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Trading By The Book - Part VI
/.K- 62 /J)= 62 D=li21 0=6162
H=6201 L=6159 C=62B0
Figure 80 The weekly oscillator for the Swiss Franc had gone flat, but the daily oscillator was showing rising bottoms. I had drawn an envelope around the Swiss Franc, and I took a breakout of the 1-2-3 low shown on the chart. I was stopped out at a profit as shown, concluding my Swiss Franc trading for the year.
Trading By The Book - Part VI
Wrap-up - Clarifications and Comments
Q. Do trading ranges always start with a gap or a large magnitude move?
A. Overwhelmingiy so. It seems that very few people have ever realized this, but if you look back over countless charts, as I have, you will see that most trading ranges begin with a gap or a price bar that is very large from top to bottom.
Q. Could you clarify "magnitude of range?"
A. Magnitude of range is simply the measurement from high to low or conversely, from low to high, of a single price bar, or from the highest high to the lowest low of a group of price bars.
Q. What exactly do you mean by Initial Stop?
A. My initial stop is always a Fail-Safe or catastrophic stop. I dont want to be stopped out before Im ready. Yet, if there were a catastrophic move in the market against me I wouldnt want to be wiped out. Therefore, my initial stop Is placed as far from the price action as is affordable for my trading account, or as far away as Im willing to risk on this trade - sometimes that is quite close to the price action. Often my initial stop is a reversing stop, especially if it is close to the price action. My intention from there on is to move it as quickly as possible to either get myself out of a bad trade, or to protect profits on a trade that is going my way.
Q. In Chapter 1 of Part I, you shorted Gold before the Close was outside of the envelope. Is that what you meant by "changing your plan?"
A. Yes. The momentum of the gap down, with the low actually breaking out of the range, coupled with the facts already given, were enough to cause me to enter an order. There is one other significant reason, and it is covered in Part V of the manual. That reason alone is enough to cause entering the trade on the day that the gap down occurred, as will become clear at that time. Using the principle in Part V, there would not have been a change of plan - the plan in that case would have been to enter on a breakout of the local low from a l-ll-lll formation.
Q. Gold didnt make much of an initial move downward after breaking out of the envelope. Does your method give a reason?
A. The reason as stated in Chapter 1, Part I, is that this was an expanding envelope. Notice that It made one new low and two new highs during the course of its life. Expanding envelopes tend to weaken over time. Therefore, look for short term profits on breakouts from expanding envelopes.
Q. You say to reverse your position if prices break out on the side of the range opposite your position. Wouldnt that take a lot of guts after suffering a sizable hit by being stopped out clear across the width of the trading range?
Trading By The Book - Part VI
A. First of all, unless there was a catastrophic one day move against the trade, my stop would have been moved up as soon as it became clear that the trade was going my way, If it immediately went against me but not to the point of a catastrophic move, I would have been stopped out long before prices moved clear across the width of the trading range. If indeed there was a catastrophic move and prices broke out on the other side of the range, I would certainly want to reverse and go along for the ride. Such a move is bound to make money. Finally, over the years I have proved conclusively that reversing losing trades results in a far better trading record than just taking a loss and getting out. If the trades have been picked according to the Book, the percentages are that reversing will lessen over 95% of losses incurred, and will, in 80% or more of the cases, result in an actual winning trade!
Q. Is it accurate to say that a fully established trading range is defined as consisting of a leg up, a leg down, a leg up, and a leg down?
A. Yes, that would give an formation. The reverse is also true W. Of course the leg usually constitutes more than one price bar in each direction. Anything short of 4 legs would not constitute a fully established trading range. For example, a leg up, a leg down, and a leg up / constitutes the ingredients for a 1-2-3 iow as discussed in Part II. A leg down, a leg up and a leg down \A constitutes the ingredients for a I-ll-li! high as discussed in Part II. Finally, a leg up and a leg down make up a hook, as does a leg down followed by a leg up V. Trading hooks are discussed in Part II.
Q. How would you define your approach to the markets, defensive or offensive?
A. Trading by the Book is based on the philosophy that a good defense is the best offense. The method and tactics used in Trading by the Book are aggressive. Im always attacking the markets, trapping it so that it cant get away from me without my being in on a move. The envelope is a trapping technique, so are one-two-three breakouts, hooks, ledges, etc. The triple testing concept of the Oscillators is aggressive and anticipatory, as are offset moving averages. Im always trying to put myself In a position where, when a market breaks out, Im along for the ride. This makes my approach conservative as well.
Q. With regards to Figure 32 of Part I of the manual, can you be more explicit about how to select the proper A,B,C swing?
A. You must go back far enough to project a swing that will give an objective outside of the trading range, and at least one leg of the swing must be inside the trading range. Normally a swing will have an easily identified top and bottom and look like this:
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