TA: Trying to find the perfect entry point for a short.
Note: I needed to publish this with 15m timeframe. But for best results (more exact values) I always draw the lines with 1m timeframe, and scale up to 15m for evaluation.
The Theoretical Base: Mathematics.
The basis of my approach is the infinitesimal calculus - remember math in school? The first derivative (D1) of a function is the rise of its curve (here: how much a price rises or falls), the second derivative (D2) corresponds to the trend of the curve rise - i.e. whether a curve is concave (rise decreases, the curve makes a "hump" and tops out) or convex (rise increases, with positive rise perhaps parabolic phase).
The Road To Practice: Find It In The Chart
D1 corresponds here with the angle of a trend line, which I put tangentially to the curve. In contrast to the other procedure with rising curves from above, with falling curves from below. About D2 at this point we only need to know here whether it is positive (curve convex) or negative (curve concave). If we compare the angle of two adjacent tangents, D2 corresponds approximately to the difference of both angles: If the angle decreases (as in the chart), D2 is negative, the curve is concave.
Trade Point Definition
The perfect trade point for entering a short is the point where D1 has become most close to zero and D2 is negative - the top of the curve segment, its upper reversal point. From there on, it goes down. The best TP for the exit is the point where D1 is most close to zero with positive D2 - the lowest point of the curve segment, its lower reversal point. Note: In practice, local highs in a downtrend are broad. I have written about the "slow death" on tops before. Those are well suited for the application of the technique described in here. On the other hand, local lows in a downtrend tend to be as narrow as a singularity and hence are hard to catch. I will write another idea later on how to approach them most closely.
With this knowledge, I now try to find these two points by putting tangents to the price curve and comparing their slopes / angles. Of course, this can only be done approximately, because the price curve never runs smoothly like a sine, but oscillates in different timescales with different frequencies and these oscillations overlap to a chaotic oscillation.
So I define the timeframe in which I want to trade and ignore higher timeframes for the creation of the tangents. Then I create approximated tangents (trendline tool) on the outside of each curve section, which connect the high point of each subordinate timeframe with the next, without intersecting the curve at any point.
The Theoretical Base: Mathematics.
The basis of my approach is the infinitesimal calculus - remember math in school? The first derivative (D1) of a function is the rise of its curve (here: how much a price rises or falls), the second derivative (D2) corresponds to the trend of the curve rise - i.e. whether a curve is concave (rise decreases, the curve makes a "hump" and tops out) or convex (rise increases, with positive rise perhaps parabolic phase).
The Road To Practice: Find It In The Chart
D1 corresponds here with the angle of a trend line, which I put tangentially to the curve. In contrast to the other procedure with rising curves from above, with falling curves from below. About D2 at this point we only need to know here whether it is positive (curve convex) or negative (curve concave). If we compare the angle of two adjacent tangents, D2 corresponds approximately to the difference of both angles: If the angle decreases (as in the chart), D2 is negative, the curve is concave.
Trade Point Definition
The perfect trade point for entering a short is the point where D1 has become most close to zero and D2 is negative - the top of the curve segment, its upper reversal point. From there on, it goes down. The best TP for the exit is the point where D1 is most close to zero with positive D2 - the lowest point of the curve segment, its lower reversal point. Note: In practice, local highs in a downtrend are broad. I have written about the "slow death" on tops before. Those are well suited for the application of the technique described in here. On the other hand, local lows in a downtrend tend to be as narrow as a singularity and hence are hard to catch. I will write another idea later on how to approach them most closely.
With this knowledge, I now try to find these two points by putting tangents to the price curve and comparing their slopes / angles. Of course, this can only be done approximately, because the price curve never runs smoothly like a sine, but oscillates in different timescales with different frequencies and these oscillations overlap to a chaotic oscillation.
So I define the timeframe in which I want to trade and ignore higher timeframes for the creation of the tangents. Then I create approximated tangents (trendline tool) on the outside of each curve section, which connect the high point of each subordinate timeframe with the next, without intersecting the curve at any point.
Trade active:
Things went on faster than expected this time. While still writing this post, the awaited decline crashed in like a hammer. I had to stop writing and place my order, so this article is published some minutes after the event. But try to reproduce this yourself with the information I had before the top was reached, and you'll see how close I came.
