PRICE SWINGS & MARKET CONTEXT

Each time the market changes direction, a new price swing is formed.

Each turning point is a swing pivot. When a rising market turns down, a swing
high is formed. When a falling market turns up, a swing low is formed.

Price swings highlight the market context.

To make sense of the market, you just need to observe the swing highs and
swing lows.

Are they rising or falling?

#1: THEY ARE RISING.

If the swing highs and lows are rising, the market is in a bull trend.

#2: THEY ARE FALLING.

If the swing highs and lows are falling, the market is in a bear trend.
#3: I’M NOT SURE.
If the swing highs and lows are giving you mixed signals, the market is
consolidating.

Markets often consolidate before reversing its trend direction. This period is
known as accumulation or distribution depending on the trend that follows.

In fact, the chart below shows the consolidation that took place before the bear
trend shown in the previous chart.
IMPORTANT NOTE ON DRAWING PRICE SWINGS

For price swing analysis to be helpful, you must employ a consistent method of

identifying swings. You must not mark out the swings subjectively.

You need to use an objective framework for marking out swings. The swings
drawn in the charts above are the tested and valid pivots taught in my course.

TYPES OF PRICE ACTION TRADING SETUPS

There are four types of price action trading setups:

1. Retracement
2. Reversal
3. Range-Bound
4. Break-Out

The first two, retracement and reversal, are setups you look for in a trending
market.

The other two, range-bound and break-out, are setups you find in a
ranging/consolidating market.

#1: RETRACEMENT TRADING SETUP

A retracement trading setup is also known as a pullback or throwback trade,
depending on the market trend. Regardless of the label, these trades capitalize
on the tendency of a trend to resume.

When analyzing a trend, it’s useful to know the difference between an impulse
swing and a corrective swing.

 Price swings in the direction of the trend are impulse swings.

 Price swings against the trend are corrective swings.
In a retracement strategy, you want to enter the market as a corrective swing
ends. The aim is to profit from the subsequent impulse swing.

Hence, the crux here is to determine when a corrective swing is over.

#2: REVERSAL TRADING SETUP

It’s trickier to catch a reversal, but the rewards are great when you do.
#3: RANGE-BOUND TRADING SETUP
In a prolonged range-bound market, fading false break-outs of the range can
yield excellent results.

However, as the market is trapped in a range, the profit potential is limited.

Hence, it’s important to pay close attention to your reward-to-risk ratio.
#4: BREAK-OUT TRADING SETUP
A break-out trade is challenging because of the possibilities of many false break-
outs.

However, if you spot the right signals, you are likely to enjoy a swift trade with an
excellent risk-to-reward ratio.

In this section, you’ve learned how to read price action and judge the market
context using price bars and swings.

We also took a look at the four kinds of setups in different market

environments. Each setup type has a different risk profile. Hence, traders tend to
gravitate towards particular type(s).

Regardless of your preference, it’s clear that we are interested in market

turning points.

And in the next section, you’ll learn three vital tools to help you pinpoint these
turning points.

WHAT’S IN YOUR PRICE ACTION TRADING TOOLBOX? 5

SKILLS ALL PRICE ACTION TRADERS MUST HAVE
There’s no professional qualification or academic courses for price action
trading.

Yet, you’re expected to know what’s going on in a market with just one input:
price. Not only that, you must make money off your interpretation of price
action. Price action is simple, but being a price action trader is tough.

In real trading, memorising candlesticks and bar patterns is not enough. You

must have a set of price action skills that you can apply to any market to make
sense of it.

I’ve identified five skills all price action traders should have. To be a great price
action trader, you need to hone and excel in these five skills.

#1: FIND SWING PIVOTS

Market prices move in swings. These swings define the market structure. They
form the basis of market support and resistance.

The market structure is like your battle field. It is the terrain in which you will
fight against your enemies. The more you understand it, the greater your
advantage.

If you want to flow with price, follow price swings. They will show you:

 The current direction of the market; and

 Potential support and resistance.

The two examples below come from the 6E futures 10-minute frame.
1. Regardless of how you define swing pivots, these two points were definitely
major swing lows.
2. Despite the rapid selloff, the market found support around the support
area.
3. This downwards trend is enlarged in the chart below.

1. Observe the swing highs and swing lows. They went lower and lower.
Attempts to rise above the previous swing high were rejected. A clear
downwards trend.
2. Support area projected from earlier major swing lows.
Some methods of marking swing pivots are Gann Swings and Percentage Swings
(Zigzag Indicator).

Like everything in trading, no method is perfect. Just pick one way to define
market swings and stick to it.

See how the market structure of price swings works with a popular candlestick
pattern.

#2: DRAW TREND LINES

Drawing trend lines is the natural progression from price swings.

To get a trend line, just connect your swing pivots and extend the resulting line
to the right of your chart.

 Trend lines tell you which direction to trade in.

 Trend lines act as support and resistance.
 Trend lines give you a sense of trend momentum.

Don’t leave your trend lines behind.

Price action methods work on most time-frames. The example below is a weekly
SPY chart. (The trend line is drawn according to a valid pivot taught in
my course.)
If you adore trend lines, take a look at Andrew’s Pitchfork. It combines swing
pivots and trend lines into an elegant trading tool.

#3: DETERMINE IF A SUPPORT/RESISTANCE WOULD HOLD OR FAIL

What are support and resistance? Do they always fulfill their role as support and
resistance? Are these supposed support and resistance levels 100% reliable?

Nope.

If you expect a support to hold, you will buy as the market tests the support
area. If you expect a support area to fail, you will sell as the market breaks
below the support zone.

Hold or fail. It affects your trading strategy.

The key to a correct judgement is patience. When in doubt, waiting for more
price action clues is the best course of action.

1. The lower swing highs and lower swing lows seem to imply a bearish turn.
 2. With the solid downthrust breaking the trend line, we were not sure if it
was still an effective support.
3. A patient trader would have held back until this higher swing low formed. It
confirmed that the bulls were still hanging around.

#4: RECOGNISE BUYING AND SELLING PRESSURE

There are micro price order flows you need to detect. Buying and selling
pressure at critical price points help to refine your trade entries.

Having a refined entry means taking on less risk and whipsaws for each trade.

Do you see the bullish and bearish pressure in the chart below?

How do you recognise buying and selling pressure?

Most price action traders use rigid price patterns to find buying and selling
pressure. But memorising price patterns is not enough. You need to understand
the psychology and rationale behind each price pattern.

Break down each price bar: high, low, close, upper shadow, lower shadow,
range. Study each price bar with respect to the preceding bar. Understand what
makes them work. Know when they work.

Only then, you can recognise buying and selling pressure in real-time trading.
Start with these guides.

 Beginner’s Guide to Reading Price Action

 A Simple Way to Read Price Action – Trend Bars

#5: USE REALISTIC PRICE TARGETS

Taking profits is a skill that is often neglected. What you need to realise is that
most trades can be profitable, given the right price target.

Finding a realistic target based on price action is critical. This is especially so for
short-term technical trading.

There are three broad categories of targeting techniques.

1. Support/resistance. (Exit a long trade at a resistance level. Exit a short trade

at a support level.)
2. Target projection based on a price formation. (Like projecting a target from
a strong price thrust.)
3. Placing target with some measure of volatility like ATR or standard
deviation.

Profits do not take care of themselves. You have to grab them off the table.

Here are 10 ways for a trader to take profit.

CONCLUSION – PRICE ACTION TRADING SKILLS

Being a price action trader doesn’t just mean knowing what’s an Engulfing
candlestick pattern, or a Head & Shoulders chart formation.

As you can see, a good price trader needs to do different types of analysis.

 Market bias (Swing pivots and trend lines)

 Trade entry and risk control (Hold versus fail, buying/selling pressure)
 Trade exit and profit taking (Price target)

If you want to be a great price action trader, who produces consistent profits
without relying on luck, you need to be more skillful than almost all other
traders. At least better than the 80% that lost the trading game.
It’s not easy, but it’s possible if you’re gritty enough.

Finally, don’t try to learn everything at the same time.

Start with understanding the bigger picture of market bias. Know what price is
doing now. Then, move on to find trade entries and exits.

Most traders start from finding entries, ignoring the market context. Most
traders fail.

ESSENTIAL PRICE ACTION TRADING CONCEPTS

The core concepts are:

 Support and Resistance

 Trend Lines
 Price Patterns

SUPPORT AND RESISTANCE

Support and resistance (S/R) is the most important concept in price action
trading.

Think of them as price zones that tend to reject prices.

A support zone is a price area that rejects falling prices. In other words, it is a
price zone that supports the market from falling.

A resistance zone is a price area that rejects rising prices. It is a price zone
that resists the market from ascending.
Standard methods used to determine S/R:

 Swing Highs and Lows (as shown in the chart above)

 Psychological Numbers
 Moving Averages
 Fibonacci Levels
 Pivot Points
 High Volume Signals
 Trend Lines

When using S/R in your trading, take note of the phenomenon of S/R flipping.

If a support zone fails, it turns into a resistance zone. Likewise, if a resistance

zone fails, it becomes a support level.
Make sure you comprehend the idea of support and resistance.

The existence of S/R zones, together with market inertia, form a major part of
a price action trader’s edge.

TREND LINES
As covered earlier, you can derive great insights simply by observing price
swings. Trend lines allow you to amplify those acumens.

Trend lines are lines that highlight trends.

A bull trend line slopes upwards. You can draw it by connecting a pair of rising
swing lows.

A bear trend line slopes downwards. Connect a pair of falling swing highs to get
a bear trend line.
As shown in the examples above, trend lines act as a support or resistance.
Hence, you can use trend lines to help you time your market entry.

On top of that, broken trend lines hint at a market reversal, making them a

prime tool for tracking trends.

PRICE PATTERNS
Specific sequences of price movement can be useful. They tell us what the
market is doing now, and offer clues to what it might do in the future.

These sequences are called price patterns. They are helpful for pointing
out entry points and potential stop-loss levels.

Hence, price patterns form an integral part of a price action trading strategy.

Short-term price patterns include bar patterns and candlestick patterns. The

diagram below shows a typical bar pattern known as Pin Bar.
Both bar and candlestick patterns are based on pure price action. Hence,
unsurprisingly, they overlap a great deal. Many bar patterns have a similar
candlestick counterpart.

To make the most out of your price pattern study, I encourage you to review
these price patterns in the pairs listed below.

Bar Pattern
Pin Bar
Inside Bar
NR7
Outside Bar

Candlestick Pattern
Hammer
Harami
Doji
Engulfing

Price patterns that tend to form over a longer period are known as chart
patterns. The example below shows the Head and Shoulders pattern, a striking
reversal pattern.
Many traders focus on finding price patterns because they signal an entry. But
price patterns should not be the cornerstone of your trading strategy.

This is because price patterns work best in the correct market context. Hence,
your evaluation of the market bias is crucial.

ADVANCED PRICE ACTION TRADING CONCEPTS

Armed with S/R, trend lines, and price patterns, you can already start looking out
for a trading setup.

But if you want to refine your price action tactics, take a close look at the
following concepts.

 Multiple Failed Attempts

 Confluence
 Multiple Time Frames

MULTIPLE FAILED ATTEMPTS

When the market tries to do something and fails more than once, it is more likely
to move in the opposite direction. (Concept of trapped traders.)

Take a look at these examples.

EXAMPLE #1: TWO LEGGED PULLBACK

This example shows the M2S trading setup that Al Brooks popularized.
In the chart below, you’ll see that the market made two attempts (two upswings)
to move against the trend. Both attempts failed, and the market fell to new
lows.

E
XAMPLE #2: DOUBLE BOTTOM PATTERN
In the chart below, the market made two attempts to push lower before
reversing up. This formation is the well-established Double Bottom reversal
pattern.

Many compelling price patterns are the result of multiple failed attempts.
Hence, this is a principle you can rely on when interpreting price action. It is also
the basis for the re-entry equivalent setup.

CONFLUENCE
Confluence refers to confirmation from different trading tools.

There are infinite possibilities here. Examples:

 A bearish Pin Bar at a resistance zone (A better short setup)

 A Triangle pattern projected a target within an earlier congestion zone (A
more reliable profit objective)
 A bullish Outside Bar breaking the neckline of a Reverse Head & Shoulder
pattern (A better long setup)

The chart below from Template For A Simple Day Trading Strategy shows an

example of confluence working in our favor.

A bearish Pin Bar formed as price met the resistance of the bear trend line. An
excellent short setup.

MULTIPLE TIME FRAMES

Using multiple time frames is an organized method to focus your analysis.

Don’t be intimidated. “Multiple” usually means just two or three time frames.
For instance,

1. A higher time frame to analyze the market context

2. A trading time frame to identify setups
3. A lower time frame to time the entry and limit risk

When using only two time frames, the trading time frame is used to determine
setups, time entries, and limit risk.

The example below used the weekly chart to determine a bullish trend. Then, a
break of the resistance on the daily time frame triggered the long trade.

Multiple time frames offer a glimpse into the fractal nature of financial markets.

Multiple time frames are valuable. But they are optional.

Simply pay close attention to the different degrees of swing pivots and trend
lines within a single time frame. After enough practice, you’ll be able to visualize
what’s happening on the higher and lower time frames, without looking at extra
charts.

You should be comfortable analyzing price action within a single time

frame first. Only then, you can reap the benefits of using multiple charts
without confusing yourself.
For a specialized reading on trading with multiple time frames, check out this
book – Technical Analysis Using Multiple Timeframes .

COMPLEMENTARY TRADING TOOLS

Many trading tools complement price action analysis. When used correctly,
these tools can be valuable to price action traders.

In this section, you will learn about three tools favored by price action traders of
all stripes:

 Moving Average
 Volume
 Price-Only Chart Types

MOVING AVERAGE WITH PRICE ACTION

A moving average is an excellent complementary tool for price action traders.

It is a simple line plotted alongside price action. Hence, it offers depth to your
analysis without obscuring price action.

A short-term moving average can highlight price swings.

The chart below uses a 3-period simple moving average (SMA) of the median
price to track price swings. Median price refers to the mid-price of the bar range.
A medium-term moving average acts as dynamic support and resistance.

For active traders, this setup works well for timing trade entries.

A long-term moving average shows the market trend.

Use moving averages as a tool, not a crutch.

As the examples above show, moving averages add value to price analysis.
However, always remember that you are not trading the moving averages. You
are trading price action.

VOLUME WITH PRICE ACTION

Volume works well with price action. Seasoned price action traders can trade

with just price action and volume.

One of the most reliable and easy-to-spot volume signals is climatic volume.

Climatic volume points to significant support and resistance levels and
might precede a trend reversal.
The chart above shows how a high volume bar set the stage for a major support
zone.

Intrigued?

The best way to study the relationship between price and volume is
through Volume Spread Analysis (VSA).

 Your First Guide To VSA

 Trading With Stopping Volume

PRICE-ONLY CHART TYPES

Typical price charts plot price against time.

Such charts continue to plot new price bars even when the price is unchanged.
This behavior leads to the unpredictable sideways price action that traders
dread.

Price-only charts remove the time element from the chart. In other words,

these charts represent real market movement.
Many traders do well with conventional charts. But most price action traders will
be intrigued by the option of a price-only chart.

The example below shows a type of price-only chart, Renko, which means brick.

A Renko chart forms a new brick only when the market moves beyond the
previous brick by a preset price range. When the market stagnates, the Renko
chart stays still.

Common Price-Only Charts:

 Range Bar
 Renko
 Point & Figure
 Heiken Ashi (This is a modified candlestick chart.)

Be careful. Due to their unique construction, these exotic chart types may defy
the usual price action analysis. Observe them with an open mind and tread
carefully.

BUILDING YOUR PRICE ACTION TRADING PLAN

We’ve covered an array of price action trading concepts. It’s time to create your
own price action trading framework.
Minimally, you should plan for the following:

 Entry Strategy
 Trade Execution
 Stop Losses
 Profit Targets

I’m not going to lie. It takes hard work to put together a functional trading plan.
But the concepts you’ve learned so far and the resources in this section will be of
great help.

The following sections contain examples, advice, and resources to assist you

with each aspect of your trading plan.

ENTRY STRATEGY
The most efficient way to learn is by examples.

I’ve selected three of my favorite simple price action strategies to get you
started.

 Trend Bar Failure

 Trading Pullbacks with Trend Lines and Channels
 John Hill’s Trend Line Theory

TRADE EXECUTION
The moment you enter the market is critical. But how exactly should you enter
into a position?

You have a choice between entering at the market, with a stop order, or with
a limit order.

Make sure you understand the implications of your selected order type – How
To Enter The Market As A Price Action Trader.

STOP LOSSES
You must always limit your risk. A stop loss order is one of the best ways to do
so.

Learn how to set proper stop losses with these guides:

TRADING PULLBACKS USING TREND LINES AND PRICE CHANNELS

If you ask a group of price action traders about their favourite tool, one of the
top answers will be trend lines. Trend lines and price channels are the best tools
for amplifying the power of price action.

In this article, you will learn a powerful pullback trading strategy. It is a simple
approach using nothing but trend lines and channels.

INTRODUCING THE TRADING TOOLS

But before that, let us recap on the trading tools: trend lines and price channels.

IMPORTANT: The explanations below are for bullish price action. Invert the rules for
their bearish equivalents.

TOOL #1: THE TREND LINE

HOW TO DRAW A TREND LINE

 1. Choose two pivots lows. (Make sure that the second pivot low is higher
than the first.)
2. Connect the two points with a straight line.
3. Project the line to the right.

HOW TO USE A TREND LINE

When unbroken, it acts as a price support.

When broken decisively, it flips and serves as a price resistance.

Remember, these rules apply to a bullish trend line that is sloping upwards.

TOOL #2: THE CHANNEL

A channel is a natural extension of a trend line. You must know how to draw a
trend line well before you can master the channel.

HOW TO DRAW A CHANNEL

1. Draw a line that is parallel to the trend line. This line is the channel trend
line.
2. Recall that a trend line is drawn with two swing lows. Find the highest
swing high between the two swing lows. This swing high is the anchor
point.
3. Now, affix the start of the channel trend line to the anchor point.
Together with the trend line, you’ve got yourself a price channel.

HOW TO USE A CHANNEL

In theory, the channel is supposed to contain price action.

When the market exceeds the channel, it is likely to be repelled back into the
channel.

THE PULLBACK STRATEGY

Now, let’s apply these tools using a standard pullback strategy template.

1. Define the market bias with a trend line.

2. Identify an overextended pullback with an opposing price channel.
3. Time the trade entry with the confluence of the trend line and the
opposing channel trend line.

Refer to the chart examples below to see this strategy in action.

EXAMPLE #1 – BAC DAILY CHART

1. These are the two pivot lows used to draw the bullish trend line. This trend
line tracked the bullish market bias.
2. These two pivot highs formed the basis of the orange bear channel.

3. When price hit the bear channel trend line, it was a signal that the pullback
was about to end.

4. The bounce off both the bull trend line and the bear price channel was a
result of solid market support. It was the ideal long entry.

You might find it hard to see the price action details in this example. But the
scale of this chart is needed to show the market context. It’s important to know
that the pullback took place in the setting of a steady bull trend.

