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Lessons from the Pros - Futures

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Questions, Responses, and Ruminations

Tue, Oct 27 2009, 10:38 GMT
by Gabe Velázquez

Online Trading Academy

Since my last newsletter was published, I've received some great emails. Some of them were in response to my last article, and one was written by one of my recent students who asked some very good questions pertaining to trading strategy. Since I believe the answers to the trading questions have very good educational value, I'm going to dedicate this missive to responding to those inquiries. I'm also going to share with readers some poignant responses to my last piece, "Discipline Transcends Trading." So let's get to it.

Juergen writes:

Hi Gabe,

Hope you had a profitable week, mine was very choppy, which leads me to a couple of questions for you.

Do you use the candlestick bodies or wicks to draw support/resistance lines? How do you determine that a previous support/resistance line is no longer valid? When do you decide to enter the gap trade? Right at the open, or do you have other rules in order to enter the gap trade? Thank you for all your teaching and if there is something that you think I should be asking, or should know, it would be much appreciated. Asking the right questions is always the most difficult thing to do!

Thanks again,

Juergen

First, let's tackle the drawing of support and resistance. The common mistake many new traders make is looking at S/R as "one line." I think it's more helpful to look at these levels in terms of "zones" rather than lines. Using the entire length of the candle, not just the body, is also useful when defining these zones. This is due to the fact that extreme prices are prints (transactions) and thus have to be considered to define these areas. Moreover, those extremes can be used to define where the stop loss is to be placed.

As an example, let's say that you spot a support area in the TF between 590 and 588. In this case, you can plan your long entry with the knowledge that the stop loss must be placed a small distance (low risk) below 588. The rationale behind the positioning of the stop is simply that if price breaches the lower band, it will signal that the buyers were not strong enough to gain the upper hand and hold that level, thus increasing the likelihood of lower prices. The actual buy will vary depending on trading style. Some traders will prefer confirmatory evidence before executing the trade, while others will place a limit order within the support zone relying on the low risk, higher odds possibilty of the level holding.

The two charts below illustrate the recent support and resistance zones in the TF (Russell 2K E-mini).

The question about the validity of a support or resistance level is a bit more subjective. In my opinion, the first time a major level is tested is when the odds are highest it will hold. However, by looking at the chart examples, you can see that even after several attempts, there were big moves away from these zones. Another strong consideration would be to look for these zones in the larger time frames (15 and 60 min) as these levels are usually more robust.

Let's address the question about entering a gap trade. Since a higher percentage of the time gaps tend to want to fill, I'm going to discuss fading the gap. The setup first involves identifying the S/R zone that the market will be gapping into. If on the opening bell, price is in a zone and the risk-to-reward makes sense, then a market order in that instance makes sense. If, however, the S/R area is some distance away, then a limit order would be more appropriate in that scenario. Below are a couple of recent gap setups examples (note that I've highlighted the gaps in yellow and the zones with magenta lines).

Hopefully, these examples will help some of you that are still learning to identify levels and perhaps trade gaps. To others, these will only reinforce some of what you've been exposed to already. Still, it doesn't hurt to review.

Finally, two weeks ago the entire Online Trading Academy family got together for our annual International Conference. It was a chance for all of us to share ideas, experiences, and generaly have a good time. One of the core themes expressed at these Online Trading Academy conferences is "changing lifes through exceptional financial education." Well, I have to say the following two emails certainly, at least for that day, may have struck a chord.

Ash writes:

Hello Gabe,

Today you wrote something that inspired me to write this email.

You wrote, in your Online Trading Academy article: "...This attribute of dogged determination is something I've always admired in people, and have tried to emulate throughout my life. It's not always easy, though, since sometimes we can get too comfortable in our current situation. When that happens, I believe it's necessary to get out of our comfort zone. Being uncomfortable can be good, as it will allow us to grow and regain that thirst for challenge."

First, thank you for these words. This is something that's very relevant to my current (non-trading) situation, and to see it in a tangible form like this is quite moving.

Holiday wishes to you and your family,

Ash

Clark writes:

Dear Gabe,

I loved your piece! I have been studying the markets for a couple years now. I have made money paper trading, and thought I was ready to go live, only to run into problems with my system, the market, the method, etc. It shakes my confidence, and then I start looking for another system. I now realize this process will continue until the day I die, if I let it.

I am at the discipline stage in trading. I believe this is way more important than which system you choose. Can I stick to it? Will I 'tweak it' next time I lose? When will it end? Trading psychology is the most important element of trading, and I loved your piece. Thanks.

Clark

It's very gratifying for me to see that writing these letters can affect some readers to ruminate about their lives and trading careers. In short, if I can influence just one person everytime I write, to commit him or herself to fulfilling their trading goals, then I will feel like I've done my job.

Until next time, I hope everyone has a profitable week.

Published on  Tue, Oct 27 2009, 11:45 GMT