• Jan

Trading extensions




The basic premise of trading the extension is slight return to normality in regards to price, once the price extends quickly, chances for pullback increase, but this only is the case if certain conditions are met, or if the extension itself is defined with very specific variables to even measure the chances of "return to normality".


Rubber band stretching and its snap-back is often used as an example to explain this process in price movements, but the issue in using such statements borrowed from physics is that this can be a very over-simplified definition of extension and what trader can expect.

Certain consistent moves of price in markets will snap back with retrace and some will not, meaning that they will keep extending more and more before they eventually snap back. And those differences in behavior do matter, as in real trading world one cannot operate with the mindset of "eventually I will be right", since that is a sure way to get in trouble.

This is why it is useful for a trader to separate each of the moves in markets into specific categories and define them well to avoid participating in certain moves that do not qualify as higher probability. Common mistake that traders tend to make is that they keep recycling same naming scheme for different type of moves, which makes them at the end confused and often getting into trouble expecting behavior on the move A to be the same as on the move B, even though that those two moves are technically not the same if categorized well. And after the same naming scheme for orange and apple then follows the same trading approach for each which in itself just makes everything worse.


Simple differentiation for the moves personally used is: - "pops": Small move under 5 candles, % of the move is non-specified. Could be on the backside of the asset could be on market open. - "extensions": Move of at least 10 consecutive bull/bear candles with 8% or more price change in the move. -"parabolics": Move only present on the front side of an asset, under very strong % move (30%+) with the parabolic curving of both volume and price.


This helps to better define rules and trade approaches on each move and to collect the behavioral data on each of them in relation to the context, rather than just bulking everything into the same basket.

From a practical standpoint, the reason why many traders get large losses on trading against the moves is that they do not have a clear distinction between the types of moves and they often start to add and add against the move too early where the "pop" eventually turns into "extension" and by the time extension turns into "parabolic" it is already too late and to loss is large as a trader was not accurately distinguished the move or did not have clear risk control differences of how to approach each of those moves with a different method of entry scaling and loss cutting.

Thus the "extension" move will be outlined in this article as a specific move set by the specific rules that are different to just any other "strong" move itself. Examples noted in the article are for all markets, as they can be applied across any instrument, but not necessarily will all instruments create an equal amount of opportunities. For example, quicker moving assets with strong volatility will create plenty of opportunities on extensions to trade, while slow-moving low volatile assets will create fewer opportunities. There is also the difference between asset classes themselves, equities will on average provide the most opportunities, crypto-assets following second, FX assets third and then the rest of assets will fall into a less likely category.



Consecutive bull or bear candles



One of the basic variables of solid extension is continuous candles within the direction of the move. For example, if the extension is moving to the upside then the majority of candles in the move should be bullish candles (90% of them) or if the extension is moving south then the majority of candles should be bearish. This ensures that the liquidity gap is created and the profit-taking does not take place at a large scale at the early stages of move, but rather at later stages mostly, exposing one side of order flow at the later stage of move.

My personal rule is that there should be 10 consecutive candles in the move before it starts to get interesting, but this will largely depend on how quickly and strongly the price is progressing, since in certain cases if price extends large % with fever candles, it can qualify as well. The idea behind having several candles in the row as opposed to just having one or two candles on trading the extension is because on more candles trader is better suited to determine how quickly the movement is expanding, while on single or two candle move that might be much harder as there is not enough context to fall back to. Without the enough data context it is impossible to tell the progression of the move over time, which is why ideally there should be 10 candles in the leg / move. The difference between more ideal (left) and less ideal (right) extensions in terms of consecutive directional candles (for bullish example, same concept but vise versa applies for bearish):




The sizes of candles should lean towards larger size rather than smaller, especially within the average context on what the ticker/asset trades in previous days. The stronger / larger the candles the better.

10 candles in a row is a good rule of thumb for the reason that in many cases when the large % move happens in only 2 candles, for example, it will actually be on the news catalyst and such extensions are far less reliable on behavior as they can push much further. Thus 10 candles rule by itself often tends to filter out the catalyst initiated moves, at least in their early stages. It should be noted that extensions as shown on the article are not traded on the catalyst / news releases, but instead in average orderflow / market conditions.



