Friday 5 February 2010

Bilateral Trade Setups

When it comes to trade setups, it's not always an either-or situation. In fact, you can double your fun with bilateral trade setups.

Start by overcoming directional bias when you look at a price pattern. Although you may see it in your mind as a long or a short, chances are it will work in either direction. The trick is to let the price action tell you which way to go.

Let's back up a step and see how this works. Many patterns exhibit well-defined support and resistance. Bilateral setups use both levels for trade execution. A long entry is signaled if price breaks resistance to the upside. Conversely, a short sale is signaled if price breaks support to the downside. But you still have more work to do before taking a bilateral trade. After all, making money is the whole point of the exercise.

Every trade setup generates a unique reward/risk profile. In other words, it tells you how much you stand to win or lose should you decide to take a position. Each side of a bilateral setup carries a different reward/risk ratio. Most of the time, one side shows more profit potential than the other side. This can be frustrating because the calculation is independent of the odds that either outcome will actually take place. So you may have a great, high-odds setup with little or no reward, or a lousy, low-odds setup that would earn a fortune if it ever happens.

The price trigger complicates bilateral trade entry. Trading signals come in all varieties. The best ones ring very loud bells within very narrow price levels. One classic example is a high-volume breakout through a major moving average. Bilateral strategies force you to locate trigger prices on both sides of the pattern. Many times one side will bark much louder than the other when price hits the associated trigger.

Bilateral setups work best when they fit into larger cycles that encourage price movement in either direction. For example, a stock drops off a broad rally into an extended correction. Smaller patterns within this correction may trigger short-term rallies or selloffs. Bilateral strategy lets the trader take advantage of the mixed environment and execute price swings in both directions.

Let's review the signposts of this two-way trading street. We need well-defined support-resistance levels, a defined reward/risk ratio on both sides of the equation, clean price triggers and a big picture that lets us execute in either direction. Sounds simple enough, and it is.

The difficulty lies in our ability to control bias and to let the market tell us which way to go. Very often the best trade is in the opposite direction from the most obvious outcome for that pattern. In other words, the majority piles in one way, but the profit comes from trading it the other way.

The good news about these fascinating patterns is they may tell you when the move is about to happen. Congestion often narrows toward a trigger point. We see this in triangle patterns where two trendlines converge in price and time. Bilateral setups may show this convergence through simple lines, or sometimes through more complicated volatility cycles.

Volatility drops off through the formation of most bilateral patterns. It tends to reach a definable low, and then trigger a sharp price expansion. Traders examine narrow range price bars near support or resistance levels in order to predict impending price triggers. They also study classic volatility indicators to locate these turning points in developing patterns.

Swing traders go long or short, depending on the opportunity. Bilateral setups cut their workloads by presenting two possible trades in a single pattern. So always look at both sides of the equation when examining a price chart. Then leave your bias at the door, and take whatever the market gives you.

via-tradingday.com