First Look. Let me say that if you are not doing as much detail on your charts as I do before placing a trade, you are making a costly mistake. You are probably trading by the seat of your pants.

This looks like a good trade so far. As for the 123-bottom formation, all the 10-20-50 rules have been met. As you can see, the #3 point went well below the 50% retracement level from the #2 point to the #1 point. (The closer it gets to the #1 point without exceeding it, the better.)

We now have some profit targets. The first one, the 50% level of the last minor move, is just above the #2 point. It’s far too close to use it as a potential profit target if you are position trading. The first target I would use is the 50% level of the last major move, which is 270.73. Actually, I would probably put my Sell Limit order just below the past support at this 50% area. Why? Because it could easily become a Common Number and then come right back down. Don’t get too greedy.

Now, where do we enter the market, and where do we put our stop-loss order? Let’s look at the next chart and see what makes sense. I’m using several charts for the sake of clarity. You would normally keep all this information on one chart. Gecko Charts is incredible at doing this.

Second Look. As you can see, the reward/risk ratio is not all that great, even if you put your stop loss below the #3 point rather than below the #1 point. Now, what do we do? Do we make the trade based on the 123 bottoms, or do we pass on it? Tough question. Here’s something to at least consider: Remember we talked earlier about buying support and selling resistance? Could we use that here? If so, how? Are your mental gears turning yet? I hope so. Have you figured it out yet? There are lots of things to think about here!

Third Look. Let’s look at the chart again in a larger view (The Third Look) and see if we can come up with a better plan. The chart is now taking on a new look and feel. Several things are going on here. The first thing that jumps out at me is the spike-down day. It closed in the upper 25% of the daily trading range. Remember, we talked about how to trade spikes in a previous lesson.

If we trade this based on the spike and it in fact works, it should also form day 3 of the bottom blip, too. This is getting interesting! Volume… what’s volume doing? Always look at what volume is doing in this case. Even though it is not shown on this chart, it’s up and that’s a good sign too. If we place this trade, our profit target will be the same, but our reward/risk ratio is now 3 to 1, not 1 to 1. Are we on to something here? Are we forgetting anything?

Should we be looking at anything else? Heck, let’s go for it. Let’s enter the market tomorrow with a buy-stop order just above the high of today. Ready?

We have a dilemma! The price has yet to reach our target price, but a top blip formed: A great warning sign that the price may drop. Based on our understanding that almost all market moves make a 50% retracement, should this move be any different? Will it retrace again? What if we get out tomorrow? If the market rallies again, we still want to be in the trade, long. This, my friend, is known as a trading dilemma! There is a solution.

You place a sell stop order just below the low of today. This way, if the market rallies, chances are you will still be in the trade (it would probably have to be an outside day to stop you out.) But, if the market drops, you want to lock in some profits. So, if we move our Sell Limit order to just under yesterday’s low (day 3 of the top blip), we lock in a guaranteed profit, but it protects us if the market does rally because we would probably still be in the trade and not get stopped out. We want the best of both worlds here. That’s what we decided to do. Let’s look at the next chart and see what happens.

Congratulations! A profitable trade and you made the right decision to get out and take some profits. But…, is the trade over yet? Do we want to get back into the market again? If so, where and how would we do that? Good question!

There are a couple of things we have learned in the course so far. One thing we've learned is that almost all prices will make a 50% internal retracement at some time. (Just like the 123 bottom formation made a 50% internal retracement when it formed the #3 point.) Will this one? If it does, how do we take advantage of it? Will it come back down again?

What we could do is wait for a 50% internal retracement to take place if the market drops down, and then enter the market long again on a bounce off the 50% or 61.8% retracement level, if it makes the anticipated 50% internal retracement. We decide to do just that. We place an alert (not an order) to be notified if the price hits the internal 50% level.

Let’s play the chart forward (I love these Gecko Charts) and see if the 50% level gets hit.

Eighth Look. As you can see, it did make the anticipated 50% internal retracement (probably a 61.8%, so we now want to go long once again. What do we use for a profit target? The same target we’ve been using—the 50% level of the last major move. So, we can place an order to go long and a Sell Limit order to take profits at the 50% level of the last major move (if it’s reached.) Our stop could be below the low of yesterday. Let’s look and see what happens next. By the way, this is a tight stop.

Sorry. I'm missing this chart for the 8th look but will try and find it.

Ninth Look. We hit our profit target and we took profits, but what do we do now? Good question! What I think we should do is wait and see if the trendline can penetrate the resistance. If it does, we might go long. If it doesn't break the resistance, we could short the market a day or so later. If we were short, we could take profits at the 50% level of the last major move of the last rally (255.02), with an exit order at the 50% level of the previous major move. Let’s look and see what happens.

(Or we could just wait and see if a reversal takes place and price drops back down to the 50% or 61.8% area. If it does we could look for another buying opportunity.) In this example, I did not do this. I just got short.

So, now we are short the market and have a profit target and an exit order to get out if the price comes down and touches the 50% level. What do you think will happen next? I bet you know!