Liquidity air pocket (no major pullbacks)



Speed of progression:


The conceptual example below shows the difference between a slow extended move that is grinding higher on small volatility and consistent micro pullbacks (half-sized bear candles after each second bull candle), while the right side shows very strong and quick move, that completes the same % drop move but at much fewer candles at a much quicker pace. The extensions that should be traded should follow the example on the right, not the one on the left since slow grinding moves tend to over-extend beyond very often. Such moves are not ideal to trade against in expectation of retrace.



An ideal equation to follow is the last 10 candles (all bull or all bear candles) with move minimum 5% (equities only, crypto needs half that), and the move is not triggered by a news event. Those three are basic components of potential extension play, however, there are external variables that trader should include into the thesis to increase probability such as:

-the extension is counter-trend move (against higher time frame)

-the later part of the move in extension the candles are on much higher volume than the initial candles at the base of the move

-the move is initiated on smaller capitalization asset (small-cap stock or alt-coin in crypto)

-the volatility of the move is far higher than average volatility on the instrument over the past 30 days.



A grade conditions:


Connecting the right variables is important to separate B grade opportunities from the A grade opportunities and avoid as much as possible B quality setups. But the first trader has to understand what is happening behind the A grade setups in terms of order flow to gauge realistic expectations on setups. Extensions are generally about trading liquidity pockets that are created after strong and even surge/drop of price, where the order book is unable to quickly enough stack the bid or the ask to prop the price (along the direction of extension), and eventually, the counter order flow starts counter move by profit-taking and market orders. That is not always the case but ideally, that should be a portion of the picture behind the reasoning.


A conceptual example of order book stacking/propping along the move to "bucket" potential fall or retrace. Example on the left is a slow movement where order book has time to re-stack under price with the bid as time gives traders enough window to do so, while the example on right is a fast move where order book will have less time to quickly re-stack the bid making strong and quick counter more likely:





Examples above are by no means a 100% guaranteed, however across large sample base of assets there is often a signature difference in terms of order book positioning as shown above. Variables for A grade conditions as outlined on the example below:







Entry approach on extensions



Entry approach, valuable rules to follow (only suggestions):



-scale in few entries instead of just single entry as timing the end of extension is not that easy unless there are clear volume anomalies present

-start with the smaller size if the price is not yet fitting A grade play to avoid participating with strong size too quickly and getting in situation where one cannot add to size anymore

-short into ask and long into the bid to be pre-positioned before the actual micro rejection, this increases RR slightly

-have fixed risk level in mind, but be flexible based on price behavior and tape, avoid using hard stops on extension plays. Trader should be flexible and adjust the risk based on how price is behaving. Tightening risk of behavior is not ideal, expanding the risk if behavior is suited towards A grade variables.

-scale stronger position size towards the stop-out level as long as the price keeps extending quickly, this means putting one last add with stronger size near the stop-out level, this last add will not stretch the loss much if trade does not work out, but it will make significant difference on winner if price turns into traders direction at that point.

Below is an example of how trades can be scaled in on the ask for a short trade before the price actually reaches that level (with limit orders) to ensure being ahead of the actual micro rejection. The basic premise is that this increases the chance of liquidity micro-gap to be created as once price micro rejects and stalls for 1 or 2 minutes, bidders will have a chance to re-fill or re-position, while if the move is right into the upper area of the price it has a lesser chance of doing so.





Example of scaling position in 3 chunks, each spaced out at an approximate similar distance. However, this distances between each add should be adjusted on the live market conditions, based on how quickly the move is progressing, if price stalls more the distance of add should be bigger, if the price is expanding fast (but not too much volume) the distance between adds can be shrunk as liquidity pocket area has higher chance to develop there.




Scaling in and cutting position is shown on example below. It is necessary to "listen" to the price behavior, to determine if cutting position or adding to it is making sense. Keep liquidity gap/pocket in mind, if the price keeps pressing strong and quick then adding might be better, while if it starts to consolidate and keeps pushing with new micro high it might be a better idea to think of cutting position instead. Personally, I do not believe in hands-off set and forget stop loss method in any market in any traded setup. Setting hard stops and leaving the screen is a lazy way and low-performance way to approach trading, instead, trader needs to research the patterns to establish what kind of behavior is ideal and what kind of behavior is less ideal, and the decision making should adjust in the middle of trade based on those conditions, depending on how price / pattern is developing. There should be robust / static rules in terms of risk control for each trader but there should be as well slight adjustment and dynamics implemented into each specific trade, based upon the specific behavior of current traded example.





