By Steve Misic, Online Trading Academy XLT-Forex Trading Instructor
Last week's article discussed two different long trade entries, the breakout entry, and the pullback entry also known as buying a dip. In this week's article, we will discuss the two most popular types of short trade entries, the breakdown entry, and the throwback entry, also known as shorting a rally. Some traders prefer breakouts for long entries and breakdowns for short entries because they like to buy and sell in the direction of the current move in price. Other traders prefer to let price retrace to the origin of the move higher or lower and then enter the pullback or throwback. I prefer to buy dips and short rallies in certain assets, and enter breakouts and breakdowns in other assets. I have rules for both strategies which include different vehicles to enter riskier trades such as using options for breakout trades instead of leveraged Futures or Forex contracts. Options limit risk to the premium paid rather than subject the trader's account to a large drawdown in the event of a failure of the breakout. In the Forex markets, breakouts are successful 70% of the time during the London session, and the failure rate is close to 70% during the quiet times. Additional rules I use include an amount of retracement after a breakout before I close the trade for a gain, with the idea that if price retraces to the origin of the breakout, I now have the opportunity to enter a pullback, or in the case of a short trade, a throwback. The good news is I am giving myself more opportunities by using both strategies as long as I follow my plan for either entry.
AUDUSD Breakdown Entry and Throwback Entry
The chart below is a 15 minute chart of the AUDUSD. Recall that the AUDUSD has been in a strong uptrend for many weeks. There are a few questions that a trader has to ask themselves when taking the breakdown trade. The first question is - am I comfortable counter-trend trading? The second question is - do I have a method for taking this type of trade on a consistent basis? If the answer to both questions is yes, then these are the steps for planning the trade using the 4 stages method on a small time frame chart.
Figure 1
Step 1. On a 15 minute chart, insert a 30 weighted or exponential moving average as a filter for the entry conditions. If price begins to trade in a range that forms after a move higher of at least 50 pips, and the moving average is close to the bottom or inside the range, then this area has the potential to be a stage 3 top on this time frame.
Step 2. Draw a horizontal trend line above the highest high and another horizontal trend line below the lowest low of this congestion area.
Step 3. Place a sell entry stop order 5 pips below the lowest low of the congestion area.
Step 4. Place a buy stop order 5 pips above the highest high of the congestion area as a protective stop.
Step 5. Your first target should be at least two times the distance to the stop loss.
Step 6. As a way to stay with the trade, draw a down trend line, and close the position if the trend line is broken.
If you want to enter the trade on a throwback, then wait to see if you have a 15 minute candle that closes below the congestion area, and short a rally back to the origin of the breakdown. You can use the rest of the steps above to manage this type of entry. For those of you that are thinking about reversing your position at your stop loss as a way to join the higher time frame trend, make sure you have strict risk management rules in place in case this trade fails. Trading is all about risk management and planning.
Good luck.
Steve Misic - smisic@tradingacademy.com
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