edgetraderplus'  Instablog

Thursday  Evening  12 November 2009

Crude Oil has retraced all the way back to its breakout, an area we have
described in detail previously,  Crude Oil - Picture Perfect Breakout, on
19 October.  We went long, then exited, Crude Oil - Standing Aside, on
23 October.   There was one more buy attempt that failed for a small loss
a few days ago, but after seeing the market sell-off into the support area,
getting long Jan Crude Oil at 77.95 this morning may be a reasonably
"safe" trade.  Whenever a market pulls back to its point of breakout, it is
a retest of the breakout, and a "safe " place to initiate a new trade.

Why?

A breakout is a clearing of former resistance which then becomes support. 
Because it is a recognized area of support, buyers will defend it to keep
the technical structure positive.  If price is allowed to drop too far back into
the breakout area, sellers will see that as a sign of weakness.  Now buyers
will have to defend against even greater selling efforts.  Easier to defend
the breakout area and avoid additional selling at lower levels. 

The breakout is labeled on the chart below.  As well, selling probes testing
the breakout area, have been identified.  There are additional reasons for
buying this most recent retest.  The sell-off lows that have been holding
76.50 - 77.00 have formed a trading range since the breakout high at
82.50, on the Jan chart.  One of the best ways to trade a trading range is
to sell the upper 25% area, and buy in the lower 25% area.  Mention of this
rule has been made in a previous article, Crude Oil - Buy , from 3 November.

This strategy presents a lower risk entry, for obvious reasons, as long as
the trading range remains intact, and there are no guarantees of that. 
Getting long at 77.95 puts the trade at 24% of the entire range.  If today's
low holds, 77.26, that puts the position at the bottom 16% of the recent low
range.  This is establishing excellent trade location.

Why not wait for a lower retest?

Answer:  What if a lower retest never comes?

To show why the entry was taken, we go to the next chart, a 10 minute intra
day chart.

There are a few other things to keep in mind.  The trend is up in the larger
time frames, both weekly and daily.  We know that the chosen long position
is in harmony with the primary trend in the time frames identified.  Trading
WITH the prevailing trend is a cardinal rule that cannot be broken.  Not if
one wants to trade successsfully over a period of time.  Non-professional
and novice traders break this rule at will.  They also do not last very long
in this business.

The smaller time frame 10 minute chart is used for timing  trades selected
from the larger time frames.  What becomes immediately apparent is that
the 10 minute chart has no trend, but is in a defined trading range, 81.60
high to 77.22 low.  We can now show why waiting for a possible lower price
level retest was not a high probability.

You can see the 77.22 low established during the opening 10 minute bar
on 3 November.  In fact, we went long the Dec contract at 77.25, and
subsequently sold half the position at 80, and the other half on a sell stop
at 78.85 on 6 November.  Now we are back at the same trade location entry,
and within the current 10 minute trading range, buying at Jan 77.95 is within
the bottom 17% of the range. 

Why there?

Great trade location in an uptrending market.  You can see the support line
near the bottom of the chart.  Price was right there, today.  The decision was
made after seeing the 4th bar from the end.  Crude Oil was down over 200
points on the day.  Note the 5th bar from the end: a wide range down with a
weak close.  It does not pay to buy weakness. 

But, we bought even lower.  Wasn't that also weakness? 

Depends upon your point of view.  Look at the volume and close of the 5th
bar, and compare it to the volume and close of the 4th bar.  The fourth bar
had greater volume, and the close was above mid-range on the bar.  This
tells us that when selling volume increased to the highest level of the day,
the down bar range was smaller and the close was as described, letting us
know that buyers came in and supported the market.  If there were no
buyers, the close would have been much lower.

Also, look at the low of the 4th bar and scan to the left to see where the low
was last Friday.  Almost exact!  The same lows from last Friday and the
Tuesday before that led to sharp rallies.  Once we saw that market activity
develop, we could read the "message of the market."  It was not guesswork,
but factual observation that buying came in at support.  We went long as
soon as a new high occurred on the intra day chart, and that was at 77.95
area, during the 3rd bar from the end.

What we could not know when we went long the little breakout is how price
would develop from that point on.  You can see the not so strong close on
the 3rd bar, and that told us to expect another retest of the low, then 77.45. 
Price actually made a new low, 77.26.  We had sell stops at 77.15. 
They held.

We drew a small horizontal line off the first low, and labeled the newer low as
a failed probe.  In other words, the market went lower but did not find any
more sellers.  Maybe some weak sell stops, but selling dried up.  With no
more selling, price had to rally, and rally back it did. 

The sell stops remain in place.  If the Crude Oil market is to continue its
trend, we expect price to hold and work higher.  If it does, we enjoy a great
edge in the selected trade location.  Everything was done for a reason and
with purpose, based on reading present tense market activity and drawing
conclusions from those factual observations.  There is no guarantee the
trade will be profitable. There could be one more low, and the process would
be repeated, or price could continue lower without rallying back.

What we know for certain, in an uncertain environment, is that the decision-
making was well-executed, and as long as that caliber of trade decision is
exercised, on balance trading will be profitable.  One can only do their
reasoned best.