• Jan

Deep lower low-higher high rotation




The focus of this article is on a micro aspect of price behavior focused around the specific structural pattern of highs / lows and the supply and demand rotations.

There are many articles and books written since the early 20th century about the flows of highs and lows in financial markets, and how using those to define the trends or potential reversals can be valuable method. But realistically such methods of trend shifts using a lower low as a guide for fresh downtrend initiation or new higher high as potential initiation of bullish trend tends to be too simplistic, as the data says it delivers just too many fakeouts if it is not placed into some more precise/specific context. This leads to the issue that using the flows of highs and lows is not as easy as many basic technical books or guides tend to make it.

The key is actually to find a very particular case-pattern, where the rotations of supply and demand are very strong and happen back to back.


From my observations, there is one component that increases the chances for fresh rotation to establish where previous behavior gets canceled with a reversal, which is the abrupt change of previous consistent behavior.

There are many ways in how one could explain the sentence or statement above, and there are few extrapolates that can be made to help support the explanation:

-Anomaly

-Severe/strong rotation

-Deep negative sentiment to a strong positive sentiment shift

-Prior liquidation serving as an order flow relief to support the rotation


Above 4 key micro variables together formulate a specific pattern in the markets, which I call deep lower low-higher high rotation, or usually to keep it shorter deep LL-HH.



To help support the explanations above, below is a basic conceptual image:



-By anomaly, it is meant that there should be a high volume climax wash candle going trough the demand area (under lows). This high volume wash candle should stand out in size relative to the other candles on the chart.


-By severe rotation, it is meant that behavior flips the side twice strongly (use the conceptual image above), first by breach of lows it goes to bearish sentiment, and then it rallies all the way up on reclaim shifting back to initial bullish behavior.


-By prior liquidation, it is meant that liquidation/climax candle wipes out a portion of long traders which makes price easier to rally after-wards as marker maker absorbs most sellers at lower prices into the climax and has fewer issues finding fresh sellers after that at higher prices.



As long as the trader is using this micro pattern in combination with additional either macro or micro approaches this can serve as a decent leaning variable for rotations in markets. However keep in mind, what matters the most is the strength at which the LL-HH rotation happens, it should be as quick and strong as possible.

The way how trader perceives where the key lows and highs are will serve an important role, and this is something that takes many hundreds hours of practice to get good at. Some traders use the help of indicators which automatically draw major lows and highs on charts, this can be nice aid for the beginner trader, but eventually, a trader should be doing it by eye, since no automation software can really weight the flow of price / order flow within whole trend structure as precise as traders eye can. The more one trains the eye the better one can get with the read of rotations over time, human eye can balance-weight the supply and demand data much better and organically than simple automated indicator could.



Psychology behind the strong cancelation of initial rotation thesis and why large short squeezes tend to be result of it:



One interesting aspect is that on macro time frames where one can track the short interest on the assets, it is noticeable how consistent is the trap that the short sellers step into when the deep LL-HH rotation is at its making.

There is usually a large increase of short participation just where in reality majority should be going long (as per data of behavior) as it usually results in strong impulsive breach of price higher. And when saying "usually" i should be clear that data is no where near 80% or anything as such, but what does matter is that data is firmly above 50%, and those cases where the squeeze does happen result on average with a 5R move (using structural depth as guide) which is significant enough by all means to pay attention to it.


The reason why often this wrong positioning of short sellers happen is due to the initial shift of behavior and the way how many short sellers analyze the price behavior. So lets take it step by step to see how many short sellers adapt their view to price behavior and why the short squeeze happens often in such case:

Phase 1: ("Trend shift, bull trend is gone"):


Phase 2: ("This is unusually strong pullback, ....but the bearish thesis remains, its still a lower high and lower low, add to short should reject retest of previous high"):



Phase 3: ("This is irrational move, how could it reclaim previous high all in the single leg move?") At this point the short squeeze is in progress. Often short sellers tend to add to short position in deep LL-HH rotations using techs as guide for cancelation, being un-aware of this particular rotational pattern soon enough.



