Price Action Trading – Page 3

Quality vs Quantity – Which is Better for Trading?

There seems to be a ton of confusion on both sides regarding the Quality vs Quantity Argument when it comes to trading. Being such an important subject for a trader, I have been wanting to write about this for some time so it’s time to put some of the myths, mis-information and confusion to bed here.

One of the big forex trading arguments going around has to do with ‘Quality vs Quantity‘, and it is often masked in the typical;

-Trading Higher Time Frames = More Accuracy

-Trading Smaller Time Frames Carry More Risk

-Anything Below The 1HR Charts is Just Noise

-Quality Trades Make More Money Than Quantity

In regards to the above statements, only one of them is true, but it is incomplete by itself and does not paint the whole picture.

Today’s article is here to dive into this subject, explore both sides of it, and talk about which of the two competing theories is correct.

Quality Is Better Than Quantity When It Comes To Trading
I know two groups of billion dollar business entities that would completely disagree with this argument. They would be Casino’s and HFT shops (High Frequency Trading).

Casinos often times (in the various games you can play there), only have a slight edge, often times 1-4%, meaning they are 51-56% likely to win at every play, with a 49-44% chance to lose. This small edge might not seem like a lot, but played out over 1000’s of times a day, and it all adds up.

HFT algos also take a similar approach. They are not trying to make huge winners and let trades run for days. They are in anywhere from hours to minutes, perhaps seconds, or even nan0-seconds. They make small trades for ultra small profit, but they do this hundreds of times a day, and make money year in year out.

These two things alone debunk the whole quality is better than quantity argument, as they are highly successful at what they do. In 2011 alone, HFT firms made over $1.2B (yes, billion) in profits. Not bad for having such an inferior trading style!

HFT methods simply use the mathematics and repetition of the edge to make profit. It’s an edge – maybe not the easiest for a human trader, but an edge nonetheless, and it makes money.

The bottom line is, if you have an edge, the more times you can apply it with the same level of accuracy, the more the edge will play out in your favor. And that leads to more profits.

A Comparison Approach
To really see the numbers and a comparison approach, let’s take System A with 60% accuracy, trading 5x a month, risking 100 pips and targeting 200 pips. Below is how the math works out;

5 trades over 12 months = 60 trades per year
60 trades x 60% accuracy = 36 winners and 24 losers
36 winners at 200 pips gained = 7200 pips gained
24 losers at 100 pips lost = 2400 pips lost
Total Profit = +4800 pips

Now, lets take System B, which is the same as System A, but bring down the accuracy just 5%, assuming you will be less accurate trading the same system on a lower time frame. Let’s have you trading 20x a month (~5x per week), risking 50 pips and targeting 100 pips (same ratio of risk to reward). Here is how the math plays out below;

20 trades a month = 240 trades per year
240 trades at 55% accuracy = 132 winners and 108 losers
132 winners at 100 pips gained per trade = 13200 pips gained
108 losers at 50 pips lost per trade = 5400 pips lost
Total Profit = +7800 pips

Assuming you risked the same equity % per trade using System B – trading quantity over quality made more pips and profit. Even if I make System A 15 % more accurate than System B, here is how the math plays out;

60 trades at 70% accuracy = 42 winners and 18 losers
42 winners at 200 pips gained per trade = 8400 pips gained
18 losers at 100 pips lost per trade = 1800 pips lost
Total Profit = +6600 pips

As you can see, even being 15% more accurate, System A still under-performs System B. Only until you get to 77% accuracy will System A outperform System B.

So this whole argument that Quality over Quantity is mathematically false.

One of the key questions you should be asking yourself then is;

Can I be 77% accurate trading my system on the higher time frames?

If not, you may want to reconsider how to maximize your edge, which is all you are really doing in trading. But the fact is that trading on higher time frames will take longer to make money as you will have less signals in the market.

Key Points
A few of the typical or vanilla counter-arguments to the quantity makes more than quality statements are;

1) Trading higher time frames is less stressful and is More Accurate

2) Anything below 1hr charts is just noise

3) Trading lower time frames causes you to over-trade and over-analyze

Of the above statements, only one is true to some degree (#1) , but again it is incomplete by itself and needs to be fully understood. Let me break down each one so you can fully understand the differences.

Trading Higher Time Frames is Less Stressful and More Accurate:
Of all the statements, this is really the only one with some truth, and it has to do with the second part (being more accurate).

I have quantitatively tested various 1, 2 and 3 bar price action signals (over 24 in total), such as pin bars, inside bars, engulfing bars, 2-bar reversals, outside bars, and more across every time frame from the 1m to weekly. Statistically, if you are just trading these patterns by themselves, they tend to be more accurate on time frames such as daily and 4hr strategies (along with the 1hr), then they do on say the 5m.

The reason for this is, a daily candle includes 24hrs of price action, therefore 24hrs of market sentiment and order flow, which is three sessions total. This can have a lot of info as to how players are positioning themselves both intraday and daily.

Thus, with a greater amount of market sentiment over a longer period of time, you can trade some of these patterns with greater accuracy.

However, as we have seen above, greater accuracy does not always = more profits. One thing should be noted though accuracy is not the same trading the often promoted NY Daily Close.

I have one system that on the NY Daily Close, on one pair, trades highly accurate, but another pair quite poorly. If you have an idea as to why, write in a comment below, but the statistics and profitability are night and day, so NY Daily Close is not ideal for all systems, pairs and time frames, and in many cases, under-performs massively.

Thus to sum it up, trading the higher time frame ‘can’ lead to more accuracy.

However, the notion of trading the higher time frame is less stressful is not true, and really a matter of having a successful trading mindset. Some people are more naturally wired to have a set and forget style of trading. Others are better at managing small details, so trading a higher time frame would actually work against their natural mindset.

There is no one-size fits all, thus the key is to find what is most natural to you.

I would like to state generally, if I was starting with a new student, I would start them on a higher time frame as accuracy in the beginning is critical to the learning process. This is exactly how it is in my archery training – in the beginning you start with a target close by, say 3-6 meters, and only after time do you move to targets farther away.

But the idea of lower time frames being more stressful is a matter of mindset, training and practice. Stress is based on how one perceives information and reacts to stimuli. To some people, being bored is more stressful, and there are tons of studies that boredom can hugely interfere with the trading and learning process. For an F1 driver, being stuck in traffic may feel like torture, but doing 150MPH may be joyful. Food for thought.

Anything below 1hr charts is just noise:

First off, this argument often comes from daily chart traders saying price action below the 1hr is just noise. Ironically, this same argument comes from 1hr chart traders who say the 1m time frame is just noise. Who is right, and is it just a matter of perspective?

The truth of the matter is, although there is a greater possibility to witness ‘noise‘ (price action that is the result of non-directional interest and order flow), on lower time frames, support and resistance levels work just the same. They simply require a little tweaking. But the bottom line is, order flow creates price action, and price action is simply information.

Using a recent example of a live intraday price action trade I did on Gold, take a look at the two charts below;

Exhibit A (4hr Time Frame Gold/USD)

Looking at the chart above, we can see three strong reactions to the $1685 level on Gold, all communicating strong buying interest at this level.

Now look at the chart below which is the third rejection on the 5m time frame.

Exhibit B (5m Time Frame Gold/USD)

Looking at the chart above, we can see the same strong reaction and buying interest off this level in the first wick. But we can also see there are two high quality price action signals off this level, with a pin bar false break, along with an inside bar + pin bar combo.

I actually got long on this trade, and made over +1415 pips of profit just using pure price action on the 5m chart.

Does the price action at the bottom of this chart look like ‘noise‘ to you?

I don’t think so, and it shouldn’t.

Learning to filter out useful information and helpful information is just a matter of training and time. But the idea anything below the 1hr chart is just ‘noise‘ is ridiculous and really a freshman understanding of price action.

Trading Lower Time Frames Causes You To Over-Trade and is Greater Risk:

Although there is some truth to this, it really is misleading. If you analyze each bar, sure, you will be over-analyzing the charts, but this applies to any time frame. In a choppy range, you are not watching every bar for clues, especially the bars in the middle of the range.