EXAMPLE #2 – 6E FUTURES (EUR/USD) 30-MIN CHART

Let’s take a look at how this simple strategy works for intraday time frames too.

1. With these two pivot highs, we drew a bear trend line.

2. An opposing bull channel was drawn with these two pivot lows.

3. Both the bear trend line and the bullish channel trend line resisted the
pullback. It was an excellent short trading setup.
Look closely at both examples. You will notice that both charts showed double
bounces off the channel trend line. Such mini double top/bottom formations are
common in setups featuring complex pullbacks.

TRADING STRATEGY NOTES

This pullback strategy is a minimalist trading method with great potential.

First, the trend line forces you to pay attention to the trend and price action.

Then, the price channel helps you to find steep pullbacks against the trend.
These high angle pullbacks tend to fail spectacularly and lead us into the best
trades.

But there is a common pitfall. Traders often get confused because they are not
sure how to select the swing pivots. They also lack a clear set of rules for
drawing the trend lines and channels. So you must figure that out first.

Learn a fixed method to identify pivots, trend line, and channels. Then,

make an effort to stay consistent. Don’t look back in time and try to adjust your
trend lines after the trade.

Take care of this aspect, and you can safely make the most out of this trading
strategy.

In the examples here, I’m using the trend line and channel techniques taught in
the Day Trading With Price Action Course. You need not use the same methods.
Instead of chasing after the best trend line drawing method, remember that
consistency is more important.

STRATEGY NOTES FOR THE DAY TRADING WITH PRICE

ACTION COURSE
In these examples, we drew the trend lines using valid pivots as taught in the
course. For consistency, it’s a rule you should stick to.

As for the opposing channels, it’s perfectly okay to draw them with basic pivots.
It’s a tweak to find more setups. (That’s what we did in Example #2. It explains
why the pullback in Example #2 is less complex than the one in Example #1.)
After all, we are fading the opposing channels. So, it makes sense to use the less
significant basic pivots to draw them.

4 TRADING STRATEGIES FOR THE TREND LINE TACTICIAN

Price action traders can’t do without their trend lines. Trend lines are practical
tools for tracking and trading trends. It makes sense to form trading strategies
with this simple but useful tool.

Many traders who seem to trade with a blank chart have in fact internalised the
art of trend line drawing. They can visualise the trend lines with actually drawing
them.

Trend lines track trends. And when it comes to trading trends, you can go
for retracements or reversals. You can work on the premise that the trend will
continue or reverse.

You can classify the four trading strategies below with this understanding.

1. Trend Line Bounce – Aggressive Retracement

2. Minor Trend Line Break – Conservative Retracement
3. Major Trend Line Break – Aggressive Reversal
4. Major Trend Line Break and Retest – Conservative Reversal

Here are the four trading strategies in detail.

#1: TREND LINE BOUNCE (AGGRESSIVE RETRACEMENT)

A trend line bounce is a classic pullback trade.

The price action premise here is that the trend (as highlighted by the trend
line) will resume.

A bull market will bounce up from a trend line. Likewise, a bear market will
find resistance and bounce down from a bearish trend line.

There are two approaches for this trading strategy.

The more conservative method is to wait for a confirming price pattern to form.

An example is shown below.
The more aggressive method is to enter wit a limit order once price hits the
trend line. It allows you to enter at a better price if the trend does resume.
However, as it lacks confirmation, its probability of success is generally lower.

If you use a limit order to enter, consider using a volatility stop-loss.

#2: MINOR TREND LINE BREAK (CONSERVATIVE RETRACEMENT)

In this context, you are looking for a minor trend line that goes against the trend.

The beauty of this trading strategy is that it uses a single trend line for two
purposes. The same trend line defines the retracement and triggers the
trade.
As shown in the example above, this trading strategy leads us into the market on
the side of the major trend. The trigger is the break of the minor trend line.

Let’s drill into the specifics of the trigger. There are several definitions of a trend
line break. To use it as an effective trigger, you must know which one you want to
use.
You can consider a trend line broken when:

 The market trades through it

 The market trades through it by a certain price threshold
 A price bar closes beyond it

Waiting for a price bar close to confirm the trend line break works well. But
there’s a drawback. In volatile markets, you might not be able to enter before
the trend pushes to a new extreme.

This trading strategy is conservative because it requires a minor trend line to

form against the current trend.

For that to happen, a more complex retracement must be present. At least, it

must be a two-legged retracement.

However, the aggressive and conservative labels for retracement trades

are not absolute. It depends on the actual price action and the way you draw
your trend lines.

It is possible that a trend line bounce setup is a more conservative strategy. For
a retracement trade, the guideline is that the deep retracements mean
conservative trades.

(Note to Day Trading With Price Action Course students: The minor trend line
here is not the default trend line drawn with valid pivots. As we are looking to
trade the failure of these minor trend lines, make an exception and use basic
pivots to draw them.)

#3: MAJOR TREND LINE BREAK (AGGRESSIVE REVERSAL)

A major trend line tracks the trend. Thus, when it is broken, it is a technical
reversal signal.
The chart above shows a great example.

While it might suggest that this strategy is perfect, it is far from it. In fact, the
trend line tracking the market had been broken many times without reversing.

Established trends seldom reverse sharply without any other signals. Usually,
you will find climatic volume and price movement before a sharp reversal. Use
these signals to augment this trading strategy.

You can also use divergences or other reversal trading tools with this trading

strategy.

The key point is that it is an aggressive reversal trading strategy. Don’t use it in
isolation.
#4: MAJOR TREND LINE BREAK AND RETEST
In this trading strategy, we don’t go short once the trend line is broken.
Instead, we give the market a chance to resume the trend. If it cannot do that,
then we enter into a reversal trade.

This is why it is a more conservative strategy.

Let’s see how it works in the chart below.

What you want to see here is an inability of the market to rise above the broken
trend line. If a broken bullish trend line resists the market from rising higher, a
reversal is likely.

Thus, here, a close examination of the price action upon the retest is

pivotal. In the chart above, the prior sideways action and the rejections from the
trend high are telling.
Taken together, they show that the market has difficulties resuming the bullish
trend. Hence, a reversal trade is sensible.

Sharp reversals are possible but unlikely. When you catch them, your reward is
huge and comes swiftly. But if you are patient and are willing to skip the sharp
reversals, this retest strategy is for you.

CONCLUSION – TREND LINE TRADING STRATEGIES

Experienced discretionary price action traders will find that these strategies are
all they need.

These four trading strategies are far from perfect. But they provide a basic
template for building your trading strategy.

For any trading strategy to work, you must be consistent. Do not draw trend
lines in a haphazard manner. Stick to a set of clear rules for drawing your trend
lines.

All trend lines in this article are drawn with objective rules taught in my trading
course. You need not use the same rules, but stay consistent with your chosen
method.

TWO-LEGGED PULLBACK TO MOVING AVERAGE (M2B, M2S)

Many price action traders claim that two-legged pullbacks are the most reliable
trade setups. The variant we are reviewing today is from Al Brooks, who
wrote three tomes on price action trading. These three books are not an easy
read, but are extremely informative for price action traders.

In his books, he identified a two-legged pullback to the moving average as one of

the best trade setups when there is a strong trend.

Before we start, let’s have a basic explanation of counting legs. Any bar that goes
higher than the previous bar starts a new leg up. Any bar that goes lower than
the previous bar starts a new leg down.
TRADING RULES – TWO-LEGGED PULLBACK TO MA
LONG TRADING SETUP – M2B

1. Strong up trend
2. Two-legged pullback down to 20-period EMA
3. Enter a tick above the bar that tested the 20-period EMA

SHORT TRADING SETUP – M2S

1. Strong down trend

2. Two-legged pullback up to 20-period EMA
3. Enter a tick below the bar that tested the 20-period EMA

TWO-LEGGED PULLBACK TO MA TRADE EXAMPLES

WINNING TRADE – M2S

This is 5-minute chart of ES futures contract, which is the main instrument Al
Brooks trades. This trade is a beautiful example of a two-legged pullback
trade.After prices crossed below the EMA, it tried to crossed back but was clearly
rejected.The strong downwards thrust confirmed the down trend, which was
what we needed before looking for continuation trades.The two short dotted
lines highlight the beginning of each leg up. This two-legged pullback looked
good with the long top tails that showed as prices approached the EMA. The long
top tails implied selling pressure.LOSING TRADE – M2B

Anot
her session of S&P E-mini futures showing 5-minute bars, which is Al Brook’s
recommendation as the sweet spot for day traders.
 1. The day started with swings up and down without a clear direction.
However, as prices made new lows, bottom tails emerged, showing buying
pressure.
2. The up swing above the EMA seemed strong as there were eight
consecutive bars with higher lows. However, there were three bear trend
bars within the swing, which hinted at persistent bears.
3. Following a two-legged pullback to the EMA, we had a bullish reversal bar
as our signal bar. We entered a tick above it but got stopped out after
some sideways movement.

A key difference between the losing trade and the winning trade is how
certain we were that the market was trending. In the winning trade example,
we saw clear rejection from the EMA, which we did not see in the losing
example.

REVIEW – TWO-LEGGED PULLBACK TO MA

Continuation trades work because the trend traps counter-trend traders. Two-
legged pullbacks are more enticing to counter-trend traders and works better as
a mousetrap for them.

Hence, in a trending market, the two-legged pullback to the moving average is a

simple and high probability trading setup.

The key lies in finding trending markets. Pay attention to signs of a trending
market and trade opportunities will present themselves. Very often, you can pay
attention to the space between prices and the moving average for a sense of
momentum. Two-legged pullbacks that follow strong momentum are better
quality setups.

However, very strong trends tend to have single leg pullbacks. If you insist on
waiting for two-legged pullbacks, then you must be ready to miss some trades in
strong trends.

Also, with regards to counting legs of price movement, there are many nuances
that we did not cover. Refer to Al Brooks’ Trading Price Action Trends: Technical
Analysis of Price Charts Bar by Bar for the Serious Trader (Wiley Trading)  to learn
more.

9 TOOLS THAT TREND TRADERS CAN USE TO FIND REVERSALS

What is your trading strategy for finding the most reliable trend reversals?

As a trend trader, you want to position yourself along with the market trend. A
trend reversal is both your entry and your exit.

This is why you must answer this question to the best of your ability. Focusing
on finding the best reversals will put you on the path to trading success.

Conversely, each false reversal can cause you to miss potential trading setups. It
will also have you scrambling to get back into the flow.

For a trend trader, the power of a multi-pronged approach is very real. With a
set of varied tools, you can find reliable trend reversals with confirmation.

This brings us back to one important question: what are the best tools for a
trend trader?

Like most traders, you probably have a general idea of how to find a reversal.
For instance, you might rely on a moving average.

But, you don’t want to stop there. There are two other things that you need to
do:

 Learn about different types of trading tools: price action, technical

indicators, and volume tools.
 Appreciate the power of including a variety of tools in your trend analysis.

With that in mind, let’s review nine tools that you can combine to find the best
trend reversals as a trend trader.

PRICE ACTION TOOLS

Price action is essential. It is a solid cornerstone of a technical trading strategy.

If price is reversing, nobody can argue with that.

#1: SWING PIVOTS

For examining price action, you need tools that are practical, simple, and useful.
This is exactly what you get with swing pivots.
What are swing pivots?

Open any chart and you will see that price does not move in a straight line. It
moves in waves. The start and end points of these waves are swing pivots.

I’ll be the first to tell you that there are many ways to define a swing. At the same
time, you should focus on one definition so that you don’t get bogged down with
too many choices.

Once you’ve marked swing pivots on a chart, higher highs mean a bullish
trend. Lower lows mean a bearish trend.

In this example, I’m using the swing definition taught in my price action trading
course.

As you can see above, interpreting swings for reversals is not always clear-cut.
But with experience, you can use price swings to find areas of potential
reversals.

#2: TREND LINES

Trend lines are essential to a trend trader’s search for reversals. A trend line
defines and tracks a trend.
The basic signal of a trend reversal is when price breaks a trend line.

However, false breaks are common. Hence, the key is the magnitude of the
trend line break.

You can draw trend lines by connecting swing pivots. Again, there are many
ways of drawing a trend line. But remember that your choice is less
important than staying consistent.

Many traders learn by drawing trend lines ex-post on historical charts. It gives
the impression that perfect trend lines are easy to find.

Don’t get into that trap. Instead, develop an objective method of drawing trend
lines. Once that is done, you can draw them confidently in real-time.

The trend line in the example below is drawn using the method taught in
my price action trading course.

Combining swing pivots with trend lines is a great trend trading method. The 1-
2-3 reversal is a basic strategy that relies on swing pivots to define a trend
reversal.

You can learn more about the 1-2-3 reversal in Trader Vic’s book.
#3: PRICE CHANNELS
A price channel is formed by extending a parallel line from a trend line.

Most trends go through a channel phase. During that phase, price

action bounces between the trend line and the parallel line. (The parallel line is
also known as the channel line).

To find reversals with a trading channel, look for overshoots of the channel line.

Note that this approach anticipates a reversal. It is unlike the trend line strategy
above which waits for a trend reversal to take place.

If you are an aggressive trend trader, this price action tool is for you.

A balanced approach is to start with watching for channel overshoots as a

warning. Then, look out for a trend line break as confirmation.

TECHNICAL INDICATORS
While price action is useful, indicators can also help trend traders in finding
reversals.

Technical indicators are also suitable for tracking a large set of instruments.  You
can easily set up clear criteria to scan for potential reversals.
#4: MOVING AVERAGE
A trend trader can also find reversals with an intermediate to long-term moving
average.

My preferred method of using a moving average is by observing its direction.

The strength of moving averages is that you can use a few of them to track
trends of varying degrees.

However, apply too many moving averages and you’ll turn this strength into a
drawback.

If you are just starting out, consider the 50-period moving average. For tracking
shorter trends, you might want to use the 20-period moving average.

#5: DONCHIAN CHANNEL

This is the indicator used by the famous Turtles.

The original strategy’s profitability might have been eroded, but the Donchian

Channel maintains its status as a powerful trend tracking tool.

In fact, the Donchian Channel is grounded with price action. It’s not your typical
indicator with hard-to-grasp formula.
The Donchian Channel has two lines. They are the highest price and the lowest
price attained within the lookback period.

This means that it is simply defining a price range using historical price
action.

Let’s take a look at the Donchian Channel in action.

Refer to this free PDF for a detailed explanation of the Turtle trading approach.

#6: MOVING AVERAGE CONVERGENCE DIVERGENCE (MACD)

As a trend strengthens, two moving averages of different periods will diverge. As
a trend weakens, two moving averages will converge.

This is what Gerald Appel observed and used as the basis for the MACD
indicator.

For trend traders, an impressive use of the MACD is for finding price

divergences. A price divergence is a powerful reversal signal. It occurs when
price and an oscillator disagree.
Technically, you can define a price divergence with two points. However, using
three points like in the example above improves the quality of the setup.

VOLUME TOOLS
Volume are important confirmation tools.

However, as they do not relate to price action directly, they tend to give early
signals that might be less reliable.

Nonetheless, when used correctly, they give the trend trader a chance to enter
the market before everyone else.

#7: ON BALANCE VOLUME (OBV)

OBV is a cumulative indicator. It means that its value does not depend on a
lookback period. It increases and decreases according to the polarity of each
price bar.
The key implication is that you should ignore its values, and focus on its
direction.

If both price and OBV are rising, the bullish trend is solid. Once the OBV starts to
lose steam, a trend trader might sense danger. A reversal might be impending.

I like to observe the OBV through a long-term moving average of its values. A
moving average helps to highlight the trend of the OBV, which is as important as
the trend of the market.

In the example below, the background colour shows the slope of the OBV
moving average. (green means up and red means down)

To learn more about trading with OBV, take a look at this article.

#8: VOLUME OSCILLATOR

The Volume Oscillator is a handy tool but you must be careful. As it is based on
volume, you must interpret it differently from price oscillators like MACD and
RSI.
Positive values do not mean that bullish prices are supported. They mean that
the trend, in either direction, is healthy. Negative values mean that the trend is
weak.

With this knowledge, trend traders can also use divergences to find potential
reversals.

Using the Volume Oscillator well is more challenging than applying price
oscillators. Practise more and you will be well-rewarded with a volume
perspective to price action.#9: VOLUME EXTREMES

Extreme volume is a sign that the trend might have run its course.In a rising
trend, sudden extreme high volume might be the result of climatic buying.
Climatic buying implies that all the buyers have bought. When there are no
buyers left, the market can only go one way – down.The same logic applies in
a falling market. Climatic volume might have taken out all the sellers. Then,
when there’s no more sellers, the market can only rise.You can spot extreme
high volume bars in retrospect easily. However, in real time, you might hesitate
in deciding how high is high.

To solve this problem, you need a more objective method to determine if

volume is high. One way is to use Bollinger Bands applied on volume data –
orange line in the chart below.

Extreme high volume also helps to define reliable support and resistance levels.

CONCLUSION – TOOLS FOR TREND TRADERS

As a trend trader, you appreciate the importance of reliable reversal signals. But
that’s only half the battle.If you’re going to look for reversals, you should use
an arsenal that includes both price and volume.Also, don’t throw indicators out
of the window. Instead, learn to use them prudently with price action as your
beacon.
As you’ve learnt, some tools anticipate a reversal while other confirm a reversal.
While no tool is flawless, you can use them to your advantage.For instance, you
can put on a small position based on the anticipation of a reversal.
Then, increase to your full position once the reversal is confirmed.

Spotting reversals is one of the toughest but most rewarding trading approach.
This is why a trend trader needs the best tools available.

THE 3 PRACTICAL USES OF PRICE CONGESTION THAT

TRADERS MISS
When you see sideways price action, what goes on in your mind? Is it danger,
opportunity, or a blank? Don’t let it be a blank. Put every congestion pattern to
good use with these 3 practical uses of price congestion.

Stop giving a useless label to sideways price action. Instead, use them to

improve your price action reading skills. These rectangles on your charts might
just be the boost you need for achieving your trading goals.

#1: CONGESTION ZONES AS SUPPORT AND RESISTANCE

Most traders look for support and resistance based on swing pivots. Some
traders use pivot point formula and Fibonacci projections for the same purpose.

These are great methods, but don’t overlook congestion areas. They project solid
support and resistance zones that are highly reliable.

The example below shows the ES 5-minute chart across three trading sessions.
Blue areas mark the Congestion Zones, and dotted vertical lines separate the
sessions. (Click on image to zoom.)
 1. Towards the end of the trading session, price congested.
2. The first half an hour of the next session found buyers around the area of
that Congestion Zone. Note the long lower tails of the price bars.
They hinted at the supportive strength of the congestion from the last
session.
3. Indeed, in the next session, the early morning price fall was halted by this
support zone.
4. Let’s rewind a little back to the Congestion Zone found in the middle of the
second session. We projected a potential support and resistance zone with
it as well.
5. The next session opened near the zone, which acted as a support area
which failed quickly.
6. However, the zone made a clear show of its power as resistance.

This method relates to the idea of using high volume formations as support and
resistance. As a market moves sideways, trading volume is concentrated within a
price band. This high volume price band then forms a potential support or
resistance zone.