The above 3 examples of trend progression with deep LL-HH rotation should help to shine some light why there is often strong bullish impulse leg following such rotations.


Observations of price action at the core are subjective more or less if not taken under very specific context, and since majority of traders do not operate within specific structural / liquidation patterns, but rather just draw on chart what makes sense to them, they do not operate within the context, which is why often such very swift back to back rotations (from strong bull shift to bear shift and back to bull shift) catch many traders under surprise, because majority just do not expect the price behavior to be so savage, flipping like a light switch on and off few times from light to dark back to light again, and yet those kind of situations do happen.


Another view of why often deep LL-HH rotations tend to catch traders under surprise is the way how weakness and strength are perceived in the markets. Think of it this way, there is no real mathematical equation that defines the behavior of price on the chart as truly bullish or truly bearish, which means that a lot is left up to the interpretation of each individual trader. This leads to the fact that what one trader sees as weakness another trader might see it as a strength.


Let me give a practical example of how in deep LL-HH rotations at the end of bearish trends often traders tend to perceive the strength as the weakness, strapping the goat label on the lion, mistakingly seeing it from the wrong angle.





Such observations often tend to position traders on the wrong side, combined with many other things to note as well. It should be no surprise that such behavior was clearly present on the ticker TSLA just before the major short squeeze of 2019 started. As the deep LL-HH rotation was setting up, many technical analysts or chartist perceived the move as likely a bounce from highs and further weakness, meanwhile, the micro of rotation was already signaling the supply will likely be breached, and it ain't gonna be pretty what's about to come next, considering the amount of short exposure that ticker has/had. The rotation was not very quick and strong initially, but all the other factors were there and present.






Deep LL-HH in up trend continuation



Basic variables of deep LL-HH micro:


Ideally, for the continuation move of the broken uptrend, the structure of up trend should have some decent consolidation. Without consolidation, and several highs/lows present it will be too difficult to tell.

This micro setup is not just about watching single low or high that gets rotated by LL-HH move, this is about the broader context where the structure has depth, and depth requires more liquidity, more highs, and lows, else the performance drops. To re-affirm the point, the deep LL-HH rotation is not about looking at single high and low to see if deep LL-HH rotation happened between those two, instead it requires prior structural context of wider and more consolidated structure such as prolonged consistent trend. Always make sure there is enough context on the chart, on left side to justify potential deep LL-HH rotation at play.


Example bellow of consolidated structure in an uptrend that is broken and then quickly reclaimed by deep LL-HH rotation and the bull trend resumes after that:



Two ways of approaching the micro



This is not to say that there are only two ways to use this micro in the trading approach, those are however my personal ways which have been battle tested over time. Essentially those are:

-Waiting for base to establish around the supply (previous high) (long at lows of base)

-Wait for clean breach of supply and join the long side then





The upside of using both of those approaches is that they have risk control already "imprinted" in their approach, where if the play fails the trader will already be inclined to cut the position based on either of the approach taken.

For example, if taking the first approach then the trader can enter around the lows of demand using the lows of base as risk, while with the second method once the key supply is breached and trader is in the position those highs now need to serve as bounce level in case if the price comes back and retests them, using the risk just under.


Either of those two methods works, but it will depend completely on the situation which of those two might be useful, depending on what the price does. It is best if the trader is flexible in using both and then adapting to use either of them depending on how price behaves (or finding another better - third way to do it).


One of the important observations to make is that if LL-HH rotation is very deep (relative to previous structural behavior) then often there will be a formation of the base at the re-test of supply level as bidders need to regroup at higher prices, while if the LL-HH rotation is more shallow it is more likely that the breach of supply will be quick without the formation of base as bidders will have an easier time to overcome the supply since they needed to spend less fuel to "get up there".


