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Price Action, Breakouts & Order Flow

Today I am writing a potent article about pre-qualifying forex breakouts, particularly understanding them from a price action & order flow perspective. When you pre-qualify a breakout, you put yourself in a position to identify it as a high or low probability breakout. To do this however, you have to understand what makes a successful forex breakout trade both from a price action and order flow perspective.

In my prior article 3 Keys for Identifying Breakouts, I talk about 3 such parameters for pre-qualifying forex breakouts. They are;

1) Well Defined Support/Resistance Level

2) Pre-Breakout Squeeze/Pressure/Tension

3) 20ema Carry

When you can identify these prior to a potential breakout, you highly increase the probabilities of trading a successful breakout. But let’s dig into this a little deeper as to why from a price action and order flow perspective.

Order Flow Behind Breakouts
From an order flow perspective, breakouts generally start with an initial balance between buyers and sellers. This usually results in a range of sorts, with two clearly defined support and resistance levels. When you get several touches on these levels, this clearly communicates where both sides of the players are parked (and likely their stops as well). The more touches on these barriers, the more players are brought in.

Those who are bullish will get in on the bounces off support, while bearish players on rejections off resistance.

However as time goes on, tension starts to build between the two camps as someone will eventually want to take control. In almost all cases, the side with the largest number of orders and money behind their camp, will win this tug of war.

This usually manifests in a higher low (HL) or lower high (LH) being formed inside the range, and more aggressive pushes towards the other line in the sand, while less or no touches on the other side, almost as if the sellers or buyers could not reach the other support or resistance level. It usually looks something like the chart below.

EURJPY 5M Chart

Looking at the chart above, you’ll see a clearly defined support and resistance level with a minimum of two touches on each side. This tips us off to where the bears and bulls are parked on the chart with stops just above/below the levels.

Now you will notice each rejection at A & B minimally went up to 125.05 before coming back down and touching the same support level at 124.80.

C pushes price back up to 125.05, but this time the rejection fails to reach 124.80, and can only make it to 124.85. From an order flow perspective, the buyers are starting to get more aggressive and confident their level will hold, so they are buying up higher (at a more expensive price).

The next pullback at E is also higher, so we are seeing a continual change of hands by the bulls buying higher from support (and their defenses at 124.80).

Now notice every push up from B, C, D, and E only makes it to a maximum price of 125.05. But with F, it goes to 125.10. There were probably some intraday bears shorting at 125.05 (now stopped out), while the rest were still short at 125.15.

Now that price is pushing up towards the resistance without ever touching the support, this communicates the bulls are taking control of the price action with more orders and money, and will likely continue to squeeze the bears out.

This price action squeeze takes out smart sellers early as they recognize they are about to get stopped out if they stay in. The slower players stay in until they are at breakeven, while the slowest and most stubborn bears stay in till they are stopped out.

EURJPY 5M Breakout Chart

Using the chart above, we see the final stage of the breakout which is the 20ema carry in Box A. This “20ema carry” is a common price action formation prior to a good breakout, as it shows;

a) the mathematical representation of price gaining

and

b) gives bulls who haven’t entered a chance to get in prior to the breakout

This is followed by a strong breakout bar at B. This large bar should be curious, for why would bulls buy up so strongly heading into a resistance level if they were worried about sellers parked there. Usually, institutional traders can smell an upcoming breakout like this, so will push really hard to take out any stops as they go after the barrier.

A “strong breakout bar” is usually a really good sign the breakout will continue as it means stops were tripped above the resistance level, and price jumped aggressively in one bar. More ideal is if it has a good “clearing distance“, for if it does, then it increases the chances all the stops were tripped by going further away from the resistance level where most of the stops were near.

Tripping The Stops
It is this latter part – the stops getting tripped, which helps fuel the breakout even further, because those bears who were short now have to buy back, and this buying back to exit out helps further fuel the upside breakout. This is why if you ever watch the prices on your actual platform during a breakout like this, it generally reads (using 4 decimal places);

1.2999
1.3000
1.3001
1.3002
1.3003 (stops tripped)
1.3006!

You can always tell where the stops were parked and tripped, because price then jumps a few pips in a shot. The reason for this is – there were no sellers between 1.3003 and 1.3006, meaning the brokers could not print a price there since there were not enough orders there to hold that price. The stops being tripped at 1.3003 were sellers who now had to buy back, and when they did, they helped to push the next market price up 3 pips in a single tick or print.

When you see this, it usually means the breakout will likely continue – as long as you have done your pre-qualifying ahead of time.

One Final Note
Like all things, we have to pre-qualify a forex breakout using several price action characteristics ahead of time. The ones listed above are just a few of the ones we use in my Course, and there are several others which will clue you off and enhance the probability of the breakout being successful or not.

