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How to Identify the Uncommon but Valuable High Probability Trade

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Technical expert L.A. Little walks you through the charts and configurations you need to recognize the setup. (Hint: There are two of them in today's market.)

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MINYANVILLE ORIGINAL There are trades and then there are high probability trades. Trades are available most any time but high probability trades are few and far between. Their infrequency is what makes them special for they require the charts to set up in far less common configurations than those usually witnessed.

This past week's sell off in the equity markets was the follow through foretold by the break of multiple swing points on multiple time frames -- a somewhat unique chart setup that occurs infrequently but when it does, it creates an excellent high probability opportunity. If you missed the short sell trades, don't fret, since the follow through just witnessed has now set up a secondary bounce trade opportunity in a few strong stocks. Allow me a few lines to explain what has happened and what is likely to follow.

A three month daily chart of the S&P 500 (^GSPC) depicts the break of multiple swing points on the same time frame, which is what got the ball rolling. The "SPL" notation used designates swing point lows which are algorithmically determined as price lows that remain lows for six consecutive bars. It's a systematically way of examining trend and trend transitions for all stocks and indexes.


Source: investools.com

Notice the two swing point lows that were closely aligned in the 1358-1360 area from the second and fourth weeks of April. Initially they attempted to support price, which is what they should do, but once they were broken, then a straight line decline ensued. Although a break of multiple swing points on the same time frame has a reasonably good chance for follow through, it pales in comparison to the rarer break of multiple swing points on multiple time frames. In the above chart, the swing point low at 1340 also doubles as an intermediate term swing point low as seen in the one year weekly chart.


Source: investools.com

The break of multiple swing points on multiple time frames almost always sees an immediate and powerful follow through. In fact, according to my research, the probability of price continuation after such a price break is extremely high and for bearish swing point breaks the power and swiftness of the move is only enhanced. This past weeks' breakdown is just the latest example of this powerful trading setup.

The next question is when do you get back in or cover your short positions. As to the latter it is most likely now. One way to determine this is to look at price projections and a common method of doing that is via AB=CD pattern projections.


Click to enlarge
Source: tatoday.com

As you can see, other than the Russell 2000, the major markets and their ETF proxies have completed the ABCD projection patterns. Although similar to what you see elsewhere, the minor tweak I make to these calculations is that they are percentage based moves, not just price. This can lead to differing results if the price move is large and my work suggests enhanced accuracy as a result.

With price stretched to its projection on the major indexes both domestically and internationally, then it behooves the trader to at least lighten up if not book the bulk of their short sell gains. The probability of a snapper rally unfolding is too great to do otherwise. Sure, there is the possibility that price stretches farther, and therein lays the danger of switching to long index positions at this juncture. Such a move isn't a high probability trade but instead just a trade. Sure, the trade can work, but if you are even a day early it can negate the trade's return and cause a lot of angst in the meantime.

Unless one assumes that the current market weakness is the onset of a bear market, then the real trading opportunity at this juncture isn't to buy the major indexes but instead to look to individual stocks that offer excellent longer term opportunities. One prime example is a company like Whirlpool (WHR). At the beginning of February the stock shot up and entered a new orbit, rising some 13+% on the day off of earnings. Until Friday, it had yet to revisit the gap it left in the wake of that moonshot.


Source: investools.com

This is an example of a slow retrace to a prior breakout area (retest and regenerate sequence) which typically has a high probability of trade success. In this case it's success rate is somewhat diminished because of the weakness in the general market and the sector, yet its overall rating remains high since the test comes on light volume into the gap area off a slow retrace.

The best trades are those trades that are uncommon. They are trades where the confluence of events line up in such a way that the probabilities are higher than usual. A break through multiple swing points on multiple time frames is such a setup and a slow retrace to a breakout area to perform a retest and regenerate sequence is another. Take the high probability trades and leave the rest to others. Over time it will serve you well.

The author's website is TA Today
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