#2: CONGESTION ZONES FOR TRADE EXITS

Most trends do not reverse sharply. They tend to drift sideways before resuming
or reversing.
If you’ve managed to join a trend and secured a paper profit, use signs of price
congestion to take your profit. You can get out with a nice real profit before the
trend resumes or reverses.

Day traders can combine congestion patterns with the time of the day for
effective exits. Congestion signals at midday and towards the end of the session
make a strong case for immediate exit.

Look at the day trading example below. It shows an entire ES trading session.

1. The sideways action here pushed the market into uncertainty. If you were
short, it was a good place to cover.
2. Bears who covered upon the midday price congestion would have avoided
this adverse movement.
3. The afternoon congestion gave another chance for bears to take profit.
4. If not, they would give some profit back to the market as it reverses
up towards the end of the session.

#3: CONGESTION ZONE AS WARNING ZONE

When the market congests for a prolonged period, it is a warning. It cautions you
that the profit potential of your trade is limited. That is true at least until the
market breaks out from the congestion.

It is best not to risk your precious trading capital when profit potential is
limited. Trying to anticipate the eventual break-out is reasonable, but expect
multiple failed break-outs. Staying out is the best policy.

It is always wise to stay out of prolonged sideways action like the one in the
chart above.

REVERSAL CHART PATTERNS

The first five chart patterns are reversal patterns.

Typically, they start by trying continue the trend. When that last-ditch attempt
fails, the reversal is confirmed.

However, remember that most reversal patterns fail, especially when the trend
is strong. Hence, trade them carefully.
1. HEAD & SHOULDERS

WHAT DOES A HEAD & SHOULDERS PATTERN LOOK LIKE?

The bullish pattern has three swing lows. The middle swing low is the lowest.
The line connecting the two swing highs is the neckline.

The bearish pattern has three swing highs. The middle swing high is the highest.
The line connecting the two swing lows is the neckline.

WHAT DOES A HEAD & SHOULDERS PATTERN MEAN?

In the bullish instance, the left shoulder and the head highlight the
downwards trend. The right shoulder, by ending above the head, halts the
bearish trend.

The break of the neckline then confirms a change of trend. Hence, the Head &
Shoulders pattern is a reversal chart pattern.

The same logic works for the bearish pattern as well.

HOW DO WE TRADE A HEAD & SHOULDERS PATTERN?

As it is a reversal chart pattern, we need an existing trend to reverse. A bullish
pattern must take place in a downwards trend, and a bearish pattern should
take place in a upwards trend. Generally, the longer the trend, the larger the
Head & Shoulders formation needed to reverse it.

For a bullish pattern, buy:

 On break-out above the neckline; or

 On pullback to the neckline after the break-out.

For a bearish pattern, sell:

 On break-out below the neckline; or

 On pullback to the neckline after the break-out.

Volume should increase on break-out.

For the target objective, measure the distance between the neckline and the
head. Then, project the distance from the break-out point.
2. DOUBLE TOP / DOUBLE BOTTOM

WHAT DOES A DOUBLE TOP / BOTTOM PATTERN LOOK LIKE?

A Double Bottom has two swing lows at around the same price level. The swing
high in between them projects a resistance line.

A Double Top has two swing highs at around the same price level. The swing low
in between them projects a support line.

WHAT DOES A DOUBLE TOP / BOTTOM PATTERN MEAN?

In a Double Bottom, the first swing low marks the extreme low of a downwards
trend. When the second swing low fails to push below it, it is a warning that a
reversal might occur. Once the market breaks above the resistance level, it
confirms the bullish reversal.

In a Double Top, the same logic applies and leads to a bearish reversal.

HOW DO WE TRADE A DOUBLE TOP / BOTTOM PATTERN?

As it is a reversal chart pattern like the Head & Shoulders, we must have a trend
for the pattern to reverse. Do not look for reversal patterns like the Double Top /
Bottom in a sideways market.

For a bullish pattern, buy:

 On break-out above the resistance line; or

 On pullback to the resistance line (now acting as support) after the break-
out.
For a bearish pattern, sell:

 On break-out below the support line; or

 On pullback to the support line (now acting as resistance) after the break-
out.

Volume should increase as price breaks out of the resistance/support line.

To get the target objective, measure the height of the pattern and project it

from the break-out point.

3. TRIPLE TOP / TRIPLE BOTTOM

WHAT DOES A TRIPLE TOP / BOTTOM PATTERN LOOK LIKE?
If you can find a Double Top / Bottom, looking for a Triple Top / Bottom is
straightforward.
A Triple Bottom has three swing lows at around the same price level, and a
Triple Top has three swing highs at around the same price level.

You can also relate it to the Head & Shoulders chart pattern. Just that in this
case, the middle pivot is equal to the other two pivots.

WHAT DOES A TRIPLE TOP / BOTTOM PATTERN MEAN?

The Triple Bottom represents two failed attempts to push below the support
established by the first swing low. Naturally, it hints at a trend reversal. A break-
out above the resistance line confirms the reversal.

Similarly, the Triple Top shows two unsuccessful tries to continue an upwards
trend and signifies a bearish reversal.

HOW DO WE TRADE A TRIPLE TOP / BOTTOM PATTERN?

The trading method is akin to the Double Top / Bottom chart pattern.

For a Triple Bottom chart pattern, buy:

 On break-out above the resistance line; or

 On pullback to the resistance line (now acting as support) after the break-
out.

However, drawing the resistance line of a Triple Bottom might be tricky,

especially if the two swing highs are unequal.

In that case, you can draw the resistance line:

  With the higher swing high; or
 With the second swing high; or
 Somewhere in the middle of the two swing highs.

For a Triple Top chart pattern, sell:

 On break-out below the support line; or

 On pullback to the support line (now acting as resistance) after the break-
out.

You can draw the support line of a Triple Top pattern:

 With the lower swing low; or

 With the second swing low; or
 Somewhere in the middle of the two swing lows.

Volume should increase when price breaks out of the resistance/support line. It

should also decrease with each upswing in the case of a Triple Top. For a Triple
Bottom, volume should decrease with each down swing.

For the target objective, measure the height of the pattern and project it from
the break-out point.

Read: Trading Candlesticks with Triple Tops / Bottoms

4. ROUNDING TOP / ROUNDING BOTTOM

WHAT DOES A ROUNDING TOP / BOTTOM PATTERN LOOK LIKE?

A Rounding Top consists of minor price swings that rise and fall gradually,
presenting a dome shape at the top of the chart.

Flip a Rounding Top vertically, and it becomes a Rounding Bottom.

Rounding Tops / Bottoms usually take a long time to form and are found more
often on weekly charts.
WHAT DOES A ROUNDING TOP / BOTTOM PATTERN MEAN?
A Rounding Top shows a gradual change of market sentiment from bullish to
bearish.

A Rounding Bottom implies a sentiment change from bearish to bullish.

This reversal formation is relatively subdued.

HOW DO WE TRADE A ROUNDING TOP / BOTTOM PATTERN?

For a Rounding Bottom chart pattern, buy when price closes above the high of
the pattern.

For a Rounding Top chart pattern, sell when price closes below the low of the
pattern.

You can take a more aggressive entry by looking for short-term price patterns
before the completion of the pattern, especially if the volume pattern is
encouraging.

Volume should decrease towards the middle of the pattern and rises again
towards the end of it.

For the target objective, measure the height of the pattern and project it from
the break-out point.
5. ISLAND REVERSAL

WHAT DOES AN ISLAND REVERSAL PATTERN LOOK LIKE?

An Island Reversal is a piece of price action that is completely broken off from
the rest of the chart.

It has a gap before it (Exhaustion Gap) and a gap after it (Breakaway Gap).

A bullish Island Reversal starts with a down gap in a bear trend. After a period of
sideways trading, the market gaps upwards to reverse the bearish trend.

A bearish Island Reversal starts with an upwards gap, followed by sideways

trading before reversing the trend with a downwards gap.

In both cases, the two gaps must have overlapping price range.

WHAT DOES AN ISLAND REVERSAL PATTERN MEAN?
The first gap represents a climatic move aligned with the existing trend.
However, instead of following through with the gap’s momentum, the market
meanders.

Hence, when the market makes a gap against the trend, it is a reversal signal.

The logic behind this chart pattern is similar to the Morning Star and Evening
Star candlestick patterns.

HOW DO WE TRADE AN ISLAND REVERSAL PATTERN?

For a bullish pattern, buy when price gaps up away from the Island.

For a bearish pattern, sell when price gaps down away from the Island.

For this chart pattern, volume should decrease for the first gap and increase
with the second gap that is reversing the trend.

For the target objective, measure the height of the Island and project it from
the breakaway point.
CONTINUATION CHART PATTERNS
As price retraces in a trending market, it forms a variety of continuation chart
patterns.

To find these chart patterns, simply draw two lines to contain the retracing price
action. Draw one line above the retracement (“resistance”) and one line below it
(“support”).

As you will see below, the relationship between these two lines will help us
differentiate the continuation chart patterns.

6. RECTANGLE
WHAT DOES A RECTANGLE PATTERN LOOK LIKE?
If two horizontal lines surround a retracement, it is a Rectangle chart pattern.

Both the bullish and bearish Rectangle patterns looks the same. However, they
appear in different trend context.

WHAT DOES A RECTANGLE PATTERN MEAN?

A Rectangle chart pattern indicates sideways action.

When the market enters in a congestion phase, it is likely to break out in the
direction of the preceding trend.

HOW DO WE TRADE A RECTANGLE PATTERN?

Remember that the trend before the Rectangle chart pattern determines if the
pattern is bullish or bearish. A Rectangle pattern continues the prior trend.

For a bullish pattern, buy:

 On break-out above the resistance line; or

 On pullback to the resistance line (now acting as support) after the break-
out.

For a bearish pattern, sell:

 On break-out below the support line; or

  On pullback to the support line (now acting as resistance) after the break-
out.

Volume should increase when price breaks out of the resistance/support line.

For the target objective, measure the height of the Rectangle and project it

from the break-out point.

7. WEDGE
WHAT DOES A WEDGE PATTERN LOOK LIKE?
For a Wedge pattern pullback, the two lines converge.

A bullish Wedge chart pattern takes place in an upwards trend, and the lines
slope down. It is also known as a Falling Wedge.
A bearish Wedge chart pattern is found in a downwards trend, and the lines
slope up. (Rising Wedge)

WHAT DOES A WEDGE PATTERN MEAN?

The defining feature of a Wedge chart pattern is the set of converging trend
lines.

It means that the magnitude of the swings within the Wedge

pattern is decreasing. This contraction in swing magnitude implies that
the Wedge is moving against the path of least resistance.

Hence, when the market moves decisively with the trend, it confirms that the

trend is resuming.

HOW DO WE TRADE A WEDGE PATTERN?

For a bullish pattern, buy when price breaks above the resistance.

For a bearish pattern, sell when price breaks below the support.

Volume should decrease as the Wedge pattern forms, and increase with the

break-out.

For the target objective, measure the height of the entire Wedge pattern and
project it from the break-out point.
8. TRIANGLE
WHAT DOES A TRIANGLE PATTERN LOOK LIKE?
There are three types of Triangle chart patterns.

 Ascending
 Descending
 Symmetrical

We can describe each variant easily with the two trend lines surrounding the
retracement,

An Ascending Triangle has a horizontal resistance and a rising support. (Example

on the right.)

A Descending Triangle has a falling resistance and a horizontal support.

(Example below.)
A Symmetrical Triangle has a rising support and falling resistance. The support
line and the resistance line should slope at similar angles to produce the
symmetry. (Example on Investopedia.)

WHAT DOES A TRIANGLE PATTERN MEAN?

An Ascending Triangle pattern is a bullish chart pattern. It shows the market in a
pause during an upwards trend. However, the rising swing lows imply
bullishness.

By the same logic, a Descending Triangle pattern, with the lower swing highs, is a
bearish pattern.

The Symmetrical Triangle is a continuation pattern as well. However, its

directional tendency is less obvious. It depends on the trend in which it
forms. Thus, it is bullish when it forms in a bull trend and bearish in a
downwards trend.

HOW DO WE TRADE A TRIANGLE PATTERN?

In a bull trend, buy on break-out above an Ascending Triangle or a Symmetrical
Triangle.

In a bear trend, sell on break-out below a Descending Triangle or a Symmetrical

Triangle.

Volume should decrease as the Triangle chart pattern forms, and increase with

the break-out.
For the target objective, measure the height of the widest part of
the Triangle and project it from the break-out point.

9. FLAG
WHAT DOES A FLAG PATTERN LOOK LIKE?
A Flag pattern has a flag pole and a flag.

The flag pole is a sharp thrust in the direction of the trend. Identifying the flag
pole is critical for the Flag pattern. Look for strong and obvious price thrusts with
consecutive bars, gaps, and strong volume in the same direction.

For a bullish Flag pattern, we need an up thrust as the flag pole. The flag is made
up of two parallel lines that slope downwards.

The bearish Flag pattern has a down thrust as the flag pole.  The two lines
making up the flag are also parallel, but slope upwards.
(A related chart pattern is the Pennant Pattern, which is essential a flag pole with
a Triangle pattern as the flag.)

WHAT DOES A FLAG PATTERN MEAN?

The key feature of a Flag pattern is the flag pole which is a powerful price move.
The Flag pattern represents a short break before the market continues moving
in the same direction.

Hence, it is an ideal continuation chart pattern.

HOW DO WE TRADE A FLAG PATTERN?

Buy on break-out above a bullish Flag pattern.

Sell on break-out below a bearish Flag pattern.

Volume should decrease as the Flag pattern forms, and increase with the break-

out.

The target projection for a Flag pattern is different from the other chart

patterns. Measure the height of the flag pole. Then, extend it from the lowest
point of a bullish flag or the highest point of a bearish flag.
10. CUP & HANDLE

WHAT DOES A CUP & HANDLE PATTERN LOOK LIKE?

The cup looks like a Rounding Bottom. The handle, which follows the cup, looks
like a typical retracement (for e.g. Wedge, Flag).

The Cup & Handle chart pattern is a bullish pattern. Its bearish counterpart is
the Inverted Cup & Handle pattern.
WHAT DOES A CUP & HANDLE PATTERN MEAN?
A Cup & Handle pattern is basically a Rounding Bottom following by a pullback.
Hence, it marks a period of consolidation in which the bulls take over from the
bears gradually.

The last retracement (handle) is the last bearish push. When it fails, we expect
the market to rise.

An Inverted Cup & Handle pattern follows a similar logic with a Rounding Top
and a pullback upwards.

HOW DO WE TRADE A CUP & HANDLE PATTERN?

The conservative entry for the Cup & Handle chart pattern is to buy on break-out
of the high of the cup. The aggressive entry can take place once the handle
pullback fails.

For the Inverted Cup & Handle pattern, you can sell when the market breaks
below the low of the cup or when the handle pullback breaks down.

The volume pattern should resemble that of a Round Top / Bottom for both the
cup and the handle formations.

For the target objective, measure the depth of the cup and project it from its
high (or low for the Inverted pattern).
To learn more about trading with the Cup & Handle pattern, refer to How to
Make Money in Stocks: A Winning System in Good Times and Bad, Fourth
Edition.

WHAT IS AN INSIDE DAY?

An Inside Day is a two-bar pattern. To identify an Inside Day, you need to
compare the current day with the day before.

 The day high must be lower than the previous day high.
 The day low must be higher than the previous day low.

Simply put, for a day to be an Inside Day, its price range must be
completely within the range of the preceding day.
KNOW YOUR INSIDES: INSIDE DAY, INSIDE BAR, HARAMI
Inside Bar is any price bar that lies within the range of the price bar before
it. Inside Day is an Inside Bar on the daily chart.

Harami is a candlestick pattern that focuses on the range of the candle

body. (Candle body refers to the range between the open and close price of a
bar.)

A Harami is formed when the candle body lies within the body of the previous
candlestick. Its premise is similar to the Inside Day, but they are different
patterns.

Click here to learn more about the Harami pattern.

WHAT DOES AN INSIDE DAY MEAN?

An Inside Day shows you what the market is not doing.

The market failed to rise above the previous day high. It also could not fall below
the previous day low. Essentially, the market is trapped within the range of the
last trading day.

The market is not moving.

Many traders think of an Inside Day as a trend reversal signal. This approach
makes sense when other factors support a reversal.
A more sensible way to interpret an Inside Day is to view it as market
indecision. It signals lower volatility in the market.

Market uncertainty might precede a reversal, but it can also be a pause in the
current trend.

You can use the relative range of the Inside Day to judge the level of indecision.

If the range of the Inside Day is just slightly smaller than the previous day range,
it hints at a slight hesitance. But if the Inside Day range is much lower than the
previous day range, it implies deep uncertainty.

HOW DO YOU TRADE AN INSIDE DAY?

ESSENTIAL TRADING NOTES

An Inside Day is a short term price pattern. It shows a pause in the market,
but tells nothing of its future direction. Hence, you must not construct a trading
strategy using only Inside Days.

It is crucial to trade an Inside Day as part of the dominant market

trend. Always assume that the market will resume its current trend after an
Inside Day. Make an exception only if there are substantial evidence of an
impending reversal.

Be careful of trading Inside Days in a sideways market. In choppy price

environment, Inside Days are unreliable and offer inferior reward-to-risk ratio.

INSIDE DAY ENTRY

Use price action to trigger an Inside Day setup.

 Enter a long setup after a break of the high price of the Inside Day
 Enter a short setup after a break of the low price of the Inside Day
ALTERNATIVE ENTRY METHODS
Instead of waiting for a breakout of the Inside Day, you may enter the market
based on the next day’s opening price. To learn more about this entry
strategy, click here for the Three-Bar Inside Bar review.

To trade a breakout in either direction, use an OCO order. It allows you to catch

a breakout regardless of the breakout direction.

Consecutive Inside Days imply that a triangle chart pattern is forming on a lower
time frame. In this case, it’s a good idea to drill down to the lower time frame to
finetune your entry.

INSIDE DAY EXIT

One of the advantages of using an Inside Day is the implied pattern stop.

When you enter a long setup, use the low of the Inside Day as your stop-loss.
When you enter short setup, use the high of the Inside Day as your stop-loss.
As an Inside Day usually has a contracted price range, it offers a relatively tight
stop-loss. While this works well to limit your trading risk, it exposes you to more
whipsaws. Hence, if you are confident of your trend evaluation, consider a re-
entry if you are stopped out.

ALTERNATIVE EXIT METHODS

Volatility stop losses are also useful for reducing whipsaws. By considering the
recent volatility, you can arrive at a logical stop-loss. This approach usually
allows the setup more breathing room to wiggle.

Learn more about volatility stops here.

Consider using a time stop. This approach is useful for scalp-like trades aiming
for a conservative target. It will help to ensure an efficient use of trading capital
and disciplined trading. An example is to exit the trade in two days regardless of
the profit/loss status.

INSIDE DAY TRADING EXAMPLES

EXAMPLE 1: INSIDE DAY WITH 50-PERIOD SIMPLE MOVING AVERAGE

In this example, the 50-period simple moving average (SMA) is our trend filter.