High volume candle climax



High volume candle at the later part of the move is ideal for extension play, as often those high volume anomalies might be climaxes of the move where the price reverses after-wards. The key, however, is that this volume anomaly has to be substantial and it has to stand out from all the rest of the candles in the move. It is not just about the fact that it has the highest volume compared to the rest of the candles, but it needs to be rather significantly higher volume. Using absorption tools for orderflow such as volume delta indicators is often a good idea to spot if climax candle indeed had large amount of counter-orderflow absorption or not. High volume anomalies especially work in more asymmetrically traded assets which do not trade very even volume all the time. Such asymmetric assets are crypto coins, futures or small cap stocks.

Assets that trade much more evenly (the order book is stacked very symmetrically, and each M1 candle has similar volume) this method will not perform well since there will not be enough clean anomalies on volume to tell where the real order flow just came in to initiate rejection. Such symmetric assets are usually higher capitalization assets such as large-cap stocks with small volatility. Futures or FX assets fall somewhere in the middle, depending on the day and liquidity conditions.


Below is example of evenly traded asset in terms of volume and average liquidity (left) and more asymmetrically traded asset (right). Right example is ideal for more frequent volume climaxes on the end of extensions(frequently present in crypto for example):




The point being that in symmetrically traded assets climaxes will be very rare or very hard to spot. While the opposite is the case for asymmetrically traded asset.

Examples below on Ethereum (ETHUSD) of high volume anomalies / climaxes at the end of extensions:



Another example of high volume rejection (on smaller candle) on Ripple (XRPUSD) and decent selloff after it.



Below is example of another extension on Ethereum with high volume rejection / pinbar candle on the latest part of move and bottom formation soon after it.





Failed extension play (risk control)


Usually the extensions after their first rejections where the price comes back and consolidates tend to keep moving further in the direction of extension afterward. It is important to keep this micro clue in mind for risk control on extensions. With simpler words, extensions that do reject tend to do it quick, while if rejection does not come quick and price consolidates the chances for continuation into the direction of extension starts to increase.

Knowing when extension might fail to deliver counter-rejection and might keep going is perhaps even more important than understanding how to find the extension or how to position in the move itself. Cutting losses on an extension that do not behave along ideal behavior can save trader a lot of unnecessary losses and mental capital and potentially spare more R towards setups that do deliver strong rejections and quick profits. For risk control on extensions, it is much better to "listen" to price behavior rather than just setting hard stops ahead. This is due to the fact that a trader does not know how the price will progress after initial starting entry, and the stop-out level should as well adjust based upon the behavior of price. Hard stops are better set only once the trader is already in with the majority of position size at 3rd level of extension and the setup itself has confirmed to be entry worthy, or potentially A grade (even if it eventually fails).


Image below shows example of how ideal extension rejection should perform (left) and how less-ideal extension behavior with consolidation might start becoming a reason to consider exiting / cutting position.



Again it should be noted, it is a must for trader to study this behavior over large sample base of examples in order to build conviction behind why such risk procedures should be taken, theory in itself does not give trader enough conviction.



Example below shows extended move on relatively smaller percentage (does not qualify 5-10% move) and the base formed after initial extension. The base then is breached with push higher. In such case it is better to cut the trade if trader is short because one never knows how much further will second leg go.



The example below is an extension and failed bounce/rejection where the price breaches initial micro bounce with fresh lows and pushes further on the second leg of extension. The time window is very important, once the first initiation of bounce is shown on rejection the price has to respond within the next 10 minutes, if it does not and it consolidates usually the second leg of the extension comes next and the micro low will break such as the case below. Extensions are about trading fast snap-back rejection, not the consolidated rejection that takes a lot of time to perform.





Study of behavioral data on winning and loosing setups



Something that trader should always do is to study the performance and behavior of winning and losing setups to find the common behavioral paths on each side.

