One of my favorite technical analysis strategies and one I often recommend traders start off with is the 4×4 strategy. During the last several months I received many questions from traders who are now using this method to trade stocks and other financial markets.
The 4×4 is one of the simplest technical analysis strategies that measures pullbacks. The premise of the strategy is to wait for a market to make a 1 month high, retrace for a few days and then resume the original trend. I will demonstrate the method on a recent trade so you can see exactly step by step the entire process.
You can see the stock makes a 20 day high followed by 4 consecutive down days. If the stock made a 20 day high 2 days earlier it’s irrelevant, if it’s not followed by 4 down days. Some traders get confused because they see the market made a 20 day price high a few days earlier; you have to look at the 20 day high in hindsight after it made the 4 consecutive lower closes, otherwise the 20 day high is irrelevant.
The second biggest issue traders have with this method is ignoring lows that are equal to each other. I guess I should have mentioned this but the 4 consecutive closing low prices can be equal to each other. This doesn’t happen very often but it does happen; you can see from the picture that two of the 4 days had equal closing prices, this is acceptable.
This is another problem area with some traders. Make sure your 5 day closing price is above the 4th day closing price. It’s not sufficient for these two prices to be equal to each other. You want to see the market turn around and show some movement on the 5th day, this is the day prior to the entry. There should be some interest and volatility during this day, so you want to see some momentum coming into the market at this stage. The stronger the 5th day the better for your entry the next day.
The 5th day is where you make your decision, if the market closes strongly and there’s some momentum coming back into the stock or other market you are trading, place a buy stop 2 ticks above the high and if your filled 2 ticks below the low to protect yourself in case the stock turns against you. One of the biggest reasons why traders lose money trading technical analysis strategies such as the 4×4 method is because they avoid placing stop loss orders.
The 6th day is the most important day, this is when your order either gets filled or gets cancelled. Remember, this strategy has to be either filled or cancelled. Don’t let your order linger around after the closing bell on the 6th day if you don’t get filled. The point of this method is for the market to snap back in the direction of the trend after a 4 day pause. If your order doesn’t get triggered you must cancel the order, no matter what your gut feeling is or what you think will happen. You have to stick to this strategy and follow all rules as precisely as possible.
This is the final part of the strategy and one that you need to pay attention to. Always know exactly what your risk level will be and always place your stop loss order at the same time you place your trade. If you are trading multiple positions, you can take a portion of your profit at 3 * the risk level and a portion of your profit at the 4 * risk level. To calculate the risk level you simply take your fill price and subtract it from your stop loss level. I wanted to go over the basics of the 4×4 strategy to clarify some important issues so that you can begin trading this method on your own. In the next few weeks I will go over a few real time examples so you can see how the trade sets up in real time.
If you enjoyed this article, you can view some great videos demonstrating the 4×4 Pullback Strategy as well as other important Swing Trading Strategies and Tactics by filling out the form at the top of this page.