Trend Trading - The Breakout Trade (Part IV) - The Entry

We know how to spot a rising (or falling) trend on our charts. If we see a series of candles with "higher highs and higher lows", we have a rising trend. If we see a series of candles with "lower lows and lower highs" we have a down-trend.

I will look at a rising trend, but keep in mind that the exact opposite applies in down trends (which can, of course, be traded just as easily using futures contracts).

In a rising trend we know that we want to buy on a dip, or "pullback". In my last article, we spent some time defining exactly what constitutes a "pullback", but for the sake of argument we will assume that we have just had two candles with lower highs than the preceding candle (which made a session high).

This puts us on alert for an entry. Our logic is that the market is trending up and that this pullback is just a price consolidation which will be followed by a new push to the upside.

But where shall we pull the trigger?

As with all trading decisions, there is no absolute "right" answer. The entry that will work brilliantly in one example will turn out to be a loser in another situation, and vice versa. Still, we do not require to be right all of the time, we just need to be right often enough to make a good profit over time.

Probably the easiest entry point to understand is the "defensive" entry. The entry point is one pip above the session high. In other words, we wait for the pullback to finish and for price to move through the previous high. The logic of entering here is that price making a new high "confirms" the trend, so now is the time to enter.

Closely related to the defensive entry is the "normal" entry. Here, you do not wait for the previous session high to be penetrated before buying; instead, you buy as soon as the pullback recovers and the previous session high is touched. You may not think there is much difference between the normal and defensive entries.

For example, if the market moves up in price to, say, 728.00 before pulling back, then our defensive entry is at 728.25 and the normal entry is that 728.00 (assuming a pip value of 0.25 such as is found in the S&P 500 e-mini contract, or any of the grain contracts). Basically, one pip difference in the entry points.

However, the entries can work out very different in practice. You have to remember that not everybody is on the same strategy. In fact a good number of players in your market will be looking for different patterns, for example a "double top". They will see the session high as a logical time to sell!

What this means to you as a breakout trader using the normal entry is that there are likely to be a lot of traders coming in with sell orders just as you place your Buy order. Consequently, your order is quite likely to be "filled" without slippage. If you are lucky, you may even get positive slippage by having your order executed one or two pips below your target price.

The defensive trade entry point, however, is often different. Not only do a large number of fellow breakout traders place orders at this point, but it is also a natural stop loss point for short traders. By this I mean that there will be traders who went short as they saw price rising towards the previous session high point (anticipating a double top formation) and placed a stop loss order just above the previous session high.

These stops are Buy orders which, combined with genuine new Buy orders placed by breakout trend traders, can cause a significant price spike at the breakout point. Consequently, it is not uncommon to experience significant slippage at the defensive entry point. Your order might be filled several pips above your target price.

Why then, you might ask, would you use a defensive entry instead of a normal entry?

The answer is that, every now and again, price will touch the previous session high just before the trend peters out and price starts dropping. If you had a normal entry, you would have gone long at the high point for the day, whereas the defensive entry would not have been triggered.

It is for the trader to decide whether it is better to use normal entries, which occasionally pick up a losing trade, but almost inevitably suffer less from slippage, as opposed to defensive entries. The decision will be based on the characteristics of the particular market being traded, and other aspects of the strategy. For example, if the trader is targeting a relatively small movement, slippage might represent a very significant percentage of the profits. Whereas, a trader looking for big moves is going to be less concerned about a bit of slippage on the entry.

Because successful traders often do the same type of trades day after day, these sort of decisions can be vital in determining their long-term success or failure.

The final entry point to be considered is the "aggressive" entry. In this case, the trader enters as soon as the pullback turns back upwards in the direction of the trend. For example, if the market has risen in an up-trend to a new session high point and there have now been 2 pullback candles, each with lower lows and lower highs than the previous candle, the aggressive entry is one pip above the high point of the second pullback candle. If the next candle is lower again, the aggressive entry moves down to a pip above the high. In this way, the aggressive entry can keep moving down as the pullback gets deeper.

Clearly, this is going to get us into the trend at a more advantageous level than the normal or defensive entries. Equally clearly, it is a more risky strategy, because it runs a greater risk of us getting into losing trades which would be avoided if we were waiting for the more cautious entry points to be hit.

However, sometimes the aggressive entry can end up being the only one which wins, particularly if there has been a deep pullback. That is because the aggressive entry can get you in early enough to reach a profit target on occasions when a normal or defensive entry gets you in too late to reach your target point.

Again, there is no "right" answer, only choices which you, the futures day trader, make after reviewing the market you will be trading. Of course, it is possible to select different entry options at different times based on your "feel" for the current market position. If you can do this, I congratulate you!

Personally, I find it difficult. So my approach is to be consistent with the rules I use for entry. I know that if I do the same thing day after day, sometimes my entry rules will be outstandingly good, and sometimes I will curse them! However, most sets of rules based on sound trading principles should yield a sufficient number of winners to compensate for the inevitable losing trades.

Obviously these entry points are well-known to all experienced traders. Because of this, they inevitably become battlegrounds in the market. Sometimes they represent major battles, sometimes just minor skirmishes, but they always attract attention. Therefore, some traders apply various tactics. For example, instead of buying or selling at the specific entry point, they may look for an entry at some "offset" from the standard entry point.

Consider a defensive entry one pip above the previous session high. If a trader anticipates a strong fight at that level, he or she may look for an entry using a limit order a few pips lower. That is, after the defensive entry is touched, a Buy-Limit order is placed a few pips lower. This obviously has the benefit of gaining a few pips in every successful trade, and it eliminates slippage on the entry (since you do not get slippage on a limit order). On the other hand, you may miss out on some particularly good long trades where the market takes off quickly after the breakout and never retraces to your entry point. You will, however, never miss out on losing trades!

You can also offset your entry order further above the standard entry point. In other words, instead of entering one pip above the session high, you may wait until the market moves up 4 or 5 pips. You do this to avoid being caught by a "false breakout" where the market just goes one or two pips above the previous session high before reversing.