A question

Discussion in 'Trading' started by freewilly, Jun 1, 2008.

  1. When I look up historical data, I saw this pattern often, but not so often that I would trade with it every time. that means, sometimes, it stays in the channel, but sometimes it breakouts.

    My observation and question are on the chart. Can I trade with it?


  2. piezoe


    Happy to answer, because it is such an easy question Please don't ask any hard questions.)

    Answer: You can't tell if it will break out. It may and it may not.

    You can trade this two ways:

    First way: Short at resistance and buy at support. Stop out if it breaks support or resistance.

    Second way: Buy the breakout above resistance or sell the breakdown below resistance. Stop out if it reverses back into the channel.

    The breakout play has a lower probability of success but a favorable expectation over the long haul. Success over the long haul, when you have taken this trade many times with most of them not working out, depends on riding the rare trend to a substantial profit, which means not exiting too soon once you are aboard a sustained trend. Nearly all sustained trends have minor pullbacks incorporated within the trend and the success of a trend-following-trade depends on not being taken out by these minor pullbacks, but rather riding the trend to it's true conclusion. This means of course that you will have to leave something on the table, when you get out, because there is no way to know you are at the top of a trend until after the top has past.

    The channel play has somewhat greater probability of success but lower profit potential.

    Looking at other considerations such as market and sector trends and company fundamentals may give you some clues as to which way price is more likely to break, but in any case you should not try to anticipate the break but simply react to it when it does occur.

    You also should decide, before you enter the trade, on the point where you will decide that you are wrong and get out of the trade. There are many criteria that can be used to make that decision and there is an extensive literature on the subject as well as related threads here on ET.

    One more point, and it is a key one. You should not take the trade sometimes and not take it others. Instead you must take the trade every time, according to consistent rules and criteria, if you want a trade with a favorable positive expectation to work out for you in the statistical sense. Otherwise you are simply gambling, and we know who wins when we gamble, the house!

    By the way, if you are looking to hop aboard a trend after a breakout, the safest entry would come from drawing the channel through the absolute range highs and lows, rather than as you have drawn it.
  3. Peizoe, good stuff, thanks.