonstrated well at this point (as shown in Figure 12.9) as the market makes a double top right at the previous resistance point and trades lower for a time before gathering itself for the push that actually goes through our buy stop, creating our second long position of the day,

Our initial protective stop for the second position falls significantly

below our entry point, an amount that may prove to be too risky for some traders. Most stop levels generated by these methods are available to the trader before the position is initiated, giving the trader sufficient time to make a decision as to whether to take the trade, and, if taken, to devise an alternate stop point more to his or her liking. As a general rule, traders will find their success will be greater over time by following a prescribed strategy for each trade, not making adjustments on each trade as they come up. However, being a realist and having had considerable experience with traders constantly tweaking systems, I feel an obligation to point out the possibilities here. As an alternative, one can choose to use another support point for interim stop placement. For instance, on this chart there is a Category 1 support point much closer to the entry point that could have been used for an initial protective stop. It is acceptable to use, for instance, Category 3 resistance for entry and Category 1 or 2 for exit if this is indeed a better fit considering the trading style and risk-carrying ability of the trader and the market being traded.

As you can see on this trade, we are able to move our exit stop to a profitable level that is activated shortly after the market tries and fails, for a third time, to extend its gains past the $37 area.

Next we will use a one-minute chart of the volatile S&P 500 market (Figure 12.10) to demonstrate the manner in which our four-step method of entering and exiting a trade is able to handle a wide-swinging, wild day in the markets. Note that this day has a range of nearly 40 full S&P points. When all the dust has settled, there has been very little change in the market from the opening bell, as the close of the day has come in very close to the open. As you can see, there is considerable activity on the chart. For purposes of clarity I have broken the chart down into three sections and will analyze each separately. From the main chart presented here, observe that step one of our method identifies the day as nontrending one hour into the trading day. The market activity is relatively equal at the time the evaluation is performed. Also, the close of the determining bar is in close approximation to the filter line, again giving us little direction as to whether to expect a rally or a price decline for the rest of the day. Thus, faced with an indeterminate structure, we can expect a nontrending day.

One can certainly look at this chart and isolate several large trends that develop during the day and question the determination of a supposedly nontrending day. Recall, however, that our definition of

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