Commodity Futures Prices
One of the simple visual techniques I teach my newer and younger students (and one I use in my own trading) is the power of simple box formations. These “boxy” formations (ranges, congestion, energy coils) become very easy to spot once you start marking them and observing their behavior.
The problem is, too many traders don't pay attention to boxes or ranges and end up entering a trade because they are following a lagging indicator that gave them an entry signal or because they were following a line, had their mind set on a trade idea, and never recognized the box or congestion forming. I have a term I use with more experienced traders (generally a bit more mature in age) to describe entering a trade in the middle of a box or range: “Trading in the killing fields.” These traders may have the right idea, but the range usually ends up running their stops and they usually end up on the sidelines watching price move without them.
Here's one of my charts that I'll use to show you how I use boxes, but the idea for these particular boxes and the eventual trade entry came from my son, Sean. These are daily bars, and I'll tell you the instrument at the end of the article, so you can look at price action and try to read what it is going to do without opening a current chart.
Note the box formation I drew in the upper-left-hand portion of the chart. This is price trading within a range, restoring spent potential energy, much like a car's gas tank getting filled while it sits still at a gas station.
There is one excellent clue to the likely direction price is going to break out of this box formation. I purposely did not mark it on the chart.
Can you spot it?
After trying to retest the prior major swing high, price failed and turned lower, a sure sign that there were large limit entry sell orders at or near the prior swing high. These are orders left by the largest traders, the “whales.” You can see that every time price attempts to test that prior high, it fails. Price is running into the limit sell orders left by the whales. After a feeble third attempt, price trades a little lower and then the significant event takes place.
Do you see it now?
Price gaps significantly lower and eventually trades down to test the multi-pivot line, filling in a simple formation I call a “mountain.” Even though it climbs quickly out of the hole and fills the gap, after three higher highs, it leaves double tops and then turns lower again and heads straight to a test of the multi-pivot line.
The first time lower, after price gapped lower and filled the mountain formation, there were limit buy orders at the multi-pivot line—again, left by large traders (the whales) because traders likes to fill gaps. The whales were already short near the highs of this formation, so it would not be unusual for them to lock in profits as price re-tested prior lows.
But if you look at the quality of the rally that followed the first retest, you can see it never made it anywhere near the prior swing high. If you were a whale, or large trader, you might be less inclined to take profits on your short position or to establish new long positions at the multi-pivot line until you watch the price action in that area.
Now look carefully as price heads lower again towards the baseline of the prior mountain formation, which also serves as a multi-pivot line. Price has no difficulty breaking through to the downside. The whales pulled their limit buy orders! See, you really can trade with the whales if you just know how to look for their “tracks.” (And by the way, I know this because in some markets, I am one of the largest traders—making me, by definition, a “whale.”)
Note that once price breaks below the multi-pivot line, which had acted as support, the line now acts as resistance. Price tries to get above it and close above it several times, but fails.
Can you guess why?
Yes, the whales don't have limit buy orders at the multi-pivot line now. They have lowered their limit sell entry orders from the area of the major swing high down to the multi-pivot line area. It always sounds so simple, but it works so often: What was support has now become resistance. This is part of the inner workings that make ranges form. And it's another reason why price often doubles the prior range. And if you look at the current chart, price doubles the range just about to the penny and then turns back higher.
This shouldn't surprise anyone. Sir Isaac Newton, the famous mathematician and physicist, was also an alchemist and devoted a great deal of time translating books written literally thousands of years before he was born; books written by the Egyptians, the Greeks, and the Phoenicians. His translation of the Emerald Tablet is still the favored translation of that important text today. Many feel he was inspired by the Emerald Tablet when he wrote his three laws of motion, as evidenced by this often-quoted phrase, “As above, so below.” Many see this simple, four-word phrase as the precursor to Newton's famous, “For every action, there is an equal and opposite reaction.”
And of course, price indeed makes an equal and opposite reaction if you look at the multi-pivot Line in the center of the chart as the center line, the major swing high and a line drawn horizontally from it as the action line, and then project the distance from the center line to the action line back underneath the center line, you get a near-perfect reaction line. “As above, so below.”
When price comes back to fill the mountain formation, retesting the lower multi-pivot Line (which is also the reaction line), you can see that once it filled the mountain by retesting the baseline, it gapped lower through the lower multi-pivot line and continued lower. You can assume the whales who were short waited to enter limit buy orders to see just how many smaller traders were caught long—and how much lower their stop loss orders would push this market.
But at some point, the selling dried up and a 'V' bottom formed, with price turning back higher and rallying just as fast as it sold off. What would smaller traders find when price approached the lower multi-pivot line from below as price rallied? Would prior support now be resistance?
Let your eyes go back to the lowest point on the chart, the (now) major swing low. Erase all the price action to the right of this low from your mind and imagine this bar unfolding in front of you in real time.