Conceptual examples of deeper and shallower LL-HH rotation:




Below is an example on Ethereum where deep LL-HH came into play, with the formation of the base around the supply level, giving trader opportunity to enter either around the lows of base or at the breach, using high volume anomaly as the guide for risk, providing 5+R opportunity in either way.






For optimal entry, there should be a base set up in such a case to support more accurate entry with tighter risk. Generally, there are two scenarios that happen in the case of the setup above. Both cases are outlined in the conceptual example below:





The left case with base is much easier to time on entry and to set tighter risk, while the case without the base on right is more difficult to time, which is why it is better to just wait for the base to set up for entry, if it does not it is a perhaps better idea to use smaller position size or to avoid entry all-together.

In cases where there is no base, the initial retrace could be quite deep, across the larger spectrum of data it varies from 30% to 70% retrace distance (measured towards its previous bull leg size). This means that the trader should weight position size more carefully or in a few scale-ins as opposed to a full-sized single entry, which can be used in the case when the base is clearly established and bidders absorb offers strongly at supply.





Deep LL-HH rotation in the climax of bear trend



It is important to have context into which this micro setup is placed into. It cannot be traded outside of context. There are many different useful macro contexts to use with this micro.

An ideal context (orderflow only, no fundamentals) is using LL-HH rotation on the strong and deep rotation of consolidated bear trend, especially if this rotation is on strong volume. Late buyers get faked out and liquidated and the MM picks up the offers and absorbs all the way up to the previous supply. After that the bear trend rotates into bull trend (on successful attempts).


Conceptual example:



Conceptual view on liquidity and the reason behind climax bottom on deep LL-HH rotation:



Some practical examples of such rotations of bear trends.


























Strength of the move at LL-HH rotation leg



As mentioned above in the article, the stronger the move into the supply after the deep lower low the better. The market maker has to show clear initiation so that trader can build a strong following thesis.

The reality is that majority of long traders will have difficulties longing assets around the highs and large supply imbalance. If one takes a chart example below, majority of traders would rather consider shorting into such supply or if anything just selling along there, but to take a fresh long position would be considered somewhat aggressive, and yet this is the core basis of how deep LL-HH rotation needs to be played, it is all about joining the single player-the market maker and not the overall market, regardless of how much of supply is still present.


Therefore the stronger the push on that single leg into the supply, the better indication it is that the market maker is being very aggressive, which is ideal for joining the long side.




Clearout washes with combination of deep LL-HH rotation



One of my preferred way to trade the deep LL-HH rotation is if this micro is in combo with a clearout. Once those two are combined they offer a stronger % response rate along with cleaner follow-through with less drawdown (straight move to target).

Ideally, the trader should be on the watch for those two combinations as much as possible.


This means that price swipes trough (under) major demand area first, clearing out the longs, and then it strongly and quickly reclaims previous high on an instant reversal back inside the structure. After such a move, there has to be instant follow-through higher, no significant pushback, the MM has to reveal the hand and price has to respond to the upside instantly. This should give the trader a better idea of how to manage the risk-on trade, not just using the price (lows/highs distance) but to also incorporate the time aspect.


Example of such very deep clearout and strong LL-HH rotation following.



Below is an example of less consolidated weaker structure but non the less followed by clearout wash, reclaim, base, and then resume of fresh bullish trend (rotation of previous bearish trend). One very important component is to watch for clear base formation such as the case below, even if the trader is slightly confused if there really is a clean deep LL-HH rotation at play the base formation should clear up the confusion in most cases and re-affirm the suggestion.



Very deep clearout under whole area demand on image below, followed by full rotation - base and rally higher.



Another slightly more asymmetric example below:


Example of shallower clearout where the demand was lined up closer together, however, the key to note is how quickly and strongly it reclaimed the clearout wash and forme the base after. The timing is always the key factor that should give trader insight that this was just liquidation of longs and that large players are now likely to resume the trend higher. Timing ratios in the context of each part of the structural action are important, just like a piece of comedy, music or any other similar art.



