This post will delve deep into the third Bearish Setup - Big Red below Support (refer our post on Chart Patterns). It is usually a continuation pattern.
This setup is characterized by a single candlestick with a relatively large red body that is able to overcome nearby support and close below it near the low of the candle. The support could comprise of a Horizontal, Pivot, Congestion or Gap or a confluence of one or more types. It indicates strong bearish momentum and the likelihood of the price declining further.
To be tradable as per our strategy, the following conditions need to be met, part of trade selection.
The setup should complete on C3 @ 3PM, C4 @ 5PM, or C5 @ 7PM. Setup forming on C2 is not eligible. Trading conditions are mentioned below separately for trades on C4 @ 5pm and trades on C5 @ 7pm. Note : If you recall from the introductory post on chart setups, trade execution @ 5PM or 7PM depends on the US open. The former applies when the US markets open @ 7PM and the latter when the US markets open @ 8PM during winters.
Trades @ 5PM i.e. completion of C4 - The setup should form at C3 or C4. If the setup forms at C3, C4 should not be an adverse green candle or a long red candle.
Trades @ 7PM i.e. completion of C5 - The setup should form at C3, C4 or C5. If the setup forms at C3 or C4, the subsequent 2H candle/s before taking the trade should not be an adverse green candle or a long red candle. In both the situations above, if the setup forms on a 2H candle earlier than the trade execution time @ 5PM or 7PM, the interim candle/s should not violate the setup or run away. A narrow range candle (red or green) or a small doji that indicates consolidation is what we are looking for. Some amount of judgment is required. IF THERE IS ANY DOUBT, DO NOT ENTER.
The close should be below the real bodies of the candles offering support though it is acceptable if the close is not below the lower wick/s of such candles. Such candles may be in the immediate vicinity or be part of a larger pattern that has formed over multiple days. However, the close should be near the low of the candle i.e. the candle should not have a long lower wick.
A close below the opening gap (also known as closing the gap), if any, is also a valid signal to go short as the opening gap is considered as a form of strong support (refer to the relevant post on Gap S&R for more details). Again, if C4 or C5 is the big red candle closing below horizontal support formed by prior candles on the same day (C1,C2,C3), it is an acceptable trade.
The body length of the big red candle should ideally be more than the average body length of the candles in the vicinity. However, even medium size candles are acceptable as long as the close is near the low.
Avoid trade if the big red candle is a first close conspicuously below several support points formed over multiple days or a first breakdown below a prominent pattern such as a Head & Shoulder or a wide and long rectabgular range. Such a conspicuous close attracts a lot of attention from sellers who are waiting to go short on a breakdown from a closely watched support zone or a bearish pattern. Such a breakdown is highly prone to retrace above the support trapping the bears. It would be safer to wait for a retracement to support and a second breakdown which has much better odds of success. However, if the candle closes below nearby support of the last coupe of days (which is not prominent), go with the trade.
There should be sufficient room to decline before encountering support. A pattern forming very close to strong underlying support may not work hence avoid.
Always keep the bigger trend in mind. You should be ready with the weekly and daily view of the chart beforehand. If both are positive, avoid short trades. Take the trade if at least one of these is negative or sideways with a bearish undertone.
By the time the candle completes @ 5 PM or 7 PM, you should have already made up your mind whether to take the trade or step aside, very very important. If you cannot make up your mind, it is best to step aside.
Chart Examples : Please study the following chart examples carefully, across commodities, paying attention to the annotations which explain the price action behind the setup. Observe carefully what happens after the trade is executed.
Trade dynamics in terms of number of lots, Stop Loss, Price Targets by lot and the profit/ loss of the trade is also provided in a table below the chart. Please revisit once we have covered these in the section on Strategy as it would make better sense then.
Win Ratio: The table below provides the Win Ratio for this setup for different commodities, a key component for trade selection.
As is clear from the numbers above, the setup has a modest Win Ratio across commodities except for Crude where it is discretionary.
Now that you know the setup, please look for similar setups on the 2H charts for our chosen basket of commodities. Please share your observation in the Comments along with an image of the chart that you are referring to. We will revert with our comments. Please click on "Next Post" to move to the fourth Bearish Setup - Outside Strong Red.
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