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Basic Trading Strategies and Techniques
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Trading signals that I use in my method are not much different from support and resistance theory and chart formations taught in books on classical technical analysis. In such books, none of the crossings, divergences, or other signals that I use with various indicators is accepted at all. My own interpretation of these signals is different from the classical and standard, so each of them requires a separate and detailed explanation.

Ascending or descending trendlines practically always give a perfect opportunity to construct a trade plan based on them. The clearer, more distinct, and more obvious a trendline is, the easier the trade should be. I recommend that you pay attention to the phenomenon I have discovered, which for some reason has been overlooked in numerous technical analysis handbooks and recommendations:

Any trendline correctly drawn through three or more points will be broken sooner or later. If such a line hasn't been broken yet, it becomes a zone of attraction for the market to return to it.

There is an obvious and rather simple explanation to this fact. Significant stops accumulate gradually behind such a line and the market then begins to successfully pursue on them.

The probability of a false break is higher if such a line has had only a few contact points for a long period of time, and the market hasn't done significant retracement along the trend yet. See Figure 9.1

In other words, a sharp and impulsively high amplitude movement followed by the break of a trend line, should serve as a warning that the break may be a false one. By contrast, the long period of market consolidation directly before the break more often specifies the high probability that significant follow-through or trend change will follow the break.

In any case, even if you don't know whether the trend line will be broken now or later, or whether this break will be real or false, the next approach to the trend line gives an opportunity to open a new position. At first you trade away from the trend line. As the market emerges from underneath the line, open a sell position. If the market emerges from the top, it gives you a signal to open a buy position. Stops, as always, are obligatory and they should be established directly behind the line, at a distance not exceeding 10 to 15 pips from it. Simultaneously, with the stops liquidating your initial position, you may place so-called entry stops for opening a new position in an opposite direction. For example, the line is used as a support or resistance (depending on the specific sit-

FIGURE 9.1 A false break of the trendline is usually a confirmation of the ongoing trend continuation.

uation) and as a border. When the market crosses this border, it automatically gives a signal to change direction of a trader's position. See Figure 9.2.

If the trendline does not break, then according to the first two basic postulates of the philosophical conception, your initial position will be to open away from the trendline, which will bring some profit in a short period of time. After placing stops, you can relax and enjoy watching a profit growing and accumulating on your position. Take profit later according to the trade plan made in advance within the time frame you selected. See Figure 9.3.

FIGURE 9.2 A trendline is like a borderline between the market territory and open space. Right ahead of an ascending trendline, you should take a short position. Be cautious, because every line drawn through any three significant points will be broken sooner or later. Each subsequent market approach to such a line increases the probability of a break. If a break takes place, stop and reverse your position a short distance from the break point.

FIGURE 9.3 This scenario is the most desirable for a trader. A trendline held once again, and a short position open ahead of the line should be liquidated and profit realized in accordance with the initial trading plan.

This one is a bit more difficult than the first one, but it shouldn't cause exceptional problems for traders. After light stress caused by initial loss, you soon will experience emotional relief. When a trendline breaks, following an active move in the direction of a break, your stops will be activated automatically. After losing 20 to 30 pips on an initial position, you already have another open position in the direction of a trend, on which you gradually accumulate profit when the market moves farther from the point of a break. See Figure 9.4. Don't forget to place stops, which should protect your new position. In this case, the risk of losses on a new position will again be equal to the risk you had on the initial one. Next, pray the break wasn't the false one.

The third scenario is the most unpleasant one for a trader. Prayers don't help when a false break occurs. After the break, which activates stops and entry stops, the market makes some insignificant movement, which has

FIGURE 9.4 In case of a break of the trendline, the initial position should be liquidated and reversed.

nothing to do with real follow-through; and then returns without giving the trader an opportunity to realize any profit. Thus the market again crosses a trendline, but from the opposite side. Stops are activated again and the trader loses on two transactions in a row, twice reacting to false signals. Even in this case, traders can still beat the situations using the following technique.