However, if you are marking your key levels on a higher time frame, and simply looking for signals at those levels, then the chances of you over-analyzing are slim. It is really a question of trading and preparation- not a fact that you will over-analyze.

The mind has neuro-plasticity to it and can learn almost any skill. You can learn to filter out unimportant bars and price action on the chart – all it takes is a little practice. Once you do, you wait for your key levels and signals, and get in without any extra analysis or stress.

The whole idea of doing less is better for you (or being lazy), I have already demonstrated, doesn’t make you more profitable. Try this same logic to exercising, playing piano or hitting a golf ball, and tell me how that works out!

As to trading the lower time frames or intraday trading equaling greater risk, is a confusion. Risk has nothing to do with the time frame. Risk has to do with three things;

1) Position Sizing
2) Size of Stop Loss in Relation to Target
3) Accuracy

I can have a 3 pip stop (via position sizing) = more risk than a 500 pip stop. I can also make more money with a 50 pip target and 20 pip stop (2.5:1 reward-risk ratio) than a 500 pip target and 250 pip stop (2:1 reward to risk ratio), with the same equity % at risk per trade. So this notion that risk is > on lower time frames is mis-informed.

Does This Mean Quantity Is Better Than Quality?
This is the real question, and it comes down to edge, personality and availability. If you are not available to trade more throughout the day, and have a full time job with only a few hours to view the charts, then I’d suggest trading the higher time frames. However, if your personality is more suited to being more active, then trading 4-5x a month could be harmful to your learning process. So remember trading rule # 1 – know thyself when it comes to trading, and find a system, time frame and style that best suits you.

And we always have to consider our edge. If we trade the daily time frame at 60% accuracy, and the 4hr or 1hr time frames more often with slightly less accurately, do the math and see how it works out. If it’s more profitable trading more often with slightly less accuracy, then do it, as long as it doesn’t throw off your life or health.

But the bottom line is, the whole argument quality is better than quantity doesn’t always hold up, and you need to do the research and the numbers to determine which has a greater edge. And without a doubt, it is a fact if you can take your same edge, and apply it more often than you are now, you will make more money and be more profitable.

Thus, in regards to the question as to which is forex trading method is better, the answer is neither one is better, but both!

Quality matters, but can under-perform. Quantity repeats the process faster of making profit, but has to be considered in the larger scheme and what is most natural for you. However neither forex trading method is better, and the best edge lies somewhere in between the two.

So don’t be fooled by any freshman arguments stating one is better than the other – because they are simply not true, highly inaccurate and misleading.

Hopefully this quality vs quantity forex trading article will put a lot of the mis-information to rest, and give you a new perspective on this critical subject. In a follow up article, I will talk about how I approach this subject in my personal trading, and what I think is the ‘Ideal Trader‘ in relationship to these two.

Kind Regards,
Chris Capre

Setups, Price Action & Context

If you think this article is going to be about learning a price action setup, you’re wrong, but it will be about something more powerful. For your future, for your learning process, and for your sanity, keep reading this article if you are not consistently profitable.

Of all my articles, the most popular and commented ones are always on some specific setup or system.

Why?

Because almost all of you have been hunting for the one system, that edge which will turn your trading around. That edge which will print money into your account day after day, week after week without much effort. You’ve probably amassed dozens of patterns and systems, yet still aren’t making money.

Sound familiar?

If so, don’t worry – that was me 12 years ago.

But I think it points to a problem for those hunting through forums, websites and videos looking for your pot of gold. All of your focus and energy has been on finding a ‘system‘ or ‘price action setup‘ that makes money.

Sure, everyone wants their own ATM machine – who doesn’t? But what is also going on is you want the market de-mystified. You want trading to be simple and easy, i.e. thinking three simple setups will solve all your trading problems and help you understand the market.

Regardless, this underlies two things which will trip you up in trading;

1) The fallacy three simple price action setups will consistently make you money if you have good money management.

2) Being uncomfortable with uncertainty.

Today’s article will be focused on the first point, and the next article will be focused on the latter.

Three Simple Setups? Really?
To begin, it is a complete fallacy that if you learn what a pin bar, inside bar and a fakeout system is + good money management = making money…that you understand and can trade price action.

How convenient that a market which has brought traders to its knees, crying, jumping out of windows after losing fortunes, that three simple setups and good money management (plus a little psychology) is all you need to be a profitable trader.

If that was the case, why isn’t everyone doing it?

Why are banks spending thousands of dollars, and months, if not years on end, training their traders, when there is such a conveniently packaged solution available?

My programmer was recently at a algo conference with some of the top hedge funds. He told me they are spending hundreds of thousands of dollars re-programming their algos every 12-24 months to keep a competitive edge.

Why would they do this if they could just learn what a pin bar was, inside bar and fakeout setup is? Wouldn’t that be easier?

Newbie traders want to hear the market can be simplified into three price action setups, that trading with the trend and good money management is all you need. It perpetuates a dream which is actually a false reality.

This is why I have always talked about learning to read the price action in real time, that you cannot rely upon systems alone. Yes, a pin bar can be a highly effective method for trading various price action situations. But it always has to be taken in ‘Context‘.

Two Scenarios
To demonstrate this point, lets take two scenarios;

1) A bullish pin bar forms after a long trending move. This trending move ended with an exhaustive candle which then proceeded to form a double bottom off a key support level. The pin bar closed bullish and formed on the 2nd bottom also creating a 3 pip breakout below the lows. Am I going to buy that pin bar if I get a corrective pullback towards the double bottom?

Absolutely!

I see that – I’m going to buy that. The pin bar was a very good setup and price action cue for me. But remember, pin bars can be both cause and the result of order flow.

However, we have the other pin bar scenario….

2) Price action has dropped 1000pips in the last two days. Then in the middle of the Tokyo session forms a tiny pin bar on the 4hr time frame that closes bearish. Am I going to buy that pin bar expecting the price to reverse? NO!

Why???

Context!

You have to understand, there is nothing wrong with the pin bar by itself. It can be a highly effective signal, or it can lead to losses.

What is the difference?

It’s not money management, or trading with the trend, or your psychology.

It’s the context with which it forms. But to understand these differences, you have to learn to read price action in real time, and what it has done in the past around those levels. That is the context you have to learn how to read.

Passive vs. Active Learning
To be sitting there passively, waiting for days on end for your three simple price action setups is trading in passive mode and flat out boring. And boredom will actually interfere with your learning process.

If you can only find one setup a week, you’re not looking hard enough because there are plenty.

There is no active learning, and active learning is what you need. In active learning, you are engaging your resources, your current level of knowledge and applying it. In passive learning, you are not engaging any of your knowledge and seeing how it works in real time, learning from the feedback loop called the markets.

If you are sitting on the sidelines for days on end, just waiting for your three simple setups, you’re wasting your time. You could be learning, trying, studying, and participating in the market which is what facilitates learning.

I didn’t just learn what an inside bar was and then trade it based on what it should do. I spent dozens of hours studying 1000’s of inside bars and pin bars, to see what was different between them all, and how did price action form after each unique one.

I have pages of notes about pin bars, how each one forms, its size in relation to the prior bar, where it forms in relation to the prior bar, in the trend, near the 20ema, in relation to the surrounding price action, support/resistance levels, etc, etc, etc.

I don’t just trade pin bars like a robot. I trade them in context, and that is what gives me an edge, to be able to read the price action in real time, and what the market has done around current levels.

A Student
One of my students wrote just yesterday on this subject:

“I am at that point where I know I want to be a full time trader. I absolutely believe that the strategies, models and methods we are taught in this course can lead to profitability, because I’m using them everyday and they lead to good profitable trades.

However, I have moved away from just seeing a pin bar or some other signal and just pulling the trigger, because I have moved toward understanding price action the way Chris talks about in his lessons, like he has done on breakouts, the aussie price action, the USDX, etc.