This chart shows three successful bearish breakouts of Inside Days shortly

after the market fell below the SMA.
You can use this straightforward method with any trend filter. Trend lines work
well too.EXAMPLE 2: REVERSAL TRADING – INSIDE DAY WITH MACD DIVERGENCE

Inside Days should never be used in isolation to trade trend reversals. However,
Inside Days can form part of a reversal trading strategy.In this example, the solid
MACD divergence pattern set the stage for a reversal trade. The bullish inside
bar at the trend extreme served as a low-risk entry for a reversal setup.

Exhaustive volume spikes are valuable reversal clues as well.

3 WAYS TO IDENTIFY A TREND WITH A MOVING

AVERAGE
Experienced traders can pick up a trend with their honed trading instincts. But
for new traders, having an objective method to find and confirm trends is
critical. A robust framework offers new traders the ability to learn first and
improvise later. For this, the moving average is one the best tools you can
use.Aspiring system traders can use these methods to kick-start for their
strategy code. As you progress, you can refine them your market
understanding.Even for experienced traders, an objective method to determine
the trend is helpful. Seasoned discretionary traders can judge their subjective
evaluation against a fixed framework. This is the only way to check your trading
instinct. If your intuition is no better than a rigid trading system, then there’s no
reason to use your discretion.If you want to learn more about trading with
moving averages, take a quick look at our moving average guide.

CONVENTIONAL METHOD – MOVING AVERAGE PRICE

CROSSOVER
The bare basic method of using a moving average to determine the trend is the
price crossover.When price cuts from below the moving average to above it, it
implies a bullish trend.When price crosses from above the moving average to
below it, it suggests a bearish trend.

Whipsaws pose a problem with this method. Whipsaws are false signals of

trend changes. They happen as the market crosses over the moving average in
quick succession. Due to this phenomenon, you might get confused during
a sideways market.
Luckily, there are more reliable ways to check if a trend is emerging. Here, you
will learn three ways to do so.

#1: SLOPE OF MOVING AVERAGE

This method is simple but useful. Just focus on the slope of the moving average.

 Sloping upwards – Bull trend

 Sloping downwards – Bear trend

In the chart below, the background color corresponds to the direction of the
moving average.

The advantage of this method is its responsiveness and simplicity. However, it

relies on the moving average alone. Thus, it’s easy to forget about price action
itself.

Trading Tip: When the price falls below the SMA, but the slope stays bullish,
consider a long setup.

Conversely, when the price rises above the SMA but the slope remains pointing
down, look for a short setup. (Works better with an SMA and not as well with an
EMA.)
#2: SWING PIVOT CONFIRMATION WITH MOVING AVERAGE

Unlike the first approach, this method forces you to pay attention to price action.
It helps you to avoid the common pitfall of relying too much on the indicator.

The price swings in the examples below are marked according to the rules
taught in Day Trading With Price Action.

BULLISH EXAMPLE – 6J FUTURES (JPY/USD) 30-MINUTE

How To Confirm Bullish Trend With Swing Pivots:

 Swing low forms above the moving average

 Price pushes to a new trend high without touching the moving average

Take a look at the example below.

1. This swing low formed above the moving average.

2. Then, without pulling back to the moving average, the market made a new
high. This push confirmed the bullish trend.

BEARISH EXAMPLE – 6E FUTURES (EUR/USD) 30-

MINUTE
How To Confirm Bearish Trend With Swing Pivots:

 Swing high forms below the moving average

 Price falls to a new trend low without touching the moving average

See the example below.

1. This swing high formed below the moving average.

2. However, the market continued to rise and hit the moving average before
pushing to a new low. This development forestalled a bearish trend
confirmation at this point.
3. Again, we observed a swing low below the moving average.
4. Then, without pulling back to the moving average, the market fell to a new
low. This fall confirmed a bearish trend.

#3: X BARS ABOVE/BELOW X-PERIOD MOVING AVERAGE

This method identifies a strong trend. At this stage, the trend is already firmly
established.

If you are looking to enter a new trend, this method is not suitable. But if you
want to confirm that the most recent trend is a strong trend with momentum,
this is the way to do it.
EXAMPLE: 20 BARS BELOW THE 20 SMA – BEARISH

The same logic applies to moving averages with different lookback periods. For
instance, 50 bars above the 50 SMA imply a bullish trend. With 50 bars, it indicates
a more stable trend than its 20 bar counterpart.

This approach is not the agilest, but it offers an objective formula to find
market trends.

Moreover, in the hands of a master trader, this method can become a dominant
market guide. Try paying attention to price action shown by the X number of
price bars. Often, it yields useful hints for traders.

For instance, you see 20 price bars far above the 20-period moving average. If
the 20 bars form a steep rise, the market is likely exhausted. Reversal or
consolidation might follow.

On the other hand, you might observe 20 price bars drifting sideways, just
slightly above the moving average. In this case, these 20 bars above the moving
average are more likely to be subtle bullish hints. A trend play is sensible.

HOW TO DETERMINE THE TREND WITH A MOVING AVERAGE –

TRADING NOTES
As mentioned earlier, these methods are more reliable than the moving average
crossover. But this added reliability comes at a cost. It takes the form of a delay.
You can only confirm the trend later.

Such trade-offs of one advantage for another is a constant theme in

trading. The key is to find the right trade-offs in the context of your trading plan.
Even among the three methods above, you can see differences in reliability and
timing.

Bonus method: Use price envelopes to define trends. See how it works in this
day trading strategy.

In the three chart examples above, each one used a different method to
determine the trend. Try applying the other two approaches to each chart
for practice. This exercise will help you appreciate their differences and uncover
more insights.

You might be thinking: why do I need to understand these methods in detail? I

already know how to interpret them. Must I really get into the nitty-gritty?

You should because these trend determination methods are not trading
strategies. You must integrate them into a trading strategy. And to do that
effectively, you must learn the underlying price action of each method.

Only then, you can wield the moving average as a powerful weapon.

If you prefer to work without a moving average and focus just on price
action, take a look at my price action trading course. It shows you how to judge
the market bias with swing pivots and trend lines.

HOW TO ANALYZE PRICE MOMENTUM WITH MICRO CHANNEL TREND

LINES

Being able to spot price momentum is a great skill regardless of your trading
style. Equipped with this ability, you will be able to stay on the right side of the
market.

There are many ways to judge momentum. You can use the momentum
indicator. Or you can watch price action carefully. After all, momentum, by
definition, is apparent on the chart.
But with the many methods to judge momentum, it’s easy to get confused.

Hence, in practice, you will find it useful to stick to a clear way to judge
momentum. Here, you will learn how to use micro channel trend lines to track
short-term market momentum.

MICRO CHANNEL TREND LINES

Let’s build on basic price action trading concepts to explain our tool – micro
channel trend lines.

WHAT ARE TREND LINES?

The purpose of a trend line is to track a trend.

Hence, a trend line is drawn below the price bars in a rising market or above the
price bars in a falling market. In the context of a bull trend, a trend line often
acts as a support for the market.

WHAT ARE CHANNEL TREND LINES?

Channel trend lines are drawn to highlight the advance of a trend.
Hence, channel trend lines are drawn above a rising market and below a falling
market.

You can draw them as parallel lines of trend lines or just by connecting the trend
extremes. The brown line in the chart below is a channel trend line.

WHAT ARE MICRO CHANNEL TREND LINES?

“Micro channel trend lines” is a mouthful. Just bear with it, and once you are
confident of how to draw them, you can call them whatever you want.

Micro channel trend lines are drawn using just two price bars. And you can
draw them in both rising and falling markets.

Let’s focus on the bullish instance here.

To draw a bullish micro channel trend line:

1. Find two consecutive price bars.

2. Ensure that the second price bar has a higher high than the first.
3. Draw a line by connecting the two bar highs.
 4. Project the line to the right of the chart.

To interpret the momentum using the line, look at its interaction with the third
bar. The chart below shows three

scenarios you will encounter.

Follow these guidelines to interpret bullish momentum:

 Closes above the line – Price momentum (Point 2)

 Hits but closes below the line – Failed momentum (Point 3)
 Does not hit the line – No momentum (Point 4)
For bearish momentum, you need to draw bearish micro channel trend lines.
Simply connect two consecutive bar lows to form a downwards sloping line.

Then, follow these guidelines to interpret bearish momentum:

 Closes below the line – Price momentum

 Hits but closes above the line – Failed momentum
 Does not hit the line – No momentum

You’ll find instances of bearish momentum in the next section.

Once you can assess price momentum with a simple channel trend line, you are
ready to move on to the next stage.

HOW TO INCORPORATE MOMENTUM INTO YOUR TRADING STRATEGY

Being able to track price momentum is an invaluable skill. But you must

combine it with your market assessment to form a viable trading strategy.

Each time you spot price momentum, you have the option of flowing into the
market with it or fading it. Your decision depends on your evaluation of the
market context.

Do you expect the market to resume its trend?

Do you expect the market to stay in the trading range?  Or do you expect it to break
out of the trading range?

Your answers to these questions will determine how you can make use of
momentum in your trading plan.

EXAMPLE 1: FADING COUNTER-TREND PRICE MOMENTUM

Momentum against the trend does not last. Often, it shows the last-ditch effort
of the counter-trend traders in the current pullback.

Once you understand this, fading the momentum becomes an excellent way to
enter a trend.
1. The market was far above the 50-period EMA and showed a strong bullish
bias. We expected the bull trend to continue.

2. This was the first and only confirmed bearish momentum in this pullback.
Buying as this bar closed below the micro channel trend line was a good idea.

However, when you enter a trade by fading a price move, it’s hard to employ a
pattern stop-loss. In such cases, volatility stop-losses are useful.

EXAMPLE 2: JOINING A BULL TREND

1. This example shows the market above the 50-period EMA. The momentum
signals were interpreted within a bullish context.
2. This bar closed below the micro channel trend line, implying bearish
momentum. You could have faded this bar to join the bull trend. This was the
trading premise in Example 1.

3. If you had waited for more price action to unfold, you would find another
reason to take on a bullish position. This bar confirmed that bullish momentum
had taken over. It offered another chance to go long.

4. During a deep pullback in a bull trend, a surge of bullish momentum is a

reliable long setup signal. However, it’s common for the market to go against
you for a couple of bars as the momentum consolidates. If the market stalls for a
longer period, consider an early exit.

CONCLUSION – MICRO CHANNEL TREND LINES & MOMENTUM

This method is simple and does not require any complex indicator. As long as
your charting platform allows you to draw trend lines, you can implement this
approach. In fact, with some practice, you can visualize these micro lines without
drawing them.

This elegant method helps you spot price momentum while staying close to
price action.Instead of using a separate indicator to analyze momentum, let
price action set the stage for you.

Note that this method focuses on price momentum over the shortest horizon. In
essence, we are analyzing the momentum over three price bars. We set up the
stage with the first two bars and seek confirmation with the third.

The concept of this micro line method is similar to the Anti-Climax pattern in
my trading course. Both exploit explosive price movement that is not
sustainable against an established trend.

Fire up your charts now. Try reading the market by visualizing micro channel
trend lines, and uncover another layer of price action information.

TWO PRICE BARS

As we expand our vision to two bars, we are able to introduce two cornerstones
in reading price action: context and testing.
PRICE ACTION CONTEXT
In trading, nothing works in isolation. The context is of utmost importance. The
same goes for reading price action.

With two price bars, we gain a context for the second bar. The first bar provides
a benchmark to aid us in reading price action.

We know that the range, body, and shadows of a candlestick discloses useful
information. For instance, a wide range bar points to high volatility.

But how wide is wide? That is a difficult question.

Using the preceding price bar, we can propose a decent answer. At least, we can
highlight bars with a wider range. Wider when we compare it with the preceding
bar.

Now, we are more descriptive when we talk about the price action.

Fr
om the chart above, we picked random two-bar combinations to explain what
the market was doing in the context of the first bar.
 1. The market was getting less volatile with decreasing bar range.
2. Selling pressure increased as the upper shadows lengthened.
3. The market got increasingly volatile as it reversed down.

TESTING PRICE LEVELS

The concept of testing refers to the market moving towards a price level to “test”
if the price level will reject the market’s advances.

The high and low of each price bar are natural support and resistance levels. The
test of these levels show the undercurrents of the market and is critical for
reading price action.

T
his is the same chart as the previous one. But here, we focused on the testing of
bar highs/lows to see what it tells us about the market.

1. The second bar rose above the high of the first bar but was rejected.
(Bearish)
2. The second bar punched below the low of the first bar and continued to
become a strong bearish bar. (Bearish)
3. After falling below the first bar, the second bar reversed up and closed
higher. (Bullish)
Two-bar combinations allows us to see the context of each bar and brings a lot
more depth into our price action analysis.

THREE PRICE BARS

With a clear read of two-bar price action, we are able to form expectations of the
market. We would expect the market to move in a certain way in the third
bar. The confirmation or failure of our expectations reveals more about the
market, and add to our price action analysis.

To form expectations, we need to make a very simple assumption about how the

market should behave.

Essentially, the market has inertia. Bullishness should follow bullishness, and
bearishness should follow bearishness. When it does not, we have to consider a
possible change in market direction.

Remember that we are only looking at three bars here. It means that we are
referring to very short-term expectations and consequences.

W
e chose random three-bar combinations from this chart. With the first two bars,
we form either bullish or bearish expectations. Then, the third bar revealed if the
market met our expectation.
 1. The first two bars moved down with good strength (body size).
Furthermore, the second bar fell below the low of the first bar without
much resistance. Hence, we expected that the third bar to turn out bearish.
Indeed, the third bar tried rising above the high of the previous bar, but
failed.
2. The first two bars were the exact opposite of the first example. They led us
to form bullish expectations. However, the third bar was rejected by the
high of the preceding bar and showed increasing selling pressure. A
bearish setup.
3. The second bar was bearish regardless of how we looked at it. Hence, we
expected the market to fall further. Instead, the third bar was bullish. This
failure of our bearish expectations point north.

READING PRICE ACTION

Our three-bar analysis process brought us through the essential concepts of

reading price action.

Once you grow comfortable with reading price action with this generic approach,
you have no need for names and labels, except for ease of communication with
other traders.

To prove the practical value of the skills you have picked up in this guide, let’s
take a look at the two examples below.

MORNING STAR PATTERN

This chart bottomed out with a morning star pattern. What is a morning star
pattern? Doesn’t matter.

1. Long lower shadow implied buying pressure.

2. Volatility decreased with some selling pressure. While these two bars were
not clearly directional, our bet went with the bears due to the long upper
tail.
3. However, instead of falling, the market rose up strongly. This failure of
bearish expectations presented a bullish setup.

This three-bar pattern is what candlestick traders call a morning star.

PIN BAR
This chart shows the popular pin bar pattern.

1. The first bar was a nice bullish bar.

2. The second bar was a strong bearish bar that fell below the preceding bar
with increasing volatility. Naturally, we expected the next bar to unfold in a
bearish way.
3. However, after testing the low of the second bar, buying pressure asserted
itself and prevented the market from falling more. This unexpected bullish
turn presented a bullish setup. (pin bar)

A ROSE BY ANY OTHER NAME WOULD SMELL AS SWEET

An unlikely Shakespearean source summarized a key idea for reading price
action.

Reading price action is not about finding pin bars, outside bars, engulfing
patterns, or any other names. It is about observing price bars as they form and
understanding what the market has done and is doing. Once you master the skill
of reading price action, you can pinpoint setups without relying on dozens of
labels. Learn how to hone your trading instincts like the samurais.

However, reading price action is not enough for trading price action. It is a
critical first step that many beginners overlook, but it is not complete.
TRADING THE ENGULFING CANDLESTICK PATTERN
WITH MARKET STRUCTURE
If you have learnt how to trade candlesticks, you must know the engulfing
candlestick pattern. Its striking name and visual makes it one of the most
popular candlestick pattern.

Reference: Japanese Candlestick Charting Techniques

The engulfing candlestick pattern has two candlesticks. The body of the second
bar completely engulfs the body of the first bar. It represents a total change
of market sentiment.

An engulfing candlestick in the right context offers a high probability trading

setup. Finding the best context with moving averages and oscillators are reliable
trading methods.

Learn: Candlestick with RSI Trading Strategy

However, in this review, we will look at a simpler method that uses the concept
of market structure to find point us in the right direction. Market structure refers
to the relationship of swing highs and lows that lend structure to market trends.

TRADING RULES – ENGULFING CANDLESTICK

BULLISH ENGULFING

1. Higher swing high and higher swing low

2. Buy with bullish engulfing candlestick pattern
3. High of pattern must stay below previous swing high

BEARISH ENGULFINGLower swing high and lower swing low

1. Sell with bearish engulfing candlestick pattern

2. Low of pattern must stay above previous swing low

ENGULFING CANDLESTICK TRADING EXAMPLES

WINNING TRADE – BEARISH ENGULFING

This is a daily chart of Allergan (AGN on NYSE). It shows a market plunge that
erased months of gains.

1. The lower swing high and low confirmed the beginning of a downwards
trend with the climatic bear bar.
2. Prices retraced up immediately after the drastic fall. The bull move stopped
as a bearish engulfing candlestick emerged.
3. The bearish engulfing candlestick pattern formed on the mid-point (50%
retracement) of the strong bear trend bar which provided resistance.

LOSING TRADE – BEARISH ENGULFING

This daily chart of Cardinal Health (CAH on NYSE) shows a bearish engulfing
pattern that didn’t follow-through.

1. Technically, there was a set of lower swing high and low.

2. However, in this case, the swings did not push out of the sideways
movement of CAH. Hence, the lower high and low structure was not a
reliable indicator of a downwards trend.
3. The bearish engulfing candlestick pattern led to a losing short trade, as
prices broke out above the trading range.

REVIEW – ENGULFING CANDLESTICK WITH MARKET STRUCTURE

Many trading strategies use engulfing candlestick patterns as a signal for major
trend reversals. That is a low probability strategy. However, as we use engulfing
patterns for continuation trades here, we have better odds.Many candlestick
traders wait for one more candlestick after the engulfing pattern as
confirmation. For this trading strategy, you should not wait for confirmation for
most trading setups. Waiting for confirmation worsens our reward to risk ratio.If
you wait for confirmation, the trading setup is likely invalid due to trading rule 3.
Basically, that rule keeps us away from taking trades that have poor reward to
risk ratio.

Observing swing highs and lows is the simplest way to follow market trends. It
builds on the market structure and does not need any trading indicator. While
this approach gives some confusing signals during deeper pullbacks, its
simplicity is still attractive. Regardless of your trading strategy, paying attention
to the market structure will help you filter bad trades.
SWING TRADING WITH TREND LINES
The trend line is one of the most powerful tool for technical traders, which
describes most short-term swing traders.

Why do I say that a trend line is a powerful tool?The power of a trend line
does not come from the profits it generates for its users. Rather, it comes from
the many facets hidden within its simplicity. Just add one line to your charts. And
you clarify trend, momentum, support/resistance, and entry timing.

HOW TO DRAW A TREND LINE?

Basic geometry dictates that we need two points to draw a line. This is exactly
what we need to do to draw a trend line.

