A strongly rising market presents two major problems for traders – one psychological, the other technical. Although we’ve all heard the saying “the trend is your friend” many times, getting on board when the market has already risen substantially is challenging. One response is to keep it simple – and reach into the traders’ tool box. And the 1,2,3 entry strategy could fit the bill.
In markets, our natural instincts are towards mean reversion. Mentally, we resist change, and expect markets to return to where they once were. This may explain why many traders have the “gut feel” to sell the market.
Technically, there are many indicators suggesting the market is overbought. On reflection, this should not surprise. Most of these indicators are oscillators of one kind or another – and the principle underlying them is mean reversion. In determining market direction, the primary evidence is price action. There is no questioning the current strong uptrend in the Australia 200 index.
Adding to the technical problems is the increasing steepness of the trend, peeling away from the trend line. This increases uneasiness about buying the market.
Australia 200 – Daily
Source: CMC Tracker
Yet, if traders observe a basic principal of trading (“the trend is your friend”), buy it they must. How can a trader on the sidelines enter this market on the long side?
One approach is to keep it simple. The 1,2,3 entry (also known as a “hook entry” or “Ross Hook” after legendary trader Joe Ross) is a good example of a straightforward, clearly defined method of joining a trend.
The principle involves waiting for a peak, labelling that point 1. The market pullbacks to a trough, point 2. Then the market rises to back to the level of the peak – point 3. The trader buys (in a rising market) at 3, with a stop loss below 2.
Australia 200 – Daily
This is a daily chart, and an entry of this sort is more likely to be used by a trader with a timeframe of days or weeks. Traders with tighter timeframes could use a 5 minute or one hour chart and apply the same principle.
It’s likely at some stage there will be a significant pullback in the market, but in the meantime many traders will favour going with the strong, established up trend rather than attempting to outsmart the market and pick the turning point.