In some patterns, the differences are very clear while in others they are not as clear, but usually, there is always some sort of data that will be enough for a trader to lean on. One such data structure for extensions is the time window at which price has to respond with rejection.

Usually, extension setups that do work out, they perform relatively quickly, where the rejection delivers a 30% retrace move (against extension leg) within just few candles.

And the setups that fail show no strong response for many minutes (10,15,20 minutes) and eventually the consolidation is breached by a fresh second extension leg. Using this time window is very helpful to identify if a trader is more likely than not on the right side of the trade (if the trader is trading against the extended move). It should be noted that all time examples are noted strictly for 1 Minute chart setups. If one was to apply this to higher time frames, the time window has to be stretched / multiplied with the correct ratio.




The time window is one of the robust examples of the kind of data that trader can use to help justify adding or exiting out of position, but by no means should it end there. It is up to the trader to dig deeper and get even more detailed data/variables to lean on such as specific behaviors on order flow (tape, chart, volume) that perhaps signal some common clues on failed setups in which winning setups are not shared as much. Some of those clues might be very difficult to find and require many hours of in-depth studies. It is up to the trader to establish whether it is justified or not, to get access to that data.

Establishing valuable variables in traded patterns requires experimentation with trial and error on the data, mind that majority of free publications on net, videos or books will only give you very basic entry/exit "strategies" but the real data that has robust value for the actual performance of specific situations is much harder to find, as that takes real work, research and cannot just be recycled from reading something and passing it forward.




Not ideal play for beginners due to looser risk controls



The issue of trading extensions for beginner traders is that it is trading approach against the directional move of the market, which can quickly put traders into a mindset of "fighting the market" especially if the price keeps going against the initial position of trader. Having patience and selectivity is thus crucial on extensions because it is too easy to get in position too quickly and then stepping into the mindset of fighting the market if price keeps extending.

Trading against the market and extended moves is something that naturally lures beginner traders, it is something that many less experienced traders find themselves comfortable trading with, which is surprising. One would expect that majority of beginner traders would be inclined to follow the trend or chasing methods in the market, but in fact, it is quite the opposite (especially for short sellers), many more are much more comfortable stepping against the move and justifying it "there is no way it can go higher than this".

This kind of mind frame is very frequent and it can be devastating to operate with, especially if the trader is not selective enough, or does not have enough experience to use previous bad examples to teach him how to better use risk management on such plays. This by itself makes extensions a difficulty often for beginners, unless the trader is very disciplined, and understands that the actual trade is not just about trading something that "has no chance of going higher".


The key issue comes from the fact that in extension trade there are no clear boundaries of price action to lean on with stop-loss (usually). This opens risk wide open and makes the risk approach very subjective if the trader does not have very clear rules on how to approach the play.

Which is why there is only one cure to solve those issues, besides getting more experience in trading the setup itself: gather the data. Know what you can expect from the behavior of the patterns by collecting large sample size and finding common attributes between loosing and winning setups. This is the critical step that many do not take, and the issue outlined above becomes that much more problematic. It does not solve all issues but it surely is the first major step to take.


Using macro trend and specific market hours to define opportunities

Often better extensions will develop in first 45 minutes of market open for equity markets , such as the case for CODX below. The volatility and liquidity will be often at highest levels around those hours for equity assets providing larger chance of extended moves in single direction.




Ideally, the extension play is where the extension is a move against the general trend of the asset. For example, the ticker is in a macro uptrend but the extension is the move south (macro up, micro down). A conceptual example where ticker is on a macro uptrend, but extension move is south (drop), which is a more ideal case to trade such extension to the long side since it follows macro direction.



Or the opposite case where the ticker is in macro down trend and the extension is the move to the upside:




This is especially useful on assets that trade in very consistent trends over months or even years, and is less reliable on assets that frequently flip the trends such as futures assets for example. Being careful especially on currency FX assets where the extensions can go in large moves if the trader does not cut losses since currencies are not bound by % moves like equities and trends initiated by extensions can go much longer than most anticipate. Certain markets or assets need an extra careful approach to extensions. Example of an asset where bullish extensions (an extension with push upwards) should be avoided traded is if the asset is in: -all-time highs -has a strong bullish bias on PA, where every low is bouncing higher -has a fresh strong bullish catalyst -has unusually large volume participation (lots of fresh buyers)

Bullish extensions under such conditions tend to fail more frequently (by failure it is meant that the price just keeps extending higher without delivering rejection / retrace), such example being ticker TWLO:





Steepness of the move



The steeper the progression of price the better, ideally all judged from 1 Minute time frame. Softer slopes signal too slow progression of price and should be avoided. The slope should be measured from the base where the extension is initiated to its current last candle (consecutive bull/bear candles).