DRAWING A BULLISH TREND LINE

1. Choose two support points.

2. The more recent one must be at a higher price.
3. Connect them. (Preferably, the line does not cut through other price bars.)
4. Project the resulting line to the right.
5. This is a bullish trend line.
DRAWING A BEARISH TREND LINE
1. Choose two resistance points.
2. The more recent one must be at a lower price.
3. Connect them. (Preferably, the line does not cut through other price bars.)
4. Project the resulting line to the right.
5. This is a bearish trend line.

From the two examples above, you can see that there are a dozen ways to select
the two points. The bullish example used two major swing pivot lows for drawing
the trend line. The bearish example used two consecutive bar highs to draw the
downwards sloping line.

Which is the right way to draw a trend line?

Both trend lines are valid and much depends on how you interpret them. In
most cases, if you choose two significant S/R, the resulting trend line bears
greater weight over a longer time. If you select two minor S/R (like in the bearish
example above), the trend line is more effective within a shorter period.

WHY IS A TREND LINE USEFUL FOR SWING TRADING?

Swing traders expect to profit from a market swing. One of the most popular
game plan is to find stocks that are trending strongly and wait to enter on
retracement. An example is the Holy Grail trading setup.Let’s see how a trend
line is an all-in-one tool for swing traders looking for trend retracment trades.

The direction of a trend line (whether it slopes up or down) shows the expected

trend. It tells the swing trader if the market is trending up or down.

The steepness of a trend line shows the strength of the trend. Shallow trend
lines show possible sideways action. Stay out of the market or swing for a more
conservative target. Ultra-steep trend lines hint at a possible unsustainable
trend. Look out for signs of reversal or at wait for a deeper retracement before
entering.

The trend line itself acts as a support/resistance offering a hot zone for trading
setups. It offers swing traders a practical way to find retracement trades as the
market pulls back to test a trend line.The break of a trend line hints at a possible
reversal, especially when the break is strong and decisive. However, remember
that in a trending market, most trend line breaks are false alarms.Fascinated by
this jackknife tool? Let’s take a look it in action.

SWING TRADING WITH TREND LINES – EXAMPLE

We are using the daily chart of the United Technologies Corporation (UTX) for
our trend line practice.
 1. With these two swing highs, we projected a bearish trend line.
2. After falling for around one month, the market recovered and rose to make
a new high. With the lowest low of this recent pullback and a preceding
swing low, we drew a bullish trend line.
3. The market tested the intersection of both trend lines with a bullish Anti-
Climax pattern. With the broken bearish trend line and the recent bullish
trend line as support, we had a great potential long swing trade.

Swing traders who like quick trades can exit after the first three consecutive
bullish bars. Traders who are more patient can target the last extreme high of
the current bull trend.

The UTX chart below shows how trend line analysis continued to offer swing
trading opportunities.

1. This area corresponds to the close-up example above.

2. As the market moved higher, we adjusted the trend line (brown) which was
again tested by a bullish Anti-Climax pattern.
3. The third trend line we drew (purple) offered support for the market again.
Note that each trend line was shallower than the one before, showing a
weakening trend.
4. Despite a brief upswing, the market fell down through the purple trend
line. The decisive and sustained downswing signalled a trend reversal.
You might be thinking that the examples above are textbook examples. I must
have looked at the chart ex-post and drawn the trend lines in such a way that
they seem to work.

You are right, partly. They are textbook examples. I needed textbook examples
to show you how trend lines work, in theory.

But I did not draw the trend lines so that they seem effective. I have a consistent
method of drawing trend lines, and I always draw my trend lines this way.
(Traders who studied my price action trading course would be able to tell that
those trend lines are drawn with valid pivots.)

TREND LINE TRADING – CONSISTENCY IS THE KEY

Drawing a trend line is a simple method for swing traders to track their favourite
stocks or currency pairs. However, many traders think that trend lines seem
perfect in hindsight but are useless in real trading.

To avoid that, do not draw perfect trend lines.

If you try to draw perfect trend lines that work every time, you will become an
expert in trading historical charts. Your trend lines will seem perfect in historical
charts, but will do nothing to help you trade in real-time. Because each time you
think of drawing a trend line in real-time, you will be filled with self-doubt over
its efficacy. (This will destroy you.)

Instead, draw consistent trend lines. Develop a method to draw trend lines.
Always draw your trend lines according to the same principles. Then, you can
draw trend lines confidently in real-time. Your trend lines might not be perfect,
but at least you can apply this powerful tool consistently.

4 PRICE ACTION METHODS TO DEFINE THE INTRADAY TREND

For all traders, the trend is the big picture. It is the rising tide that lifts all. For day
traders, the intraday trend makes the difference between a session of windfall
profits and one of major losses. By trading along with the intraday trend, we are
following the path of least resistance to day trading profits.

As the trend is the big picture, it seems removed from current price action.
Hence, many traders are tempted to leave price action out of the trend
equation. They rely on a distant moving average to define the market trend and
do not factor in price action. These traders are missing an important
confirmation tool.

Using indicators to identify the intraday trend is reasonable. However, if we link

them up with price action, we are able to enhance their prowess. Hence, in the
first part of this two-part series, we will focus on using indicators with price
action to track the intraday trend. In the second part, we will discuss two other
methods to find the intraday trend.

1. MOVING AVERAGE WITH PRICE ACTION

This method uses a 20-period simple moving average (SMA) with price action to
clarify the intraday trend. Essentially, we are looking for a shallow pullback
followed by a new high (low) to confirm a bull (bear) trend.

To confirm a bullish intraday trend, look out for the following conditions. The
rationale for each condition is in brackets.

1. Price touches the moving average. (Establishes baseline. Useful for

sessions that open with a gap.)
2. Price stays above the moving average for at least one bar. (Bullishness)
3. Price retraces down towards the moving average without making any bar
high below the moving average. (Lack of bearish commitment)
4. Bull trend confirmed when price rises above the last extreme high.
(Confirmation of bullish market structure)

To confirm a bearish intraday trend, look out for the following.

1. Price touches the moving average.

2. Price stays below the moving average for at least one bar. (Bearishness)
3. Price retraces up towards the moving average without making any bar low
above the moving average. (Lack of bullish strength)
4. Bear trend confirmed when price falls below the last extreme low.
(Confirmation of bearish market structure)

Let’s take a look at an example from the NQ futures market.

This session opened with a bullish gap.

1. Instead of guessing if the gap would start a new bull trend or close the gap,
we waited for price to return to our benchmark SMA.
2. Price touched the SMA.
3. This bar stayed below the SMA, confirming the bearish momentum,
4. This bar made a higher bar high but could not even rise to test the SMA.
5. As the market fell past the last extreme low below the SMA, we confirmed a
bear trend.

This intraday bear trend held up for the rest of the session, despite a 50%
pullback in the middle of it.

Trading with just a 20-period moving average is an excellent starting point for
any trader.

2. PRICE CHANNEL WITH PRICE ACTION

In this second technique, instead of using a simple moving average of bar closes,
we use two moving averages of bar highs and lows. The resulting lines form a
price channel to help us clarify the intraday trend.
Jake Bernstein employed this concept in his Moving Average Channel Day Trade.

Since the indicator in this case is more complex, the interpretation rules are
simpler. When two price bars stay completely above the channel, we define a
bull trend. When two price bars stay completely below the channel, it’s a bear
trend.

The example above shows how the price channel helped to define a change of
intraday trend.

1. Although the market has risen sharply since this session opened, according
to this method, we could only define a bull trend at this point.
2. These two bars changed the intraday trend to bearish.

There are different ways to build a price channel. Other than using moving
averages of bar highs and lows, you can also use Keltner Bands and Bollinger
Bands. As these price channels are constructed differently, you will need to
adapt the rules for defining the intraday trend.

FINDING THE INTRADAY TREND – A COMPARISON

Both the SMA method and price channel described above use indicators to
clarify price action, but in different ways.

By comparing them, we are able to understand both methods better. The SMA
method focuses on finding lack of momentum on pullback to identify new
trends. The price channel method finds powerful moves that lift the market
beyond the price envelope to start new trends.

3. HIGHER TIME-FRAMES
As mentioned in the first part of this series, the trend is the big picture. It is a
higher level perspective of the market. Hence, one popular method to determine
the intraday trend is to look at the price action of a higher time-frame.

The example below shows how we used the hourly bar highs/lows to find the
intraday trend for the 5-minute time-frame.

This chart shows the 5-minute time-frame in the top panel and the
corresponding hourly chart in the lower panel.
 1. This hourly bar made a lower low and confirmed a bearish intraday trend.
2. This bar made a higher bar high and turned the intraday trend bullish.

For more examples, refer to Kane’s Stochastic %K Hooks Day Trading Strategy. It
is a classic example of using a higher time-frame for intraday trading. It uses the
hourly chart to assess the intraday trend before trading in the five-minute time-
frame.

For multiple time-frame analysis, the Triple Screen System in Dr Alexander
Elder’s book “Trading for a Living” is also a great starting point. In his solid
system, he recommends a factor of five when considering higher-frames. An
example would include the 1-minute, 5-minute, and 25-minute time-frames.

4. TREND LINE

Price action traders love trend lines. It is useful for both intraday and longer
term analysis.

By linking up swing pivots, we get trend lines of varying slopes and importance.
Trend lines highlight the market structure of swings and project their
momentum and speed.

The basic interpretation of a trend line is that the trend reverses after it is
broken. The example below shows how a broken bear trend line hinted at the
later bull trend.
This method is simpler in the sense that it does not use any indicators and
focuses on one time-frame. However, to make it work, you will need to master
the skill of drawing trend lines.

THE BEST METHOD FOR FINDING INTRADAY TREND

No method of determining the intraday trend is perfect. There will always be

instances when the market resumes its earlier trend just as we conclude an
intraday trend reversal. There will always be cases when we confirm a trend only
when it starts reversing.

Such instances are unavoidable. This is why we have trading setups to pinpoint

entries and limit our risk.

Each of the four methods above has its specific drawbacks.

For the two methods that rely partly on indicators (discussed in part one),
we need to decide on the look-back period of the indicators. Without a sensible
look-back period, the indicators will add little value to our trend analysis. The
suitable value depends on the market volatility which is ever-changing.
The higher time-time method then depends on our choice of the higher time-
frame. Which higher time-frame reflects the intraday trend? The half-hourly and
hourly charts are popular among day traders. But forex traders might prefer the
4-hour time-frame.

As for the trend line method, the clear challenge is in drawing meaningful
trend lines. If we draw trend lines indiscriminately, we will find more whipsaws
than trends. The crux is to draw consistent and relevant trend lines.

SWING TRADING WITH STOCHASTIC OSCILLATOR AND

CANDLESTICK PATTERNS
New traders make the mistake of treating candlestick patterns as simple trading
signals. They do not realize that most candlestick patterns are defined using the
last two to three price bars and ignore the price action context.

Hence, it is crucial to combine candlestick patterns with other methods of

analysis. In this swing trading strategy, we will use the Stochastic Oscillator to
find high-quality candlestick patterns.

STOCHASTIC OSCILLATOR
There are three types of Stochastic Oscillator: Fast, Slow, and Full. (Learn more
about their differences.)

For this setup, we will use the Full Stochastic Indicator. It has three inputs:

1. Look-back Period for %K (5)

2. %K Smoothing (3)
3. %D Moving Average (3)

The Stochastic (5,3,3) setting is sensitive, and hence suitable for finding short-
term retracement trades.
MORNING/EVENING STAR CANDLESTICK PATTERNS
Gaps are characteristic of daily charts that swing traders use. While gaps pose a
risk for swing traders, they reveal precious market clues.

The Morning/Evening Star candlestick patterns take advantage of these

“clues”. Thus, we will focus on these patterns in this review. Of course, you can
also use the Stochastic Oscillator to confirm other candlestick signals.
TRADING RULES – STOCHASTIC WITH CANDLESTICK
PATTERNS
LONG SWING TRADE

1. Market is trending upwards.

2. Stochastic (5,3,3) is below 20. (oversold)
3. Buy once a Morning Star candlestick pattern is completed.

SHORT SWING TRADE

1. Market is trending downwards.

2. Stochastic (5,3,3) is above 80. (overbought)
3. Buy once a Evening Star candlestick pattern is completed.

For simplicity, you can use price action and the Stochastic Oscillator to judge the
market trend. Refer to the examples below.

TRADING EXAMPLES – STOCHASTIC WITH CANDLESTICK

PATTERNS

WINNING TRADE – SYY LONG SWING

 Thi
s is the daily chart of SYSCO Corporation (SYY on NYSE). The bottom panel shows
the Stochastic Oscillator.

1. Look at the last two points when the Stochastic was oversold. Compare the
price levels. If the more recent oversold point is at a higher price, we are
bullish.
2. With a bullish view, we looked for Morning Stars. This Morning Star did not
occur with an oversold Stochastic reading. Thus, it did not fit our trading
rules.
3. The second Morning Star had the support of the Stochastic Oscillator and
fitted the bill. We went long as the Morning Star completed.

In this example, we managed to skip the losing pattern and take the profitable
one with the help of the Stochastic Oscillator.

LOSING TRADE – INTC SHORT SWING

 T
he chart above shows the daily price bars of Intel Corporation (INTC on NYSE).

1. Look at the last two points when the Stochastic was overbought. Compare
the price levels. If the more recent overbought point occurs at
a lower price level, we are bearish bias.
2. We ignored this Evening Star pattern as the Stochastic Oscillator was not
overbought.
3. This second Evening Star pattern formed as the Stochastic Oscillator
became overbought. Thus, it was a valid bearish setup. However, this setup
failed quickly as the market gapped up.

While we managed to filter out the first Evening Star with the Stochastic
Oscillator, we could not avoid the second one. This short setup, despite its
failure, was reasonable.

One minor factor that might have deterred us from going short was the price
gap highlighted by the green box in the chart above. The market has a tendency
to rest obvious gaps like this one. Hence, if we held this expectation, we would
not have taken the short setup.

REVIEW – STOCHASTIC WITH CANDLESTICK PATTERNS

Combining candlestick patterns with technical indicators is a sound approach.

Here, we combined an oscillator and a three-bar pattern to find pullback trades.

This trading strategy is not perfect and is certainly not profitable if traded
mechanically. However, it offers a solid starting point for both system and
discretionary swing traders.
Both the Stochastic Oscillator and candlestick patterns are well-defined. Hence,
they are easy to code into market scanning software. For swing traders finding
opportunities among hundreds of stocks, this is a huge advantage.

I looked at the Stochastic Oscillator and price action to decipher the trend to
avoid adding indicators. You can certainly use other methods to track the market
trend. (For e.g. market structure, moving average)

TARGETS
The most direct way to take profit is to use a target limit order. This means
that as we enter a trade, we place a limit order at a price objective.

How do we decide on the target price?

For the technical trader, there are several reliable options.

1. CHART PATTERN TARGET PROJECTION

A basic target projection method uses classical chart patterns as a basis. These
chart patterns include Triangles, Rectangles, Head & Shoulder, and more. If you
use chart patterns in your trading, why not use them to project targets as well?

Although we draw each chart pattern differently, the target projection method is
similar. It always involves taking the height of the chart pattern and extending it
from the break-out point.

The example below shows how to project a bullish target from a Rectangle chart
pattern.

(For detailed steps of projecting targets from other chart patterns, refer to

our 10 Chart Patterns for Price Action Trading.)
To project the target in this example:

 Measure the height of the Rectangle pattern; and

 Project the same distance from the break-out point at the top of the
Rectangle to get the bullish target.

Likewise, we can arrive at a bearish target if we project the height of the

Rectangle from its bottom.

2. FIBONACCI EXTENSION
Other than relying on geometric chart patterns, traders also use the golden
ratio to project targets. The golden ratio is closely related to the Fibonacci
sequence which is a common trading premise.

Fibonacci traders uses Fibonacci Extensions for projecting targets.

Using a charting software with Fibonacci drawing tools, you can mark these
potential target levels easily.
As shown above, drawing Fibonacci Extensions is a two-step process.

1. Identify a significant impulse move. In this example, we want to find a

bullish target. Hence, we selected a bullish impulse swing.
2. Project the extensions using Fibonacci ratios (0.382 and 0.618). For
instance, multiply the height of the impulse wave by 0.382. Then, extend
the product from the high of the impulse swing.

For Fibonacci Extensions, the choice of the impulse wave is critical. Select a clear
and major price thrust for best results.

3. PAST SWING PIVOTS

Swing pivots are market turning points. These turning points are
effective support and resistance levels, especially those at major market tops
and bottoms.

Hence, by projecting them into the future, we get reliable price targets.
Generally, we look for bearish targets using past swing lows and bullish ones
with swing highs.

This example shows a short trade. Using past swing lows, we projected several
resistance levels representing potential targets. The nearest resistance is clearly
the most conservative target.

Observing past swing pivot points is a straightforward and robust way to find
support/resistance.

4. PRICE CHANNEL PROJECTION

A price channel consists of two parallel lines. The nature of the channel depends
on its slope.

 Lines slope upwards – Bull channel

 Lines slope downwards – Bear channel
  Lines are horizontal – Trading range

Learn more about trading with channels with this article.

The chart above shows a NR7 long setup. We projected a target using a price
channel.

1. Draw an upwards sloping trend line with two swing lows.

2. Draw a parallel line starting from the most recent high. (Channel line)

The plan is to exit once price hits the channel line. As the market progresses, the
channel line rises. Hence, our target price is dynamic, and we need adjust the
target order higher to keep up with the channel line.

This is in stark contrast to the tactics we discussed earlier. They are static targets
which do not need adjustments.

In addition, as shown below, a channel method is the natural choice for traders
operating within a trading range, aiming for small profits.
5. TIME TARGET
Let’s look at targets from another dimension. Try time.

Having time targets refer to taking profits once a certain time period has lapsed.
This method of taking profit is relevant and perhaps critical for options traders
and day traders.

Options traders (specifically buyers) need to manage their prospect of gains

versus potential loss due to time decay. Typically, the loss of time value
accelerates as we approach the options expiration date. Hence, having a time
target is useful for tackling the problem of time decay.

Most day traders work within the confines of a single trading session to enjoy
intra-day trading margins and to avoid overnight risk. For them, there is a
natural time target at the end of each session.

Combine a time target with a price target for the best of both worlds.
TRAILING STOP-LOSS
Let your profits run.

I’m sure you have heard this maxim before. If you want to adhere to this trading
advice, using a trailing stop-loss is your best bet.

A trailing stop-loss is one that follows behind the market. It has the dual function
of locking in profits and letting profits run.

However, the art of trailing stop-loss is demanding. If we trail the stop-loss

order too closely, we might suffocate the trade. If we trail it too far behind the
market, we risk giving back a large part of our profits.

For a systematic way of trailing stop-losses, use one of the following methods.

6. PARABOLIC SAR
J. Welles Wilder invented the ADX for tracking trends and the RSI for clarifying
momentum. It is hardly surprising that he has something up his sleeve for
trailing stop-losses.

Let us introduce Wilder’s Parabolic Stop-and-Reverse (SAR).

From its name, we can tell that clearly, Wilder intended to use the Parabolic SAR
for more than just trailing stop-loss. He wanted to reverse the trading position
after being stopped out.