What are the market positions of the mid to smaller players? Which way are they leaning?
As the bar unfolds that will eventually prove to be a significant low, mid to small traders may have tried to hold long positions on the way down at several areas of assumed support, but unless they never use stops and have unlimited capital in their accounts, they have either been stopped out of their long positions or they are now short.
This is the perfect time for the larger traders, the whales, to “pull the string” on these traders and begin buying with both hands to see how far the mid to smaller traders will reach to chase the market higher. When price approaches the lower multi-pivot line from below, the whales are not leaving limit sell entry orders; they are still busy pushing price higher, running the stops of the mid to smaller traders as price continues to climb. The buying does eventually slow, and now if you look closely, you can spot whale tracks.
Can you see them?
Price made a 'V' bottom and then broke above the lower multi-pivot line. Once the buying slowed, price came back to test that same lower multi-pivot line from above, but look at price bounce off it. The whales have been pushing the market lower the entire time and now see the mid to smaller traders are out of their long positions, and even see some of them went short on the break to new lows. The whales may have covered a good portion of their short positions on the way down, but they haven't begun to build up sizeable long positions yet. But looking at the price action at the lower multi-pivot line, there appear to be some significant limit buy entry orders at that level.
If you have a large position or are trying to accumulate one, this is where experience pays off. Price expended a great deal of energy testing and breaking through significant levels in near-vertical moves; both the market and traders are short on focus and energy. Experienced traders know that after these types of moves, the market often pauses and trades within a range, so rather than chase price higher, an experienced trader will watch the price action and see that price has once again doubled the range, with the lower multi-pivot line being the center line, a horizontal line drawn off the major swing low being the action line, and the top of the current range being the reaction line. Once again, we have Newton's “As above, so below.” The whales who still have some short positions left from much higher levels, or the whales attempting to build large long positions don't rush into the market and chase it higher; instead, they put in orders around the center line, the lower multi-pivot line, and let price come to them as it trades almost lazily for quite some time.
But price can't trade within this narrow range forever. Do you see any signs it will break to the downside and continue the trend lower? Do you see any signs the recent major low was a significant low and price will now break out of the current congestion to the upside?
Frame the two possibilities in your mind and try to imagine what it will take for price to break to the downside or to the upside. If it helps, print out the chart and draw in the two possibilities. Practice anticipating the movement of price—not to trade in front of it, but to help prepare yourself so you are ready to act once price makes its move.
Price dances around the middle multi-pivot line. It isn't making a great deal of progress above the line, yet it is unable to fill the open gap below the market—a sign of significant strength. It's a sloppy formation, yet if you look carefully at the last few bars on the chart, you can see that price tried to enter the open gap and failed; on the last bar of the chart, price gapped open higher and traded higher. Price trades as if there are significant limit buy orders at the top of the prior open gap.
Are these whale tracks? Does price action like this speak to you as clearly as if you could see the orders left by the larger players?
Price breaks out of the narrow range to the upside, then note it tries to trade lower back within the range but fails; resistance has become support. The next day, price gaps open much higher and trades higher for two more days before it gaps open higher again. Note that price leaves these gaps open and trades higher, heading right for the middle multi-pivot line. But what will price do when it gets there? Are there limit sell orders waiting, or is the majority of the market caught short?
Do you think price will head higher, breaking through the middle multi-pivot line? Do you think mid-size and smaller traders got caught trying to sell this market in this sharp rally, expecting the gaps to be filled?
Do you think price will test the middle multi-pivot line and then turn lower after finding a good deal of limit sell entry orders—and perhaps some limit sell orders left by the traders who were able to read price well enough at lower levels to get long for this quick ride higher?
I am preparing to teach gifted elementary and middle school children across the country this upcoming school year how to use technical analysis to make money trading stocks, so I seem to be spending more and more of my time evaluating stock charts. And of course, I funded my son Sean with a small seed account after his wonderful performance in this same program last year, so I am watching his results with an actual financial interest! The prior charts in this series were prepared by me so that you would have a perspective on this particular chart. Sean knocked on my trading room door after the market closed several weeks ago and told me he was going to put in orders to attempt a long position in this stock.
As has always been the case since I began teaching him, I didn't share my opinions about the actual potential trade; instead, I looked at his use of the trading tools he has been taught, especially the money management tools. I calculated the risk/reward ratio and then internally pondered his logic behind the trade, as well as his areas for entering stop loss orders and profit orders. I told him it was an interesting chart and made sure that if he had limit buy entry orders in the market, he also had actual working stop loss orders in the market for protection, and he assured me he did. As with all traders I mentor, if I find they are trading without “hard” stop loss orders in the market to limit their losses, I no longer work with them. Harsh as it sounds, if Sean violated this rule, I would close his account immediately and our “working” relationship would be permanently ended.
