1- Exhaustive Guide to Price Action Cycles and Multi-Time Frame Trading

Foundations of a Systematic Approach

• Necessity of Stop Losses: It is considered absolutely vital to use stop losses on every single position. They are a non-negotiable component of a disciplined trading strategy.

• Systemic Framework: Reference is made to the foundational keys required to create a trading system, specifically cited on page $58$ of the author's book. This text serves as a guide for building the structural components of a trading plan.

• The Power of Price Action Cycles: Understanding the actual cycle of price action is unique and essential for two primary reasons:

  • Mitigating Losses during Corrections: It helps traders stay out of corrective environments. Historically, traders often experience big profit runs only to give them back during market corrections. Reducing this "give-back" significantly improves both trading performance and mental health/stability during market drawdowns.

  • Avoiding Premature Profit Taking: Humans naturally seek security and may flee to safety by selling too early. Understanding the cycle provides the comfortability needed to sit through natural pullbacks and rests in an uptrend, while also signaling when to be proactive in selling as the cycle reaches exhaustion.

Technical Indicators and Chart Setup

• Exponential Moving Averages (EMA): The primary indicators utilized are short-term EMAs.

  • $10$-Day EMA: Represented as a Red line on the chart.

  • $20$-Day EMA: Represented as a Blue line on the chart.

• Simple Moving Averages (SMA): Longer-term reference points are maintained on charts for broader context.

  • $50$-Day SMA.

  • $200$-Day SMA.

• Philosophy on Moving Average Selection: There are frequent debates regarding specific parameters (e.g., using a $9$-day vs. a $10$-day, or exponential vs. simple). The speaker contends that these specific nuances do not matter significantly. The moving averages should be viewed merely as reference guides that price tends to set up around; the actual execution is based on the behavior of the price bars themselves.

The Price Action Cycle: Bull Phase

• Reversal Extension (The Bottom):

  • Characteristics: Marked by extreme volatility and high fear in the market. Usually occurs after the market has been selling off for several weeks.

  • Sentiment: At this stage, the last "holdouts" finally get scared and sell out (hitting out).

  • Trader Action: This is a signal that the asset is "sold out." One should not necessarily enter here but rather wait for volatility to contract and for price bars to tighten.

• Wedge Pop:

  • Characteristics: Follows the reversal extension. Volatility declines and price bars tighten, often right under the moving averages.

  • Trigger: A push back up through the moving averages triggered by a price pivot.

  • Significance: This marks the beginning of the "easy part" of the trend, shifting into a true intermediate-term uptrend where price action becomes more predictable.

• EMA Cross Back:

  • Characteristics: Occurs after the initial burst higher from the wedge pop. It is a natural pullback where price tests the moving averages to find support.

  • Risk Management: This is a low-risk area for entry. Traders are advised not to "chase" the wedge pop; instead, they should wait for the cross back, which almost always occurs eventually.

• Basin Break:

  • Characteristics: A consolidation phase lasting typically between $1$ to $3$ weeks, though sometimes longer.

  • Pattern Alignment: Can align with traditional technical patterns such as the "cup and handle" or "flat base," particularly when emerging from a larger $15$ to $20\%$ correction.

  • The Two-Break Rule: One can see multiple basin breaks in a cycle. However, after two basin breaks, the cycle is reaching an intermediate-term late stage, and the trader should be alert for exhaustion.

• Up Exhaustion Extension (The Top):

  • Characteristics: The opposite of the reversal extension, driven by greed rather than fear.

  • Sentiment: "Rocket boosters" are turned on by the public. Sentiment on platforms like Twitter reflects a "to the moon" mentality.

  • Technical Indicator: Price becomes highly extended from the $10$-day EMA. High volume often accompanies this stage.

The Price Action Cycle: Bear Phase

• Wedge Drop:

  • Characteristics: Confirmation that the exhaustion extension has peaked. Price drops back down through the moving averages.

  • Action: If the trader did not sell into the exhaustion extension, the wedge drop is the signal to step aside and avoid trouble.

• Velocity of Downside Movements: In bull markets, downside corrections happen much faster than upside moves.

  • Upside Duration: Often lasts $8$ to $12$ weeks.

  • Downside Duration: Can occur in just $2$ to $3$ weeks.

• The Corrective Cycle Sequence: On the downside, the steps (Wedge Drop, Cross Back, Basin Break, Reversal Extension) happen in quick succession. The market then typically spends an equal amount of time basing out that volatility between the reversal extension and the next wedge pop.

• EMA Cross Back (Downside): This is a rally back up into the moving averages where price finds resistance rather than support, leading to further declines.

Fractals and Time Frame Analysis

• Fractal Nature of Markets: The price action cycle is totally fractal, meaning it repeats on all time frames ($Monthly, Weekly, Daily, Hourly, 15$-minute, and $5$-minute charts).

• Trade-offs in Time Frames:

  • Lower Time Frames: Offer more signals and allow for tighter stops, but are prone to more "whipsaws" (false signals).

  • Higher Time Frames: Provide fewer signals but are more reliable with fewer false moves. This is a fundamental principle of technical analysis.

• Multi-Time Frame Alignment: Traders can use lower time frames to find entries that align with higher time frame analysis. This allows for larger position sizes due to tighter stop-loss placement.

Tactical Trade Management

• Weekly Time Frame: Used for "Big Picture" analysis. Helps determine if the market is extended, in a basing pattern, or in a period of "nothingness."

• Daily Time Frame: The primary time frame for trade management and general execution (intermediate-term focus).

• Hourly Time Frame: Used during market hours to monitor price action as it approaches specific levels.

• $15$-Minute ($5$-Minute) Time Frame: Used strictly for the final execution of the trade (the actual "pulling of the trigger").

• Warning Against Overtrading: Traders should avoid looking at $5$ and $15$-minute charts unless they are at a specific price level intended for execution. Constant monitoring of low time frames leads to chronic overtrading. The goal is to trade less by only acting at levels defined by daily and weekly charts.

Scanning and Market Sentiment

• The Weekend Routine: Scanning monthly charts every weekend is a vital exercise. Even if the specific stocks are not traded, it provides a "feel" for the overall health of the market.

• Breadth and Sector Analysis: If many sectors are setting up healthy patterns (e.g., small and mid-cap banks setting up even while the trader focuses on tech), it suggests the market is unlikely to experience a "waterfall decline."

• Index-Cycle Correlation: Seeing a Reversal Extension on a major index can encourage a trader to become more aggressive in their individual stock setups.