However, here, we are only focusing on using it as a trailing stop-loss tool to lock
in our profits.
This indicator plots a marker below each price bar in a uptrend and above each
bar in a downtrend. Its underlying concept is that time is money. Hence, as time
passes, the Parabolic SAR accelerates closer to the market price.

In this example, our entry was the bullish pin bar (doji). The blue dots plot the
Parabolic SAR, which provides a natural trailing stop-loss for our long trade.

Towards the right of the chart, you could see that the blue dots are intolerant of
prolonged sideways movement, and catches up quickly.

The exact calculation of the Parabolic SAR is a tad complicated. If you want to
figure it out, the best resource is Wilder’s New Concepts in Technical Trading
Systems .

7. CHANDELIER STOP
The ideal trailing stop-loss should give enough room for minor pullbacks. Thus, a
sensible approach is to consider how volatile the instrument is.
The Chandelier Stop does that by taking the Average True Range (ATR) as a
measure of volatility. The ATR is another concept from Wilder. (Yes, we are really
indebted to him.)

In a nutshell, the ATR measures volatility using the average range of each price
bar and adjusts for any gaps. If you want to see the formula, it’s here.

 Chandelier Stop (Long Position) = Highest High of a Period – (Multiple x

ATR over a Period)
 Chandelier Stop (Short Position) = Lowest Low of a Period + (Multiple x
ATR over a Period)

You need to decide on two inputs: Period and Multiple. A common setting is
a Period of 22 and a Multiple of 3.

To find out where to place our stop-loss, multiply the ATR(22) by 3. Then, minus
that product from the highest high of the past 22 bars for a bullish target.

The example below shows the use of a Chandelier Stop (in blue) for a Morning
Star candlestick signal.
8. NEW TRADING SIGNAL

The basic idea is to trail stop-losses behind new trading setups that form in your
trade’s direction.

This is a discretionary technique. It can take various forms depending the setups
that catch your eyes. Just remember that if the setup is good enough for a new
trade in the same direction, it is a sufficient basis for us to adjust our stop-loss.

The example below uses Pin Bar signals to trail stop-losses. But you can pretty
much use any price pattern or indicator signal you are familiar with.

We marked out the Pin Bars in the chart above with our Price Action Pattern
Indicator.
ONGOING PRICE ACTION
We covered taking profits with a target limit order. We have also talked
about taking profits with stop-loss orders.

Now, let’s see how we can take profits with market orders. This is a flexible
approach to decide if we need an immediate exit to keep our profits.

9. REVERSAL SIGNAL
This is the commonsense exit.

 Enter with a bullish signal. Take your profits with a bearish signal.
 Short with a bearish signal. Cover with a bullish one.

This a nimble tactic. However, in trending markets, this method might

cause premature exits and limit our profits. This is because a trend sustains
itself by giving false reversal signals to trap traders out of the market and have
them chase it.

In the example below, we entered with a bearish Engulfing candlestick. Then, a

bullish Engulfing pattern prompted us to take profits.
10. CLIMATIC MOVE
Climatic price action is a reversal signal that is particularly effective as a profit-
taking cue.

Look out for:

 Bar range expansion

 Price movement at an increasing rate
 Extreme volume
This chart shows an example of exiting at the market following a climatic move.

1. We shorted at this bearish Reversal Bar.

2. Price fell with a parabolic curve.
3. Concurrently, volume increases.
4. The above signs of a climatic move prompted us to cover our short
position.

After a climax, the market tends move listlessly (as above) or reverses sharply.

BONUS 11 – POINT & FIGURE (P&F) CHART TARGET PROJECTION

P&F is a unique chart type that focuses only on price action and filters out small
price movements (noise). For an introduction to P&F charting, read this section
of our guide to price chart types.

It has its own set of chart patterns and unique target projection methods
including the horizontal counts and vertical counts.
As P&F charts use pure price action, it might offer a more reliable price objective.
At least, it gives us a second opinion for targeting.

If you are keen to learn more, pick up a copy of Jeremy du Plessis’ book on P&F
charting.

THE PERFECT TRADE EXIT

There you go, ten ways to exit your trades with a profit.

How do we decide among these methods? Consider the following.

TRADING STYLE (TREND OR RANGE)

Let your trading style determine your bias towards target orders or trailing stop-
losses.

If you trade trends and want to let profits run, use trailing stop-losses. (Like
the Turtles who stop and reverse with each opportunity.)

If you scalp for small profits within a trading range, use target orders.

The premise of range trading is that the market is within a trading range. It
follows that the trading range limits our profit potential. Hence, using trailing
stop-losses to let profits run is inconsistent.

TRADING TIME-FRAME
Your trading time horizon is also a key consideration.

Day traders will benefit from having target orders. The range of each session
limits their profit potential. Facing such limits, there is little point in letting profits
run with trailing stop-losses. Target orders are suitable.

If you can hold on to positions without time constraints, then trailing stop-losses

might be preferable.
LOOK FOR CONFLUENCE OF TARGETS

For those using target limit orders, find the best price targets using the concept
of confluence.

This means that if you get a Fibonacci extension target, a chart

pattern measured target, and a major swing pivot clustering around a price level,
you smile.

PERFECT TARGET? WAKE UP.

Trying to look for the perfect exit is as dangerous as attempting to find the Holy
Grail of the perfect entry.

It does not exist, and you will never be happy if you chase it. You will end up
hurting your trading performance.

THE TYPICAL CONSTRUCT OF A VOLATILITY STOP-LOSS

There are three ingredients for a volatility stop-loss:

1. Volatility measure
2. Safety multiple
3. Price anchor

First, you choose a way to measure volatility. (e.g. standard deviation is 7)

Then, you decide on a safety multiple. Its purpose is to add a buffer for market
noise. It is also a reflection of how aggressive you want to be in placing your
stop-loss. (e.g. multiple of 3)

Take the product of the volatility measure and the safety multiple. The result is
the stop-loss distance in terms price. (e.g. 7 x 3 = 21)

The next step is to choose a price anchor. (e.g. last closing price is 215)

Finally, from the anchor price, project the stop-loss distance. That will help you
find out where to place the stop-loss.
The direction to project depends on your direction of your position. (e.g. for a
long position, the stop-loss will be placed at 215 – 21 = 194)

FIRST INGREDIENT: VOLATILITY MEASURE

There are two common measures of volatility among traders.

1. Standard Deviation
2. Average True Range

#1: STANDARD DEVIATION

Standard deviation is the default volatility measure in the finance industry.

According to StockCharts.com, Standard Deviation is:

A statistical term that measures the amount of variability or dispersion around

an average.

Imagine a price series in which every single price data equals to its average. (i.e.
zero dispersion around the average)

How would such a price series look like? Constant. Flat. Completely devoid of
volatility.

Hence, the dispersion around the average of a series (above or below) measures
volatility.

Most charting platforms can calculate standard deviation for you. But it’s always
good to know what goes into the computation. Work through this Excel guide by
Adam Grimes to compute the standard deviation.

Examples of stop-loss methods that use standard deviation:

 Bollinger Bands
 DevStop

#2: AVERAGE TRUE RANGE (ATR)

Welles Wilder introduced the ATR in his book, New Concepts in Technical Trading
Systems.
According to Investopedia, true range is the greatest of the following:

1. Current high less the current low

2. Absolute value of the current high less the previous close
3. Absolute value of the current low less the previous close

The ATR is a moving average of the true ranges. The typical look-back period is
14.

Wilder came up with the idea of a true range to account for gaps between
price bars. If you were to take the average range, you would have missed the
volatility due to price gaps between bars.

True range accounts for gaps with points 2 and 3 above.

In a market that does not gap, ATR is simply the average range. This is because
the price bar range (point 1) will always be the greatest.

Examples of stop-loss methods that use ATR:

 Chandelier Stop
 Keltner Bands

SECOND INGREDIENT: SAFETY MULTIPLE

The safety multiple is a key feature of a volatility stop-loss.

The volatility measure is an objective calculation of the market’s price

tendencies. On the other hand, the safety multiple is the subjective input from
the trader.

A low multiple means a tight stop-loss that places risk control above profit
potential. A high multiple produces a stop-loss that risks more but offers the
market more room to breathe.

This means that the multiple reflects the trader’s expectations of price action.

2 and 3 are common safety multiples used in volatility stop-losses. You can use
them as a starting point to experiment.
The best approach is to derive a default multiple based on back-testing your
markets. Then, refine them based on the circumstances of each trading setup.

For instance, for a long term trend-following trade, a higher multiple is wise. For
a breakout trade that you expect to hit the target swiftly, a low multiple is
suitable.

THIRD INGREDIENT: PRICE ANCHOR

Once you get a stop-loss distance, you need to project it from a reference price
(anchor).

Common price anchors are the high, low, and close of the price bar. Some
traders also use a price moving average as the anchor.

For a long position, using the bar high as a price anchor produces a tighter stop-
loss. For a short position, using the bar low has the same effect.

Using the closing price is a good compromise. A stop-loss that updates with the
completion of each price bar uses the closing price as the anchor.

Traders who want a smoother series of price anchors will prefer using a moving
average.

TYPES OF VOLATILITY STOP-LOSSES

In this section, we take a look at 8 different volatility stop-loss methods.

The point of this section is not to offer an exhaustive reference.

It aims to show how you can combine the three ingredients above to produce
various volatility stop-loss strategies.

#1: CHANDELIER EXITS

This powerful image was used by Chuck Lebeau to describe his volatility stop
approach. (Alexander Elder discussed the Chandelier Exits in his book – Come
Into My Trading Room.)
It uses a multiple of the ATR and “hangs” it down from the highest high of a look-
back period. Typically, it uses a 22 look-back period with 3 x ATR. (Exact formula
here.)

Making sure that you understand how Chandelier Exits work is worthwhile. A

few of the stop-loss methods that follow are improved versions of the
Chandelier Exit.

#2: BOLLINGER BANDS

Bollinger Bands are rarely touted as a stop-loss tool. But its usage of standard
deviation makes it a natural candidate.

For instance, the lower Band works well as a stop-loss for a long position. I’ve
kept the Chandelier Exit on the example below for comparison.
As the Bollinger Band is not designed as a stop-loss tool, it widens when volatility
is high. Hence, when you use it as a stop-loss tool, remember to ignore the parts
where the Band moves away from price. Adjust the stop-loss only in the
direction of the trade.

Common multiples used for standard deviation are two and three. Why?

Around 95% of the fluctuation stays within two standard deviations around the
average. Around 99.7% of the variation stays within  three standard deviations
above and below the average.

While this is only true of normal distributions, it’s a good starting point.

#3: KELTNER BANDS

Like Bollinger Bands. But in this case, ATR is used instead of standard deviation.

Also similar to the Chandelier Exit. But in this case, the price anchor is a moving
average instead of a price high/low.
#4: KASE’S DEVSTOP
Cynthia Kase’s DevStop seeks to enhance the Chandelier Stop.

The main idea is that ATR is not the only important factor to consider when it
comes to setting stop-losses. The variation of ATR is critical as well.

To understand the DevStop, let’s break it down into the three parts of a volatility
stop-loss:

 Volatility measure
 Multiple
 Price anchor

DevStop replaces the ATR with the True Range of 2 Bars (TRD) and uses it as the
basic building block.

For the volatility measure, it uses the standard deviation of TRD instead of

simply using the TRD.
The safety multiple ranges from 1 to 3.6. The seemingly odd number with
decimal is in fact an attempt to account for the skew in the distribution of TRD.
(TRD does not follow a normal distribution.)

The price anchor is a moving average of the TRD.

To see the DevStop in action, take a look at this article by Cynthia Kase.

Learn more about DevStop in Cynthia Kase’s book – Trading With The Odds.

#5 KAUFMAN’S VOLATILITY STOP

Perry Kaufman discussed this stop-loss method in his book A Short Course in

Technical Trading.

Again, you can think of it as a result of tweaking the Chandelier Exit.

Instead of using ATR, he uses an average of the simple range as the volatility
measure. (i.e. high – low)

As for the price anchor, the most recent price low is used for a long position. The
most recent price high is used for a short position.

Bulkowski has discussed this method on this website here. There’s also a nifty
calculator here for this stop-loss strategy.

#6: ELDER’S SAFEZONE STOPS

Alexander Elder described the SafeZone Stops in his book – Come Into My
Trading Room.

In Chandelier Exits, ATR is a direction-neutral volatility measure. It ignores the

fact that with-trend and counter-trend price action have different volatility.

To account for this, Elder uses DM instead of ATR as the volatility measure. DM is
a directional movement system designed by Wilder.

DM is an intuitive concept. Positive DM is the difference between current bar

high and last bar high. Essentially, it is the price territory that the bulls have
managed to conquer in one price bar. The same logic applies for negative DM.
From Incredible Charts
Elder’s improvement on the classic volatility stop-loss makes sense. But as the
formula is more complicated, it might not be among the default indicators on
your platform.

If you want to give SafeZone stops a try, check out Incredible Charts, Motive

Wave, or MT4.

Safezone Stops
Traders adjust their stops over time in the direction of the trend in order to lock in profits. As an
alternative to Moving Average and Average True Range trailing stop systems, Alexander Elder
introduces SafeZone Stops in Come Into My Trading Room(2002).

Dr Elder designed SafeZone to eliminate the "noise" component of a trend and hopefully avoid
having stops shaken out by that noise. He uses a 22-day Exponential Moving Average to define
the trend, but I prefer a longer (63-day) exponential moving average. Elder then calculates
directional movement in a similar fashion to Welles Wilder's Directional Movement System and
applies a multiple of between 2 and 3 to determine the trailing stop.
Safezone Trading Signals
Safezone stops are primarily used to time exits from a trending market. Use the exponential
moving average to determine the trend and select the Safezone long or short option.

 Exit long positions when price crosses below the Safezone stop.
 Exit short positions when price crosses above the Safezone stop.

Safezone cannot be used to signal entries as with some stop-and-reverse systems.

Example

The RJ CRB Commodities Index late 2008 down-trend is displayed with Safezone (short, 22-day,
multiple of 3) and 63-day exponential moving average used as a trend filter. Entries are taken
when price makes a new 5-day low while below the moving average (or 5-day high when above
the MA).
 Mouse over chart captions to display trading signals.

1. Go short [S] when price is below Safezone and closes below the 63-day exponential
moving average
2. Exit [X] when price crosses above the Safezone Line
3. Go short [S] when price makes a new 5-day low while below the 63-day MA
4. Exit [X] when price crosses above
5. Go short [S] when price makes a new 5-day low while below the 63-day MA
6. Exit [X] when price crosses above
7. Go short [S] when price makes a new 5-day low while below the 63-day MA
8. Exit [X] when price crosses above the Safezone Line

No long trades are entered while price is below the 63-day exponential moving average, nor
short trades while above.

Safezone Setup
Default settings for Safezone are a 22-day period and a multiple of 2.5 times. Longer term
traders may opt for wider multiples of 3.5 or 4.0.

Safezone Formula

Define the Trend

First compare Closing Price to an exponential moving average to define the trend.

 If Closing Price is above the moving average for the selected period, that means that the
trend (and the MA slope) is upward.
 If Closing Price is below the moving average, the trend is downward.

Directional Movement
The second element is Directional Movement. This is calculated in a similar fashion to DI+ and
DI- in the Directional Movement System:

+DM = Today's High - Yesterday's High (when price moves upward)

-DM  = Yesterday's Low - Today's Low (when price moves downward)

The difference is that you can have both +DM and -DM on the same day. If there is an  outside
day then both calculations will be positive. For an inside day both calculations are zero.

Directional Movement Days

Calculate the number of days with +DM in the selected period; and the number of -DM days.
Elder uses the same selected period for Directional Movement as he does for the moving
average, but there appears to be no reason why this could not be varied.

When the Trend is UP

Calculate -DM Average:

Sum of -DM for the period / Number of -DM days

Then calculate the Stop Level for today:

Today's Stop = Yesterday's Low - 2.5 * -DM Average

To delay/prevent the stop from being lowered, use the maximum of the last 3 days' stops.

When the Trend is DOWN

Calculate +DM Average:

Sum of +DM for the period / Number of +DM days

Then calculate the Stop Level for today:

Today's Stop = Yesterday's High + 2.5 * +DM Average

To delay/prevent the stop from being raised, take the minimum of the last 3 days' stops.

Note: We use a multiple of 2.5 in the above example, but any multiple between 2 and 4 is
acceptable.
Safezone Evaluation
SafeZone has a number of strengths:

 Stops are less likely to move lower during an up-trend (or higher during a down-trend);
 SafeZone does not assume that the trend has changed every time that your stops are hit;
and
 SafeZone uses Directional Movement rather than ATR as a measure of volatility. This is
an excellent concept. It attempts to isolate counter- trend movement as the risk factor
when following a trend and removes the other irrelevant component of volatility
(movement in the direction of the prevailing trend). A runaway trend (or blow-off) may
show little or no counter-trend movement, meaning that stops move tighter as the trend
accelerates into a blow-off.

Potential weaknesses:

 SafeZone fails to adequately distinguish between counter-trend movement and

movement in the direction of the prevailing trend — at the start of a trend or if the trend
reverses within the selected time period. All -DM and + DM is treated equally, whether
the trend is up or down, giving an incorrect reflection of counter-trend movement.
 The relatively short time period over which directional movement is calculated may not
adequately reflect potential counter-trend movement.
 SafeZone relies on an exponential moving average to indicate trend direction, introducing
some lag. There is nothing, however, to stop the trader from substituting another trend
indicator in place of the moving average.

#7: BULKOWSKI’S BETA-ADJUSTED TRAILING STOP-LOSS

This trailing stop-loss method was first featured in a 1997 article.

The volatility measure used here is beta. While beta is common in portfolio
management, you don’t see it much in technical trading.

According to Investopedia, beta is:

A measure of a stock’s volatility in relation to the market.

The beta of the entire market is always 1. Stocks that are more volatile than the
market has beta greater than 1. Stocks that are less volatile than the market has
a beta smaller than 1.

Note that beta is a relative measure of volatility. This is different from the other
measures mentioned earlier.

Due to this difference, this volatility stop-loss strategy differs from the typical
template.

It does not use a safety multiple to determine the stop-loss distance. Instead, it
prescribes one based on combinations of a stock’s beta and price. The
prescribed distance is based on Bulkowski’s intensive back-testing.

The table of prescribed stop distance is a useful reference. But it’s difficult to

derive your own values without having solid back-testing skills.

#8: WILDER’S PARABOLIC SAR

Parabolic SAR is an impressive indicator that incorporates both price and time to
place stop-losses.

Thus, it’s not surprising that the formula of Parabolic SAR is one of the hardest to
grasp. If you want to get a complete understanding, you can refer to Wilder’s
book or this web page.

The defining parameter of Parabolic Sar is the Acceleration Factor (AF). The
default value is 0.02. Each time the trend advances, the AF increases by 0.02.
This explains its distinctive parabolic shape.
“SAR” stands for Stop-And-Reverse. It refers to a trading approach that seeks to
be in the market at all times. Once a long position is stopped out, reverse into a
short position. And vice versa.

This approach is not always suitable. But it does suggest a creative use of
volatility stop-losses – for trade entries.

In the right context, the trigger of a stop-loss might be a signal to enter a trade in
the opposite direction.

