Trickery at Tops: Contingency plans for tricks and traps.
Previously we made a case for a “Textbook” reversal setup.
The case for a macro bear has now fully developed. (substack.com)
Now we’re going to look at some market tricks and caveats we need to be aware of. A big market reversal should be really tricky at the top. It’s a grave mistake to underestimate the potential for the market to run stops above the levels you expect.
In the main, things that worked in charting in the 1920s - 1930s work the same today, with the addition of spike outs. Here’s a simple comparison to illustrate.
In 1929 the DJI bull trap would end exactly on the retest of the 200 SMA. It really was that simple a signal.
Essentially the same signal occurred in 2007/8, but if you’d bet on the 200 SMA you’d probably have been squeezed out.
The second test of the 200 SMA traded slightly above, but the 200 SMA would indeed mark the top of that rally. The trading above it being a head fake.
Another example of this is fib retracements. Many books and sources will cite the 61 fib as the reversal fib. This was probably one of the first things I learned about fibs and I went and traded loads of them. I found almost invariably price went further. Tight stops would be stopped out in a spike almost every time off 61s.
61s frustrated me for a while and then I started to try to adapt for spike outs and found most often they stopped somewhere around 72-73% retracement. The 76 fib would usually get close to hitting, but it would not actually hit. Entries close to the 76 fib were optimal and I could use stops behind 76.
Used this for day trading for a long time very successfully and then a major swing trade retracement setup. I dropped my limits in just before the 76 with my stops over it. Market ripped from 61 like I expected, started closing longs and filling shorts - and then it blew through my stops. Big wick over the 76, and boom.
Move happened, I missed it. Spiked out.
I was stunned. I thought I’d mastered the spike out. I was entering into what should be the spike out. That’s when I learned big events can have more substantial spike outs. Then in the BTC rally after the 50% crash I accounted for all these fib adjustments and spike tolerance, and it did this.
And I found out in really big events the spike out rules should be considered “Market hates reversal traders” and you should be ready for various types of bull traps - including new high bull traps (Perhaps the most effective ones).
In the end the BTC top signal was a simple harmonic. Easy to spot after the fact but not being aware of it I was shorting into a big D leg. Not a good place to be.
I learned a lot from this trade. After it, it was so obvious to me I should have got long the break of the 61 and targeted 127 or so with short limits 161. With my experience of practical application of harmonics this was very tradable, but I’d locked in on the idea we’d reverse at the 76 + head-fake. Which was a big mistake.
I could have got long the 61 break and it would have covered the cost of my 76 shorts. So simple in hindsight.
At this point in SPX we’ve accounted for all these spike out nuances I am aware of. We’ve been patient with the early bear traps and leaned towards waiting on the spikes. Had some tolerance for a 76 spike out so long as it’s inside of spike out pattern and lot long where we’d be entering into the D leg of a harmonic if that was to come.
As much as I’ve used my experience day trading these patterns and trading the big version of them through 2021-2022 to try to lower the chances of being caught out, spiked out or just worn out to a minimum, all of these things do rely on norms holding. Elliot waves and harmonics have caveats and risks.
Let’s look at moves that are possible inside of the strategy rules and plans on how to deal with them.
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