Price Action: Trading Broad Bull Channels (Part 4)

A strong breakout will convince traders that the market is beginning a trend.
However, whenever the market contains a lot of trading range price action
or is in a broad channel,
and you see a strong breakout,
you must worry that it could be a "second leg trap"
that traps traders into buying at the high
just as the market is about to reverse.

A parabolic rally buy climax:
one leg up, one pause bar, a third leg up,
followed by a bad bar
and a possible transition into a broad bull channel.

Traders always pay attention to how far the breakout is from the breakout point.
Those pullbacks drop below the breakout point.
Once they start seeing this,
they will begin selling at new highs,
or at least some bears will sell at new highs.

If the market pulls back below the breakout point,
this forms a "staircase pattern."
Traders will use the breakout magnitude to determine stop loss and scaling levels,
planning to go short in a bull trend.
But only experienced traders should do this,
because sometimes you will encounter this situation:
if you sell at this high,
the market rallies dramatically and never comes back below that high.
So you must be able to manage your trade.

Therefore, only experienced traders
should go short at the prior high,
and only when the pullback drops below the breakout point.
Why do pullbacks occur?
Because the trend itself has deep pullbacks, indicating it is not particularly strong.
Bulls prefer to buy on pullbacks
rather than buying at new highs.
They tend to take profits near new highs.
They may not exit exactly at the new high,
but if the market starts stalling above the prior high,
they will begin taking profits,
which causes another pullback.

Then bulls will buy again during the pullback
and again sell at new highs to take profits.
Bears know bulls are doing this.
They can see the downward reversal
and see bulls buying below the high.
Therefore, bears will go short at new highs and add at higher levels,
betting on a deep enough pullback
to earn at least a scalp profit.

"Counter traders" are always drawing lines,
especially in broad channels or trading ranges.
They are looking for support and resistance.
Each time a reversal appears, they draw a new line.
You have a line connecting the highs;
a new high appears, and you draw another new line.
You have a line connecting the lows.
Below is support; above is resistance.

You observe what happens when the market approaches these lines:
is it a strong breakout, or a reversal?
Usually it reverses,
because these lines form the channel,
and the market tends to reverse near the top or bottom of the channel.

When we are in a broad bull channel like this,
75% of breakout attempts fail,
whether at the top or bottom of the channel.
Therefore, traders tend to enter on reversals —
buying on upward reversals at the bottom of the channel,
selling on downward reversals at the top of the channel.

We have a trendline, and traders sell on downward reversals.
Two reversal points allow you to draw a trendline.
Traders sell on each downward reversal, all the way along.

Bulls do the opposite:
they draw lines at the bottom.
Each time the market drops below a line,
they buy on the upward reversal,
betting the bear breakout will fail.

If you intend to sell at the prior high in a bull trend,
you must have good trade management skills.
This is an advanced technique
not suitable for beginners.

But if you can manage trades well,
advanced traders can do this.

What "trade management" means
is using an appropriately wide stop loss
and scaling into positions.
Through scaling, they increase the probability of profit
but also increase risk.

So where should the "appropriate stop loss" be?
You must use a wider stop loss.
One approach is to use a stop loss based on a "measured move."
If bears want to continue adding at higher levels,
they need to place their stop loss above the bulls' profit zone.