Saturday, May 19, 2012

Why You Gotta Be So Mean (Reverting)?

error: the white oval should be on the next spike to the right

This was  /cl from Friday -- a beautiful example of a key pattern that I believe -- from months of observation, has a high probability of returning anywhere from 5 - 10x one's risk (of 8 - 10 ticks)

The left chart is a 15-minute candle look that clearly shows a downtrend.  So yes, one SHOULD be looking for places to get short.  However, occasionally, the market offers a lay-up inside out trade -- in which we go long and hope to catch a ride back to the upper (descending) trendline, which can often be a sharp, fast move.

The key elements are:
1) What would it take for /cl to stop falling and mean revert?

    In this case around 9:43 am -- /cl dropped to 92.01 which was almost exactly the low of the overnight session around 1:15 am (this is the place I mistakenly placed the white oval).   So this was a perfect double bottom and natural place for a bounce.

2) Is there a bounce pattern?

   A double bottom is not enough to go long, especially since the Higher Timeframe trend is down.  (Heck every time frame is down.).  But a 3-bump pattern -- especially one that is tight and perfectly symmetrical as can be seen on the right chart, is a very strong indicator of the market gathering up for a bounce.

And as you can see, the next 25 minutes is pure joy for longs -- as /cl screamed up -- right into resistance as drawn by the descending trendline, and continued its natural course downward.

The 3-bump pattern does not occur very often but it is one to watch for when attempting a mean-reversion trade, especially if you can identify a potential bottom (double bottom this time).  You would only risk 8-10 ticks.  3-bump patterns work right away or they don't.  You don't have to give them room.

Now enjoy the weekend already.

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