I believe that as traders we can trade these strategies and make some money, but we will not evolve as traders if we don’t begin to read and understand the price action that is occurring around these different setups.“

When I read this, I was nothing but smiles as the light went on. This student gets it, and gets what I have been teaching. He understands that pin bars, inside bars, and all the other methods have a purpose – but they are not the road and vehicle towards profitable trading.

Although they are highly informative about what the order flow is behind the price action, he understands they are both cause and result. This means he understands sometimes they are the cause of order flow, and other times, they are the ‘result’ of order flow. They are not simply just one or the other.

It also means he is spending his time learning to read the price action in real time, to understand what kinds of order flow would create such price action. He is not passively waiting for setups, and then pulling the trigger like an automaton. He understands that these setups have to be taken in context.

In Summary
Don’t waste your days on end in waiting mode for your simple three setups to occur. Understand three simple setups will not lead you to profitable trading, nor understanding price action. If it did, everyone would be doing it and that is all they would be teaching at banks and hedge funds.

Understand trading price action means learning to read price action in real time. It means being an active and deliberate learner.

Understand that price action setups are highly valuable tools – but they have to be taken in context. You have to learn to read what kind of order flow would create such price action, and how to trade this flow.

I hope this helps and that it changes the way you look at price action and your learning process.

Please make sure to leave your comment, like and share this post.

Kind Regards,
Chris

Forex Strategies, Price Action Trading

Price Action Angles – Trading Forex Price Action

I wanted to write a brief article on a simple method I use to analyze price action – that of drawing trend lines to read the forex price action angles, or the speed of the buying/selling in the market.

I’m going to use an example to highlight how they can be useful for understanding trends, transition phases in trends, and when to look for key price action reversals in the market.

Exhibit A: EUR/USD Daily Chart

Looking at the forex price action trading trendline chart above, the EURUSD started 2012 dipping to 1.2600 before starting an impulsive bull run which climbed almost 900+ pips in a month and a half. Now if you look towards the left side of the chart, you’ll see a pullback to the horizontal line. Price rejected off this line, forming a piercing pattern that climbed 6 out of 7 days and over 500+pips.

This is the move in line A.

After reaching the peak from move A at about 1.3500, price then sold back in 11 days back towards the same support line. Although the low from this sell-off was a tad higher, take a look at the bounce off the level.

Notice how it had 3 bear days in the 8 day move (2 more than in prior move), but only went about 400pips (20% less)?

To me, when I see two rejections off a key level, I’ll draw trend lines on both of them (underneath if they are bull moves, and above if they are bear moves). The reason I do this is to measure the strength or speed of the buying/selling. This is communicated to me by looking at the price action angle of each trend line.

In this case, I have a weakening angle from A-to-B. This communicates a weakening effort by the bulls and that the bears are trying to take control of the market. Keep in mind, this is all happening above a support level, so the bulls still have overall structural control.

When you however look at the last bounce off this noted support line, we can see a massive weakening in the angle. When I see three structural, or price action angles weakening successively, this usually is a sign of an impending breakdown. What is also interesting is the C leg took 12 candles to gain only 250pips (50% less than A-leg, and 38% less than the B-leg). Put these two together, and you should be looking for a breakout to the downside.

What is interesting is how price action formed a pin bar strategy off this key level. If you were just trading pin bars as is, without the ability to read price action in real time, you would have taken the long on this pin bar setup, but then got crushed on the ensuing breakout which is below.

Exhibit B: EUR/USD Price Action Angle Weakening/Trend Change

Working with this chart above, we can see how even though there was a pin bar setup at the horizontal support level, price dropped right through that – stopping out traditional pin bar traders who were not reading the price action in real time, or the change in the angles.

In a flash, the trend was reversed and the pair sold off over 600+pips in less than a month. Had you been reading the price action angles in real time, you would have spotted this potential trend change, and looked to get short instead of longing off the pin bar setup.

This is one way to use forex price action angles to help with your reading and understanding price action.

Another way you can use them is in understanding parabolic or climactic price action moves. These can also be understood via these trend lines and angles. But they are a simple tool which is highly useful in forex trend trading, understanding transition phases in trends, and when to look for possible reversals.

I hope you enjoyed this article and found it a useful addition to your price action trading toolbox.

For those wanting to learn to trade price action, get access to the traders forum, a lifetime membership with free updates and more, visit my forex price action course page.

Forex Strategies, Price Action Trading

3 Keys for Identifying Breakouts

Breakouts are some of the tougher environments for traders, and understandably so because they represent potential, but often fail.

I’ve already written an article for trading breakouts Post-Breakout, but what about the Pre-Breakout moments where you have to make that key decision to trade it or not?

How do you identify them and what are the key elements that precede strong breakouts?

This is the key point of this article – to give you 3 tips for identifying a soon to be strong breakout so you don’t get trapped in a false breakout.

I will go over the three elements you will want to find before considering a breakout, then briefly highlight what is behind them from an order flow perspective. By learning to spot these breakout trading clues, you can position yourself to trade higher probability breakouts and capture a larger portion of the upcoming move.

1) Well Defined Support/Resistance Level
The first pre-requisite to identifying a healthy pre-breakout situation is having a clearly defined barrier in the form of a support or resistance level. The classic case is when you have a trend in place (lets say uptrend) and then the price action runs into resistance at a key level.

Ideally, you want there to be at least two touches on this level before defining it. The more horizontal and neater this level is – the better. But it should be noted, this is just a pre-requisite and generally by itself not enough to identify a healthy breakout setup. The reason for the two touches is to identify a sticking point where players are parked and what level they are defending that the (bulls in this case) are unable to penetrate.

By finding both parties present, we have the environmental potential from an order flow perspective to create a healthy breakout. In this example, the sellers are clearly holding a price they want to defend and have stops just above it. By them staking their defense in a clear location, it communicates where their orders and stops are likely parked. It is tripping those stops, along with bringing in new buyers that is the goal of the bulls.

Below is an example of a clearly defined resistance level after a downtrend and consolidation period, communicating there are bears clearly defending a level.

Image 1.1

2) Pre-Breakout Pressure or Tension (Squeeze)
The second element you want present prior to a breakout is a pre-breakout pressure or tension that manifests as a squeeze. This pre-breakout tension is highly important because it creates a friction and pressure upon the defenders (in this case the bears). As the bears realize their rejections off a key level are getting smaller, while the bulls continue to gain more upside and territory, it causes a friction in their minds that forces them to make a critical decision (either stay in and defend, or exit the market).

As the room gets smaller and smaller for them to work with as the bulls squeeze the bears out, sellers defending a level will often exit early, leaving the defense to those who are not realizing the game is up. This further weakens the defenses at these levels until very few are left to carry the burden.

You can easily identify a price action squeeze and this pre-breakout pressure, or tension, by the price action forming higher lows in attacking a resistance level, or lower highs when attacking a support level. This is a combination of the current bulls willing to buy up the instrument at a worse price, along with new bulls wanting to get long before the breakout. A good example is presented in the same chart which I will zoom in on to highlight.

Image 1.2

3) 20EMA Carry
Another key element you will find prior to breakouts is the 20ema begins to carry price leading up to the key resistance or support level that is being defended. This is not so much that traders are placing orders there prior to the breakout (although many will), but also a visual representation of how the squeeze is taking place.

Just looking at the chart above, we can see in the beginning, after the first rejection off the key resistance level, price penetrated nicely below the 20ema. But as we get closer and closer towards the right where the squeeze is taking place, you see the market barely go below it for more than a single candle before resurfacing.

Also, you will notice how the first few times the rejection approaches the 20ema, it breaks through after one candle. But towards the end many candles start to float above it where some traders are entering in anticipation of the breakout.

Another really good example was one I traded and blogged about ahead of time with the AUD/USD on the 1hr time frame. The pair had been trending up for 110 pips over two days, but ran into a key resistance level that it got stuck on at 1.0081 (image below).

Image 1.3

Using the example above, notice how the 20ema in the middle of the chart is penetrated about 20pips, but then as we get closer and closer to the resistance level and the squeeze begins to happen, notice how the 20ema begins to carry the price action, and the penetrations get smaller and smaller?

