When Hansel and Gretl were led into the forest, they marked their route back with breadcrumbs. It was a good idea but had one flaw: the birds came along and ate them all up. Hansel and Gretl were lost in the forest and were lucky to end up at the Gingerbread house.
Have you ever felt that way when trading?
You can use breadcrumbs in the market to help show you where you’ve been. This is important because it’s not just you who is looking back at the path. It’s the entire market, collectively. Everyone, including “the big guys,” looks back to see what happened in the past.
It is equally important to understand two related points: What to look for, then What to do with this information.
What to do with the information
Historical “breadcrumbs” cannot be used to predict what will happen in the future. That’s like trying to drive forward while looking only at the rear-view mirror. That’s what happens when you use most oscillators such as moving averages, macd’s, stochastics, relative strength index and commodity channels.
However, historical “breadcrumbs” can be used, quite effectively, to tell you what to do should your path cross that breadcrumb again. Using the Hansel & Gretl analogy, if they had tied a string to a tree at each intersection of paths, then if they had come across that intersection again – from any direction – they would have known what to do, where to go.
What to look for
The most common historical “breadcrumbs” are clear turning points – the Highs and Lows of the day, of the week, of the month, and so forth. These are the most obvious. Everyone can see them. The problem is, everyone can see them. So everyone gets ready to do what they are going to do, when a High or a Low is reached. Quite often, the buying will pause when the high is reached. Then, one of three things will happen:
1) Reversal
2) Pause and Run
3) Congestion
I will go into more detail about these three in my upcoming book. However for our purpose, suffice it to say that there is an even chance of any one of these three occurring when prices touch a previous High “breadcrumb.” That means, there is a 67% chance that whatever you want to do, will fail. Those are not great odds.
Are there other breadcrumbs that can help? Definitely. Enough that I was able to build a simple, objective trading method around them.
Next Week: The Profile of the Market
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