This originally appeared as a blog post in Scott Hoffman’s Futures Insight Blog on Thursday, July 7th.
This morning, I got a call from a self-directed client. I generally do not offer unsolicited advice for do-it-yourself traders unless they are doing something blatantly dangerous, or if I am sure they are wrong. Otherwise, I let them make their own decisions; you learn the most about trading when you do things for yourself.
The client called around 9 AM CT, around the time the pit session opens for the live cattle futures. He sold August live cattle futures at 113.45, placing a stop loss at 113.95. This was a bit over the last high of 113.825 from 24 June, for a risk of $200 per contract.
Although the risk on the trade was small, I would not have sold it at that price. I understand the appeal of trying to pick a top and sell near the highs, but at that price level I thought his trade had no better than a 50% chance of being right, and I like to think I have a better edge than that before I trade.
The main issue with this broker’s trade decision at this price was the pattern from the past two days. Tuesday had the narrowest range of the previous seven sessions and closed with a doji. Yesterday continued the consolidation, showing another balanced, tight range day.
August Live Cattle Futures Daily
This is evidence of a market reaching a short term equilibrium point. We often see a new trending move start out of an equilibrium like this, but it is difficult to know whether the new trend would be higher or lower.
Fortunately, we do not need to predict which way the market will go. We can let it tell us its direction so that we can then get in and go along for the ride. If it moves higher, we get long after it starts higher. We sell only when the market starts trading lower. With a setup like this, selling into a market that is rallying is like standing on the train tracks looking in one direction for a train while there is another train barreling down at you from behind.
If I were the client who wanted to short the live cattle, I would have waited to sell until the market started breaking down; in this case, I would have sold when the market broke under yesterday’s low at 112.375. A selloff below yesterday’s low would be evidence that the market was heading lower when I shorted.
Trading is all about having an edge. Sometimes giving up some of your edge on price is outweighed by the gain of trading in the direction of the trend. I use these kinds of setups to initiate shorter term trades. Even if you are a longer term trader, you are still a day trader on the day you enter and exit your trades. Identifying these kinds of patterns can help you better the execution for your entries and exits. Being cognizant of these setups keeps you off the train tracks while waiting for your train.
© Scott Hoffman
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