This is a combination of very few sellers defending the level, while the bulls in anticipation of a breakout (realizing they have control) are likely entering new positions to get in ahead of the upcoming breakout (I was one such trader). Eventually the pre-breakout pressure and tension became too intense and the bears gave up when the bulls made their push, tripping stops and creating a large breakout bar with a strong close.

In Conclusion
Identifying breakouts can offer highly profitable opportunities when you can position yourself well. But to do this, you must be able to identify highly probable breakouts with these 3 key elements which are;
1) Well Defined Support/Resistance Level
2) Pre-Breakout Pressure/Tension (Squeeze)
3) 20EMA Carry

If you can learn to spot these key elements prior to a breakout, along with reading various other price action clues, you will find yourself entering in higher probability breakouts, increasing your success and profitability. You will also find yourself not getting trapped by false breakouts which can wreak havoc on your account and confidence in trading them. Thus it is critical to read and identify the key elements prior to a breakout.

For more info on how to trade price action, along with lifetime membership, getting access to the traders forum & more, make sure to visit my price action course page.

Forex Strategies, Price Action Trading

2 Key Clues to Understanding Support and Resistance Levels

While my trading team and I are mostly on vacation for the month of July, I wanted to write a brief article giving 2 key clues to understanding forex support and resistance levels, which is also a follow up to my prior article the best support and resistance levels part 1. If you can learn to understand these two key points, you will be able to detect key levels, when they are more likely to hold, and when they are more likely to be broken.

1) Prior History, Time Degradation, & Reactions to Key Levels in the Past
When analyzing to see if a level is one where traders are more likely to place trades around, we have to see how price reacted to those levels in the past.

Did price react very strongly to it in the past, say approach it one time, then reverse sharply off of it? If so, then its very likely the next time it approaches that level, traders will place orders around there expecting a similar reaction.

Why?

If price produced a very violent or strong reaction to it in the past, this was because a large amount of money was put on the line stating ‘this is the line in the sand, this is highly over-valued or under-valued and we are placing a large bet here’. When this happens, its the first institution to get in that has the highest chance for profit, because they are the first to try and reverse the pair, thus getting the best price. But they also carry the most risk.

Regardless, if their reversal attempt works, other institutions will catch wind of this, and attempt to get in as close to the rejection level as possible. It really becomes a race between the institutions who can get the best price so many vie for it. This helps to further fuel the rejection and create a stronger reaction.

Smart traders take note of this level producing such a strong rejection and will more than likely take a play off of it a second time expecting it to hold. If an institution placed a large amount of money at a key level, they will likely defend it a second time (along with others as well). So expect this level to hold.

But…the reaction the second time around is usually not as strong.

Why?

Because more people are aware of it the second time. If it was a support level that produced a violent bounce, the second time around the sellers heading into that level will take profit. This means there is less of an opposing force on the sell side, so when the market bounces, there are less sellers who have to exit and thus fuel the counter trend play.

A good example of this is below in the daily Gold chart

Chart 1.1 Gold Daily

Gold was in a strong uptrend for all of 2011, eventually reaching $1900 an oz after climbing 3 out of every 4 days from July into mid August. Looking at the chart above, gold sold off quite heavily after reaching the $1900 level, selling off almost $200+ in 3 days.

Notice how the second time it approached this level, it held, but took over 13 days to sell off the same $200 amount. The first reaction was far more violent, while the second more tempered. The level held just fine, but when you see these situations, expect the response to be not as violent but still providing a great trade opportunity.

So anytime you see violent reactions to a level, look to place a trade at that level, expecting it to hold and produce a similar measured move. Obviously, if the reaction happens on a higher time frame, there is a greater chance it will produce a similar reaction. Whereas on a lower time frame, this will probably be less likely so be a little more choosy when looking to make a play like this.

Other factors to consider besides the strength of the reaction when understanding support and resistance levels is if the level produced a breakout pullback setup, has held several times in the past, and how much time the market spent at those levels. All of these factors will determine if there is a good setup there at that level.

2) Current Price Action
So often when people talk about levels, they only focus on the past and seem to forget to look at how the price action is behaving in the present. Just because a level held nicely in the past doesn’t mean it will this time and you’ve probably experienced this, expecting a level to hold only to watch it get broken.

By learning to read the price action in real time, you can see if the market is approaching it with strength or weakness, impulsive-ness or corrective-ness, and then use this information to determine if a level will hold the oncoming assault or buckle forming a breakout or trend continuation.

Levels are just areas where traders place orders, but if the defenses of those levels are weak, they will not withstand the attack, so it is crucial you are always watching price action in real time to determine if this will hold.

Although I place my orders at key levels I think will hold, if the market is approaching it with several signs of strength, then I will consider waiting for a price action trigger at this level, or for it to hold before placing my order.

Below is an example of a key level that held in the past, but completely failed the second time with the market showing strength and signs it was going to fail.

Chart 1.2 EURUSD Daily

When the EURUSD started its massive sell off in late April, it did so in impressive fashion shedding over 600pips in 13 days with only one bull candle in the entire selloff. When it was approaching the yearly low (at B on the chart) around 1.2627 in 2012, notice how the selling started to pause going from really large impulsive candles to two small doji-like candles. The transition or change from large candles to small suggested hesitation on the sellers part heading into a key level they suspected might hold.

This weakness and hesitation was a good real time price action clue the market was likely to produce a bounce from the yearly low, and bounce it did, forming an engulfing bar which bounced about 150pips in two days. Many of our price action traders got in on this one, not only reading the weakness, but also using quantitative data on price action specifically for the EURUSD which communicated a likely reversal.

But notice what happens after a two day bounce – price then sells off aggressively again taking out the prior days lows and eating into over 75% of the two days’ gains. This communicated to us in real time the sellers came back in force and were making an aggressive attempt to take out the level. So this was a good price action clue not to place another buy order at this level.

Notice how after it broke, the level served as a key role reversal level which gives us an opportunity to get short and join the trend.

There are many other clues one can use to read the price action in real time to determine if the level will hold or break, but these are just a few hints you can look for, along with looking for price action triggers off these key levels and quantitative data to support your level as well.

In Summary
So these are just 2 key clues you can use to understand forex support and resistance levels. It is critical to understand specifically how the market responded to a level in a past to determine first if it is a good level to make a play on.

But, so many times I hear traders talking only about how the market reacted in the past, and not paying attention to how the price action is developing in the present – which is a real time communication to the underlying order flow behind the attack on the support or resistance level. By learning to read this, along with level 2 quotes, you can greatly increase your ability to understand and place trades around key levels, either using them for reversal plays, breakout pullback setups, or looking for potential breakouts around these key levels.

For those wanting to learn to trade price action and understand resistance and support levels, get access to the traders forum, quantitative data on price action, lifetime membership & more, visit my forex price action course page.

Forex Strategies, Price Action Trading

3 Tips for Trading Breakouts

With the holiday coming tomorrow, I wanted to write a short price action article with 3 quick, but highly useful tips for using a breakout trading strategy. If you can add these forex breakout strategy tips to your price action toolbox, you can significantly increase your success rate when trading.

1) Time of the Day
One of the key components to a successful breakout is volatility. When you have greater volatility, you have more orders/players behind the market and therefore increase the probability the breakout bar will have more force behind it. This helps the breakout bar to take out more stops and push the market further in the breakout direction.
But, volatility fluctuates tremendously throughout the day. Statistical analysis has pointed out to how breakout strategies actually function far better during the London and NY session while tend to fail during Asian market hours. This is simply to do with volatility, so the time of the day you take the breakout trade will have an impact on the success of your trade.
Ideally, breakout trades are taken during the following times;
-1st three hours of London session
-30mins before NY open up to 30mins before London close
A great example of this is in the chart below how price consolidated for a day and a half, then broke out massively during the 2nd hour of the London session.
Image 1.1 EURJPY 1hr Chart

Outside of these times, the probabilities decrease for your breakout trade (variably depending upon hour) as volatility is either low or in a declining phase and may not have the order flow behind it to break through the key levels. Also avoid taking breakout trades several hours prior to major economic announcements, or going into major holidays where trading and liquidity will be subdued.