Another example below, with shallower clearout.


The key concept is only to keep focus in the cases where the price really does reclaim the initial climax wash very quickly and within a single leg. There should be no major consolidations on the bull leg up, the move should be straight forward upwards.




If confused or unsure, focus on climaxes only



For those with less of charting experience a good starting point would be to only focus on observing potential LL-HH rotations at the very high volume candles which might be the bottoming points of bear trends. This means that such candles need to be in a bearish trend, swiping under all previous micro lows, and potentially some macro low to be the part of liquidation cascade.


Focusing on climaxes only will help filter out the cases where the trader would perceive deep LL-HH rotation while not being present, due to in-experience.


Below are two examples of deep LL-HH rotations after climaxes on LINK cryptocurrency.

Climax washes are especially nicely highlighted often in crypto due to the way how those assets trade, great practice ground for such approach.






Small caps



When it comes to small-cap stocks there are two very distinct types of tickers to separate to not confuse a trader. The trader needs to understand that there are certain behaviors or certain tickers where such micro has a chance to appear at a decent rate, and there are certain tickers where it is highly unlikely to happen.


1.Supply in control tickers with strong backside

2.Heavy volume tickers with strong frontside


On tickers with strong backside momentum where the ticker is consistently printing lower lows, it is highly unlikely for LL-HH rotational micro to appear and the reason is few folds. First such tickers are likely to be full day faders where it is not likely for demand to all of sudden to appear during the midday and secondly there just is not enough time for the trend to even have chance rotating in most cases since the ticker barely has 3-5 hours time window to do so.

For example, in gold or crypto markets there is no real-time constraint to the liquidity for the most part (excluding Asian session) since market is 24 hours/5 or 7 days a week, while in smaller-cap equities it is a different story.


For the second case, it is however the opposite story. The statistical chance for deep LL-HH micro to appear on strong volume frontside ticker is strong enough for the trader to pay attention to it (or HH-LL opposite micro as well).


This means that the volume and backside/frontside formation of the ticker should be the guide for the trader if one should or should not expect the micro to appear.


The logic behind is relatively straightforward, a large portion of deep LL-HH micros are liquidation attempts triggered by market makers, which means if the ticker is low liquid on the strong backside there is no real intent for the market maker to participate, while if the ticker is liquid and strong...there might be an opportunity (shake out the longs and then go for shorts).



Conclusion



Deep LL-HH is only a micro, it should support your entry thesis and it can be great combination if placed into right context, but it is important not to get "too close to the chart".

The issue is also some traders are not good at picking where lows and highs are as there is certain subjectivity to the view on this. Was current low actually here, or is this candle on the left that is forming the actual whole low? Those kind of questions require a lot of charting hours to get the right meaningful flow right.


If anyone is interested in digging deeper into this micro, make sure you study on plenty of historical charts of the liquid assets, there is no substitute for that, this micro requires plenty of chart hours to get it implemented practically with avoiding seeing it everywhere, which could very easily happen if one is not careful.


Plenty of examples given on the article are for crypto markets since those are often very liquid and present a lot of frequent opportunities, however, there are no exceptions to any market, this method applies to any liquid market, whether its equities (small-large cap), FX, gold, crude, crypto or else.


It should be added that to someone less experienced in charting a lot of said might look like a cherry-picking, as there is a very subtle variable that needs to be stacked correctly together for that kind of rotations to be at play. For anyone willing to learn the approach, try to be as selective as possible and make sure that all the variables shine trough at each attempt before trying to fit it into the loophole of deep LL-HH rotation.


As well the majority of examples given are for deep LL-HH rotations, however the same concept just in reverse applies to deep HH-LL rotations, i stick to the initial ones mostly because my eye is trained so, but it is up to every trader to figure out which bias suits him/her better.



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