Swing Trading Framework 2 (Price) Prepared for: Pro Trader Subscribers Prepared by: Paul Andre Prepared at: November 7, 2018 EXECUTIVE SUMMARY Objective: The main objective with part 2 of this framework is to help traders identify value in price that produces consistent asymmetrical risk:reward opportunities in any liquid asset class. Goals: Help Traders Identify What Value In Price Looks Like Provide Examples Of Asymmetric Trades Via Price Structure Showcase The Significance Of The 50EMA Highlight Ideal Trading Environments Introduce Turning Points Please keep in mind that we will be strictly focusing on price during this release, with the additional filter of Time, such as Multiple Time-Frame Analysis, in part 3. 2 of 12
WHAT IS VALUE? A word that is thrown around frequently within the trading community, yet it often goes undefined, and leaves many new traders confused as to what it actually means. Personally, the way I define value is an opportunity in any liquid market that allows me to clearly define where I m wrong on the position, yet produces asymmetrical returns if I m proven correct. This directly connects back to the risk-adjusted return which we discussed in the introduction, as I always want to reduce my risk through direct risk management, but I must include price discretion before actually committing capital. The Three Filters Of Risk: Risk Management: Direct risk management by reducing trade exposure to 1% Price Discretion: Only committing 1% once price is at Value for asymmetric returns Time Horizons: Filtering our entry through the lenses of Time once price is at value By processing each trade idea through the three filters of risk, not only will you boost your risk-adjusted return, but your confidence in markets will increase through the direct experience of placing asymmetric positions consistently. 3 of 12
ASYMMETRY Definition: Uneven or lacking balance. In an asymmetrical situation, a portion of something does not have the same exact form as another portion. Opposite of symmetry. Trading Is Counter-Intuitive Just like we discussed within the introduction to this framework about how less is more when trading markets, counter to traditional career norms, thinking asymmetrically is also very counter-intutive. Traditionally, we are taught to appreciate symmetric design from an early age, whether that s through architecture or art, and generally speaking, the more symmetrical someone s face is, the more attractive they are considered to be. Symmetry is often interchangeable with the word balance, and seeking balance within most of life s endeavors is crucial to success, however, this is not true when it comes to trading financial markets. The more imbalanced a market becomes, the higher the probability of us making asymmetrical returns by trading against the majority. As traders, we must always seek asymmetry. 4 of 12
Example: Trader A: Risks $1,000 to Make $1,000 (Symmetrical Trade) Trader B: Risks $1,000 to Make $3,000 (Asymmetrical Trade) Notice how much more attractive Trader B s position is, where Trader A s symmetrical trade looks very similar to playing Baccarat at the casino. Advantages Of Asymmetric Returns Risk Adjusted Return: Boosts RAR which reduces our personal risk, and makes our portfolio more attractive to outside investors. We Can Be Wrong More Often: The beauty of seeking asymmetric returns is it allows us to be wrong more often, allowing a string of losses to made up with one successful trade. Trading Against The Majority: The real money is made in markets when trading against the majority, and asymmetry is naturally achieved when a market is unbalanced, allowing us to trade against the majority when they all pile on one side of the boat. Five to one means I m risking one dollar to make five. What five to one does is allow you to have a hit ratio of 20%. I can actually be a complete imbecile. I can be wrong 80% of the time, and I m still not going to lose - Paul Tudor Jones 5 of 12
PRICE STRUCTURE One of the issues that many new traders face is struggling to identify what type of price structure is worth trading, and what is meant to be tossed aside. Additionally, another layer of complexity is added when you throw in market cycles, price patterns, consolidation, etc. My goal is to keep things extremely simple to start by providing the different types of price structure that consistently produces asymmetric risk:reward profiles. Trending Swing Environment: The easiest environment to understand is the trending swing environment that often manifest on the daily time-horizon, forming consistent runs & pullbacks, with price channels often accompanying this market cycle. Real-Time Examples: We have a beautiful real-time example of this trending environment beginning to develop on the $DXY, with price starting to form consistent runs & pullbacks, setting the stage for a bullish channel on the daily time-horizon. 6 of 12
Notice that as price reaches exhaustion after a pullback, we have asymmetric trading opportunities to target the previous highs with an average Risk:Reward of 3:1. Keep this market on your radar as we move into 2019 to view how a trending environment takes shape in real-time. 7 of 12
Taking this a step further, we can see that although we may be lacking true reversal candles, we can see how powerful the 50EMA becomes in a trending environment; becoming a dynamic indicator of collective perceived value. I always view exhaustion, price deceleration, price patterns, and the dynamic value of the 50EMA over candle-shapes; which I find the least important. 8 of 12
Price Patterns: The next market environment that allows us to capture pure asymmetrical positions is by trading pure price patterns. My favorite price patterns that tend to outperform are pure head & shoulders, falling / rising wedges, and breaks of major price channels. Additionally, the beautiful aspect of trading price patterns is we can easily define where we are wrong on the position, which allows us to filter our trade idea through the 3 filters of risk outlined above. Real-Time Examples: We have a great real-time example of a head & shoulders pattern offering asymmetric risk:reward on the EUR/CHF weekly time-horizon; allowing us to clearly define our risk, while outlining our asymmetrical reward. It s important to note that the re-test of the head & shoulders neck-line coincides with the weekly 50EMA; acting as dynamic resistance and collective value. We can see that even during a head & shoulders topping pattern, the weekly 50EMA is being respected by the market as a potential downtrend begins to form. 9 of 12
If we turn to the recent price action on the EUR/USD, we can see that a rising wedge reversal pattern became the catalyst for a bearish downtrend to form, with the weekly & daily 50EMA s acting as dynamic resistance & collective value. 10 of 12
One important observation to make is when price breaks the 50EMA on the daily time horizon, we will often shoot the gap towards the daily 200EMA, which surprise is the weekly 50EMA. I highly recommend performing your own backtesting to witness this relationship firsthand. 11 of 12
Price Exhaustion Is The Tipping Point Please keep in mind that we have yet to dive into interconnectivity / confluence factors / and entering positions correctly. I wanted to strictly focus on viewing price as value through the lense of moving averages, as it offers us the best visual representation of price moving into a significant high or low. We have to keep in mind that as price decelerates after a run into the 50/200 EMA s, we always have the convergence of traders exiting out of profitable trades during the run, and new traders jumping in to trade the high/low in the opposite direction; generating a turning point as price equilibrium is achieved. Turning Points It s important to always time your trade entry & exits during turning points in price, where price & time become interlocked and change direction. We have outlined what dynamic value from a EMA perspective looks like, but what about time? How long does an average pullback last, what time horizon forms counter-trend reactions, and how do we utilize multiple time-frame analysis effectively? The answer November 21st 12 of 12