2) Use Options Data to Aid Your Timing
Daily FX has a useful piece of data in their technical analysis page whereby they publish a Volatility Percentile feature. This is derived from options prices with a higher number communicating options traders are expecting greater volatility, while a lower figure suggests more range bound/reversion to the mean type play.
Image 1.2 Volatility Percentile Data

You can simply check the data at any time (per pair) to see where the volatility percentile figure is at. When you are thinking of taking a breakout trade, ideal is to have the Volatility Percentile figure above 70% or greater, suggesting options traders are expecting a greater amount of volatility in the market and thus increasing the probability of your breakout trade working out. If several of the pairs are above these percentages, then there is broad market participation which will likely create strong impulsive moves in the market which are ideal for breakout trading.

3) The Longer the Compression, the Better
Usually breakouts give you several warning signals ahead of time a breakout is happening, either via a squeeze in the price action to one side of the market, a tightly coiled range or higher low/lower high forming inside the range. Regardless of what the clues are, the longer the compression in the price action, the better.
Why?
Markets, traders (and brokers) do not like tightly bound up price action. Smaller ranges and markets mean less continuation and directional follow through. If markets turn around quickly, they offer us less profit in the direction we have chose. But a long compression in the price action will build up a pressure and friction which eventually needs to be released. The longer this builds, the better, for when it breaks out, the market can often go for a large move in the breakout direction as seen in the chart below.
Image 1.3 NZDUSD Daily Chart

You will notice in the chart above how the price action was consolidated in a tight 200pip range for almost two months. But when it broke out, forming the breakout bar, it sold off for the next 5 days in a row, 11 out of 12 days and 13 of 15 days, selling off for over 700pips.

In Conclusion
Breakout trades can offer some really profitable opportunities, but can be maximized by adding these three forex breakout strategy tips above which are;
1) Time of the Day
2) Using Options Volatility Data
3) Looking for long compression periods prior to the breakout
If you can learn how to spot these, along with other various price action clues, you can increase the profitability and success rate to your breakout trading.
For more info on how to trade price action and breakouts, along with lifetime membership, getting access to the traders forum & a lot more, make sure to visit my price action course page here.
Other Related Articles:
Key Price Action Elements to Breakouts
The Best Support & Resistance Levels
Breakout Role Reversal Setups

Forex Strategies, Price Action Trading

The Best Support and Resistance Levels Part 1

Today I am going to give a lesson on how to find some of the best support and resistance levels in the market. If I had to say – I think there are three types which are the best support and resistance levels you could find. But it would take a long time to go into each type, what are the characteristics of each, what they mean from an order flow perspective, and how to trade each type.

So I am going to cover in today’s lesson, what are some of the most critical variables to look for when evaluating support and resistance levels. If you can learn to spot these levels, read the price action and key variables before the market reaches these levels, you will greatly enhance your trading, by finding better entries, knowing how the market is likely to react off a level, and how to increase the probability of your trades.

By first learning to read these key variables which I will list below, they will provide you with a lot of information in terms of;
-how the order flow is relating to them
-how these levels will improve the probability your trade or rule based price action system
-how you can trade these key levels

Note: I want to hear your feedback on this lesson, like what key points stood out for you, what you found useful, how you can apply this to your trading, or…even if you want to throw tomatoes at me, I want to hear your comments 🙂

I will start this lesson by talking about what are some key things to look for when evaluating support and resistance levels. I will then describe with some details how each variable informs you of the order flow behind the price action. Then I will go over some basic methods of how you can trade them. I will also give examples to demonstrate how these elements work, then end with a brief overview of what we covered.

Key Things To Evaluate Support and Resistance Levels

If I had to list what are the key things I use to evaluate support and resistance levels, it would be the following;

1) How price reacted to this level in the past (held, became a breakout – pullback level, bounced violently or timidly off of it)
2) How significant is it (lower time frame, higher time frame, held for how long?)
3) How is price reacting or responding to it now
4) What is the speed or impulsiveness price is approaching it now
5) What is the price action context prior to this level

All of these things communicate information to me about the uniqueness of this level, how the buyers/sellers reacted towards this level in the past, how likely they will respond to it in the future, and what they are most likely to do at this level.

Zones & Areas

It should be noted that I do not consider support and resistance levels to be lines in the sand, but more of a ‘zone‘ or ‘area‘. That means I do not consider a resistance level to be one price, but likely several pips on either side. This could be due to differences in price feed, server time, what other traders think of that level, and how they would play it.

A scalper will more likely get as tight to the level as possible, but scalping orders rarely are large in volume or market movers. However, a swing trader or large institution will likely be getting in at several levels, and the level you might be spotting may be one of them they are placing a large order at.

Because of this and all the different ways institutional players relate to these levels, support and resistance levels for me are zones or areas which could be anywhere from a few pips wide to 10+, maybe more depending upon the time frame the level relates to.

Obviously a level from a weekly time frame over years would have a little more play then an intraday level on the 1hr chart so take this into consideration.

What Each Variable Communicates

Although I could spend an entire treatise writing about all the things each variable above communicates, I will go over the key points here.

1) How Price Reacted To This Level In The Past – this is a big one as it tells me what the major players thought of this level. Was the pair highly over/under valued here and it produced a violent reaction in the past? If so, then the first time it comes back to this level, we can expect a strong reaction. Why?

If the reaction off a level was fast, that translates into heavy buying/selling with some large player initiating the rejection. This is followed by other players quickly rushing in to get as close to that price as possible, essentially chasing for the best price, but agreeing with the initial rejection. These levels are defended with a lot of money, and if price does not come back for some time because it traveled fast and furious off this level, then the next time it gets there (especially if it’s the first time back), expect a strong reaction.

Exhibit A – Gold Daily Chart

When gold sold off massively due to huge margin increases by the metals exchanges, it crumbled hard and everyone was wondering where the bottom was. It found it eventually at $1532 where in one day, it opened at $1640, jumped up $23, dropped $130, then bounced $96 from the lows which was quite an amazing rejection inside one day. This is a violent reaction, so traders were definitely taking notice of it the next time it approached this level. Can you guess what happened when it got there again?

Second Approach Gold Chart

As you can see, price held this level with a tiny breach, then bounced the next 4 days in a row, suggesting strong follow up buying on this rejection. The first time back usually is a slightly lesser bounce since many know of the level, and thus less traders are trapped (or surprised) from a violent rejection the first time around. But usually, this level will hold.

Remember, this is one scenario of how price has related to it in the past. All the other types of reactions communicate a different story.

2) How Significant Is It (lower time frame, higher time frame, etc) – this really has to do with time as all support and resistance levels have what I call a ‘time degradation‘ to them. Simply put, traders have a memory, but they are more inclined to take recent information as more valuable then information a while ago, especially if they are short term traders. Generally, higher time frame levels will dominate and last longer than lower time frame levels. Also, when possible, I’m more interested in drawing levels that are more likely to maintain the trend as that is the more probable scenario. I particularly relate to these when reading the impulsive vs. corrective moves in the market.

For more information about understanding impulsive vs. corrective moves, make sure to watch the video here.

But once you have established the trend according to the impulsive vs. corrective series, look for breakout pullback level where the trend continued, or major swing highs/lows where the trend paused and pulled back to. These will often present great opportunities to get in with trend.

3) How Price is Reacting To It Now – Is price closing on a support level, and just sitting there, with smaller and smaller bounces off it? If so, a breakout through the level is more likely as there is no strong buyers able to push back, and the sellers continue to squeeze them out of the market. Was there a strong pin bar reversal off this level? If so, it could be telling you it will likely hold on a second attempt and start a reversal, hence look for an entry close to the level. How price reacts to the level in the moment can tell you if it’s likely to hold or not, but this analysis should be done before it reaches the level.

Often times the market will demonstrate a price action reversal signal at these levels. Keep in mind, this is the ‘effect‘ of how players responded to the level, not the cause. Order flow was the initial cause, and the level was the location. Everything else was a response to the initial reaction off this level. Hence these price action triggers are often ‘secondary entries’ (or sub-optimal) regarding the level. Sometimes a price action trigger, say a pin bar on a 4hr chart can be an engulfing or piercing bar on a 1hr chart. So sometimes it helps to look at a lower time frame to see what the more micro responses off this level are, or what the price action context was leading up to it.