PROS AND CONS OF VOLATILITY STOP-LOSSES

PROS
Stop-losses are often based on price patterns, and support and resistance. It
might also be based on a reversal signal, be it from price action, volume or an
indicator.

However, you might not always find appropriate price action formations for
stop-loss placement.

This is where volatility stop-losses shine. Regardless of the price action, you can
always place a stop-loss based on volatility. It’s always a viable stop-loss
method.
Due to this reason, it is also effective as a trailing stop-loss. A trailing stop-loss
should trail, regardless of the price patterns that form.

Furthermore, volatility stop-loss is based on an objective method and is easily

programmable. This makes it especially useful for algorithmic traders.

CONS
The key disadvantage of volatility stop-loss is that it requires input parameters.
And these parameters have a great impact on their effectiveness.

There’s a huge difference between a safety multiple of 1 and 4.

Most traders start with the default setting. Many will go on to optimise them
based on their testing results. However, it does not guarantee that they will work
in the future.

a̶ss̶ ̶u̶m̶p̶t̶i̶o̶n̶

Another disadvantage of volatility stop-loss stems from its main assumption. The
volatility measure used is based on historical volatility. Hence, we are assuming
that future volatility is similar to historical volatility.

This assumption does not always hold true.

One example is when there’s news release with huge market impact. When
there’s important news, volatility rises and stop-losses based on historical
volatility become ineffective. A recent instance is the Brexit result.

THE SENSIBLE WAY TO USE VOLATILITY STOP-LOSSES

#1: REMEMBER PRICE ACTION

Volatility stop-losses bring out the statistician in traders. It’s certainly helpful to
try out different volatility measures, multiples, and price anchors. But never
forget price action.

Let’s say you are in a long position. Your volatility stop-loss is just above a major
support level which the market is likely to test.
In this case, do not follow your volatility stop-loss strategy blindly.

Adjust your stop-loss to a safe distance below the support level. You can do so
by using the support level as the price anchor for your volatility stop. Or you can
increase the safety multiple.

#2: INCORPORATE OTHER STOP-LOSS METHODS

Two other common stop-loss methods are patterns stops and time stops.

If you entered the market based a chart pattern (e.g. Head & Shoulders), you
should definitely make use of it in your stop-loss placement. This approach is a
pattern stop and is extremely relevant for price action traders.

The same goes for a bar pattern like the Hikkake shown below. To incorporate
volatility, you can set the pattern stop one ATR wider to accommodate for
whipsaws.
Time stops are critical too, especially for options traders. Even if you don’t trade
options, using a time stop can improve the efficiency of your trading capital.

(The Parabolic SAR accelerates over time and is a stop-loss method that
integrates time.)#3: EMPLOY DISCRETION FOR TARGETS

It might be tempting to use trailing stop-losses guided by volatility. But for some
trades, you might be better off taking your profits before your trailing stop-loss
is hit.

Your targeting decision boils down to the type of trade you are taking. Trailing
stop-loss might be ideal for capturing the long term trend. But a well-placed
target order is superior for a quick intraday scalp.

#4: PAY ATTENTION TO THE STOP-LOSS TRIGGER

This is a small detail that might have a big impact on your expected results. What
price are you using to trigger your stop-loss?

Most traders use the continuous current price. This means that at any point,
once your stop-loss is hit by the market, your stop order will be executed.

However, there is an alternative tactic that’s common among swing traders. They
use the closing price of the day to trigger their stop-loss. This means that
intraday hits of the stop-loss level do not trigger the stop order. Only the closing
price matters.

The advantage of this approach is that wild intraday spikes are avoided.

The disadvantage is that you lose control over your potential loss. This is
because the market might close far beyond your stop-loss and cause huge
unexpected losses.

In any case, you must understand the implications of the exact stop-loss trigger.

#5: PRIORITISE RISK CONTROL

A volatility stop-loss is just one part of the risk control puzzle.
Don’t forget to adhere strictly to your position sizing model. If not, you might risk
too much without realising.

Take a look at The Logical Guide To Setting A Stop-Loss.

CONCLUSION

Never forget this: stop-losses are meant to be hit (when the market does not go
your way).When a well-placed stop-loss is hit, rejoice. Because the stop-loss has
performed its duty. It has limited your risk.The caveat here is that the stop-loss
must be well-placed. It should not be random. When a random stop-loss is hit,
well, it’s just random.Volatility is a remarkable tool to help you place great stop-
losses. With it, you can achieve that delicate balance between profitability and
risk control.

WHAT IS BAR-BY-BAR ANALYSIS?

Bar-by-bar analysis does not mean that every price bar is significant. It does not
mean that you must attribute some meaning to each price bar you see.

In that case, why do we call it bar-by-bar analysis? Because it works on the

principle that every bar might be important.

Might be important. This is why it’s necessary that we pay attention to each price
bar.

Might be important. This is why we must not over-analyze. You can struggle to
give some value and meaning to each and every price bar, but the effort is not
worth it. Usually, it does more to confuse you.

This is also why you will find that I’m skipping bars in the analysis below. I am not
cheating, that’s just how price action analysis works.

Analyzing price action is about:

 Figuring out what is happening now to

 Form expectations of the future as a basis for
 Evaluating what really happens so as to
 Anticipate what will happen.

It’s not about making impressive predictions that are always right.
GROUND RULES FOR THE EXAMPLES
In these examples, we will:

1. Select a random part of a chart.

2. Focus on analyzing a 20-bar section.
3. Use the most recent pivot high and low to offer an analytical context.

The examples below might be a little overwhelming. At least for those who are
not familiar with price action analysis. You might want to check out some of
these articles first before tackling the examples.

 Beginner’s Guide to Reading Price Action

 Using Trend Bars to Read the Market
 Market Demand and Supply

EXAMPLE 1 – HD DAILY CHART

In this example, we will look at the daily price chart of Home Depot (HD on
NYSE).

PRICE ACTION CONTEXT

In the red box, you will see the 20 selected price bars. The two dotted lines mark
out the most recent swing high and low just before the selected area.
BAR-BY-BAR ANALYSIS
The chart below shows the analysis. It’s wordy. Click on it to enlarge.
 1. This bearish outside bar tried to reach for the last swing low.
2. It failed, and the market found buying pressure instead.
3. The preceding bearish bar was a test to see if the buying pressure would
hold. And this bullish outside bar confirmed that the bulls were serious.
4. However, price rose quickly in a climatic way to test the last swing high.
Despite the seemingly strong upwards thrust, the market could not clear
above the resistance.
5. The market fell and went into a trading range. The four consecutive bullish
bars did not push the market higher. Note its bearish implication.
6. Indeed, the market went lower after that.
7. However, the market rebounded quickly. (Remember that when bearish
expectations fail, the bulls prevail.)

THE PRICE ACTION THAT FOLLOWS

This red box shows the area we just analyzed. Take a look at how the price
action unfolded after that.
EXAMPLE 2 – CL 3-MINUTE CHART
In this example, we will look at an intraday chart that shows the 3-minute bars of
crude oil futures (CL on NYMEX).

PRICE ACTION CONTEXT

In the red box, you will see the 20 bars we will be analyzing. The dotted lines
mark out the most recent swing high and low just before the area for analysis.

BAR-BY-BAR ANALYSIS
The CL analysis is in the chart below. Click on the image to enlarge.

1. This bar was a powerful break above the last swing high. The bulls might be
exhausted.
2. The selling pressure here cemented the idea that the bull run might be
over.
3. First real attempt by the market to push lower.
4. However, the bearish thrust received no follow-through. These two bullish
bars implied that the bulls were still in control.
5. The top shadows here were significant. They show selling pressure in the
same price range where the sellers were found earlier. (Repeated selling
pressure within a tight range is a solid bearish signal.)
6. This series of three bullish bars was not as bullish as it seemed. Not only
did the streak fail to make a new high, the last bar showed a longer top
shadow.
7. The market was not committed to any direction. Trend bars in both
directions did not get much follow-through.

THE PRICE ACTION THAT FOLLOWS

This red box shows the area we just analyzed. Take a look at how the price
action unfolded after that. The chart shows the next 20 bars, which crosses into
the next trading session in this case.
EXAMPLE 3 – 6E 15-MINUTE CHART

In this example, we will look at the 15-minute chart of the popular forex futures

EUR/USD (6E on CME).

PRICE ACTION CONTEXT

The red box shows the 20 bars we will analyze below. The dotted lines mark out
the most recent swing high and low just before the box.

BAR-BY-BAR ANALYSIS
Click on the image to enlarge.
 1. After this strong bullish bar, we thought that the market would breach the
last swing high.
2. But it did not. That failure to push to a new high had bearish implications.
3. The market fell before drifting sideways.
4. This bearish outside bar broke out of the trading range and acted as a bull
trap. It was a possible short setup.
5. The market fell again with a climatic thrust.
6. Another trading range, indicating a pause after the climatic bear thrust.

PRICE ACTION THAT FOLLOWS

This red box shows the area we just analyzed. Take a look at how the price
action unfolded after that. It confirmed that the last bearish thrust was indeed a
climax which preceded a reversal.
CAVEATS
LIMITED ANALYSIS

In these examples, I’ve limited the market context to the last set of pivot high
and low to keep things simple. I’ve also ignored the finer price action features
before the 20 bars.

When you do real analysis, things will be more complex. You need to analyze the
market bias by going further back in time. You will certainly need to expand your
view beyond 20 bars.

ANALYSIS IS NOT TRADING

An analyst is just trying to figure out what happened and what might happen
next. A trader needs to figure out how much to risk and target and decide if
there’s money to be made.

The examples above demonstrates price action analysis, not price action trading.

I did not write down where to enter and exit. But you can certainly find your own
trades based on the analysis.
This article is not about trading. It’s about analysis, which is a cornerstone of
successful trading.

CONCLUSION
If you pay attention to price, you will find great value. But it’s a skill that takes
time to develop.

TRADING THE ENGULFING CANDLESTICK PATTERN WITH

If you have learnt how to trade candlesticks, you must know the engulfing
candlestick pattern. Its striking name and visual makes it one of the most
popular candlestick pattern.

Reference: Japanese Candlestick Charting Techniques

The engulfing candlestick pattern has two candlesticks. The body of the second
bar completely engulfs the body of the first bar. It represents a total change
of market sentiment.

An engulfing candlestick in the right context offers a high probability trading

setup. Finding the best context with moving averages and oscillators are reliable
trading methods.

Learn: Candlestick with RSI Trading Strategy

However, in this review, we will look at a simpler method that uses the concept
of market structure to find point us in the right direction. Market structure refers
to the relationship of swing highs and lows that lend structure to market trends.

TRADING RULES – ENGULFING CANDLESTICK

BULLISH ENGULFING

1. Higher swing high and higher swing low

2. Buy with bullish engulfing candlestick pattern
3. High of pattern must stay below previous swing high

BEARISH ENGULFING

1. Lower swing high and lower swing low

 2. Sell with bearish engulfing candlestick pattern
3. Low of pattern must stay above previous swing low

ENGULFING CANDLESTICK TRADING EXAMPLES

WINNING TRADE – BEARISH ENGULFING

This is a daily chart of Allergan (AGN on NYSE). It shows a market plunge that
erased months of gains.The lower swing high and low confirmed the beginning
of a downwards trend with the climatic bear bar.

1. Prices retraced up immediately after the drastic fall. The bull move stopped
as a bearish engulfing candlestick emerged.
2. The bearish engulfing candlestick pattern formed on the mid-point (50%
retracement) of the strong bear trend bar which provided resistance
3. .LOSING TRADE – BEARISH ENGULFING
This daily chart of Cardinal Health (CAH on NYSE) shows a bearish engulfing
pattern that didn’t follow-through.

1. Technically, there was a set of lower swing high and low.

2. However, in this case, the swings did not push out of the sideways
movement of CAH. Hence, the lower high and low structure was not a
reliable indicator of a downwards trend.
3. The bearish engulfing candlestick pattern led to a losing short trade, as
prices broke out above the trading range.

REVIEW – ENGULFING CANDLESTICK WITH MARKET STRUCTURE

Many trading strategies use engulfing candlestick patterns as a signal for major
trend reversals. That is a low probability strategy. However, as we use engulfing
patterns for continuation trades here, we have better odds.

Many candlestick traders wait for one more candlestick after the engulfing
pattern as confirmation. For this trading strategy, you should not wait for
confirmation for most trading setups. Waiting for confirmation worsens our
reward to risk ratio.

If you wait for confirmation, the trading setup is likely invalid due to trading rule
3. Basically, that rule keeps us away from taking trades that have poor reward to
risk ratio.

Observing swing highs and lows is the simplest way to follow market trends. It
builds on the market structure and does not need any trading indicator. While
this approach gives some confusing signals during deeper pullbacks, its
simplicity is still attractive. Regardless of your trading strategy, paying attention
to the market structure will help you filter bad trades.
HOW TO IDENTIFY DEMAND AND SUPPLY USING PRICE ACTION

Want to find demand and supply in the market? Just look at the market depth
screen and you will see orders to buy and sell at different prices. Those numbers
show demand and supply.

That’s all. You’ve found demand and supply. What can you do with it? Nothing.

Now, think again. Do you really want to find demand and supply?

In a liquid market, there is constant supply and demand. People are always
willing to buy and sell at different prices. Demand and supply are everywhere.
There is no need to find them.

What you really want to find are the price zones where supply overwhelms
demand and where demand overwhelms supply.

 The former is known as resistance. When the market bumps into

resistance, price will drop. Then, you can make money by shorting the
market.
 The latter is market support. With the support of demand, price will rise.
Then, you can profit from a long position.

In a nutshell, we want to find market turning points, and not merely demand
and supply. Follow the three steps below to find and trade these profitable
turning points.

1. FOCUS ON A PRICE LEVEL (ZONE)

It’s difficult to analyze the market without a focal point. If you look for turning
points at every price level, you will only find confusion.

How do you know which price level to focus on? Which price levels are potential
market turning points?

There are many ways to find potential turning points. You can use swing pivots,
calculated pivot points, Fibonacci levels, and volume signals. Learn about these
methods and make use of those that make sense to you.

EXAMPLE
In this example, I focus on a valid swing pivot. (The concept of a valid swing pivot
is explained in my price action course. Essentially, it is a form of major market
pivot.)

The ES 5-minute chart above shows a valid swing low. Pay attention to this price
zone to find out if demand prevails.

2. OBSERVE WHAT HAPPENED (HAPPENS) AT THE POTENTIAL

SUPPORT/RESISTANCE
SIGNS OF STRONG DEMAND

When the market tests a potential support, look out for:

 Bullish price pattern

 Inability to clear below the support
 Increased volume
 Congestion

SIGNS OF STRONG SUPPLY

When the market tests a potential resistance, look out for:

 Bearish price pattern

 Inability to clear above the resistance
 Increased volume
 Congestion
Look for these price action signals in the past, as well as in real-time price action.
The more signs you see, the more likely you’ve found a true support/resistance
zone.

EXAMPLE

Let’s take a closer look at the same ES 5-minute chart to check the price action.

1. Volume increased as the market dipped into the price zone. It was a clue of
a demand surge.
2. Bullish price patterns formed as the market tested the support
zone.  (Marubozu and Outside Bar)
3. It was clear that the market had difficulty closing within or below the
support zone.

These signs confirmed that demand would likely overwhelm supply in the
indicated price zone.

3. LIMIT YOUR RISK

Once you’ve found a potential support or resistance level, remember the word
“potential”. It is a tendency and not a guarantee.

Hence, you should limit your risk when you trade supply and demand zones.
There are two trading approaches to do so.
METHOD ONE – DEMAND CONFIRMATION

Let price show you the way. Look for price patterns. Then, use stop orders to
enter as the market confirms your opinion.

You will enter late, but you will save yourself from many bad trades. The main
drawback of this strategy is that you will enter at a worse price. Hence, use this
strategy only when you expect significant profit potential. Otherwise, the
reward-to-risk ratio is too low.

METHOD TWO – TRADE AGGRESSIVELY

Get in early (without confirmation) with a tight stop-loss and a conservative

target. In this case, use a limit order placed within the support/resistance zone.

This strategy is ideal when you are:

 Confident of the demand and supply conditions;

  But are uncertain of how far the market would go.

EXAMPLE
In our ES 5-minute example, the support zone looked reliable. Hence, we were
confident that demand would stop the market decline.

However, given that the market has been falling, long positions were against the
recent trend. It was unwise to set ambitious profit targets.

Under such considerations, the aggressive trading approach is suitable.

 A
consistent stop-loss and target of 2 points will work for both trades. It
produced two swift and high probability scalps. (The stop-loss and target
depends on the market volatility.)

USE PRICE ACTION TO UNDERSTAND HOW DEMAND AND

SUPPLY INTERACTS

Remember that you are anticipating the strength of demand and supply. We are
interested in their interaction.

 Will demand conquer supply at this price level?

 Will supply overwhelm demand at this price level?
 What does this (series of) price bar(s) tell me about demand and supply?

TAKE ONLY THE BEST DAY TRADING SETUPS

Taking the best day trading setups will make you the best day trader.

Many people think of day trading as moving in and out of the market
rapidly, and making daily profits.

That is what brokers would like you to believe, because they earn a commission
for each trade you make.

The reality is different.

YOU NEED TO SLOW DOWN YOUR TRADING
If day trading is only about trading rapidly throughout the day, then it is not a
game for retail traders like us. Because we are slow (very very slow) compared
to these guys.

Let’s slow down so that we can put the odds back in our favor.

DAY TRADERS HAVE PLENTY OF TRADE OPPORTUNITIES

There are ample day trading setups each day. But this is a double-edged
sword for day traders.

PROS OF AMPLE DAY TRADING SETUPS

 Learn more in a shorter time frame.

 Grow our trading account at a faster rate. Daily compounding leads to
astronomical figures.
 Be more selective and take only the best day trading setups.

CONS OF AMPLE DAY TRADING SETUPS

 Not enough time to check and learn from our trades.

 Lose our shirts within the day.
 Over-trade. Over-trading is not merely taking many trades. Over-trading
means trading so frantically that you ignore your trading edge. It is one of
the worst sins of traders and many day traders blow out their account
because of over-trading.

Learn: How to Stop Over-Trading

TAKE ONLY THE BEST DAY TRADING SETUPS

This is the only way to avoid all the cons, and go for the pros.

By taking only the best day trading setups, you will have more time to review
your trades, and still gain experience faster than most traders. You will avoid
over-trading and keep up your trading edge.

Think of taking the best trading setups as a luxury only available to day
traders.
Position traders might need to wait for weeks before having a trading
opportunity. They must take every trade that comes along for fear that the next
trade will only come weeks later.

Taking only the best trades is not an option for them.

Ma
ke full use of the day trading perspective and take only the best setups
HOW TO IDENTIFY THE BEST DAY TRADING SETUPS?
First, learn your trading setup well and understand the market conditions for it
to work. Burn the rules for buying and selling into your head.

Next, while evaluating each trading setup, ask yourself this: Are there any
reasons not to take this trade?

These are some reasons that might make you reconsider taking that trade.