Now I have to make a short break to look after my trades again, and then I'll write the rest: how to identify the last wave - the top. It'll be short, I promise.
Now I have to make a short break to look after my trades again, and then I'll write the rest: how to identify the last wave - the top. It'll be short, I promise.
Trade closed: target reached:
Finish: Finding The Last Upside Wave And Anticipating The TP
As you see, the angles of the tangents diminish with a growing rate. Why? Again mathematics: We said, at the entry of the short D2 has to be positive, at the exit TP negative. This means it has to change over time. Do you guess it? This happens in waves, too. And we can get their slope by derivatives.
The angle of the tangents changes by a figure which changes itself (this is D2), and the change rate of this figure is D3, the third derivative of the price function. If D2 rises as needed for the model, D3 must be positive approaching the entry TP. We can approximate D3 up to the PT as a constant, if the waves in our rising channel have similar lengths - which happens most often. In our example chart D3 is approximately 2 - meaning the angle difference nearly doubles from wave to wave.
We said, that at the entry TP, D1 (equalling the angle of a tangent), has to be most close to zero. To get there, the angle change to the tangent on the last TP has to be such, that any tangent to a further wave would either have a D1 less zero (be falling) or a D3 less zero (curve does not top, but nears a straight line asymptotically).
In other words: The angle difference between T-1/T0 has to be bigger than the angle difference between T-2/T-1 (= 4) by a factor at least in the size of the quotient of the last two angle differences (4/2 = 2), which means in our case it's bigger than 8 (= 2 x 4). If this number is bigger than half the angle of T-1, we're not going to have another tangent with positive slope - means we're approaching the top.
In our case, the angle of the last tangent T-1 was 12, and 12/2 < 8 - so we're about to top with the current wave. We approximate the slope of the current tangent as 12 - 9 = 3 (which fulfills all requirements aforementioned). Now, where's the price gonna hit the slide? This is not easy to say. If one looses patience, others will follow suit, there are a lot of automated orders etc. But we can find an indication which in practise oftentimes fits: We measure the length between all those points we connected with our tangents, and calculate the average. Chances are good, that T0 will hit the top around this distance away from the last point a tangent touched the curve. This point on T0 is our proposed TP for entering the short.
As you see, the angles of the tangents diminish with a growing rate. Why? Again mathematics: We said, at the entry of the short D2 has to be positive, at the exit TP negative. This means it has to change over time. Do you guess it? This happens in waves, too. And we can get their slope by derivatives.
The angle of the tangents changes by a figure which changes itself (this is D2), and the change rate of this figure is D3, the third derivative of the price function. If D2 rises as needed for the model, D3 must be positive approaching the entry TP. We can approximate D3 up to the PT as a constant, if the waves in our rising channel have similar lengths - which happens most often. In our example chart D3 is approximately 2 - meaning the angle difference nearly doubles from wave to wave.
We said, that at the entry TP, D1 (equalling the angle of a tangent), has to be most close to zero. To get there, the angle change to the tangent on the last TP has to be such, that any tangent to a further wave would either have a D1 less zero (be falling) or a D3 less zero (curve does not top, but nears a straight line asymptotically).
In other words: The angle difference between T-1/T0 has to be bigger than the angle difference between T-2/T-1 (= 4) by a factor at least in the size of the quotient of the last two angle differences (4/2 = 2), which means in our case it's bigger than 8 (= 2 x 4). If this number is bigger than half the angle of T-1, we're not going to have another tangent with positive slope - means we're approaching the top.
In our case, the angle of the last tangent T-1 was 12, and 12/2 < 8 - so we're about to top with the current wave. We approximate the slope of the current tangent as 12 - 9 = 3 (which fulfills all requirements aforementioned). Now, where's the price gonna hit the slide? This is not easy to say. If one looses patience, others will follow suit, there are a lot of automated orders etc. But we can find an indication which in practise oftentimes fits: We measure the length between all those points we connected with our tangents, and calculate the average. Chances are good, that T0 will hit the top around this distance away from the last point a tangent touched the curve. This point on T0 is our proposed TP for entering the short.