Sean viewed the upper yellow area as a new box formation and he was impressed that price climbed from one box formation to another, leaving a large open gap on the way, which was still unfilled. He particularly liked that traders tried to push price below the box formation in an attempt to fill the open gap, but this down move was an immediate failure. In his opinion, whales had left large limit buy entry orders at or near the top of the open gap, and he wanted to enter a long position if price headed lower to retest the recent lows.
Sean wanted to buy a retest just above the recent lows, at 53.60, with an initial stop loss order at 53.08. Where did he get his stop loss level? He felt there would be large limit buy entry orders at or near the top of the open gap. If there were enough sellers to push price through to the middle of the gap (the high of the open gap is at 54.17 and the low of the open gap is at 52.00, so the middle of the gap is (54.17 + 52.00) / 2 = 53.085), or if he was wrong and there were very few limit buy entry orders and price made it to the middle of the open gap, he felt it likely they would at minimum fill the open gap to the downside—and this would be a significant change in behavior.
His logical profit target would be just below the multiple highs clustered together, at 58.45.
He would be risking 52 cents on this trade to make a potential $5.37, which means his risk/reward is 537 divided by 52, or just over ten-to-one—a nice risk/reward ratio by anyone's standards. The stop is small by his standards and the risk/reward is very attractive. He liked the trade entry setup, so he entered his limit buy order and his initial stop loss order. Remember, he can't enter a limit sell order to take profits until he has a position, so that order will have to wait.
What do you think about Sean's trade setup and the logic behind it? Do you see what he thinks are tracks left by large limit buy entry orders (“whale tracks”), or do you see a clear break of the boxy formation to the downside?
As I said earlier, I don't tell Sean or any of my students my opinion of their trade entry ideas; I personally find that when other traders dissect my trade entry idea on a potential trade with me, it changes the clarity or conviction I have of that particular trade, so I will check their money management and make sure they are using their trading tools correctly, but I wait to share my feelings about their trade idea until after the trade has either played out or been discarded because price never let them into the trade.
But I once I've seen Sean's trade entry idea, I am intrigued. To me, it isn't a strong enough reason to go long—at least as he presented the idea on his chart. But maybe he is seeing something he hasn't or can't communicate. For example, maybe his “charting eyes” are good enough to “see” the frequency of price, but he hasn't drawn that in, or perhaps he recognizes the frequency internally, but isn't in the habit of drawing it in or doesn't have the tools to draw it in yet. Remember, I do not teach the elementary and middle school traders about action-reaction lines and Median Lines.
I begin to look carefully at Sean's chart to see if there is a reason for price to run out of downside directional energy where he wants to enter his long trade. Besides the potential for large limit buy entry orders at the top of the open gap, might there be a reason based on price's frequency for price to run out of directional energy here? Or is Sean simply leaning on potential whale tracks and willing to take the trade because it has a very small stop and a great risk/reward ratio?
I start by drawing in an up-sloping multi-pivot line, beginning at a prior swing low that also formed the baseline of a mountain-and this baseline would later become an important multi-pivot line that mapped out the consolidation before price formed the current open gap and box formation above it. This up-sloping multi-pivot line is also a center line. Note how it catches the frequency of price in both of the box formations and how it cuts through the center of the open gap formations. This line seems to catch frequency; let's see if the frequency is found elsewhere on the chart.
I add a parallel up-sloping line that starts at the swing high that forms the same mountain. It's a nice parallel line, one I label an "action line," but will it have any meaning going forward in price and time? The question goes back to "As above, so below." Will "equal and opposite" have any meaning on this chart?
Now I measure the distance from the action line to the center line and project that same distance forward in space and time. To complete the projection of frequency from the up-sloping center line, I add an up-sloping parallel line-the reaction line-at this projected distance.
Now I do what I teach my younger traders to do when evaluating a chart: I slide my chair back a good three or four feet, close my eyes for a few moments to clear my head, and take a clear look at the entire chart. I see the stacked box formations separated by the open gap, and more, I see where the reaction line projects forward in price and time-right where traders just tried (and failed) to fill the open gap.
When I first glanced at Sean's chart, I wondered if price was simply going to rally slightly and then continue lower in a cascading formation. But this reaction line gave an excellent projection of where price should run out of downside directional energy. Price turned right at the projection! Now let me add Sean's limit entry, exit, and initial stop loss orders to this market map:
Now, there's some noise present in this market, but remember these are daily bars, so this gap has been unfilled for almost a year! The distance between the center line and the action or reaction line is a similar distance, so you have to expect some noise. But all in all, it's a very compelling chart, and I am willing to lean on "As above, so below" until the gap is filled. After spending some time of my own drawing on Sean's chart, I like his entry set up, I love the size of the small stop and the risk/reward ratio, and the chart does project the frequency of price nicely.
