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A Plan for Identifying and Trading Pullbacks Neural network technology and trading systems Profit Target Exits Gunning Slippage Contrarian Trading Testing speed Linear Programming Optimization & Curve-Fitting What if the Markets Change? Monte Carlo Simulations Walk-Forward Testing What are genetic algorithms? A Plan for Identifying and Trading Pullbacks Automated Trading Systems for Financial Markets and Recommendations for Their Usage One of the trickiest judgment calls traders face comes when a market retreats from a strong run. The challenge is figuring out whether the market is just in pullback mode or rolling over. According to Hubert Senters, Vice President of TradeTheMarkets and a savvy trader of CBOT® mini-sized DowSM futures, Fibonacci retracements can help traders decide which mode the market is entering. Having identified a pullback, Senters says what he calls the "Pullback and Ambush" trade is a good way to capitalize on this market situation. For those unfamiliar with Fibonacci retracement ratios, Senters offers a succinct explanation: these ratios refer to certain pullbacks or retracements the market is likely to experience before it continues in its original direction after making a run, whether up or down. The most common ratios are 23.6, 38.2, 50, 61.8, and 100 percent. To identify a given ratio-e.g., 61.8 percent—traders can locate the difference between the low and high of a move. The relevant Fibonacci level will then be the high minus 61.8 percent of that difference. Most technical analysis packages will plot these levels as horizontal lines on the price chart. When setting up a mini-sized Dow pullback and /or ambush buy trade, Senters prefers to use a two-minute chart, and he follows a few simple rules: Set up the two-minute chart so you can see the open gap in the morning. Senter prefers to use a 9:30 a.m. open and a 4:15 p.m. close (both Eastern time), but a session chart will also work. v Look for an up move to top out. This provides the basis for drawing the Fibonacci lines. Draw the Fibonacci starting point at the low of the move and end it at the high of this move. Look for the market to come back to the 50 percent retracement level and to trade below this level, but not to close below the 61.8 percent level. This area between the 50 and 61.8 percent lines is the ambush zone (it is labeled on Exhibit 1 [Senter's Figure 1.1]). • Set a 10 to 15 point stop for this two-minute pullback and/or ambush trade, and scale out at the target levels. Senters says, "My target is based purely on the price action of the trade. Once the price enters the ambush zone, I look for signs that it is going to stop, reverse, and continue its up move. Specifically, I'm looking for the low bar in the zone to be overtaken by price action". Exhibit 1 shows how Senters uses Fibonacci levels to define an ambush zone. Point 1 marks the low point of the move and the point where you start your Fibonacci trendline tool. Point 2 shows the top of this move and the point at which you end your Fibonacci trendline tool. Point 3 shows the key point where the market trades below the 50 percent line but does not close below the 61.8 percent line. This is the ambush zone. Incidentally, Senters says, "If the market closes a time segment below the 61.8 percent line, the trade is off. Just leave it alone". Having identified the ambush zone, Senters next decides on an entry point, a stop, and a target price. Exhibit 2 [Senter’s Figure 1.2] locates these trade details on the price chart. Senters says, "The entry point for this trade occurs when the low bar is overtaken by the price action of the next bar". Notice a series of three descending red bars roughly above the 10:40 mark on the chart. The green bar that follows them marks the low point of the pullback. The next green bar, above point 2, closes higher; this makes this 11,104 price the entry level for the trade. This is where you buy futures. For this trade, Senters places the stop 15 points below the entry level (11,089). The first target price will be the 76.4 percent Fibonacci level, which is a price of 11,129 and is labeled Target 1 in Exhibit 2. The second target will be the 100 percent level (11,139) and is labeled Target 2. Deriving the targets is straightforward, according to Senters. Using the pullback move from point 1 to point 2 on the chart for a Fibonacci range, target 1 (11,129) is 76.40 percent of that, and 11,139 is 100 percent of it. "All you are doing is reversing the Fibonacci levels after you are in the trade", Senters says.Suppose you initially bought two CBOT mini-sized Dow contracts. The plan is to scale out of this trade by selling back one contract when the futures price reaches Target 1 and the other when the price reaches Target 2. At Target 1, a price of 11,129, the trade will have gained 25 index points, or $125 (25 index points x $5 contract multiplier). At the Target 2 price of 11,139, the second half of the trade will have gained 35 index points, or $175 (35 x $5). The total for the two parts of this trade comes to $300, a gratifying result considering the short-term nature of this trade. Of course, you can just as easily construct sell trades using this method. As Senters points out, all you have to do is reverse the process, and you’re in business. Source