But no matter what, there will always be clues as to what the major players are doing at this level, and what the more likely scenario is. Look for impulsiveness (strength) off the level, or weakness (corrective price action) off this level for initial clues.

4) What Is The Speed Or Impulsiveness Price Is Approaching The Level – this will really tell you a great deal of information whether a level is likely to hold or not. If you are trading with trend, and with the move when it is approaching a level, how strong the move is heading into it, and what is the underlying characteristics behind the price action (speed, acceleration, etc), will tell you what is more probable.

If a level is an intraday level, or one from only a day ago, a really impulsive move is likely to break through it. If it’s a daily low or high, or a level that held for a week or longer, it will have a better chance of holding. Think of it like a moving object. Consider the size of the object in relationship to what the obstacle in its way is. Normally, force x acceleration (& mass) will tell us whether the obstacle ahead will cave or not. Unfortunately, we do not have exact information about the orders at a level, such as the number and size of them which would equate to mass and volume of the object. Level 2 quotes would help in this fashion, but if you don’t have that, then what?

Why not use the other principles above, such as;
-how did price react there in the past
-how significant is it
-how is price reacting to it on first touch

Weigh those against the force, or impulsiveness of the move, and you’ll be able to get a better idea.

A good example would be the following chart below of the AUD/USD on the daily time frame

Price approaches the level with some volatility, as there are solid moves on both sides of the fence with bears maintaining control on the way down. Price bounces off the level with a piercing pattern and then a second attempt forming a pin bar reversal. But then after a small retrace, price attacks the level with vigor, selling off 4 days in a row, taking out the last 13 days gains. Does this resonate strength to you? Do you think it will break? See the chart below

Exhibit B

As you can see, price was exhibiting a lot of strength and impulsiveness heading into the support level. There were definitely some clues ahead of time this was going to break. Such as how price barely lifted off the level each time, and attacked it twice without ever gaining much ground to the upside.

Keep in mind, the trend was already down leading up to it, so with trend traders used these pullbacks to get back in the trend. The last time they said enough is enough, and went to take out the barriers at this level. The buyers at the support level likely exhausted themselves on the first two rejections which failed to gain traction.

Putting all these components together would have communicated a breakout was likely, which would have helped your current short, or give you a second opportunity to get back in on a textbook breakout pullback setup for a high probability-low risk trade.

In Summary

So there you have a few key variables to look for in finding the best support and resistance levels. Remember, price action patterns form at these levels and are the ‘effect‘, not the cause of the move. They do communicate information to us as traders, what we are looking for is the price action context before we reach these key support and resistance levels. Hence, it is these key levels where orders are being placed first.

Thus, by learning how to read the price action and the key variables I listed above, you can greatly improve your ability to spot good setups, improve your entries, placing trades where weak players are getting in, and the stronger players are looking to enter.

Please make sure to comment below, and click on the like buttons to share this article 🙂

For those wanting to learn to trade price action, get access to the traders forum, lifetime membership & more, visit my price action course page here.

Forex Strategies, Price Action Trading

Engulfing Candle – The Truth No One is Telling You

Have you ever tried to trade engulfing bars? Maybe you are currently doing so?

How has that been working out for you so far? A guess would be not so good.

There is a reason why your engulfing candle trading strategy isn’t working.

A simple but powerful truth the so-called price action authorities out there won’t tell you. A truth that reveals trading engulfing bars or any other one- or two-bar reversal pattern for that matter, not only puts you at a great disadvantage in the market, but it also has a very negative impact on your trading performance.

Now you must be asking yourself, if trading engulfing candles is a sub-optimal way of trading, why do so many price action sites and teachers market this way of trading as much as they do?

The reason behind that is very simple. The whole concept of trading simple 1- or 2-bar candlestick patterns from key support and resistance levels is very easy to understand, teach and learn. Thus, it is also very easy to market and sell to any new retail trader entering the trading arena.

Most retail traders come to the markets with unrealistic expectations and are therefore extra vulnerable to the “quick fix” trading approach these patterns offer. “Trade X, Y and Z patterns at A, B and C spots in the market and you’ll be making a lot of profit in no time.”

Other reasons this concept is so attractive for beginning retail traders is:

a) It gives the trader a clear “signal” (reason) to enter the market which means less headache/work for the trader.
b) It gives the trader a false sense of “confirmation”. A way of “confirming” the validity of a level creating the illusion of certainty.

This is of course a myth which we’ve discussed in earlier articles such as this one.

Keep in mind, quick and easy processes rarely lead to high quality results. More often than not, the output equals the input.

Before we go deeper into why trading engulfing bars puts you at a disadvantage in the markets, we have to give a very simple definition of the engulfing candle pattern.

For a bearish example of an engulfing candle pattern:

The A bar is a bullish bar (bar that closed up) and the B bar is a bearish bar (bar that closed down), whereby the high of the B bar is above the high of the A bar, but the close of the B bar is below the low of the A bar. If the low of the B bar is below the low of the A bar, but closes inside the price action of the A bar, then it is an outside bar pattern which is a different reversal pattern.

For a bullish example of an engulfing candle pattern:

The A bar is a bear bar, and the B bar is a bull bar, whereby the low of the B bar is below the low of the A bar, and the close of the B bar is above the high of the A bar. If the high of the B bar is above the A bar, yet the B bar closes inside the price action of the A bar, then it would be a bullish outside bar pattern.

Below are two visual examples of Bearish and Bullish Engulfing Bars:

Trading Engulfing Candles - Engulfing Bar Clarification

Now that we’ve established what an engulfing bar is, let’s take a look at why using engulfing bars as a “signal” and/or “confirmation”, is a sub-optimal way of trading and puts you at a disadvantage.

Professional traders do not trade based on any kind of 1-2 bar candlestick patterns, why should you?

There is a reason professional traders make money, whilst the majority of retail traders don’t.

It can also easily be said that when retail traders are getting in the market, professional traders are already in profit.

Why’s that?

Let’s look at an example using a chart to illustrate this.

Below is a 1 hour chart of the AUD/USD in which we can see a short-term resistance level that rejected price followed by a breakout and false break. Price then came back to re-test the level again and formed an engulfing bar.

Now, there are two ways to trade these engulfing bars according to the majority of candlestick teachers/sites.

a) Enter at the break of the low of the engulfing bar, or…
b) enter on a 50% retracement into the bar.

Let’s assume we trade this engulfing bar the way it’s taught by most and compare both types of entries to a professional way of trading the same level. We will use the same stop loss- and target location in all three examples.

First out, the trade entering on a break of the low of the engulfing bar. The stop loss is placed at a healthy distance above the resistance level.

As you can see from the screenshot, this trade would have a stop loss of 17 pips and a target of 25 pips resulting in a potential +1.47R

Now, this is how a possible 50% retrace entry would have played out not changing anything but the entry location.

In this example price never retraced back into the bar and continued to sell off. Using this approach, we would have missed out completely on this trade opportunity.

For the sake of this comparison, let’s assume price did pull back to the 50% mark into the engulfing candle. We then would have had a stop loss of 11 pips and a target of 31 pips resulting in a risk/reward ratio of 2,81R.

Not bad, almost a 100% improvement in risk vs. reward.

Let’s compare this to taking the trade directly off the resistance level, again, leaving the stop loss and target untouched.

This is where it gets interesting. This trade would have had a stop loss of only 7 pips and a target of 35 pips, resulting in a risk/reward of 5R(!).

This fact alone should make you raise your eyebrows and realize that using engulfing bars as a way to enter gives you a sub-optimal entry at best.

Now, most engulfing bar traders would argue that using engulfing candles as “confirmation” of a level increases their win rate (which isn’t true!). But, for the sake of the argument let’s play with the thought that it is and give the engulfing bars a +20% higher win rate.

To be able to compare the 3 different examples above in detail, let’s put the numbers against each other over a 100-trade sample size.

