Price Action: Trading Broad Bear Channels (Part 3)

Sell zones

Whenever a strong decline occurs followed by an attempted upward reversal, bears will look for shorting opportunities in the middle third of the most recent down leg.

Some will place limit orders to go short at the 50% retracement from high to low. Others will go short when price reverses down.

If you go short at the 50% retracement, risk and reward are equal. But since the market is in a bear trend, the market is more likely to reach the expected reward target than to hit your stop loss, making this a favorable trade (trader's equation).

A broad bear channel is often sideways, looking more like a trading range than a trend channel. Traders may choose to go short in the top third rather than the middle third. They might place limit orders to go short near the prior high, or go short at a fixed percentage, such as the 50% to 60% level of the bear leg.

Most traders should use stop orders to go short. So when the market enters the upper third and starts reversing down, traders can place a sell stop order below the prior bar.

Bear trends come in three forms: breakout, tight channel, and broad channel.

The stop loss should be placed above the most recent major lower high. For example, when a strong decline makes a new low, that high becomes a key level. As long as any bounce does not break above that high, bears can argue the market is still in a trading range or bear trend. Once it breaks above that high, the market is no longer a bear trend — it is either a trading range or a bull trend. If you are short because of the bear trend and price breaks above this high, you know the market is no longer a bear trend, so you should exit. You can go short at any time, including on breakouts to new lows.

Most traders will not chase shorts at new lows.

Bears go short on rallies, then take profits somewhere below the prior low. Taking profits with limit orders at the low is reasonable. You can also take profits at reversal points below the low, such as when a micro double bottom and a stronger buy signal bar form.

Remember: A broad bear channel is essentially a downward-sloping trading range. Therefore, bears should expect bounces, and these bounces usually last many bars. Sometimes they are even strong enough to temporarily put the market in "Always In Long." But as long as any bounce does not break above the most recent major lower high, the market is still in a bear trend. If the market spends most of its time consolidating and bears still believe it is a trading range or broad bear channel, they will wait for price to approach the prior high before selling.

Bear trend — expect every upward reversal to eventually fail. So if a large bull bar appears in the upper-middle third of the most recent decline, bears will go short at the close, betting the breakout will fail and the bear trend will continue.