When you can pre-qualify them correctly, you will find breakouts quite easy to trade and accuracy levels around 60-70% as this is what my more profitable students are doing consistently just trading breakouts.

But, you have to pre-qualify them, like any price action setup. We never just trade them in isolation, as we are not pattern traders. We are price action traders, and we always trade setups & price action in context.

Any good system can perform badly without the proper context. Pin bars can be a highly effective system, if traded in context. But without understanding the type of trend, or volatility levels, you will likely lose money trading pin bars in isolation, even if you trade them at key chart levels.

Thus, we are never just trading patterns on a chart. We are always trading them in context, and this is exactly the same for breakouts, so always pre-qualify them ahead of time.

Look for the three characteristics above, try to trade them with trend more often then counter-trend, and you’ll find they can offer highly profitable trades, with some of the better reward to risk ratios out there, such as 3, 4, 5, or many reaching 7 or 9:1 reward to risk ratios.

My Top Trading Mistakes for 2012

The learning process never ends for a trader. The market is always evolving and you have to adapt. Algorithmic trading was about 3% of the FX market in 04′. Now 28% of it is just HFT’s alone! Think that has changed the intraday price action? Absolutely!
Thus, you must always be learning, evolving and challenging yourself. There are always refinements and greater depths to what you are doing, whether you are trading price action, ichimoku or other rule based systems.
Regardless of your skill level in trading, you are going to make mistakes. I make mistakes, but I learn from them with alacrity. I quickly analyze what I did wrong, visualize what I would do differently, clear my mindset and get back to business. The difference between a professional & beginning trader is usually two-fold;
1) they make less of the typical mistakes beginners do
and
2) they rebound much faster, control the damage quicker and get back to business
Analyze your last year of trading in your journal. I’m willing to bet if you eliminated just one or two mistakes you continually repeat, your current losing year would have been a profitable one. If you ended the year break-even, then it likely would have been highly profitable.
Eliminating mistakes is one of the fastest ways to profitability. The sooner you discover, eliminate and transform them, the faster your equity curve will climb.
Thus, in the spirit of this, I will share my top trading mistakes for 2012 in the hopes you can learn from them.
1) Trading and Investing are Two Different Things
I am a trader first and foremost, but I also am invested long term in physical gold.
To ‘invest’ in physical gold, you constantly have to understand what is happening in the physical AND paper market. It helps to study central bank buying of gold, physical supply, how it is used as a safe haven against bad governments, etc.
However, I also trade gold using intraday price action strategies, and sometimes my methods/opinions on one get mixed with another. Long term I am a bull on gold, and have been since 2004/05 back at the $400 levels.
Many times in the last 3 months, I was long paper gold. Yet intraday price action would be screaming for me to get short. My broker allows hedging – so why wasn’t I shorting physical? Because my long term investing bias was interfering with my short term trading methods.
One of my top trading mistakes for 2012 was forgetting that I am a trader first and foremost, and to not let my bullish bias or investing strategies interfere with an obvious price action setup.
A good example is I bought paper gold at $1633, which I blogged about as a high probability breakout. At one point I was up 51x my risk, meaning for the 300 pips I was risking, I was up about 15200 pips.
By the time I walked away from the trade, I was only up 6500 pips. I didn’t follow exit rules because of my long term investment bias.
Remember, a trader and investor are two different things, and you must understand the difference.
2) Trading Against Impulsive Price Action
One of the base models I use for trading is understanding impulsive and corrective price action.
To sum it up briefly, impulsive price action moves are when the institutional market is heavily buying or selling and driving the price action directionally. With training and practice, you can learn to read the order flow behind price action, particularly by identifying these impulsive price action moves.
A few times this year I traded completely against these moves. Case in point – meet exhibit A, ironically on……wait for it……Gold!
Gold 4hr Charts

Looking at the chart above, you will notice on the bottom left points A and B which showed strong price action rejections. Buyers stepped in at this level, driving prices almost $50 higher in about 6 days.
At C you will notice the pin bar at C which was the second sign the bullish move was ending. Any idea what the first was?
Regardless, after the pin bar, price action failed to make a HH (higher high) and started with selling off impulsively at D, then more sellers came in at E, and by F, once it broke the role reversal level, price got monkey-hammered dropping $30 in 4 hours.
I had a buy order at the support level at G, so made some profit on the bounce, but missed the fact the market was still showing impulsive price action selling.
So at H what did I do? I bought some again, hoping for a similar move. The result is below, but you get the idea.
Gold 4hr Chart Exhibit B