The steeper the move the less time it took to complete it, the less time it takes, the lower the chances for limit bid to stack under the price and "bucket" the sellers once they come (for short setup, use reverse meaning for bull play). That is why if the move is grinding up very slowly the limit buyers have more time to stack the order book with limit orders on the bid and prevent sellers from smashing trough.

Volatility is the key indication of trade-able or non-trade-able extension

The crucial variable that indicates a higher chance of bounce, and a higher chance of liquidity pocket to establish is the scale of volatility. The scale itself cannot be measured by indicators (ATR etc...) because it is not the absolute number that matters, but rather the number or scale in relation to what volatility the asset trades on average. A trader needs to measure the volatility of the extension move by comparing the speed/strength/size of candles to the previous price action of the intraday chart (1,2,3 days ago) on the traded ticker to establish if volatility on extension move indeed is high or not. The higher the volatility the better. An example case where the extension move is on far higher volatility compared to what asset traded on the previous day:




Measure volatility to calculate correct R / position size


Measuring volatility on the potential traded asset is a must. One of the reasons why traders who often trade extensions have very wide swings in P/L is because they either use unified size approach on every trade (for example 1 lot on entry trade or 1000 shares on every trade) and they use the same scaling in / adding approach for every trade taken. This is a sure way to create large swings on the account and to actually remove edge components from the trading itself since luck starts to play a large role which should never happen over 100 samples (well at least in a perfect world). To address this issue check the first article on the blog about R sizing to understand why this is an important aspect to understand, and this is required in order to equalize the impact that each trade has on account as much as possible. Using chart and eye only to gauge what might or might not be extended is not how to approach position sizing, there should be a combination of chart/eye and the math itself, and the math comes from volatility scale. Conceptual example, if a trader trades two extensions which on the chart all look identical in terms of the move itself, but if the same position size and adding of size is used on both, there will be a significant difference in P/L impact on traded account. This has to be avoided by measuring volatility and adjusting position size to it, combined with the price move on the chart itself (visually).




In deal execution every trade (if it is identical grade play) should impact account as equally as possible in % terms. This means dollar impact on equity should be equalized as close as possible. Above 2 examples are as far apart as possible, which is not the way how trader should approach trading of extensions and their position sizing.




30% retrace target




Below image shows how 30% target is measured from the base of where extension started. Using micro consolidations to better help define such initiations of move, or key breakout levels.




30% rejection / retrace target is measured relative to the whole size of extension move, conceptually shown below:





Also, to keep in mind, this is only rough target estimate as per data (if the setup is isolated), but it is far better if the trader is using this setup in the context of some larger macro set up or using the tape/level 2 to better define more accurate targets per each setup depending on how price behaves. 30% retrace target is ideal average take-profit target if micro setup of extension is isolated from the rest of variables on asset / ticker.




Completed 30% retrace target and adjustment of position afterwards


Once the initial retrace target is reached trader should re-adjust or scale-out portion of position even if unable to fill at the preferred target price, as statistically, the secondary move has a decent chance to happen after that, especially if the price consolidates for a while. Such an example is shown below were from the top to bottom 30% rejection target was met, theoretically, a trader should take this distance into account even if the fills on his/her position are not perfectly at where the current top of price is. 30% retrace is not measured from traders' position entry, instead it is always measured from the actual current top of the move.



Trading extensions as outlined in this article is not about catching the trend reversal with a huge move, instead, it is about catching that 30% retrace of the extension leg and capitalize on that. Extension trade can be used as micro within a larger macro concept where a trader will use extension entry for potential 5+R trade but there should be solid reasons outside of just extension itself for a trader to justify such large target on trade.


