Chart of the week: A very disciplined trade

Centrica is now cookin' with gas

In my Chart of the week for 3 October, I asked if Centrica was poised for a rally based on my reading of the very bearish sentiment picture and tramline formation. In fact, my bullish view was somewhat premature - and therein lies a familiar tale.

No trader on earth can pinpoint precise turning points all the time. Most are lucky to snag a few well-timed low risk entries a year.

So today I will explain how I handle a situation that does not immediately pan out as I expect. Remember, we are always dealing with probabilities, never certainties.

If you wait for 'confirmation' of a trend, you will likely enter just as the market turns against youI have based my trading career on attempting to pinpoint major turning points in established trends.

Being able to enter a contrarian trade with little risk close to the turn is my holy grail, simply because it offers the possibility of extracting a huge percentage of any subsequent move.

Also, entering near a major high or a low is actually the least "risky" trade, compared with trying to catch an established trend. This is contrary to what most believe - and also to most traders, it feels like a very scary policy (myself included). You are staring at a well-established trend and trading against it! Most pundits warn this is crazy.

But if you wait for "confirmation" of a trend, you are most likely entering just as the market is poised to turn against you in a correction that may stop you out. You will be very disheartened and possibly lose interest in that market - just when it starts going your way!

It takes discipline to wait for a counter-trend correction, to enter where risk can be low.

Conventional "wisdom" has it that no-one can time the markets - you read this all the time. I totally disagree - and my trading record, I hope, goes some way to backing up my claim. Of course, those pundits who cling to conventional thought are unable to use technical analysis for their benefit and so trash it. Isn't human nature wonderful?

You do not need many of these "whale" trades each year to rack up impressive annual gains and, with the magic of compound interest, a most satisfactory profit can build within a few years. That also takes discipline, of course.

Huge negative sentiment on CNA this year were ideal conditions for a turnaroundHere is the updated weekly chart for Centrica. Note the upper 'blue' tramline. It has multiple accurate touch points.

At the 400p high in 2013, investors were madly in love with the share, but by the time the bear trend had completed early this year, they hated the thing.

There were headlines about how customers were leaving British Gas in droves - and that fuelled the negative sentiment. But these are ideal conditions for a possible turn-around.

The arrow marks the 3 October market, which had broken above my upper tramline. Normally, that is a bullish signal and the correct trade would be to go long on the break.

But, sometimes, the break fails and the market trades below the tramline again. Here is the daily chart showing the break and pull-back:

Using the tramline method, a long trade was initiated on the break at the 240p area. But the rally couldn't hold and when the market broke back below the upper tramline, that was the signal to exit the trade at around the 218p area for a loss of 22p.

And this is where discipline comes in - the market dipped to the 198p level, which is into support from the previous low in June and also at the upper edge of the breakaway gap formed in February.

If that support could hold, a break back above the tramline would indicate the bull move was back on. An entry at around the 212p area would do it. If the market backed down again, a protective stop at the 205p level (just below the recent low) would suffice - and offer a very limited risk of 7p.

But the rally did continue into last week and the trade is in profit at around the 220p level. That trade would not have been possible if I had taken my eye off the ball and not persevered - which is another trait associated with having a disciplined approach. I recommend it.

Wishing all my readers a very Happy Christmas and a most prosperous New Year!

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.