This originally appeared as a blog post in Scott Hoffman’s Futures Insight Blog on Thursday, October 03, 2013.
Breakout setups are one of my favorite patterns to trade. However, even if you miss a market that has a breakout move session, the increased attention and market activity often creates a good trade setup in the following session as traders chase the previous day move.
Crude oil futures had a breakout setup on Tuesday. This was logical, given that the weekly EIA petroleum inventory is released on Wednesday. Tuesday’s breakout setup yielded a strong rally on Wednesday (in spite of a bearish EIA report, go figure). What did Wednesday’s rally tell us to anticipate for Thursday?
The Taylor Trading Technique (the basis for Swing Trader’s Insight) says that market moves end in “excess”, that irrationally exuberant or pessimistic traders push the market above or below “the fair value price”. This is what gets many traders to buy at the high or sell at the low of a move. It’s also a condition that the TTT seeks to identify and trade.
A breakout rally (as we saw in crude oil on Wednesday) tends to create an “excess high”, which the TTT seeks to trade as a Sell Short day. On a Sell Short day we look for one last push higher, taking the market above the high of the previous session (our “reference price). We anticipate this last push will fail and then look to go short when the market moves back below the previous session high.
I like to trade markets that still do some business in the pit. It’s not because I like to execute trades in the pit, rather, markets with a pit trade often make tradable moves around the time the pit opens. Stock index futures are a good example of this; on the stock market open the futures often give an entry based on a retest of an old high or low. This lets us look for trades during US trading hours, whereas with some markets trade entries may occur in the middle of the night.
Crude oil futures are a market with enough pit trading to give setups during the day (the crude oil pit opens at 8 AM CT). For November crude oil today, the Sell Short day signal meant we would look for a failed rally above Wednesday’s 104.23 high to give our short sale signal.
At 7 AM (when I’m usually in the office) crude remained below Wednesday’s high, so we could still look for the last push to get short. We got that move around 8:30 AM, as crude oil rallied in conjunction with stocks rallying into the stock market open.
Our short entry occurred shortly after 8:30 as CLX dropped back below Wednesday’s 104.23 high. Our initial stop loss went above today’s session high of 104.38. Our short entry was predicated on the high of the move being in so if it made a new high after our short entry then the market would prove us wrong.
However, we weren’t wrong this time, as crude pushed lower. The overnight session low of 103.45 was our first profit target; we could simply cover shorts there or use it as a reference price to gauge whether or not we should remain short.
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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