This article touches only on approach with extensions that limit the profit target to approximately 1 or a maximum of 2 R per trade. Anything else above that if stretched higher, trader needs to have solid reasons for doing so, else the win rate drops significantly. Personally, if my covers are missed (for short play) and price re-bounds higher in such case my approach is to scale at least half of position at break even on retest back and usually the rest half of position at break-even or small loss especially if the price keeps consolidating. Below is outlined such approach conceptually (again those are just my methods and by no means a must to follow):



Ideal hours for extensions



Certain assets have clustered time zones each day where the amount or the degree of extensions will be higher relative to other hours of the day, however this completely depends on asset class. Below is outline of which assets have clustered extensions usually around certain hours:


-Equities: Open hour of first 45 minutes for each market (US, EU, Asia...)

-Crypto: No time clustering, any hour of the day is just as good as any.

-FX: No clustering depends a lot on macro conditions and the time of year.

-Crude: Usually first 30 minutes of US market open.

-Futures: First 1 hour of US market open.




Using micro combo setups along extensions for better accuracy



To scale in position with tighter risk a good way to approach it is by using combo setups of a smaller scale. Usually, those are tape/level 2 indications of strong orders, absorptions, or any other combinatory setups that overlap at the same time with extension. An example of such a combinatory setup of the micro stall of weakness is shown below.



Such oportunites are not always present, which is why in majority cases trader should start to participate with smaller size (feeler) ahead, since expecting every situation to provide combo setup would be very frustrating as it does not happen in majority cases.




Using alerts wisely




Extensions are well supplemented by the use of alerts, especially for a trader who is trading multiple assets at the same time. Alerts placed at the right price locations can reduce the amount of time that trader needs to input on each ticker, they increase the patience since a trader can set a strict price alert at which point he/she qualifies the extension to be trade-able while excluding the rest of development of potential or non-potential setup.


It is very common to see that traders who do not use alerts and keep staring at the same ticker for a long time are more likely to jump the shot too quickly. Alerts will keep you fresh and force you to wait for the extension to be closer to its "perfect" setup window rather than being too early when it might still be a B play or not even that. Mental capital will be better spent on searching for other opportunities meanwhile until the tracked setup hits required alert to deserve its attention. My personal preference is to first identify the price moves that have the potential to develop into an extension move. Once such move is identified in its "infancy", the general approach I use is to set 3 price alerts all spaced out at even price distance above the current price move (if looking to short the bullish extension).

The first (lowest) alert will trigger to let me know that the asset should gain attention, while the actual entry alerts are only second and third alert, which both need to trigger before the entry becomes valid. The process is outlined below on image:




Using an automatic / script screening system that seeks for potential plays is also a good idea. For example, TC2000 and many other charting platforms allow the creation of such a filter/alert system, but essentially trader should still combine the use of alerts with such a system to manage few assets or setups at once if needed or to better sharpen the automatic search system itself.










Conclusion


Extensions are decent setup to populate playbook with since it allows a high amount of opportunities across many markets each day, this makes it ideal not just complimentary play but as well leading play for traders who prefer to focus only on one or two trading methods. To capitalize on the extensions it is essential to use alerts well or using a scanning software that has the search function well made. Without the use of alerts or decent search filters, it is more likely to miss the play. Or tracking extensions only on the assets that are watchlisted by the trader, where certain macro reasons are present to initiate trade is even better. The downside of trading extensions is however two-fold:

-subjectivity on patterns definition -trading against strength move where the risk rules can easily begin to stretch too much, especially for less experienced traders To define extended move it is very easy to get lost in the subjectivity of how to define the movement in the first place, which is why having strict rules on what does and what does not define the extension is very important.

The rules outlined above are my own, but the trader could use those to build upon and create an even more strict set of rules to avoid any confusion or subjectivity even further. One should have a very clear view of the rules since risk management will heavily depend upon that. The most common place where traders take huge losses is right in the area of trading extensions that are not specific enough and not well defined, where the trader starts trading against it too soon and just keeps adding to position without any clear risk insight or even what to expect from the price move itself. Eventually, the situation gets out of control and turns into a large loss. And the majority of those situations can be avoided by having strict rules on how the extension is defined, being very selective on which extensions to participate in and which not, and what defines a potentially failed rejection. Those three rules are a must to establish for any trader before starting to trade extensions.

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