|
This is the first of a four part weekly series to trading the E-minis and US Treasuries. I have chosen “trading bull traps” to lead off with, because it is the pattern that we are currently trading.
The four part weekly series will be as follows:
- Trading Bull Traps in E-minis
- Key Reversal Signals to look for in E-mini's and Treasuries
- Trading Steidlmayer's False Auctions and Candlestick Tails
- Behavioral Finance Modeling in E-mini's and Treasuries
The last in the four part series provides the key “context” for all the trading signals discussed in the first three parts. Traders and investors should never take a trade signal without fully understanding the “context” or “color” in which a particular market operates.
Defining Bull Traps:
Bull Traps are a type of false breakouts above a well defined trading range. They are distinctly different in quality and character from trading Peter Steidlmayer’s False Auctions, which is another type of false breakout and one we will discuss in detail in the 3rd part of this series. Typically, trend-following trading systems are breakout trading systems that try to capture a price move once it breaks out above or below a trading range. The assumption that these trading systems make is that once price breaks out of a trading range it is a valid signal that the market will begin trending in the direction of the breakout.
C’mon Puke to Me
But not always, sometimes prices reverse back into the trading range. When this happens, it is a called a bull trap, because it catches all the bulls and trend following systems thinking that prices would continue in an upward direction on the wrong side of the trade. Because most trend-following systems are designed to wait for the breakout above a defined range (usually this is at least a 20 day or 20 bar trading range, but any breakout usually suffices for momentum traders and trading systems trying to optimize and lever up) before entering in the direction of the price trend, when prices reverse back inside the trading range, all these systems are caught long and wrong. They are underwater. Then it is a matter of “Harry the Hat” squeezing these bull trend following systems and momentum traders saying “C’mon Puke to Me, Puke to Me.”
And because invariably these trend-following systems have stop losses back inside the range, most of them get stopped out before the trend resumes in the direction of the original trend. If the alert trader can successfully identify a bull trap, he can find shorting opportunities just like Harry the Hat. And btw, Harry the Hat was a helluva a trader in the bond pits back in the 1980s. I don’t know if Harry the Hat actually traded bull traps, but he would definitely take the other side of the trades taken by the big houses, and then taunt them with his trademark “C’mon Puke to Me.”
Now, identifying and trading bull traps in the E-minis are significantly different than identifying and trading bull traps in stocks. Though individual stocks experience bull traps too, this is not necessarily a transferable pattern to stocks, however, the pattern recognition and bull trap trade setups can sometimes applied to the treasuries. For purposes of illustration, we will stick with examples from the SP500 E-minis shown in the charts below.
 Click on image to enlarge!
There are 4 bull traps that have occurred on the chart above since Obama got elected on Nov 4 2008. Typically, the bull traps have occurred about 2% or 23 to 29 points above the previous swing high, and that the trap occurs roughly around the 21st day. Note also how since the market shifted from bear to bull trend, that once in a breakout, the market tends to hover for a week or more before price reverses direction and re-enters the prior trading range. These signature attributes are what allowed us to look for a topping pattern around 1100 during the Q3 2009 earnings season. In fact, this bull trap in October occurred during the earnings season, when chances of a “distribution high” are fairly significant.
At this juncture, we do not yet know how far or for how long the stock market will have to remain under water, and below its Q3 09 highs in Q4 09. We do have a few ideas as to what the extent and duration that this decline should have. There is an 88 day cycle due on Monday Nov 9, a day after the Nov 6 NFP report. Economists have high expectations for this NFP report, and these expectations are at risk of being dashed, so, we would expect a low to form after the Nov 6 NFP report. Nov 6-9 is a good window to watch. We would also expect that this decline should allow the stock market to reach oversold conditions for the first time since July. The stochastic is in sync with the 88 day low to low cycle too cited above, as it was oversold in March and 4 moths later in July. As for price, green lines have been drawn across the 1008 election high and the Sept low at 991. Though the correction could end as early as the Nov 2 ISM report, this 991-1008 zone is the best place to expect the correction to end if the decline persists into the Nov 6 NFP report.