Example 1 – Entry at break of engulfing bar:

Entry:                    0.75830
Stop loss:             0.76000 (17 pips)
Target:                  0.75580 (25 pips)
# of trades:         100
Win rate:             60%
Losing trade:      -1R
Winning trade: +1,47R

Calculation: 60 x 1,47 + (40 x -1,00) = 48,2

End Result: +48.2R return over 100 trades

Example 2 – Entry at 50% retracement into EB:

Entry:                    0.75890
Stop loss:             0.76000 (11 pips)
Target:                  0.75580 (31 pips)
# of trades:         100
Win rate:             60%
Losing trade:      -1R
Winning trade: +2,81R

Calculation: 60 x 2,81 + (40 x -1,00) = 128,6

End Result: +128.6R return over 100 trades

Example 3 – Entry at S/R level:

Entry:                    0.75930
Stop loss:             0.76000 (7 pips)
Target:                  0.75580 (35 pips)
# of trades:         100
Win rate:             40%
Losing trade:      -1R
Winning trade: +5R

Calculation: 40 x 5 + (60 x -1,00) = 140

End Result: +140R return over 100 trades

Comparison

Entry at break of engulfing bar (win rate 60%):                                   +48,2R
Entry at 50% retracement into engulfing bar (win rate 60%):        +128,6R
Entry from S/R level (win rate 40%):                                                        +140R

These numbers should put this discussion to bed once and for all. Why?

Engulfing bars won’t increase your win rate by 20%. Even if they did, the best entry option of the two engulfing bar examples would still produce less profit compared with our entry at the level.

On top of this there are even more things to consider…

You will not always be presented with an engulfing bar at your chosen support and resistance levels which further works against you.
It will render you passive when perfectly good trade opportunities present themselves.
You’ll sit there waiting for a pattern to emerge only to see the move play out in front of your eyes (a move which professional traders are profiting from).

To summarize

Using the engulfing bar “confirmation” to enter trades is a sub-optimal way of trading, working heavily against your overall trading performance by:

Decreasing your trading opportunities drastically and reducing the number of times you can apply your edge in the market.
Giving you a worse entry.
Increasing the size of your SL.
Decreasing the size of your target.

Engulfing bar traders only have one argument to counter the above. They claim that trading using engulfing bars increases their win rate and thus makes up for the drawbacks mentioned above. Even if that was true (which it is not), the so called “blind entry” still performs better as shown in our calculations above.

By looking at this objectively and comparing the numbers we can see that trading using engulfing bars is a sub-optimal way of trading. The only reason it is so widely spread throughout the retail market is because it makes trading easy, plus the “confirmation” part caters to the lack of trust beginning traders have in the markets and their own trading.

So, the differences between a professional trader’s entry and a retail entry should be very clear by now. Especially with all the other content we’ve posted before.

If you want to continue to have sub-optimal retail entries, then you can use the forex engulfing candle as tool to trade the markets.

If you on the other hand want an entry location that gives you a lot more trading opportunities along with a better overall performance, then you’ll want to adjust your trading method.

This is what we teach in our price action course. Now, if you found this article useful, please make sure to like, share and tweet it below, and we’d love to hear from you what “a-ha” moments you have from this article.

So, please come over to see more content like this on our website at dev2ndskies.wpengine.com where all the discussion is happening and leave your comments there.

But thank you for reading this forex engulfing candle article from 2ndSkiesForex.com, where we teach you how to increase the way you trade, think and perform.”

Now that you’ve read the article and had a chance to analyze the two methods and how they perform differently, which one wins?

What do you think? Please share and comment below.

Forex Strategies, Price Action Trading

How Many Patterns Do You See Here? A Forex Trading Quiz

I have been working really hard lately on my upcoming book ‘Trading Price Action‘ which I am seriously looking forward to finish and deliver to the world at large. Currently I am dissecting a chapter on pattern recognition and came across this interesting chart. In trading, we often look for fixed patterns we are trained to see, such as;

Inside Bars
Pinbars
Outside Bars
etc.

Although this has its benefits to spotting key formations in the market which can lead to good price action setups, we can actually get stuck into a routine of just looking for patterns with relatively fixed variables. This can actually hinder our overall pattern recognition skills to spot newer patterns and this is one of the most important skill sets of a trader – pattern recognition.

I have talked about methods to build this pattern recognition ability, such as brain gyms, like Lumosity as a way to build up the neural connections and spot patterns more easily in the market as one method. Another is going back and looking at historical price action, and in I thought this would be a good exercise for you to work on a particular chart I am writing about in my book.

The Exercise

First off, you will need a watch or a something that keeps track of time as you will want to time yourself on this. If your phone has it, set the stopwatch feature whereby you hit go, and it starts counting the time. For this forex pattern recognition quiz you will also need either a sheet of paper and pen, or a word document open to type your answers.

What you are going to do is for the next several minutes (as much as you need) look at the chart below and tell me what patterns you see in the market. Not what kind of bars you see, (pinbar, inside bar, etc.) as that does not take too much skill and is something that can be easily learned. Practicing something that is easily learned does not breed new neural connections which is what we want to do here.

What you are looking for is patterns in the price action behavior, what do you notice about the price action, what patterns are you seeing that repeat themselves. There are actual behaviors in this chart you are about to see that repeat themselves. This is what you are looking for – patterns in the behavior. They can be of any kind, but ideally, the ones you find that are most useful for trading.

Remember, if something happens once – its an occurrence. If it happens twice – its a pattern. If it happens three times, its a program derived from minimally one pattern. So what you are looking for is anything that repeats itself 2x or more. Thus, take as much time as you need.

Write down or type all the patterns you can find in this chart. I am going to cover up the name of the pair, and the dates, but I will tell you what the time frame (1hr chart). There is one line on the chart which is a 20ema which can be used if you so wish in your discoveries.

Keep in mind, I have gone back anytime in the last 30yrs to find this chart, so even though the prices may seem like they offer a hint, there are a lot more possibilities of pairs that had these prices so try not to think about the pair. You are just looking for patterns in the price action behavior.

With that being said, get your stopwatch, pen/paper or word document open. As soon as you begin, start your stopwatch and begin to write or type as many patterns as you can see. Once you are done, then mark down the time as you will need this later.

Ready? Begin with the chart below.

Ok, now that you are done, make sure to write down the time and how long it took you to find all the patterns that you did.

The next step is to look at all the patterns and price action behaviors, then come up with a few strategies based on what you noticed. This is because I am going to show you the very next candle in the chart, and if you really did a good job at isolating some key patterns, you probably have at least one strategy for the next candle (regardless of what it is).

Once you see the following chart with the next candle in this series, the go back to your list of strategies, and decide what you think is the most appropriate for the new candle. Make sure you have written all the rules for the strategy, such as your entry, stop and limit. Position sizing is not important – just that you can isolate a pattern, make a trading strategy off this, then apply it on the next candle.

Ok, so you should have all your strategies and rules in place for taking (or not taking) a trade on the next candle, which you will see in the chart below.

So this is the chart one bar later. To make it a little easier for you to make a decision, I have decided to provide the data on the last blue candle with the black dot above it which has the following pieces of data;

Open: .8275
High: .8285
Low: .8260
Close: .8280

One more piece of data, the low on the red candle prior was .8259.

So armed with all that data, along with all the patterns you recognized in the price action, and with the strategies you came up with, take a moment to figure out what is the best strategy to trade this blue candle. You can either decide to;

a) trade this blue candle
or
b) not trade this blue candle

If you decide to do A and trade this blue candle, then what you are going to do is decide what is the best strategy to trade it. This means having all the rules for entry, along with placing your stop and limit. Now here is the kicker;
Whatever strategy you use, has to be out of the position in 3 candles.

Why?

Because these are the last 3 candles for the week, and the market will close for the weekend which is also a holiday weekend and there is a G20 meeting which will have a major impact on the market.

So, that is the challenge. Come up with a strategy that you think is best to trade this pair now that the blue candle is closed. You have to be out of it in three candles so you can be out for the holiday weekend, hopefully in profit with a smile on your face.