The correctly identified and drawn trendline divides trade space into two parts. Usually, the market doesn't allow such an important line inside the established range. The market shouldn't continue crossing the trend- line repeatedly in different directions. Here it will be possible to apply the trading technique based on my method and the principles of money management. Don't allow the market to leave a narrow 20 to 30 pips zone with the trendline going through the middle of it, unless you have a position open in the direction of the current movement of the market. In that case, each time, you should place stops at 15 to 20 pips distance from both sides of a trendline for liquidation of a previous position and open a new position in an opposite direction. See Figure 9.5.

Sooner or later, the market will leave its congestion zone at a distance, sufficient to cover all losses from trade on a choppy market. The only problem might be that something considered sooner for the market, could become too late for a trader. Therefore, you must limit the number

FIGURE 9.5 A false break usually leads to two consecutive trading losses. These could be avoided by applying some intraday trading techniques that allow evaluation of the probability of a false break.

of consecutive losses to three, four, or five and make a decision that depends on the size of the trading contract, size of your account, margin requirements, and strength of your nerves.

There are some other methods of dealing with false breaks, including methods of definition of their probability and also some other approaches using money management. We will talk about these later, in Part V. In any case, you always have to assume that any break of any trendline can be a false one.

I devoted a separate chapter of the course to different strategies in case of a false break of various trendlines, necklines, technical formations, borders, supports, and resistances.

Because in this chapter we talk only about the trendlines angled to the horizon, there is one important detail you have to pay special attention to: The signal to enter the market at the break of the trendline is valid only when the market breaks the ascending supportive trendline or descending resisting trendline. When the market breaks a rising resistance or falling support, you have to react to such a signal with the caution of the great probability that the break will become a false one. See Figure 9.6a and b.

FIGURE 9.6 Figures 9.6 a and b show that if multiple unsuccessful attempts to break a trendline are seen, then a trade plan should be based on entering the market on the break of such a trendline.

The formation of the channel on the charts of any time frame indicates to me an opportunity to make a profitable trade. The channel is one of my favorite technical formations because I can easily define the degree of risk, which also can be supervised easily during a trade. The channel gives a clear view of the size of the potential profit. When I receive signals from the channel formation, the risk/reward ratio (RRR) exceeds the average RRR that I have when I make transactions on signals received from other sources. See Figure 9.7a and b.

There are three types of channels: ascending, descending, and horizontal. They are often formed on short-term intraday charts and are good just for a short-term trade. Channels are present on daily and weekly charts, too, but as a part of a long-term trend, their borders frequently are a bit dim.

Trading on signals given by channels on the charts does not differ much from trading on the recommendations of technical traders, and it is similar to the principles of trade on ascending and descending trend- lines. A trading cycle usually starts from the lower border of the ascending channel, by opening a long position and by opening a short position from the upper border of the descending channel. Stops need to be placed behind a channel border, and in case the stops are activated, a position in an opposite direction (stop and reverse) could be opened.

A target for the channel trading is an area on the opposite side of the channel, where the initial position is liquidated and opens a new position in the opposite direction. Stops need to be placed outside the nearest border of the channel; but if they are activated, you must reverse your position only if there are additional confirmations and signals about possible continuation of the market move in the selected direction. The profit will then be realized again on the opposite side of a channel, then the cycle repeats again up to the moment when stops will be activated and the position will turn in the opposite direction.

Penetration of the upper border of the ascending channel or the lower border of the descending channel is not a valid signal to enter the market in the direction of a break. Only penetration of the lower border of the ascending channel or the upper border of the descending channel is a sufficient signal for opening a position in the opposite direction from a channel. See Figure 9.8a and b.

FIGURE 9.7 Channels are some of my favorite patterns. They always are obvious on the charts and provide opportunities to trade in both directions, with measured objective targets and tight stops.

FIGURE 9.8 I never start my trading by entering the market on the break of the upper border of an ascending channel and the lower border of a descending one, if there are no other additional signals received at the moment.

