Book: Kane Trading on: A Totally New 5-Point Pattern
March 18, 2007 Commentary (weekend edition)-
Today should be a good commentary, in my opinion. I will cover a few things we have been looking at in here recently, and then I'll do some Russell work. My approach today will be a little different, trying to stay with my concept of keeping it fresh and covering more varied, and sometimes complex, ideas of the methodology. I am trying to keep my emphasis on the setup down to something proportional to what it is in my own 'Trading Plan', about 10%-20%. The latter part of today's work was inspired by a question I received in the free forum about target trading versus my trailing stops method, and how what a lot of the students post in there has a 'target' look to it.
Now, I can't address how various people take from my work (and others), create their own plan, and make the methodology their own. I encourage that approach, taking what works for you, rejecting that which doesn't, and coming up with a personalized approach that works for you, and suits your personality and style. So, I can only say how I use the methodology. I can only answer a question like I received from my perspective. I want to add that this question came from a very high-level trader whose skills I greatly respect. His style is to trade targets, and I have no problems with that approach, if it works for a given trader. My approach is a bit different, but I think some of the differences are more semantical than actual, and my emphasis on never having a 'profit target' may be getting a little misunderstood.
I will attempt to clarify this a bit with today's work. Understand, though, that I'd really prefer to sit down with the above trader for an entire day and show him, with charts, exactly what I am talking about. I can't do justice to this topic with a few charts and a few paragraphs in here (although I frequently do get rave reviews about this commentary, and last week's was particularly well received). At best I can elaborate on some aspects, and leave the reader with some ideas to work on. The nuances of my work are just too detailed and elaborate to cover with a venue like this. If you want more depth, you'll need to work your way through the material, via the books, members' archive, and in a mentorship. Sorry, but quality takes time, effort, and resources, in my opinion.
Before we begin, I have two items of business. First, I posted a new free article entitled Jim's 10 Favorite 'I want to blow up my account' Trader Tricks. This is a fun article, and so far I have received some great feedback about it. I hope everyone enjoys it, and gets my point. Second, Scott over at Harmonic Trader has just wrapped up a new book, and it is filled with a lot of new, novel additions to the field he has coined 'Harmonic Trading'. I have looked the work over, and I can say it is totally new material.
Understand, I get nothing if Scott sells books; I have no financial interest in his work. I just don't come across totally new, novel material dealing with Fibs, patterns, and the like too often, and this is 'the best of the best' of his work, in my opinion. He has developed a new pattern based indicator methodology, which can be used in conjunction with the price patterns, and it is really intriguing. This is a guy, in my opinion, like myself, who is pushing the cutting edge of his work at all times.
Let's move on to today's work. I'll start with a look at crude, via the USO we looked at awhile back.

Chart 1
Here's the same USO chart I showed way back before the area was hit. The spirit of the area has held, and even produced some downward reaction, but not 'cleanly', or without a fight. I have suspected all along that this area would not hold, and my evaluation of a bullish case is, in part, based on how this area is handled. Notice that although the 'crazy' trendline and key Fib area was fully respected, the main set line is, if anything, now 'under' the price action, like support of some kind.
Although I have another possible set that would be just overhead for all this price action, I am suspecting this may be basing for a launch. Price action is key now for any premise I may be considering. I think the main point is, although it wasn't a perfect 'V spike' reversal dead off the area, this spot was 'seen', and does hold some important information for me.
Let's look at what leans hogs did since last week.

Chart 2
Here's the same chart from last week. Open interest is rolling out on this, but since I have all the chart work done here, I'll stay with April for now. Note, too, how different the next contract looks. The second last arrow is where I was last looking, as we saw last week. The last arrow was the open on Monday. Take a look at what hogs did from there! Plenty of entry triggers, and then it goes, dropping like a rock.
Notice the first group of gap data, right in the median line area, and the next group, right at the lower parallel area. I just can't accept that this is random. This set was in last week's commentary, I sure hope everyone followed along as this unfolded. You might want to look back at this chart after we finish today, since the premises I tend to create for hogs vary greatly from what I generally create for the Russell, and this will be something to consider after you see the gist of today's main point.
Let's start, first, with a quick look at the Russell cash daily chart, from last week.