At the support level where my first long worked out, I went long again at H and the same level. Shortly after I was stopped out.
Instead of realizing I was trading against the trend and impulsive price action, I was looking for a reversal. I consequently missed the obvious breakout pullback setup at the same level I was looking to get long, which then became a role reversal level. This is what happens when you trade against the trend and your system.
Not only do you miss several good with trend setups, but after you get stopped out, you usually miss the follow up trade from your price action system to take advantage of the move.
3) Let Your Trade Run Until Your System Tells You To Exit
Barring any extreme or black swan event, I usually just let my trade run until my rule based system tells me to exit.
However on a recent buy on the GBPJPY, after getting a great entry and banking about +300 pips, I exited the trade, even though my system was still telling me to hold long and hadn’t given an exit signal.
Looking at the chart below, you can see on the top left at B a critical resistance level which started the massive 300 pip sell off.

Price started to show signs of exhaustion, and started a reversal. My ichimoku strategy picked up a buy order just above 126.60. Shortly after, price climbed rapidly gunning it for the same resistance level at 129.50. After the weekend gap rejected, I took profit banking about +300 pips.
Not so bad you say…until you look at the chart below.

Not only did my system hold on for another + 300 pips, but it gave me a re-buy signal around 132 and is still currently long today. I missed that one as well from being ‘upset’ about exiting early. Needless to say this would have over tripled my profits. Even though my system never gave me an exit, I got out of the position.
Not letting runners run is one of the most costly mistakes a trader can make. Yes, it is important to understand what is a high quality signal, but I’m guessing if you let just 10 of your trades run until the system gave you an exit, you would have made almost double your profits on those 10 trades. For me, it was actually 2.4x more. Food for thought.
In Closing
Part of trading is making mistakes, but a key component of your success is learning from your mistakes and making less of them over time. Regardless of your skill level or how long you have been trading, you will make mistakes. Anyone who only posts their successes and doesn’t admit to their failures is hiding behind a wall of fear and a false reality.
I make mistakes and I’ve been doing this for 12 years. But I learn from them continually and make less of them as time goes on. This translates into more profits, smaller drawdowns, less emotions, and a smoother equity curve.
Eliminating mistakes is the fastest path to making more profits. But the first step is becoming aware of them. This is where the trading journal comes in handy. If you’ve made 300 trades last year, are you really going to remember every mistake you ever made? Unlikely, this is why you have a journal, to help you become aware of your mistakes.
The second step is to actively work on eliminating and transforming them. If you repeat a mistake over and over again, then the cause is likely psychologically, and something that can be re-wired through ERT training and developing a successful trader mindset.
But the bottom line is you can transform your mistakes into strengths, and most definitely into greater profits. In almost all cases, making less mistakes can be the difference between a winning and losing day, month or year. And in almost all cases – will lead to significantly greater profits.
Kind Regards,
Chris Capre

Forex Strategies, Price Action Trading

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

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

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.

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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

Pin Bar Trading: How You Can Use it to Find Likely Turning Points

Today I am going to discuss Pin Bar trading, which can give some insight into a potential price action reversal, entering traps, and getting into trends.

In this article, I will specifically talk about how you can use it for aiding your key support and resistance levels to find likely turning points.

I’ll also talk about what a pin bar is communicating from a price action and order flow perspective, and how to trade them.

The term was originally penned by Martin Pring calling it the Pin Bar, which stood for ‘pinocchio bar‘ or a bar that is telling a lie.

Why?

Martin had noticed that these types of bars come up in strong trending moves, but what they do is initially create a break of the highs or lows for the move, but then break back into the range of the prior candle.

This break of the highs or lows is the ‘telling a lie‘ part of it, trying to get short term traders in on the break.

When the candle breaks back into the range, they are then trapped and if the price action continues to break in the opposite direction of the trend, then those traders who are trapped have to exit their longs/shorts, thus helping fuel the reversal.

But lets take a look at a general pin bar in the image below.

Looking at the image above, the blue bar at the bottom is a pin bar, which generally should open inside the body (and/or wick) of the prior bar.

The pin bar itself should form a new low in a downtrend, or a new high in an uptrend.

This is what creates the ‘trap‘ for the traders that entered short on the break below the lows. With the bar closing up, the new shorts are now trapped and if price climbs enough, they will have to exit for a loss which will help fuel a price rise and the reversal.

Now lets take a look out a little further at this pin bar in the context of the price action around it with the chart below.

Now that we see the larger picture here, price was selling and then formed a SL at .8100. Price then bounced to .8275 where it ran into resistance and created a pullback from the SL.

Price then sold off for 8 candles (32hrs) only to run into a pin bar a prior support level, giving us a really good price action trigger to go long and reverse this move. Let’s see how it played out in the following chart.