Ideal (or almost ideal) horizontal channels are very rare on long-term charts, but they can be seen on the intraday charts. They are best seen on five-minutes to one-hour charts, or even on a four-hours chart. Because such a channel is formed by two horizontal lines, drawing through at least three points each (according to market laws mentioned earlier), both lines most likely will be broken in the near future. My experience shows that:

• In the overwhelming majority of cases, the first break of a channel is
false.

• After the break, there is a minor move in the same direction, then the
market comes back inside the channel.

• After returning into a channel, the market crosses it and penetrates an
opposite border.

• After the second break, there is a significant follow-through, which
usually exceeds the width of the channel.

Some of my templates are based on signals given by a horizontal channel formation. They will be discussed in Part IV, devoted to intraday trades. The choice of a trade tactic in the formed horizontal channel depends mainly on individual preferences of each trader rather than on the market condition, which basically repeats the same scenario just described, with few variations. Any essential deviations are very rare, but they are possible. When I speak about trader's individual preferences, I have in mind the trader's desire to accept additional risk for an opportunity to gain greater profit. That depends on the degree of his conservatism, time invested in market supervision, individual experience, and speed of reaction to a specific situation.

I use trade signals given by various technical formations a bit differently from the usual manner accepted in classical technical analysis.

H&S is the most recognized reversal technical formation and is very popular among beginners. Many novice traders can see H&S even if there is not even a trace of it on a chart. Seeing H&S where it does not exist occurs not only because of someone's bright imagination but also because of insufficient knowledge of the basics of technical analysis. The alteration of waves in the market occurs constantly, and practically any sequence of contradictory movements can erroneously be interpreted as H&S. This mistake often happens when a trader has an open position and is searching for additional confirmations of his point of view. Wishful thinking can play a malicious joke on a trader, and this actually happens rather frequently.

Therefore, before you apply technical signals related, for example, to H&S, learn to identify the formation first. In all textbooks of technical analysis, there are remarkable pictures showing how this formation should look. Therefore, I recommend that all readers refresh their memories about the shape of H&S, and do not digress from the standard description of the formation. When you have any doubts about unequivocal identification of a formation at the practical trade, it is better not to consider the formation as such. The formation can pretend to be real, if at least nine or ten traders are able to identify it. See Figure 9.9.

However, all obvious formations have one basic and obvious defect that the overwhelming majority of traders can see. Because you cannot expect to take a lot of money from the minority of the market participants (in this case, those who are not capable of identifying the formation for some reason), then complications are most likely to arise. This paradoxical defect requires a solution.

On the one hand, technical analysis recommends that a trader open a new position in the direction of the market's movement at the break of a neckline. On the other hand, under market laws, the crowd that thinks alike always should lose. The conclusion is: the probability of the correct (i.e., textbook) scenario of the H&S formation should not exceed 50 percent; for this reason, a trader has no statistical advantage, no matter how he acts in a similar situation.

The exit from an inconvenient situation is rather simple. First, because the neckline is a critical line, it is possible to apply a money management system such as the one already described in the example of trendlines, and use stops with reverse to achieve a desirable result. Then, you have to wait until the market leaves a critical zone going in one or the other direction. Secondly (and I frequently apply this method), you can play in advance of the situation and open a new position before such a formation is fully developed. In the case of H&S, I prefer to take a new position at the point I expect to see a potential second shoulder top. The point of a potential second shoulder top is determined by drawing a line parallel to the neckline through the top of the first shoulder, which is already formed.

In the case of inverted H&S, such an entry point will be a possible low of the second shoulder. Stops have to be placed according to intraday supports and resistances, but they can also be placed on some fixed distance from the opening position determined according to scale and size of this particular formation. Such an approach requires some practical experience, but it is easy to learn. All you need to do in such case is pay attention to the situation and keep it under control at all times.

In this formation, my recommendations on a trade is the same as in the case of the H&S formation, but only in the part related to entry in the market on the break of a neckline. Don't take a position without completion of the second top (bottom) because it is not always possible to define precisely a point of entry into the market. Sometimes this formation deviates from a horizontal axis of coordinates and inclines on the side. My view is not different from the recommendations of classical technical analysis: protect yourself from a false break by placing relatively tight stops and reversing the position if stops are triggered.

