Most traders wait for confirmation signals before entering the market, long or short, but that's a risky strategy in a modern environment where whipsaws and fakeouts are the rule of the day. Learning to anticipate price movement gets us into the action much earlier than our competition, and we can then use the reactionary crowd
Of course, this strategy sounds easier than it is in real-time practice, because we're social creatures looking for other warm bodies before we assume risk. In other words, most of us don't feel secure entering the market until the time and sales ticker, the level II screen, and a fast-moving stock tell us the coast is clear.
What do I mean by confirmation? Market players get fixated on the charts, waiting to see how everyone else reacts at key price points before they're willing to assume risk. However, it's often too late to act by the time they observe the movement and volume that confirms the breakout or breakdown they want to trade.
On the flip side, anticipation presents traders with lower-risk opportunities than buying a new high, or selling a new low. Simply stated, an anticipatory strategy means acting without waiting for the actions of other traders. It's a price-based approach that requires a strong stomach because it feels like shooting in the dark, especially during the early stages of the new trend.
Realistically, early entry doesn't always make money. In fact, it can even trigger more frequent losses than reactionary market strategies. However, average loss size will be considerably smaller as long as tight stop losses are used for new positions. The flip side is that multiple shots can be taken at promising patterns until the trade finally "sticks" and moves to a substantial profit.
This works especially well with patterns that look great but show few obvious entry points. The trader addresses this ambiguity with a campaign that's willing to take a series of small losses before giving up and moving on to the next pattern. The variable -- i.e., number of losses -- is defined by the maximum drawdown for a single position forecast in the broader trading plan.
Let's look at three current charts that show anticipatory trade setups.
has been moving higher in a steady uptrend since bottoming out in December at $2.58. It stalled at resistance near $9.40 nearly two weeks ago and has been moving sideways in a tight pattern since then. An early position taken within this congestion, with a stop loss around $8.60, might enjoy the fruits of the next breakout.
These narrow range patterns offer a perfect fit with anticipatory strategies. These include triangles and other scenarios in which an active trend goes dead while it shakes out profit-takers and moves into position for the next rally or selloff wave. An early entry signal triggers when the instrument prints a NR7 bar, which represents the narrowest range price bar of the last seven bars.
International Game Technology
bottomed out at $6.81 in March after a long downtrend. It rallied above the 200-day moving average in May and dropped into a broad sideways pattern. The stock rallied above pattern resistance at $16 this week and hit $18.15 before starting to pull back. A decline to new support should offer a great trade entry.
Market dynamics work against reactionary traders because by the time they're willing to act, smarter folks who took early positions are booking profits and heading back to the sidelines. This natural conflict sets up ideal conditions for a buyable reversal into the price level that attracted their attention in the first place.
bottomed out near $8 after a historic downtrend. The recovery effort reached the 200-day moving average in April, with price moving sideways for almost two weeks and then breaking out. The uptick stalled a few sessions later, above $28, with the stock grinding out a falling wedge pattern for the last four weeks.
A great way to play anticipatory trades is through stocks that are caught between a rock and a hard place. Look for patterns showing strong conflict between buyers and sellers, and little room for either side to prevail. It's important to act quickly when this scenario sets up because the conflict eventually forces one side to lean too far and get trapped.
This setup offers ideal dynamics for a breakout or breakdown. The trick is to place limit orders on both sides of the conflicted pattern that will trigger, depending on which way that price finally breaks. After establishing the position, cancel the second order and get a stop loss behind the trade, in case of a whipsaw.
Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.
Know what you own: Farley mentions Wells Fargo. Other companies in the banking industry include JPMorgan (JPM) - Get JPMorgan Chase & Co. (JPM) Report, Citigroup (C) - Get Citigroup Inc. Report, U.S. Bancorp (USB) - Get U.S. Bancorp Report and Bank of America (BAC) - Get Bank of America Corp Report.
At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.
Alan Farley is a private trader and publisher of
Hard Right Edge
, a comprehensive resource for trader education, technical analysis, and short-term trading techniques. He is also the author of
, a premium product that outlines his charts and analysis. Farley has also been featured in
. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.
Farley appreciates your feedback;
to send him an email.
click here to sign up for Farley's premium subscription product, The Daily Swing Trade, brought to you exclusively by TheStreet.com.
TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.