After selling off for 8 candles and 32hrs straight, price action then formed a pin bar, which was the low in this move reversing 90 of the 130pip sell off (over 61.8% of the move).

We actually blogged about this trade ahead of time and many of our price action traders got long on this one for a nice 3:1 reward-risk setup.

We placed our entry on a small pullback into the pin bar, and targeted .8225. Price went about 10pip past our entry and then encountered a new wave of selling.

But as you can see, the pin bar itself was the key price action trigger in setting up this reversal.

Let’s take a look at another example, then we will talk about finding a good entry for the pin bar along with time frames.

Here is the EURUSD on the 1hr time frame. Price has been climbing for over a day from 1.3140 – 1.3290 and then forms a pin bar at the top of the uptrend.

Notice how in forming this pin bar, price had already been struggling around 1.3270/80 to make any new significant highs. Let’s take a look at how price action responds to this pin bar formation.

Looking at the chart above, notice how after forming the pin bar, price then formed an inside bar right after the pin bar, telling us there was definitely a pause from the pin bar rejection which is interesting since

a) price was already struggling around 1.3270/80 and

b) the bulls had been in control for so long

Where did they go all of a sudden? This should have been a clue the market was about to reverse and the pin bar was the trigger.

Price then traded sideways for a few hours, but then sold off heavily shedding +180pips from the pin bar highs giving a highly profitable trade with very low risk so hopefully this gives you an idea of the pin bar formation as a whole.

Pin Bar Entries

In terms of finding a good entry, one method is to take a pullback into the pin bar itself, but this should always be based upon the order flow around the pin bar and the key levels around it. If the bulls/bears are in control at the time of the pin bar, there is a good chance they will attempt to break the highs/lows of the pin bar so a pullback gives a nice option to get in the market.

There are actually many pin bar entries, and they should depend upon the context of the price action around and leading up to the pin bar itself.

Depending upon how the price action is leading up to it and around it will determine and communicate what is the best entry, but the pullback is one solid option you can use for now.

In my price action trading course, I actually discuss how to quantitatively break down a pin bar as we have tested over 10yrs worth of data on over 15 pairs, totaling over 100,000+ pin bars.

From this information, we were able to come up with a very precise definition of a pinbar, along with giving you exact entry parameters for each type of pin bar, and how to find optimal targets.

One methodology suggested has been to find a 2:1 reward to risk target, or next key support/resistance level. But testing has shown this not to be an optimal method for trading this, as many times price can way under/overshoot the target, either leaving you stopped out before your target, or missing out on a lot of potential profits.

Time Frames

In terms of time frames for trading pin bars, they really can be traded on all time frames from the 1min, to the weekly chart. However, as a pure pattern, testing has shown them to be a lot less accurate on anything lower than a 1hr time frame, so we suggest using them on the 1hr, 4hr and daily time frames if you are only going to trade them as a pure pattern.

We always recommend trading them with price action context, and never just as a pure pattern.

It is not that they cannot be used on the lower time frames, but in isolation, they will be a lot less effective, so you will need to add additional optimizers and parameters to enhance the strength of them.

Also consider on the 1hr, 4hr and daily time frames, more traders will be watching them, and thus get into the trade – likely strengthening the reversal.

Along those lines, think about it this way. If price action forms a pin bar on a 5min chart, we are talking about a rejection that lasted 5mins. Think of how many orders or transactions occurred during that time.

Now compare that to 1hr of price rejecting, 4hrs of price rejecting (half a trading session), or a daily pin bar showing price had rejected for an entire day across three different sessions with three different sets of investors all weighing in saying this price rejection was a significant one.

If you consider that, then it makes more sense the 1hr, 4hr and daily ones will have greater strength to them, but again, it all comes down to context

In Summary

Thus as we can see, the pin bar formation is a strong price action pattern communicating a rejection of sorts in finding tops and bottoms, telling us a counter-trend move is likely to begin.

Obviously this is an over-simplification of a pin bar trading strategy, but we can see how it works and understand it from an order flow perspective.

There are many other variables and types of pin bars, which will enhance or weaken the pin bar, such as body size, close-type, prior price action, was it a trap, was it hitting off key levels, etc. In any case, this should give you a good introduction on what a pin bar is, what it means from an order flow perspective, how it works from an order flow perspective, and one way you can trade it.

There are various other pin bar trading methods which use this so should you want to learn more about then, then feel free to check out my Price Action Course. I teach quantitative methods for pin bar trading and discuss live setups all the time.

Tag Archive for: pin bar

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Quality vs Quantity – Which is Better for Trading?

Price Action Angles – Trading Forex Price Action

The Best Support and Resistance Levels Part 1

Pin Bar Trading: How You Can Use it to Find Likely Turning Points

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