A three-pointer, bar by bar

I played a lot of basketball as a young adult. A sport relatively new to the UK at the time, I consider it the one major factor that gave me the confidence to go on and achieve my career aspirations as a pilot.

The shot on the left from sometime in the early 70s and the reunion (good to see there is little change!) last week.

How to relate this to trading. Well, sometime in the 80s the basketball three-point rule was introduced. This is a lower probability shot taken from beyond the three-point line, a designated ark surrounding the basket.

Thank goodness they introduced this, as our opposition last week were younger (obviously), fitter, bigger, stronger – we had little chance of getting near the basket for the more probable closer shot. However, our long-range (low probability) shots, and particularly from the little bald guy on the left, were excellent.

The equivalent in trading is a trade taken at an inflection point, where the probability is low but the reward can be at least three-times the risk.

Here’s an example: a bar by bar trade taken yesterday morning.

(Before I do so, I must explain that due to the uncertain volatility to sterling from Brexit negotiations I’ve dedicated myself over the last couple of weeks to being familiar with the currency pairing USD/JPY. You may recall that previously I favoured GBP/JPY. The former has, in general, smaller bars, however, the spread is correspondingly small.)

For a couple of days the chart has been in a broad trading range. From the higher timeframe chart (not shown) the upper channel of the range is higher than bar 1 marked on the chart. However, as the higher time frame chart is always in short it would not be unusual for a decrease in price at this point. From the close of bar 1 we only have a moment to decide. I enter the trade short.

We are aware that the close of our entry bar has engulfed several of the previous bars and closed below the 20 bar exponential moving average. However, significantly the bar has not yet crossed a change in premise line (marked by the red arrow). In basketball terms, a weak two-pointer.

The next bar (bar 2 on the chart) goes against us. It closed higher than previous closes but is still below the recent wick marked by the green arrow.

Another bar higher, a close beyond the wick and the likelihood of at least another move higher (and probably up to the channel line of the higher time frame chart). We’re out of the money with this trade. But we’ve structured the trade so that we have a distant stop position.

Price starts to show some bearishness again and after a slight pull back we set a limit order to short at the high of the previous bars which gets filled from the wick of bar 3. (A low probability three-point basketball shot!) We are now entered short twice – once at the close of bar 1 and again from the high of bar 3. (Our stop for both is at least a measured move above the last leg of bar 2 and its subsequent bars).

Hurrah, we get our anticipated short which puts us back into the money with our initial entry and in good profit with our second entry. The doji at bar 4 puts uncertainty back into the mix, and I exit both trades.

This was correct as the market then went long. The purists would say that bar 5 is a good probability long…..however, after a ‘three-point bounce off the ring and in manoeuvre’ I wait, stay flat and gather my thoughts.

 

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