Chart 3
The lower arrow is the spot I pointed out that I was watching, for obvious reasons. I then had two key overhead areas I was watching, the first we were right at last weekend, by the second arrow. The second area was just above that, by the median line. I had no idea if it would get over the first area, I only knew I wanted to watch these areas (and some more, not shown on this chart), for some 'context' as I assess the lower timeframes. The Russell sure saw the first area, and it dropped right off that, hit a sliding parallel area off the low at the first arrow (sliding parallel not shown), and jumped up, forming a pattern I discussed at length in the forum, as well as with my mentor students. So far, the daily layout here has been very useful for me, and played a big role in my lower timeframe premises this week.
Let's move on to today's main topic, targets and trailing stops. I am always saying I don't use 'profit targets' at all, in fact those words are nowhere in my fully comprehensive 'Trading Plan'. Honestly, I hate the sound of them. But here's what I mean. To me, a 'profit target' is a predetermined area where a trader will take his or her profits, no matter what the price action is doing. Many times this is done with a GTC order, so the trader could be out running errands, for all it matters. For some 'Trading Plans' this is a completely acceptable method, and I am in no way saying anything against that. I'm just saying my style, my methodology, is a trend trading methodology.
That means the percent winners is going to be lower, by choice, and the money is made 'in the higher reward/risk profile'. I have explained this in detail in Kane Trading on: Trade Management, and it is in many other works. For a trend trading plan to work, the winners have to run, or one doesn't get that high reward/risk, it gets 'chopped off'. I take this one step further in that I am forever creating somewhat detailed trade premises, and they guide me in my management. The premises will include details like what I feel are they most probable areas for the trade to run to, and what some other scenarios may be if that area is hit but not 'seen'. Trailing stops keep me in at that point, allowing the trade to run, as I need for my plan, but they are frequently tightened up quite a bit as the highest probability area is approached.
A 'profit target' trader, on the other hand, may close the trade on an expansion bar with volume, as they scream some unexpected news item on financial television, only to see it run ten or twenty times as far, and the trader will be happy with the profit in hand. That may work great if the plan takes all that into account, but my plan requires 'runners running'. No, not just explosive news events, but those nice runners where things unfold naturally, and it trends for awhile. That's my plan. But it's based on my premises, and that's what I hope I can show now, although I can honestly barely scratch the surface of it in just the next few paragraphs.
Let's start with a 60-minute chart of a major area from this week. This was a big topic for discussion in the forum. (Why do I keep mentioning the forum? Because I feel it is an awesome resource with a lot of depth and detail, and many full set buyers haven't even taken a look, and it's totally free.)

Chart 4
The Russell started up, and the lower line intersection in that area are the lower parallels from a key daily and 60-minute sets. As soon as it started up I saw the intersection above for the median line of the bigger set, and the upper parallel from the smaller set. There is also a sliding parallel on there, but the area is clear. There was, of course, a tight Fib grouping there (not shown) with key numbers I look for in such situations, and showing me a lot of harmonicity, or I wouldn't even be looking here. So, here's an area where I'm looking at the short side, if and only if I get an entry trigger.
Let's see what happened from here.

Chart 5
The Russell dropped like a rock off the area. What looks like a small gap down looks 100% different on a tick chart with overnight data. Recall what I said when this entire worldwide movement started. So, this did triggered nicely, and was a classic Kane Trading play. But look at the area it is now at. An obvious .886 retracement at the median line. This is not a 'profit target', or a target of any kind, it is an 'area of interest'. My trade premise sees this is the mostly likely area for this to reach, and then a bounce may start.
Depending on the time of day, the greater overall 'context', what the lower timeframe price action looks like, and so on, I may or may not want to play a bounce that starts there. It all depends on what I see unfolding. I may actually have several premises and potential trades on this on different timeframes, and yes, some may be opposite, actually 'offsetting' each other. This is a difficult concept to grasp, but it has been discussed by other people.
Now, if this area isn't respected, what else do I see? Look at those two lines right below. I have a lot more work than I am showing here, but the key spots are clear to me. How tight I make my trailing stop here depends on my evaluation of this area, the probabilities here, and the price action heading into it, among other things.
Let's see what happened from there.

