What Works in Trading & Why: Tactical vs Strategic Corrections (Part 2B) This is the Part 2b, the third of 6 installments. If you think you missed the first two (Part 1 & Part 2A), just send me your email according to the instructions at bottom and I'll send you what you all previous installments in PDF format (with full color charts included.) === Part. 2 : Ideal Trade Location & Variant Perception B. ISOLATING TACTICAL CORRECTIONS In the first section of Part 2, we explained how different traders who reference different timeframes can observe the same price, yet draw different conclusions about the odds of future price behavior. We call this type of divergence a "variant perception" -- it's important because it creates a transient inefficiency which can be exploited to extract a reward that's some multiple of your risk exposure. Here in this second section of Part 2, we'll define a second type of trade location which we call a "tactical correction'. You'll need to download the chart set titled charts_2B.zip (below). TACTICAL CORRECTIONS. Tactical corrections are simply shallow reactions in a primary trend. A tactical correction in a bull market is a retracement that does not drop low enough to engage any rising quarterly equilibrium price levels. Chart 1. In the weekly Gold futures chart, <<attached>>, the reaction at A is a tactical correction because it DID NOT drop low enough to engage the strategic buy zone at the rising quarterly equilibrium price levels. The reaction at B is a strategic correction because it DID engage the strategic buy zone by dropping below the upper light blue line near B. Likewise, a tactical correction in a primary bear market is a retracement that does not rally high enough to engage any declining quarterly equilibrium price levels. Chart 2. In the weekly 10-year Treasury Note futures chart, <<attached>>, the rally to A is a tactical correction because it did not rally high enough to engage any declining quarterly equilibrium price levels. On the other hand, the rally at B is a strategic correction because it DID engage the strategic sell zone by moving above the light blue line near B. TRENDS RUNS & HI-MOMENTUM All tactical corrections do not offer a compelling risk-reward. In fact, many are problematic because all countertrend corrections are trying to retrace back to equilibrium which normally implies a deeper reaction is in store. So tactical corrections, in general, produce a win-ratio which is more random, closer to a coin-toss. There is a special class of tactical corrections, which are compelling--they occur in a context of a high-momentum trend run. There are lots of technical ways to define a high-momentum price move. I'll give you an example of the sort of filter I look at to isolate tactical corrections in a high momentum environment. Chart 3. Here is another look at the Gold weekly <<attached>>. The thin olive green horizontal lines delineate the high and low of each month. The green zones E1-to-E3 represent the uppermost level of strategic buy zones (refer to Part 2A) -- which are just updated estimates of rising quarterly equilibrium. Carefully, notice that the lows of the monthly ranges X, Y and Z (Dec '05 through Feb 06) never retrace back to quarterly equilibrium. HI-MOMENTUM DEFINED: If the bids are so strong that price rises for three consecutive months without retracing back to quarterly equilibrium then a high momentum condition is in place. During hi-momentum, tactical corrections have higher win-ratios and can provide asymmetrical risk-reward. We (meaning readers who are following this market analysis weekly and myself) use this assessment of price action in a high momentum market context to initiate major long positions in Gold in Mar '06. Chart 4. Here is another look at the Bond weekly <<attached>>. The green zones E1-to-E3 represent the uppermost level of strategic sell zones -- which are just updated estimates of rising quarterly equilibrium. Carefully, notice that the highs of the monthly ranges X, Y and Z (Mar '05 through May '06) never retrace back to quarterly equilibrium. This suggested the rally in Jun '06 at A was occurring in a hi-momentum condition and the correction was offering a technical condition for stalking a short or reducing any long inventory from lower levels. In a tactical correction, like the rally to A in Chart 4, a variant perception arises because momentum traders are correctly assessing the odds as favoring a continuation to new lows, whereas a group of value traders are incorrectly those odds, or prematurely accumulating at a price they consider to be too low. Variant perceptions are an important part of market dynamics because in markets which are often efficient, we need to reach a critical state where perceptual divergences between different groups of market agents (traders) are such that one group is forced to unwind or adjust their collective inventory which creates exploitable swings. === This post is also available as a PDF and may be easier to follow. I publish this type of analysis (in more detail) free for a range of important current markets as PDFs. If you want to follow current live examples and learn more about putting this to work and how to manage trades simply go to my blog: http://www.street-noise.net/ Find the gray box on the right side column where you can drop me an email address. It's currently FREE to all.