With that being said, I am going to post the next three candles tomorrow on the following page around this same time;
https://dev2ndskies.wpengine.com/strategies-for-forex-trading/forex-signals/

You will want to look for the post which will be called ‘Forex Trade Signals and Setups Feb. 21st‘

In this post I will provide the chart with the next three candles, and then you can compare how your strategy did and share with me what your strategy was, rules for entry, stop and limit, and what the final result was.

What I am going to do is share with you my strategy, what patterns I isolated to come up with it, and how it played out. I will give you a few details ahead of time, but want to explain the background to this challenge:

I came to this chart as I was doing some practice through my charting program, which will take any pair, hide the dates, the actual pair, change the numbers on the prices, but will correlate them to the real historical price at that point in time.

Then what it does is challenge you to trade that chart in that point in time bar by bar. If you want to trade at the end of the bar, you do, if not, you don’t. It does a very good job at giving you real practice in reading price action because you are trading bars as they come in real time, just like real trading.

Sure, its not real money, but the point is to learn to find patterns in the price action which is a great exercise to do, especially when the market is closed on the weekends.

Now here are some points I’d like to share;
1) When I started looking at this chart, in < 1 min, I was able to isolate 4 key patterns, even though there were many more
2) from these 4 key patterns, in < 1 min, I was able to come up with a trading strategy for the next bar if it had certain characteristics
3) with this new blue bar, I was able to trade it having a R:R ratio of 3:1 based on the strategy I came up with

And I will leave you with that for now. So make sure to come back tomorrow to the link I shared above, to see the next 3 bars, and how your strategy did. Then make sure to leave a comment how your strategy did, what was the entry, stop and limit, or if you didn’t trade at all.

Remember, there are no points for cheating, so only honesty here. It really does nothing for your trading process if you are;
a) not honest, and
b) only try to inflate your ego by looking cool on this post

Remember, in a week or two from now, this post will rarely be seen, and nobody will really care how you did so skip the ego part of trying to look cool, and just be honest with what you did and how it played out.

The whole point of this forex pattern recognition quiz is to be an exercise whereby you;
a) test your pattern recognition skills
b) see how quickly you can come up with the patterns
c) see how quickly you can formulate a strategy (or strategies) based on the patterns you noticed in the price action

This is about as close to what you are doing in real trading – spotting patterns, finding opportunities, and trading the right edge of the charts as they come to you, bar by bar. You have to make decisions based on what you see and what you think will happen.

But in reality, nobody knows what will happen with the next bar – and that is the friction we all love (or dislike) in trading. Its the mystery, of what will come next, of not knowing, but seeing if we can find the answer ahead of time by being a detective and looking at all the available clues. Some of us are closer to Sherlock Holmes, and others are closer to Inspector Clouseau.
Regardless of where you are at, the mind has a neuro-plasticity to it which means you can learn to be an expert in spotting patterns and key price action clues from charts just like these. In an article I will write on this Thursday, I will discuss some key things you can do to improve your learning process, so you can enhance your pattern recognition skills, along with tailoring your educational process to help accelerate your learning curve to trade profitably and successfully.

I look forward to your responses tomorrow.

Kind Regards,
Chris Capre
Twitter; 2ndSkiesForex

If you liked this article, make sure to click the ‘Like’ button at the top of this article 🙂

And also check out my latest article called Ode to the 4hr Charts whereby I share an entire years trading report of one my students and how they made 110% in year, just from learning two of my strategies.

Forex Strategies, Price Action Trading

Ode To The 4hr Charts…

I want to share with you some results and tell me if you think these would be considered professional grade, or highly impressive to say the least;
110% gain for 2011
124 Trades, 74 winners, 50 Losses
59.67% Accuracy Rate
Largest Win: $14,360
Largest Loss: $8,180
Max Win = 43% larger than Max Loss
Max Consec. Wins: 16
Max Consec. Losses: 6
Max Consec. Win Streak 2.66x Larger Than Max. Consec. Loss Streak
Largest Trading Position: 1M
Overall, this could make the grade for a professional trader. In fact, I know many that did worse (a lot worse) then him and would be happy with his results.
The 4hr Charts
There has been a lot of talk and garbage being spoken about trading off the 4hr charts, how its trading as a hobby, how you’ll only be an amateur, how if you want to be a professional trader, you need to trade off the 1m, 5min, 15m, smaller time frames. Ridiculous, but we are going to demonstrate why.
I’ve been wanting to show people the power of trading the 4hr time frames for a while. Although I have many students doing it, nobody is solely trading off the 4hr. They usually add the daily, or 1hr and have a mix of time frames and systems. In comes Tony.
Do you remember Tony? I wrote about him in the Pyramid of Trading article whereby I talked about him back in early Oct. At that time he was up 76%, and ended the year up 110%. Meaning, he gained another 34% in the last three months – impressive to say the least.
Tony had one thing going for him which was the best edge one could have – discipline. Tony had very little experience, no business/finance degree, just a desire to learn, patience and discipline. He came to me in late 2009 wanting to take some private mentoring sessions.
I taught him less than a handful of systems which he learned well and practiced on in 2010. By the end of the year, he settled on his two favorites:
Price Action
& my Shadow System.
He learned his risk parameters, his style, how he wanted to trade, what was the best pair for him, then went for it. He settled on trading the AUDUSD only on the 4hr time frames using those two (Price Action & the Shadow System).
I am going to show you his entire trading report, which averages about 10-12 trades a month with the max being 16 and the least being about 8. You already have the stats above so lets show you the entire trade history for 2011. I have covered his personal details and acct number to protect his privacy, but all the trading is there which you can see below.
Screenshot 1

Screenshot 2

Screenshot 3

Screenshot 4

Screenshot 5

Screenshot 6

So there you have it, an entire year of trading. To recap his performance;
110% gain for 2011
124 Trades, 74 winners, 50 Losses
59.67% Accuracy Rate
Largest Win: $14,360
Largest Loss: $8,180
Max Win = 43% larger than Max Loss
Max Consec. Wins: 16
Max Consec. Losses: 6
Largest Trading Position: 1M
This should finally put to rest the ridiculous talk and idea you only have to trade one time frame or smaller time frames to be a professional or highly successful trader.
All of this is thanks to Tony for sharing his results with me. He traded only on the 4hr time frame for an entire year. A lot of his trades were done in a day, but many went a few days, with several going 4-6 days holding time. All he traded was Price Action and my Shadow System on one pair for an entire year. Disciplined, patient, and highly profitable.
How many educators show results from their students, especially of this caliber? I believe I am one of the few, and Tony will not be the last. Maybe the next person is you – hopefully it is.
To also separate myself and end the debate, at the end of this year, I’ll show you audited results from an account I opened up just to demonstrate I am not just a good teacher, but a good trader as well. I will publish the audited results from a professional accounting firm, on my site so you can all see I am the real deal.
I have no idea how i’ll end up for the year, but whatever it is, you will see it. Even though my fund has an 8+yr audited track record (which should be proof enough), this will settle it, as it will only be my trading, only me pushing buttons, not anyone from my trading team, or any account from my fund. Just my own individual account opened just for this. This should end the debate. Hopefully then I can stop answering questions about my legitimacy, focus on trading, and teaching people who are serious about learning to trade successfully.
There are 3 things I live and breathe every day and have been for over the last 10yrs;
Yoga
Meditation
Forex Trading
I make my living and have been for almost a decade from trading. I study it every day and every moment I can get a chance. The only thing that is right up there with the three things I listed above is Teaching People to Become Successful Traders. I’ve seen every kind of trader you can imagine (from time frame to profitability), and there is no one person who holds the monopoly on the truth of trading and the learning process.
And to the rest of you with open minds and a serious desire to learn, this demonstrates you can be a profitable and highly successful trader, regardless of your time frame, system or background. With the right effort, discipline, and patience, you can be a profitable and successful trader as well.
Ode to the 4hr Charts and profitable trading.
Kind Regards,
Chris Capre
2ndSkiesForex.com
Twitter; 2ndSkiesForex