Bulkowski's Retrace Day Trading Setup (short)

Written by and copyright © 2005-2011 by Thomas N. Bulkowski. All rights reserved.

This trading setup uses the 5-minute chart to take advantage of price making a strong move up. You short the stock after it peaks then use a tight stop as price descends.

Retrace Day Trading Setup Background

The idea behind this trade is to find a strong move up, wait for the turn, and then short the stock to capture a portion of the retrace of the prior up move. You can use this setup on any time scale but you can narrow your potential loss if you use a short time period to exit, like the 1-minute scale.

Retrace Day Trading Setup Methodology

The figure shows an idealized retrace trade. You can use the 1 or 5 minute scale for this. Price begins trending upward at A with a tall white candle. Candle B has short shadows and the candle opens near where the prior candle closes. Candle C is similar in appearance but that is not important. What is important is that you have at least three consecutive white candles. Many times, more than three candles will form a strong up trend. You do not want to see much overlap between candles and few or no consolidation regions. Those consolidation regions will slow or stop price when it turns.

In this example, candle D ends the uptrend. Candle E forms as a color change. This is the signal candle. It may not mean a trend change but you can use it to prepare. Place an order to short the stock a penny or two below the low. I show that as point F. Place a stop a penny above the top of the candle at E. If the candle is tall then switch to a shorter scale (move from the 5-minute scale to the 1-minute, for example) and place the stop. If no good stop location exists, then place a stop a penny above the mid point of the tall candle's body.

If you are using the 5-minute scale to find the setup then switch to the 1-minute scale as price approaches the target. The ideal target is at least 50% of the prior up move. That is half the move from the swing low at A to the swing high at D. Other retrace values are 38%, 50%, 62% or even more of the AD move. If price approaches the 38% retrace target then switch to the 1-minute scale for the exit.

To exit the trade once price nears the target, place a stop a penny above the prior candle's high. Lower the stop as each new candle appears. In this example, the initial stop is at E then the stop location follows each candle lower as price descends. At candle H, the stop is a penny above the prior candle's high at G. Candle H pierces the stop and takes us out of the trade.

Retrace Day Trading Setup Checklist

• Begin with the 5-minute chart to identify a strong up trend
• The ideal trend will have white candles with tall bodies, short shadows, and prices with little or no overlap. This is the AD move in the above figure
• Look for at least three consecutive white candles
• When a candle changes color (candle E), from white to black, that is the signal candle. It may mean a trend change
• Place an order to short a penny below the signal candle's low (the price at F)
• When the order fills, place a stop a penny above the signal candle's high (the price at E)
• Compute the exit (target) price as a 38% or 50% retrace of the prior up move (from swing low to the next swing high, that is, a portion of the AD move in the above figure)
• As price nears the target, move the stop to a penny above the prior candle's high (a penny above the high price at candle G when H forms, for example)
• Alternatively, you can place a stop a penny above the prior candle or 2 candles behind as price drops. You need not wait for price to near the target before using the prior candle high as the stop location but you may be stopped out prematurely
• If a tall candle appears, place a stop one penny above the middle of the body: .01 + (open+close)/2
• Eventually, price will hit the stop and take you out

Retrace Day Trading Setup Example

The chart shows an example of the retrace trade. Price climbs in a strong trend on the 5-minute chart beginning at candle A and topping out at B. Candle B becomes the signal candle, the first indication that the trend might change. The candle is red while the others to this point have been green. Place an order to short the stock at C, a penny below the candle's low.

The next candle gets you into the trade at 42.35. Place a stop above the candle's high, or 42.49. The target would be half the move from A to B (40.45 + 42.48)/2, or 41.47. A closer target would use 38% of the distance down from the high, or 41.71.

As price nears the 41.71 target, move the stop to a penny above the prior candle's high. On this 5-minute chart, that would take you out at 41.67 (on candle E), slightly below the 41.71 target but still above the 41.47 target.

-- Thomas Bulkowski

Copyright © 2005-2011 by Thomas N. Bulkowski. All rights reserved. Honk if you hate peace and quiet!