This originally appeared as a blog post in Scott Hoffman’s Futures Insight Blog on Thursday, September 19, 2013.
Chart patterns that combine breakout setups and gaps can make for good trade opportunities.
Tuesday morning I was talking to a client, call him Jim, who was short the November soybean futures. There was a gap from 1332-0 to 1331-4 in the daily chart that hadn’t yet been filled in. Jim thought they might fill in the gap on Tuesday while I thought they might wait at least a day.
Somewhere I remember someone saying (maybe Tom Demark?) that markets were less likely to break out if in the previous session the market had moved in the direction of the anticipated breakout. Breakouts tended to be more likely if the previous session moved in the opposite direction of the anticipated breakout.
So on Tuesday I thought a downside breakout was unlikely. Then on Wednesday soybeans had a small range and an inside day- two patterns that indicate a breakout setup. Additionally Wednesday was a bullish day, as the close was higher than the open.
So for Thursday soybeans had a breakout setup and a pattern that suggested we anticipate a downside move. However, just identifying the patterns isn’t enough; we only trade when the market begins to do what we anticipate.
Out of the breakout setup, soybeans gapped higher on the open last night. When a market has an opening gap on a day that it already has a breakout setup, it’s often going to be a good candidate for a trade, as it’s another pattern that tells us to anticipate a directional (breakout) move for that session.
During the night session the opening gap never got filled in; the overnight low was 1351-6 and Wednesday’s high was 1349-6. This gave us the setup for a downside breakout- either short it when it broke below the night session low or when it broke below Wednesday’s high (an Oops sale). On the upside we could look to go long if it rallied above the overnight high of 1361-2.
The initial move off the day session open was a rally. Fortunately (for us), it made a day session high of 1361-0 before turning lower. A subsequent selloff took beans through the two entry prices about 20 minutes later, triggering the short sale. The initial stop loss could go above the day session high of 1361-0- that’s a little wider than I’d like but that’s what stood out on the open.
Fortunately we didn’t need to worry about that stop loss; it quickly continued lower after our entry. Around 9:45 AM there was a failed test of Wednesday’s high; this gave a second entry opportunity and a confirmation signal for the short.
On Tuesday Jim and I discussed a game plan for what to do when the market finally filled in the gap on the daily chart. We agreed the best course of action would be to see what the market did when it fill in the gap- either stay short if it looked like it would remain below the old low or cover shorts if it looked like the low would hold.
In what seemed like inevitability today, they went down and filled in the gap shortly after Noon. However this low held and they drifted higher, gathering some upside momentum late in the session. Covering the shorts was the correct call here; we could have looked to reshort it if it made a new low later in the session.
STOP ORDERS DO NOT NECESSARILY LIMIT YOUR LOSS TO THE STOP PRICE BECAUSE STOP ORDERS, IF THE PRICE IS HIT, BECOME MARKET ORDERS AND, DEPENDING ON MARKET CONDITIONS, THE ACTUAL FILL PRICE CAN BE DIFFERENT FROM THE STOP PRICE. IF A MARKET REACHED ITS DAILY PRICE FLUCTUATION LIMIT, A "LIMIT MOVE", IT MAY BE IMPOSSIBLE TO EXECUTE A STOP LOSS ORDER.
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