Trade Management – Trade Entry
Trade Management is the most important aspect of ZoneTraderPro. When I was learning to trade and went to a seminar, the guru was always saying “Develop a Trading Plan.” The only problem was that he never went into how a trading plan was created. That’s just a minor detail that should have been included in the $3000 seminar fee. In this series of blog posts, we will look at 3 aspects of trade management and how a trading plan is developed for ZoneTraderPro. Those three aspects are the trade entry, what you do once you are in a trade, and your trade exit. Nothing in this post is meant to endorse a trading plan or method, it is only a discussion of the relevant issues when making a trade. It is incumbent on the trader to test and develop any trading plan with trade management strategies before executing a live trade.
One important aspect of this series is that almost every example used in this series came from 2/07/14. I didn’t have to go and search through months of charts to illustrate a point. That is because the fundamentals of the pattern trading and filters used by ZoneTraderPro are continually repeating themselves and fundamental to Trade Management.
Risk and Reward
There are 5 patterns that ZoneTraderPro is programmed to identify. Those are the trend trade, reversal trade, exhaustion trade, exhaustion trend trade, and the TICK divergence trade. The software is currently being updated to automatically identify TICK divergence. Because each trade is different, there is different risk/reward for each trade. Generally I would like a 2:1 reward to risk ratio. ZoneTraderPro will place a blue line on the chart which is the theoretical stop. ZoneTraderPro does endorse or support any specific stop and it is incumbent on the trader to develop a trading plan that includes stop placement.
Trade Management – Trend / Reversal / Trend Exhaustion Trade Entry
The ZoneTraderPro software is set to display a trading arrow one tick from the (red/green) intermediate zone. The arrow may move 1 tick until it touches the intermediate zone, and then it will not move any further. The arrow will not disappear or redraw after it touches the intermediate zone.
Here is a nice series of trades to illustrate the entry into two winning patterns and two patterns that would be classified as breakeven. We will come back to these trades in part 2 and part 3 of this series. But let us look at the entry and possible stop placement of these trades. The short trend trade is first. This trade had a good setup. The TICK filter was hit going into the trade with a lower TICK low and when price traded at the intermediate resistance zone the TICK basically matched the previous high. The Euro/dollar indicator was bullish, and turned bearish when the ES making a new high which is very unusual. The chart is however bullish when the market trades 4 ticks through the intermediate zone, setting up the reversal trade. The trend trade was not stopped out using the theoretical stop. The theoretical stop was drawn 6 ticks from the entry of the trade. Six ticks was developed because at this point there is only a 3.6% statistical chance the trade will win, once there is this much adverse excursion. The theoretical stop for the exhaustion trend trade has similar reasoning.
The long reversal trade is next. The TICK high going into the trade is 334 and the previous high was 344, so we have basically a matching high. Going into the trade the TICK low was a -300, and the previous low was -395, so we have a higher low which is what we want to see. We see that the risk was two ticks.
How was two ticks calculated? There was a short trend trade that had 4 ticks of adverse excursion which setup the reversal pattern. Notice that there is a line drawn 6 ticks from the intermediate zone which had trend trade adverse excursion. The statistics indicate that that when there is a 4-5 tick adverse excursion on a trend trade, there is an 8.4% chance that there will be a winning trade. So with 4 ticks of adverse excursion there is a pretty good reason for the stop to be drawn there.
The identical patterns (in reverse) are next identified on the chart. We have a long trend trade, that had a higher high TICK filter of 585 and a higher low TICK of -145. But as in the previous trend trade we immediately developed 5 ticks of adverse excursion. Additionally note the trend line of the $TICK at the bottom of the chart. Not until the trend line was broken was there a reason to buy the market. This leads us into the last reversal short trade. This was again a perfect setup with a lower low TICK filter, and a lower high TICK. The dollar was still bearish.
What was not discussed is the state of the Bond market in each trade, and it matters. The bond market is an correlated inverse of the S&P market. So when the bonds are at resistance we should look for a long trade. It is also an important ZoneTraderPro trade filter. There are 6 points of interest on the bond chart. I have placed arrows at the same spots on both charts. What is most important to take away from the bond chart is that from point 1, the bond market is trading at strong trend resistance. The bond chart then trades to intermediate support and we have a trend trade pattern.
At point 1 the bond market is at strong trend resistance and the S&P is at countertrend support. You would expect the S&P to go up at this point, but it is a questionable trade because of risk/reward. At point 2 on the charts, we answer the reason why the trend trade failed. It failed because the bonds were falling and still 3 ticks from intermediate support. For that trade to have worked, the bonds needed to at point 4 of the chart. At point 3 the bonds had almost touched intermediate support and traded up. The chart at this point does not favor the long trade, because price had traded within 1 tick of support, and then traded up. The long trade however had extremely low risk and $TICK in its favor. At point 4 the bonds are now solidly trading in support and there are buyers meeting the sellers. The S&P is at countertrend resistance, and for exactly the same reason we did not take a long trade at point 1, the risk/reward is not favorable here either. At point 5 the bonds are now trading up and the ZoneTraderPro theory would suggest that you would expect the market to continue trading higher. That is what happens and the reason the long trade has adverse excursion. At point 6 the bond buying resumes and we have another extremely low risk short reversal trade.
As we see from this chart the bond market was in bullish patterns from the open, with ZoneTraderPro marking the low with an exhaustion pattern and identifying additional exhaustion trades.
Trade Management – Exhaustion Trade Entry
The exhaustion trading pattern has different considerations for entry. This is because the exhaustion trading pattern starts to print as a test of a high/low. The arrow will move until it reaches the blue countertrend zone. The reason that there is a wider entry margin is because about 30% of the exhaustion trades test the high/low and the test ends up holding, so by definition all of the high/low test trades are winning trades. The theoretical stop is drawn 4 ticks from the start of the blue countertrend zone. The logic behind 4 ticks that once there is that once there has been that much adverse excursion, it is common that the market will trade to the strong trend zone, about another 4 ticks away. The TICK divergence trade logic is being currently being written into the algorithm. The entry to the TICK divergence trade will be the blue counter trend zone so the theoretical stop will be 4 ticks from the start of the blue zone, similar to the exhaustion trade.
The following example is an exhaustion trade that has traded to the blue counter trend zone, and illustrates the reduced risk. Additionally this trade also has TICK divergence. The bond market is trading at blue countertrend support and can be seen establishing a base leading up to the trade.
