Australia 200 Index – 1,2,3

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

20130220 xjo

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

20130220 xjo 1232

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.

About michaelmccarthycmc

Chief Market Strategist - CMC Markets and Stockbroking Regular on ABC, BBC, Bloomberg, Channel TEN, CNBC, SBS and SKY
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6 Responses to Australia 200 Index – 1,2,3

  1. dealar says:

    A really interesting post Michael.

    I have been reading lots of comments about this market of late and seeing bears getting more and more vocal.

    Any pullback will no doubt be labeled an “I told you so slide” by the bears

    I wonder how a trader strikes a balance between ‘the trend is your friend’ – and at the same time not being wedded to your opinions like a lot of people in the bear camp? If you look at the right timeframe I bet a lot of the bears think (perhaps correctly) that they are still with the trend.

    Thanks again for the great article.

    DeALaR

    • Thanks DeALaR.

      Those bears are like the economists who’ve predicted 7 of the last 3 recessions….

      As a trader and a manager of traders I often came across the challenge you’re talking about. One senior trader once explained to me that he’d “learned to listen to the market, rather than trying to tell the market what to do”. I’ve found being too flexible has its problems too. The best response I’ve found is clearly defining my entry, stop, and target (not always a price) BEFORE i enter the trade, then sticking to them no matter what (easy to type, harder to do).

      All the best in the markets

  2. Desmond says:

    Thank you Michael, for putting into words what I (and I’m sure many other traders) are feeling – and also suggesting a plan to deal with the current trend.

    Desmond

  3. Pingback: Australia 200 Index – 1,2,3 in Action | CMC Markets Blog

  4. David says:

    Thanks for the post Michael, could you apply the same 1-2-3 principle to other markets like FX as well?

    David

    • Hi David – yes – the 1,2,3 is not only clearly defined, it is applicable to all trading instruments. Please bear in mind that many traders will use the 1,2,3 entry ONLY where there is an established trend

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