Reversal Bars

I use reversal bar patterns primarily as entry signals in my trades.  I use simple reversal bar pattern and double reversal bar patterns.  Here are the rules to recognize a simple reversal bar pattern:

• Price must make a higher high (for longs) or lower low (for shorts) that the previous bar
• The Reversal bar must close inside or better (higher for longs, lower for shorts) than the prior bar
• The third bar cannot exceed the reversal bar

The double reversal bar pattern is somewhat similar:

• Bars must have equal highs (for shorts) or equal lows (for highs) to start the pattern
• Neither bar can close at the top (for shorts) or the bottom of the bar (for longs)
• A close that exceeds the prior close is best but not always needed.

While these patterns have proven to be reliable entry signals I have found that they are difficult to identify on the fly primarily if you use 576 or 144 tick charts like I do.  Therefore to make this task easier I have developed two simple Tradestation paintbar indicators that I use in combination on my lower timeframe chart (144 tick).

The chart below shows both paintbar indicators applied to the 144 tick chart of the E-Mini S&P 500 (@ES).  Long reversals are plotted in blue and short reversals are plotted in red (these colors and the thickness of the painbars are customizable via the indicator’s input dialog).  Obviously these indicators are not used in isolation but in combination with other signals.  For instance if you are waiting for a pullback to a moving average to go short, you may want to wait for a short reversal bar to plot and give you that entry signal.

The code is straightforward and provided below in EasyLanguage.

The implementation of the double reversal bar makes the enforcement of the third condition, namely “A close that exceeds the prior close is best but not always needed” optional.  Removing this condition is done by setting the ‘ThirdBar’ value to false on the input dialog.

Don’t make fun of the small winners

In the previous post I spoke about my current daily target of 5 points in trading the mini ES.  This target may seem low (mainly as it only results in a gross earning of $250 per contract) but in fact it can lead to some significant annual results, provided that the trader can demonstrate consistency in meeting this daily target.  For the sake of argument, let us assume a starting trading capital of $5,000.  Next let us establish as a rule that one can only trade 1 mini ES contract per $5,000 of capital.  And finally let us establish that we will not trade more than 10 contracts at any point.  Once again, provided that the trader can achieve 5 points per day, here is a spreadsheet that calculates the potential weekly returns:

As we can see we will expect an average weekly return of 5 points per day, times 5 trading days per week, that leads to 25 points per week.  By compounding the trading profits and following the rule of 1 contract per $5,000 of trading capital, by week 13 we have reached our cap of 10 contracts per trade.  Assuming 48 weeks of trading (4 weeks off per year is average), this leaves me, by the end of the trading year, with over $500,000 of gross profit.  Obviously one has to factor in the commissions, data feed costs, etc. but overall those become relatively insignificant and are also potentially tax deductible.

So at this point my goal is to make 5 points per day consistently as I realize that if I can achieve this goal I will have developed a skill that is worth half a million dollars per year, which gives me a lot more earning potential than in most salaried positions.  It is this earning potential combined with a genuine interest in trading that keeps me focused on my goal.

Consistency

Achieving consistency of results in trading is still something that eludes me.  If I evaluate my success on a given day based on my end-of-day tally of points earned (or lost) I find quite a bit of variation.  Yesterday for instance I took 25 points out of the markets on the ES Mini but the day before I ended the day at -10 points.  This kind of variation, although I am still purely on simulation at this point, doesn’t really give me the confidence to trade live.

However there is another way to approach the problem.  The first step is to define a daily target, for instance let’s use 5 points.  If I reach +5 points, I consider myself “limit up”, i.e. a winning day and I book this profit.  The rest of my trading day goes on but I do not count the subsequent wins or losses against this profit.  Likewise if I reach -5 points, I consider myself ‘limit down’ and I have to book that loss for the day.  I have found that this approach has the following benefits:

• Having a daily targets enables you to become more selective about the trades that you take and drives your trade management.  For instance if my target is 5 points per day, there is no need to jump on every single setup, I may just want to wait for the “A+” setups, the more conservative ones, and only take those.  Likewise if I am in a winning trade and I am already 2.5 points on the trade, I may want to book that profit as it represents 50% of my daily target.  The daily target also influences the stop losses and profit targets.  If I typically use a 576 tick chart for setups, I may want to use the 144 tick chart for stop placement (for instance at a pivot) and the indicators on the 144 tick chart for profit targets (e.g. an outer Bollinger Band).  The smaller timeframe chart would indeed provided tighter stops and more conservative targets which would suffice for a daily target of 5 points since we are not necessarily looking for the ‘big’ winners.
• It significantly reduces the variation in the results.  I have found that in many cases I would reach over 10 points but I would then take a string of losing trades and end the day negative.  My take-away from that day was that I had a losing day.  Using a conservative daily target, i.e. 5 points, turns that losing day into a winning day as you book your profits as soon as your reach your limit.  When you look back over a period of time, the assessment then also becomes binary, either a losing day (limit down) or a winning day (limit up), and I can then establish a gauge that once I reach over 80% of winning days I would go live.