5% Bull Traps on the Way to the 2000 Stock Market High
Another time that was convenient to look for bull traps was during the final stages of the 1982-2000 bull mkt campaign.
 Click on image to enlarge!
In this chart, note the July 1998 made a 5% higher high in 15 weeks. The July 99 high only made a 3.5% higher high in 11 weeks. And the March 2000 high made a 5% higher high in 11 weeks. The March 2000 high borrowed the 11 week high to high cycle from the July 1999 high and it observed the 5% higher high rule from the July 1998 high.
There is another type of bull trap to be measured, but because price does not actually reverse back into the prior trading range, it is not technically called a bull trap. Still, it is a variation of a bull trap. The technique is to simply measure the high to high in percentage. In the roaring bull market of the late 1990s, caution was always warranted when a new bull campaign approached a 20% gain above a previous high. And these are the kinds of things that traders and investors can look for to know when it is prudent to be cautious with respect to following the primary trend or when to actually think about shorting against a primary bull trend. Traders and investors need not just be ‘trend-followers.’ They can, if savvy and nimble enough, successfully countertrend trade as well as long as they can spot when to cover their shorts. The short-cover is usually a very small time window, so traders do need to be alert or they will usually give back most of their gains. It helps to be clear that what you are doing is countertrend trading. This makes it mentally easier to short-cover, and not merry a bearish bias that is either early or ill-considered.
 Click on image to enlarge!
The final type of bull trap to consider is that which results from symmetrical percentage moves from a low to a high. Between August 2004 and May 2008, we saw several rallies exhaust themselves at 15% to 17%. These rallies were much weaker than their counterparts in the late 990s. One reason these were weaker rallies is because a secular bear market began in 2000.
 Click on image to enlarge!
Just being aware that these variations or types of bull traps exist is an important lesson for traders and investors. There are other types of bull traps than simple High to High or Low to High bull trap models to consider, but by and large, these percentage traps are the most significant and most likely to work. When considering a counter-trend or trend-following setup, you must also consider its success rate. The less likely a reversal pattern is to work the more likely you will lose money. Whether a trade setup is a trend-following or counter-trend setup, proper execution is key to success. We really only want to look for and trade trend-following setups or countertrend setups that are frequently recurring, and that have a high success rate. It is hard enough properly executing frequently recurring setups, it is pure folly to consider setups that are not frequently recurring. It is for that reason alone that I will never discuss any kind of setup that is not frequently recurring other than to dismiss it, whether trend-following or countertrend following.
Over the years, I have become a bit of a short-selling expert by default over the years. The reason for this is that I did most of my trading research since 1994 working with SP500 floor specialists. Market makers that are required to provide liquidity to the public have a natural short bias precisely because the public has a natural long-side bias. The floor specialists had to figure out ways to make money by selling to the public in a rising market. It was my job to help them make that money.
For my own personal trading, in spite of my honed art, I have a long-side trend-following bias in the stock market, because the stock market generally disciplines most participants to do just that. It’s just easier. That said, I won’t hesitate to sell short, when the market gives me an edge. US Treasuries, on the other hand, seem to be much easier to trade from either the long side or the short side.
My 15 years plus experience as a market researcher, newsletter author, and trader keeps me always focused on identifying when and where a move to either the upside downside will exhaust, and not just from a technical perspective. It is extremely important to understand the behavioral aspect of when trend exhaustion and climaxes in buying or selling will likely occur. It is a good habit for all traders and investors to develop these skill sets. We will explore market behavior, and behavioral modeling, more in depth in part four of this educational series.
Next week, we will look specifically at frequently key reversal signals that I look for to confirm the end of a move to the upside or downside in the SP500 and US Treasuries. Remember, there are tons of market signals out there. Most of them are just market noise. If a signal is not frequently recurring, the signal is broadly worthless in its applicability. Don’t be afraid to throw away signals that do not frequently recur or that do not have a high success rate.
Stay tuned for more in Part 2 coming soon!
For more from John Bougearel, visit Structural Logic |