I add one other line: I connect the last three swing highs on the right-hand side of the chart. Each is lower and price may have trouble climbing above this down-sloping magenta trend line. Sean used a similar simple trend line to take partial profits in his first live trade, Burger King, and it turned out to be a gorgeous area to take profits. I wonder if he will see this same line (I won't show him because I want to see what he can "see" and how he uses his trading tools).
Nearly two weeks go by before Sean is filled on his open limit buy order. Remember that because he will soon be in school all day long, I do not allow him to watch the markets during the day. He is allowed to check his orders and the day's price action for fifteen minutes at 4:30 pm Arizona time; he can then cancel and replace his orders, do charting homework, and enter new orders if he finds a new trade entry setup he likes that fits his trading style and is within his trading rules.
I get a knock on my trading room door at about 4:35 pm that day-he's long and he's excited! I ask to see his trading plan and a printed chart of his new position (this is a requirement I make of all my students). If you want to talk about a position, you must bring your trading plan and a current chart showing your orders and your interpretation of the current market structure, whether it is an in-person meeting or a virtual mentoring session.
I'm not surprised to see Sean has added the magenta down-sloping line connecting the prior three swing highs and will take profits on half his position if price gets there before stopping him out of his new long position. Sean is excited price did not make a new low for the move, and though I don't say anything to him, I notice that price closes near its lows on a wide range bar. Is this the resumption of the cascade lower? Or does Sean see whale tracks better than most traders? I'll give him this: He is either entering this market at just the right time, when no one in their right mind (other than whales) want to get long and many mid to smaller traders are being stopped out of long positions from higher levels, or he is entering right as price tips off a cliff and begins a freefall that fills a gap that has been unfilled for nearly a year.
But he has a plan, the stop is small compared to his maximum allowable stop, and the risk/reward ratio on his original profit target-if he is not stopped out of this position-is well over ten-to-one! The risk/reward ratio on the first half of the position-selling half just before the down-sloping magenta trend line that connects the prior three swing highs-is better than seven-to-one. He has a plan, he has a position, and his stop and profit orders are in the market. Now he just has to manage his emotions and follow the plan.
Now the trading gets fun! Sean was buying when everyone else (except the whales) were selling. When price opens higher and fails to make a new low, a multi-day rally begins, and on the fourth day after he get's long, price gaps open higher and closes near its high, nearly filling the first half of his profit target at 57.39. When he checks his positions and orders at 4:30 that afternoon, he decides to cancel his initial stop loss order and move it up to break even. He's now working a limit sell order on one half his position at 57.35 and he's leaving his original limit sell order at 58.45 on the balance of his position.
Watching him plan and execute his plan tells me a great deal about his ability to become a consistently profitable trader: Does he stick with his plan? Can he execute his plan and keep his emotions in check? This is currently a winning trade, and because he moved to break even, he won't lose money on the trade, but how will he react to a live losing trade, with real money? If he takes profits on this position and then prices explode much higher to the upside, how will he feel emotionally? As I said in an earlier article, “Welcome to ‘Mastering Yourself,’ son.”
Sean's limit sell profit order for half the position was filled the next day at 57.35, a few cents off the high of the day. Price began to sell off and managed to fill the open gap this past Friday (as I write this), but note that after opening on its low and filling the open gap, price closed on its high. It will be interesting to see how price reacts if it makes it back up to the magenta down-sloping line since it has now had “three drives to the top” along this simple trend line.
As I write this, move my chair back three feet, close my eyes and relax, then open them and take in the entire chart, I believe Sean's original take on this chart was correct: Price climbed out of a box formation, left an unfilled gap (which is still open nearly a year later!), and is now creating a new box formation. He read the whale tracks correctly: There certainly seems to be some significant limit-buy entry orders at or near the top of the open gap. And I believe he had enough profit in the position that he had to move his initial stop loss order to a break even stop order.
Where will price go from here? Will the whales still have limit buy orders in the market if price sells off and approaches the top of the open gap again? Will the magenta trend line contain the rise of price if it climbs back to test it again? The beauty of the markets is that these are all good questions, and only price knows where it is headed. The rest of us can only create trading plans and execute them. Sean executed his plan extremely well: He has taken $3.75 per share on half his Costco position and he is long at $53.60 on the balance with a breakeven stop loss order. He's playing with the market's money, and that's always a good thing.
I hope you found this article interesting and informative. It's a new experience for me to be an investor, and of course, to watch my own young son plan and execute live trades in the markets. I catch myself biting my tongue at least once during each conversation, because I have promised myself I would not give him my advice—and looking at his results, he hasn't needed it so far!
I wish you all good trading! - Article source and charts