Chart 6
The mini bounced right up, and right to the most probable area I was watching, where a big pattern completes right there, at the third arrow. This was another big topic, both in the forum and with my students. Once you study the work one like this will jump right off the screen at you. The point here is, if there is this key, tested line and major pattern coming together, is this an area I factor in to my premise, and tighten up my stop as the area is reached? Do I want to be prepared so I can go short, if I get the desired reaction and entry trigger? To do that, I have to have the trailing stops kick me out in that 'sweet spot' where I feel the trade here is over, but the entry trigger, which I lean on the heavy confirmation end of the spectrum, hasn't kicked in yet. I am not a 'flipper', doing it in one shot.
Before I continue with this discussion, let me quote from a book I am reading 'Only the Paranoid Survive', by Andrew S. Grove, the Intel guy. In discussing business transitions he says: "The timing of the transfer of resources from the old to the new has to be done with this crucial balance in mind. If you move resources from the old business, the old task, the old product too early, you may leave a task only 80 percent finished. With a little bit more effort, you could have reaped the full benefit. On the other hand, if you hang on to the old business too long, the opportunity for grabbing a new business opportunity, to add momentum to a new product area, to get aligned with the new order of things, may be lost. There is a period in between that provides the best compromise..." Keep this in mind as we discuss this from a trading perspective.
The area where one trade ends, and the next triggers, will vary immensely depending on the timeframe, and this is the gist, the key point, of today's work. This is something I usually cover in great detail in a mentorship, where I can go one-on-one for hours and hours with the charts. If the traded timeframe is the same, it can be tricky, or even impossible, to get out and then into the other side. If the traded timeframe must be the same, I sometimes look for a first pullback type if entry for the second trade. Most of the time, though, I can see the major areas ahead of time, and I construct premises, like a pool player thinking many shots ahead, such that I can still take a future potential trade and do what I want to do now. Also (and perhaps hence), it is not an issue at all if my current premise is on a lower timeframe than my upcoming premise/potential trade.
The movement needed to trigger me out will be relatively small, or smaller, than what it would take to get me into the higher timeframe setup, and so there is a big sweet spot with no overlap. As I have said many times, not meant in a bragging way at all, I am an expert in timeframes, in my opinion. This is one way that I utilize the various timeframes to construct plays over time that can be fit together. This is one advantage in trading, one that gives me a better opportunity than the example I cited, in that I can vary my timeframe and really do a lot more in this transition zone that one can, perhaps, do in a 'regular' business situation.
I'll finish with a 5-minute chart as the area of the last arrow on the last chart was approached, the big pattern completion area.

Chart 7
There is nothing specific about the 5-minute timeframe here, I chose it because I can show what I want to show on this timeframe. I added a regression channel and a moving average on there. These are not my specific trailing stop methods here, although they could be. I chose them to demonstrate my point. The lower arrow was where this started to move up off that median line and .886 area. If my premise is to trade the much larger pattern, and I'm playing this move up to that pattern, my traded timeframe for this is much lower. I want out as soon as I feel this has played out on my traded timeframe. The price action tells me that. I want a tight stop as the area is approached. In case it starts just a tad shy of the area, I want to be ready.
The pattern is big, on a high timeframe, I'm interested in that setup, and this is a much smaller timeframe play. By the time of the second arrow the flow has changed, and any technique I would be using here would have me out. Now, could it keep going? Could it blow the pattern area out, and really start smoking? Yes, but that wasn't my highest probability trade premise, so my management was not based on that. The Russell did set a nominal new high, right in the key area, and it dropped beautifully off the area. As you can see, there was a lot of room, and no overlap, with my premises, and the sweet spot was huge, from this perspective. And if the flow just keep going up, then nothing would have triggered a close of a trade in the upward direction.
Well, that just about exhausted me, so that's it for today. It seems kind of funny that I could say we have barely scratched the surface in regards to what I have to say on this topic. The gist is that I am forming premises based on my experience and perceived probabilities of what I feel the issue may do, and then I construct a plan that will allow me to do the most that I possibly can with what is unfolding. This pretty much always is based on letting the price action run until it tells me otherwise. Keep in mind, too, the example here has lots of lines 'overhead' on both sides. If an issue is trending, setting new highs or lows, without any good lines 'overhead', I tend to keep the stops loose and give it room to run. That's the premise I use, and it guides the management. The 'context' tells me what premise to construct.
On a final note the chart of the week is still ICE. It is just clinging to that area, and that is a big clue. Look at what happened when they bid up BOT, trying to snatch it from CME. Look at the huge pop in BOT and the huge drop in CME. Isn't it curious how the most key area I feel ICE has had since it started trading just happens to come together right before they make such a huge move on the competition? I have found this to happen more often than one might think it would. This is an active space, so watch ICE and all the issues, as there will likely be a lot of action there.
The next commentary will be next weekend's edition, posted by Sunday evening, March 25, 2007.
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