In technical analysis, various triangle-like formations, including wedges, have various names and definitions. According to technical analysis, the market behaves differently after completing the formation of each specific type. Because false signals and fraudulent movements are frequent, it's hard to predict where the market will go after a break of a border of the formation. Anyway, a triangle or any other similar formation almost always allows a trader to make a profitable transaction without dependence on any other reasons and circumstances. When trading triangles, I don't bother to think if this is a continuation or a reversal type formation. My approach to triangles is rather simple.

First, very frequently there is an opportunity of early identification of a triangle after two highs and two lows are formed, through which it is possible to draw lines that supposedly will then become borders of a triangle. Early identification of the triangle allows making 1 to 2 trades inside this formation by opening positions from the bottom/top side in the direction of an opposite side, which will be the target. As the market reaches one side, liquidate the position, take profit, and open a position in the opposite direction, already having the opposite side of the formation as a target. In both cases, stops should be placed outside the formation and on both sides if the triangle is a narrow one. See Figure 9.10.

FIGURE 9.10 The broadening triangle is the only formation I really dislike. It looks obvious in the figure, but in reality it is very hard to identify before it is built completely. Most of my own irreversible losses can be attributed to this pattern, which is relatively rare. Only a third approach to one of the borders gives a useful and recognizable signal to enter the market in the direction opposite to the most current trend.

Usually a real break comes after the market has already touched each of the sides three times. (Sometimes it happens even later, on the fourth or fifth touch, but there is no need to wait so long.) After making trades inside a triangle, from one side and to another, simply wait for fourth (or subsequent) touch of one of the sides and open a position in the direction of a movement after the market breaks out from the formation. See Figure 9.11. Here again, you can be trapped by an unpleasant and unexpected false break. In case of a false break, the position should be liquidated when the market returns inside a triangle. The profit should be taken at the level projected from the break point and at the distance equal to the triangle height. See Figure 9.12.

The second interesting factor of dealing with triangle-like formations is that, actually, a false break is in many cases even better for a trader than a real one. It arms him with a high degree of probability to forecast the further course of events, because a false break is nothing else but a perfect confirmation of the market choosing the opposite direction for its next sizeable move. See Figure 9.13.

The false break of a triangle border in the majority of cases is an excellent confirmation of further market intentions. It indicates the future

FIGURE 9.11 There shouldn't be a problem trading on a triangle-like formation. Everything is obvious, and a trader can start by entering a position toward one of the borders (heading inside) or on the break of any border (heading outside). Choosing a point to place stops is also an easy task.

False break
FIGURE 9.13 Trading option in case of a false break of the triangle.

market direction, opposite of the false break. A false break in one direction allows the trader to make the assumption that the market again will cross the triangle and most likely will then reach the objective target, which can be calculated easily.

We will discuss the use of a triangle as a base for construction of trade plans, in Part V.

Rectangles, flags and some other formations from the theory of technical analysis have the advantage of precisely outlined borders. These borders can and should be used as critical levels, such as supports and resistances. If the width of a particular formation is sufficient, then it is possible to trade inside it, from one border to another. After breaking any one of formation sides, the position should be reversed.

The false break of a formation with a precise border is good, as was mentioned in the case with triangles, and the technique of trading is practically the same.

In spite of the fact that these two formations look beautiful and obvious in pictures in technical analysis textbooks, I have not found practical application for them in my method. The absence of precise borders in such formations doesn't allow you to plan in advance a trading tactic and then use it. It is almost impossible to receive a true signal about when to enter the market at a certain level and nor do these formations define where to place stops. These formations more often become obvious only when all the events have already taken place and it's already too late to do something about it.

Sometimes more reliable signals to open a position appear, and even acceptable levels for stops form inside such formations. In other cases it is possible to catch these movements, as I did a few times. The trader who reacts to a signal not connected with a basic formation signal, or by accident happens to be in the right place at the right time, feels deeply self-satisfied and wise. I have no objection to feeling satisfaction, but there is no wisdom in such an event.

You never know nor can you predict where the market will go next, and you should never forget this.