by Rick Ratchford
There are plenty of methods available that a trader can use to enter trades. Some may be good, some bad. What is important when looking for a method of entry is whether the risk exposure is manageable for trader using it. Not every trader can or wishes to trade a method that exposes him to excessive risk. There are those with small accounts just trying to get an edge, and there are those whose psyche simply finds exposure to possible large losses unacceptable regardless of how deep their pockets happen to be.
Some approaches to trade entry, such as many trend following systems expose the trader to potential losses that are quite large on average. If you couple this with the low win-to-loss ratios of many of these systems, you could find yourself in some pretty big drawdowns that may be very discouraging. So it is important that the method one chooses to use for entering a trade exposes the trader to low acceptable losses if the trade does not turn out as expected or hoped.
Having a low risk entry method of course is not all that is important for trading success. For example, a method could basically suggest that your stop-loss be no more than x amount of dollars away from your entry to keep the initial entry risk low. But then if the method has a poor timing model for entry to begin with, you may find that your stop-loss orders get hit more often than not. Lots of low losses can add up to one big loss if the win/loss ratio of such a method is low.
It is common knowledge that the lowest risk entry location with the greatest potential for profits happens to be within points of a new major top or bottom. However, in an attempt to enter from a major top or bottom early enough requires many to guess. This type of approach is considered to be 'top or bottom picking' and very dangerous to do. This is because the market has yet to show that it intends to form a top or bottom at that time.
Now there exists methods to isolate the day or week that a daily or weekly top or bottom will likely occur. But note the word 'likely' used here. A high probability turn is just that, a high probability. No man knows with 100% certainty that it will indeed occur. The wise trader will recognize this with whatever method is used for anticipating these tops and bottoms and realize that steps should be taken to at least 'confirm' the expectation before entering the trade.
With my preferred method of anticipating market tops and bottoms, isolating these tops and bottoms are done on a regular basis. Because of the nature of market cycles, a future top or bottom can be isolated with a high degree of accuracy. Once a particular top or bottom is expected to form, the trader with insight will then look for some indication that the anticipated top or bottom is occurring as suspected. It would be at that time that the trader can plan his entry with the least amount of risk exposure.
The basis of my work is on market cycles. Not of the fixed duration variety you may see advertised by some big name cycle gurus. Individual time cycles may be of fixed intervals between tops and bottoms, but the market patterns we see on price charts are the 'composition' of several cycles. The resulting cycle pattern will not be fixed. To learn more about this phenomena, consider the works of J M Hurst. Electronic Engineers are well aware of the effects of combining two or more Sine waves (cycles) together. The result looks just like your price charts.
So with my particular method of isolating high probability future tops or bottoms, the next task is to keep the risk low when entering the trade in the event that the turn does not materialize. By studying thousands of charts over the last 13 years, I've noticed a very consistent pattern that helps in keeping the risk low upon entry. This pattern is based on the very fact that EVERY NEW TREND starts with first the extreme (i.e. top or bottom) and is soon followed by a correction of some kind. This correction can be simply a one-day affair or take several days to unfold. But regardless of the duration or magnitude, a correction WILL occur.
Noting this consistent pattern, it became obvious that if the method can isolate the high probable time period for a major top or bottom, confirming this as early as possible could be done by determining the next short-term correction using the same method of timing and allowing the market to fill you into the trade if indeed it occurs. If the anticipation is not correct or too early, the likelihood of having your order filled is extremely low. Additionally, upon having the order filled because the anticipated turn does indeed occur, the risk exposure would only be the difference between the fill and the extreme of that correction, normally only the range of one price bar.
Obviously, if it is a weekly bottom that is anticipated for a particular time period, the trader would look for a new weekly low to form within that expected time period. From there, the trader would note that price will start to move higher as that is the only way a weekly bottom or new bullish trend could possibly start. Viewing this from a daily price chart, at some point price will start to drop again (correct). If a new bull trend is to actually form, this correction should fall short of moving lower than the original weekly low that started this possible new bull trend. Where it stops correcting is the LOWEST risk entry location to go long if you are anticipating a weekly bottom is being formed and the trend is turning up.
Of course, during the correction phase following a new weekly low, for example, the trader would need to use his timing method to anticipate where this correction may likely end. He knows that it must end before moving lower than the current weekly low if his expectations are initially correct. This may be done by looking for corrections of 38%, 50%, or 62% of the initial move off the weekly low. Or as done with my cycle timing method, to simply look for the correcting bar to enter the daily cycle turn time frame before considering entering the trade.
Upon entering that daily time period, an entry order in the way of a BUY STOP above that price bar's high would fill me only if price starts higher the next day. To be filled this way allows the market to make that correction low price bar now a bottom itself, and most importantly, a bottom that is higher than the weekly bottom you anticipated early on to be the beginning of a new bullish trend. The range of that new correction bottom is your initial risk exposure, so you know in advance how much you need to risk for the trade. If acceptable, you'll know this up front.
In addition to waiting for the correcting price bar via the daily price chart to move into my cycle turn time period, following a new weekly bottom, I like to note if that particular price bar reaches some pre-calculated support value. For example, more often than not a correcting price bar that is destined to become a new daily bottom itself will usually occur not only within a certain time period as discovered via my cycle analysis, but will fall on support as well. Such support can be calculated using various methods available today, such as the Fibonacci ratios I provided in the previous paragraph, time and price squaring, Gann Angles, or simple trend lines for example.
To stay in this business of trading for the long-term requires that we keep our risk exposure low and plan to enter trades with the best potential for profit. I've provided the approach that I've found to be low-risk by letting the market prove our expectations as correct before our order is filled, and to allow us to know in advance what our initial risk exposure will be. Whatever timing model you choose to use, always keep in mind that that bull trends and bear trends have certain patterns that persist over time. New bulls will form higher correcting bottoms and new bears will form lower correcting tops. Know this and trade well.