Interesting Lessons From Friday’s Almost Trend Day Down

Wow - what a day.  We had another surprise news rally that drove the market higher against the overwhelmingly bearish backdrop.  It was a near-repeat of February 12th, when all signs pointed lower though price rallied sharply into the close thanks to a news leak… but that’s not what’s important.  Let’s look inside the DIA (DIA) 5-min chart to see high-probability trading insights and lessons from the intraday action.

DIA 5-min:

First of all, the day began - rather unsurprisingly - with a large downside gap that made a quick attempt to be filled, though price ran afoul of the falling 20 EMA, setting up good trend retracement entry trades with a short bias (with a target of the gap-opening low).  I generally do not recommend trying to fill (trade to fill) gaps greater than $1.00 in the DIA, but instead look to be - in this case - getting short in the direction of a gap.

Price actually made new lows at 11:00 am then formed a classic 45 degree angle retracement back to the falling 20 EMA (in an AB = CD corrective pattern itself) and formed two back-to-back dojis, which were your signals to get short again and play - this time - for a potential “Measured Move” of the prior impulse, as the price was potentially setting up a Bear Flag (or larger AB = CD pattern).  Price got its target into the 1:00 hour with new lows on the day.

Ironically, this was almost identical to the pattern on Thursday, February 12th when we had two fractal bear flags that achieved their target at exactly the same point… which launched a large-scale rally.  Once is coincidence.  Twice….?

Anyway, price began its upswing retracement back to the falling 20 which, by this time (remember we can’t see the big rally about to unfold), we should be anticipating or trading under the assumption we have a Trend Day on hand and thus should have been looking to short-sell the next pullback at 2:00 (perhaps with a stop above the 50).  Ultimately, this trade was slammed and the stop was taken out rather quickly as news of private capital injection (possibly) broke which sent the market surging on this news… again, ironcically just after 2:00.

Anyway, what I wanted to demonstrate was the Elliott Pattern that formed.  I actually was able to trade this successfully (buying the 4th Wave pullback in anticipation of the 5th, that is - I was stopped out as the rally broke).  I recognized the classic 1 and 2 wave and then saw the massive rally that I expected had to be some sort of 3rd wave and then waited to buy in on the next retracement, which actually took us almost down to confluence (cradle) support via the crossover of the 20 and 50 EMA (nice place to put a stop).

My minimum target was a new high but maximum target was yesterday’s close (which happened to coincide with the 200 SMA) so the price action gave me exactly what I was anticipating… which I felt made up for the stop-loss taken on the news break.  The market then went on to form an ABC retracement back down to work-off the gains.

For those familiar with Elliott, please refresh Wave Characteristics.

Wave 1 is often the “This is a countertrend rally only so let’s short it when it turns over” while Wave 2 is the “See?  I told you so.  We’re still in a downtrend.  Let’s short this thing to new lows” but Wave 2 ends above Wave 1’s starting point, confusing people and as Wave 3 emerges and takes out the peak of Wave 1, many short stops are taken out and others are buying the market, which is what creates the “thrust” “impulse” or “power.”

Wave 4 is known as the peaceful Profit Taking Rally (or “Surprising Disappointment”) while Wave 5 suckers people in to buy at the highs just as price has exhausted itself and is about to reverse.

Anyway, knowledge of these principles helped me turn in a nice profit towards the end of the day that I might not otherwise have realized without applying my growing knowledge and experience with the Wave Principle.

There are plenty of other insights from Friday’s trading action, so print off your charts, hand-annotate them, and see what you come up with!

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