 Prices are stuck in a tight trading range (series of dojis) in which price
action is wild and unpredictable.
 The signal bar closed against your market bias.
 There are major support/resistance between your signal bar and
your target price.
 A trend climax took place before your pullback trade. (A sign of trend
exhaustion.)
 The signal bar has an abnormally large range which increases your risk,
and might show exhaustion.

If you cannot find any reason not to take that trade, then that is the best trade.
Understanding the concept behind your trading setup will also help you find the
best trades.For instance, the Hikkake candlestick pattern profits from trapped
traders. Naturally, the best Hikkake setups are those with the most number of
traders trapped.

INSIDE DAY NR4 (ID/NR4)

Toby Crabel did some serious work on volatility patterns in price movement. The
Inside Day/NR4 (ID/NR4) is one of the patterns he wrote in “Day Trading with
Short Term Price Patterns and Opening Range Breakout“.

An inside day is one with a lower high and higher low than the previous bar. NR4
is a bar with the narrowest range out of the last 4 bars.

Hence, ID/NR4 is an objective criterion for identifying days of decreased

range and volatility.Once we find an ID/NR4 pattern, we aim to trade the
breakout as volatility resumes.

TRADING RULES FOR ID/NR4 RULES FOR LONG

1. An inside bar with the smallest range out of the last 4 bars.

2. Place buy stop order above the high of the bar.
3. Wait for a breakout to trigger order.

RULES FOR SHORT

1. An inside bar with the smallest range out of the last 4 bars.

2. Place sell stop order below the low of the bar.
3. Wait for a breakout to trigger order.

TRADING EXAMPLES FOR ID/NR4 WINNING TRADE

This chart shows the daily prices of EUR/USD. The green arrow marks an inside
day with the smallest range out of the last 4 bars (ID/NR4).

We placed a buy stop order placed at the high of the ID/NR4 was triggered the
next day. Prices went up for the next few days.

The previous bullish price action was ideal for this long position.

1. The outside bar with a long bottom tail points to buying pressure.
2. The buying pressure was sustained by the bullish follow through.
3. The three bearish bars before our signal bar was great but the support
from the previous swing low (blue line) held up. The bar that tested the
support showed an extended bottom tail (buying pressure).

LOSING TRADE
This daily chart of chemical giant DuPont listed on NYSE shows an ID/NR4 (green
arrow).

We entered the next day as prices broke the high of the ID/NR4 bar. Prices
moved sideways for a few days before stopping us by breaking out of the low of
the ID/NR4 pattern.

Dupont was trapped in a trading range. In a range, we should sell high and buy
low. However, the ID/NR4 gave a buy signal at the top of the range.

Let’s take a look at the specifics.

1. After the breakdown of prices, a clear double bottom was formed.

2. Prices bounced off the double bottom with bullish action.
3. This terrible reversal bar (gravestone doji) confirmed that DuPont had
entered a range. This single bar should deter most traders from going long
until more bullish action unfolds beyond the range (marked by the two
blue lines).

REVIEW – INSIDE DAY NR4 (ID/NR4)

ID/NR4 are days with low volatility and small range.

Unlike the Bollinger Squeeze which identifies a drop in volatility over several

bars, ID/NR4 shows only a single bar contraction in volatility. Accordingly, ID/NR4
is a short-term volatility pattern.
Hence, it is crucial to look at the price action context before taking any
trades with ID/NR4. Experiment with a trend filter like a moving average and
pay more attention to the market context.

(Need help finding the pattern? We have an indicator fOr you.)

The winning example shows that, given the right context, this pattern is a great
low-risk trigger.

However, if the market is in a range, the ID/NR4 pattern might be part of a

prolonged congestion. 

A SIMPLE AND EFFECTIVE PRICE ACTION TRADING SETUP

Observing price action is the simplest way to trade.

Yet, many price action trading setups are not simple at all, requiring
interpretation of complex and subjective chart formations.

The worst part is that traders often memorize price action trading setups
without understanding the concept behind them.

In this article, we will introduce a simple and effective price action trading setup
– Trend Bar Failure.

BASIC DEFINITIONS FOR PRICE ACTION TRADING

TREND

In price action trading, higher highs and high lows show an upward trend. Lower
highs and lower lows show a downward trend.

In our examples, for simplicity, we will be using the slope of the 20-period

EMA as our trend filter.

You are free to use your own methods and discretion to find the trend. Some of
the more popular trend tools are moving averages and the ADX indicator.

One tip for identifying trends: trends are obvious. When it is doubtful whether
the market is trending, it is not trending.
TREND BAR

A trend bar is one that represents a trend on a smaller time-frame. It opens and
closes on opposite ends of the bar.

A bull trend bar opens near its low and closes near its high. A bear trend bar
opens near its high and closes near its low.

What does a trend bar mean?

It means that traders have committed to one direction. Remember that in every

bar, the number of contracts sold and bought are the same. The only reason for
a bar to end up with a higher price is that the buyers were more aggressive than
the sellers. The reverse is true for a bear trend bar.

How does a trend bar look like?

While we can identify trend bars subjectively depending on the market context, I
prefer a more objective measure. A trend bar has a body that is greater than
50% of the entire bar range.

TRADING PREMISE

These premises set the stage for this price action trading setup and explain its
concept. The explanation below is for a bull trend. The reverse is true for a bear
trend.

1. TRENDS TEND TO CONTINUE.

This is one of the principles of technical analysis. As trends tend to continue, our

edge lies in following the trend.
2. TREND BARS AGAINST TREND HINT AT THE ENTRY OF COUNTER-
TREND TRADERS.

In a bull trend, bear trend bars represent counter-trend traders trying to reverse

the trend. The committed bearish traders are counter-trend traders.

3. THE TREND CONTINUES AS COUNTER-TREND TRADERS FAIL IN THEIR ATTEMPT

TO REVERSE THE TREND.

According to our first premise, the trend is more likely to continue than to
reverse. Hence, it is likely that the counter-trend traders are wrong. The bearish
trend bar is likely to fail without significant follow-through.

As the counter-trend traders realize that the bull trend is not reversing as they
anticipated, they will cover their short positions and might even reverse to
buying.

THE TREND BAR FAILURE TRADING SETUP

Following the premises above, the entry for a trend continuation trade takes
place when a trend bar against the trend fails.

If a trend bar is not followed by another trend bar, we should prepare

ourselves for a Trend Bar Failure.

RULES FOR LONG

1. 20-period EMA is sloping up (or if your trend assessment is bullish)

2. Bear trend bar
3. Low of bear trend bar broken (without forming a second bear trend bar)
4. Place a buy stop order above the high of the bar
5. Cancel order if not triggered within one bar

RULES FOR SHORT

1. 20-period EMA is sloping down (or if your trend assessment is bearish)

2. Bull trend bar
3. High of bull trend bar broken (without forming a second bull trend bar)
4. Place a sell stop order below the low of the bar
5. Cancel order if not triggered within one bar

TRADE EXAMPLES – ES FUTURES (5-MINUTE)

 We have
marked the trend bars in the charts. Bull trend bars with green arrows and bear
trend bars with red arrows.

1. A strong bearish bar followed by a bullish reversal bar. It had good

potential, but the buy order placed at the high of the bullish reversal bar
was not triggered.
2. A bearish trend bar tested the EMA without much follow-through. The
bull trend bar triggered the buy stop order, and led to a profitable trade.
3. This bear trend bar was also an inside bar. The two failure trades (failure
of inside bar and trend bar) led to the 6 consecutive bull bars.
4. Although the bar after the marubozu was not a bear trend bar, its high was
not broken and our buy order was not triggered.

We cancel orders if they are not triggered within one bar. This is because the
best trades happen quickly like a knee jerk reaction. By cancelling orders that
are not triggered swiftly, we are avoiding the second best trade and taking only
the very best trades.

TRADE EXAMPLES – AMEREN CORP (DAILY)

 You
can use this price action trading setup for swing trading as well.

1. A doji broke the low of the bear trend bar. However, the buy order was not
triggered.
2. An irresistible trade, with the an outside bar hitting our buy stop order
after testing the EMA.
3. The strong bear trend bar had little follow-through, but the buy order
was not triggered.

TRADE EXAMPLE – EUR/USD (WEEKLY)

Price
action trading setups work well in the forex market.

1.  The bear trend bar failed with a bull trend bar. This pattern is also known
as the pipe pattern.
 2. This trend bar failure was also an inside bar failure. However, the signal
bar was a doji and not ideal.
3. The bear trend bar had limited follow-through. Although this trade was
profitable, prices went sideways before resuming the trend. A more
conservative trader would have exited during the sideways congestion.

TRADE EXAMPLE – SPDR S&P 500 ETF (MONTHLY)

This
simple price action trading setup is robust enough for long-term analysis as well.

1. The bear trend was also an outside bar. This meant that the bears
overwhelmed the bulls in that bar. However, the next bar was bullish
reversal bar. This was good trade with a nice follow-through. However,
it might end up as a loss if our targets were further.
2. Another nice pipe pattern that tested the EMA.

CONCLUSION
The Trend Bar Failure trading setup is extremely simple and versatile. It is
the ideal starting point for price action trading.

The basic premise is the trapping of counter-trend traders. However, it

manifests in different forms like inside bar failure and the pipe pattern.

As shown in the many examples above, you can use this price action trading
setup in time-frames ranging from intraday trading to longer term monthly
analysis.
A SIMPLE WAY TO LOOK AT PRICE ACTION – TREND
BARS
Understanding price action is simple.

I am not talking about trading price action, but just reading it. I am referring to
grasping what the market is doing right now.

Price action results from the struggle between buyers and sellers. It is the
footprint of the fight between the bulls and the bears. When you look at a chart,
it makes sense to focus on finding the bulls and the bears.

To find them, you don’t need to memorize dozens of candlestick or chart

patterns. Let’s keep things simple.

The only concept you need is the Trend Bar.

WHAT IS A TREND BAR?

I explained the concept of Trend Bars in this setup. I borrowed the term from Al
Brooks’ books, but I am using a more technical definition.

A Trend Bar has a body that is greater than 50% of the entire bar range.

If a Trend Bar closes above its opening price, it is a Bullish Trend Bar.

If a Trend bar closes below its opening price, it is a Bearish Trend Bar.

GUIDELINES FOR READING PRICE ACTION WITH TREND

BARS
  Consecutive Trend Bars in the same direction display strength. Recognize
it.
 Opposing Trend Bars imply a fight between the bulls and the bears. Find
out who wins.
 Isolated Trend Bars are potential traps. Traps, by definition, are tricky. Is it
really a trap?

PRICE ACTION CHART EXAMPLES

Let’s take a look at two detailed examples of this useful concept in action.

CHART MARKUP LEGEND

 Cyan Background – Trend Bar

 Blue Circle – Consecutive Trend Bars in the same direction
 Pink Dash Circle – Opposing Trend Bars
 Green Arrow – Isolated Bearish Trend Bar (possible bull trap)
 Red Arrow – Isolated Bullish Trend Bar (possible bear trap)

EXAMPLE 1: SPY DAILY CHART

1. Clear war zone with four consecutive alternating Trend Bars.

2. Bulls tried to push back without much impact.
3. Bears came back stronger.
4. Both fights resolved in a bullish way. Likely that bulls have regained
control.
5. Bullish strength as expected.
 6. A fight that looked bullish. But we knew that the bulls did not have a clear
win as the last extreme high was not exceeded.
7. This thrust confirmed that the bears have taken over.

You can take a closer look at the red and green arrows. In the right context, they
present solid bear and bull traps.

EXAMPLE 2: ES INTRADAY 5-MINUTE CHART

1. The session started with the bulls in charge.

2. However, price soon stalled as both the bulls and the bears got involved.
3. Bears were in, but lacked strength when viewed in context.
4. Accordingly, this was an excellent bear trap. (Chance to buy.)
5. The bulls won this fight as price broke out above.
6. More bullishness after some struggle.
7. Sideways drift with two more instances of opposing Trend Bars. Bears win.

OPEN A PRICE CHART AND START READING

This approach to reading price action is simple. This is why it works on all time-
frames and instruments. (I selected the charts above at random.)

It takes some practice, but anyone can do it too. Open a historical chart, mark
the Trend Bars, and practice how to interpret the constant price war.
After getting the hang of it, use the same method to understand the live market.

Remember that this is NOT a trading strategy. You need much more to form
a price action trading strategy.

This is a price action method for understanding market movements. It’s not
perfect, but it is a solid first step to understanding price action.

4 TRADING STRATEGIES THAT PROFIT FROM TRAPPED TRADERS

Why do we need to understand the concept of trapped traders? What are

trapped traders?

We want to find trapped traders because trapped traders lose money. If we find
them and take advantage of the order flow they create, we can take their money
from them.

There are two types of trapped traders. We can easily empathize with them
because at some point in our trading, we were trapped traders as well.

TWO TYPES OF TRAPPED TRADERS

1. TRAPPED IN LOSING POSITIONS

The first type of trapped traders are trapped in a losing position. What do they
have to do eventually?

They must exit their positions as dictated by their stop-loss orders.

2. TRAPPED OUT OF WINNING POSITIONS

The second type of trapped traders are trapped out of winning positions.

For instance, you are in a long position and prices dropped and hit your stop-
loss order. Almost immediately after you got stopped out, prices shot up again
moving quickly up towards your original price target.

What would you have done?

Probably, you would chase after the market and try to get into the move.

DAY TRADING STRATEGIES WITH TRAPPED TRADERS

Trapped traders are not a new concept in trading. In fact, there are many trading
patterns that rely on trapped traders.

We have reviewed the follow trading strategies before. Here, we will point out
the trapped traders in each trading setup. This will allow you to focus on the
high quality trading setups with a healthy amount of trapped traders.

1. HIKKAKE TRADING STRATEGY

Hikkake is an inside bar failure trading strategy. It waits for a break-out of an

inside bar to fail. Then, Hikkake traders enter as the breakout traders are getting
out of their positions.

This diagram shows the different perspectives of the trapped traders and the
Hikkake traders.

If you
understand the concept of trapped traders, you will know why Hikkake works
exceptionally well.

Inside bars are narrow bars which means less trade risk. Traders love to lower
their risk, and will not give up a low-risk inside bar break-out trading setup.

What does this mean for the Hikkake trader? It means more trapped traders,
and higher chance of success.
So what is the first step to find high probability Hikkake setups? Find the best
inside bar trading setups. Then wait for them to fail.

2. TWO-LEGGED PULLBACK IN A TREND

Another well-known price action trading strategy is the two-legged pullback in a

trend.

The diagram below shows the perspective of trapped traders. The two-legged
pullback starts from the low of a down trend.

The power
of two-legged pullbacks stems from the trapping of two groups of traders. This
diagram shows only one group.

You can try to figure out where the other group of trapped traders are and how
they went into the trap. (Hint: They went against the down trend.)

The concept behind this setup is similar to the Re-entry Trading Strategy.

3. PIN BAR TRADING STRATEGY

The pin bar really goes the distance to trap traders by poking up above a swing
high or below a swing low.

Not only that, its long tail confirms that a nice trap is present.
 The
best pin bars are those that went beyond major swing highs and swing lows.
This is because many traders enter or exit their trades at major swing highs and
lows. These traders, if trapped, will fuel our blast to profits.

4. TREND BAR FAILURE

Earlier, I shared a simple price action trading setup based on trapped

traders with our newsletter subscribers. Its simplicity makes it one of the most
versatile and effective price action pattern.

CONCLUSION – TRADERS’ TRAP

One simple way to improve your trading with these trading strategies is to
change your perspective.

Think like trapped traders but do not act like them. It is not that difficult
because all traders, including you and me, were once trapped.

PRICE ACTION RE-ENTRY TRADING STRATEGY

Re-entry trading is a high probability trading concept in my course – “Day
Trading with Price Action“. It is a simple but powerful concept that works in all
markets. In this article, I will explain it with price action patterns in the forex
futures markets.

Does the following experience sound familiar?

 1. After carefully studying the market bias, you took a long Pin Bar trade in
the EUR/USD forex market.
2. Accordingly, you placed a pattern stop just below the Pin Bar.
3. Shortly after, the market fell and hit your stop-loss order.
4. Almost immediately after you got stopped out, the market leapt up again.

If you were nimble and alert, you might have re-entered the position. If not, you
might have been left standing in the dust while the market blazed ahead without
you.

In any case, you would be frustrated and have suffered a loss due to the first
original Pin Bar entry.

Thus, in the re-entry trading strategy, we aim to skip the first entry and enter the
market only upon the “re-entry” opportunity. A re-entry opportunity often offers
a higher probability of success.

Essentially, while our trading premise is the same, we delay our trade entry.

A re-entry trading strategy takes the following form:

1. Find a trading setup with any price pattern. (Original setup)

2. Do not take the original setup.
3. Wait for the traders of the original setup to be stopped out.
4. Enter as the market reverses and moves in the direction of the original
setup.
As the traders of the original setup were stopped out, they would need to seek a
re-entry. In other words, they were trapped out of their positions and had to re-
enter. Their re-entries would help to push the market in our favour.
TRADING RULES PRICE ACTION RE-ENTRY

In this set of trading rules, we will use the Pin Bar, a popular forex price action
pattern, as our basis for re-entries. You can replace it with any other price action
pattern. LONG RE-ENTRY TRADING SETUP

1. Look for a bullish Pin Bar

2. The next bar must move above the high of the Pin Bar
3. The market must fall below the low of the Pin Bar (but not too far below)
4. Look to buy when price breaks above any bullish bar

SHORT RE-ENTRY TRADING SETUP Look for a bearish Pin Bar

1. The next bar must move below the low of the Pin Bar
2. The market must rise above the high of the Pin Bar (but not too far above)
3. Look to buy when price breaks below any bearish bar

EXPLANATION OF TRADING RULES

1. Original setup (do not take)

2. Original setup triggered
3. Original setup stopped out
4. Confirmation that the stop-out was a false alarm (“re-entry”)

FOREX PRICE ACTION RE-ENTRY TRADING EXAMPLESIn these examples, the blue
line is the 20-period EMA. The Pin Bars shown are marked out with our Price
Action Patterns Indicator. (Get the indicator for free.)

WINNING TRADE – BULLISH RE-ENTRY (6E FOREX FUTURES)

This is a 30-minute chart of the 6E forex futures (EUR/USD).

1. A bullish Pin Bar bouncing off the EMA. It was a decent setup, but in our re-
entry trading strategy, we do not take it.
2. As the market rose above the Pin Bar, some traders initiated their long
positions.
3. Two bars later, price fell and hit stop-loss orders placed around the low of
the Pin Bar (a common pattern stop level).
4. The market recovered quickly and offered a re-entry chance with a second
bullish Pin Bar. We bought as price broke above its high.

After our entry, the market rose with a strong thrust.

LOSING TRADE – BULLISH RE-ENTRY (6J FOREX FUTURES)

This
is an hourly chart of the 6J forex futures (JPY/USD).
 1. A bullish Pin Bar bouncing off the EMA after finding clear support around it.
2. The Pin Bar was triggered and some traders went long. (not us)
3. After overshooting the last trend high, price fell and hit stop-loss orders
placed at the low of the Pin Bar.
4. As buying pressure emerged (lower shadows), we bought as the market
rose above a bullish Marubozu.
5. The market meandered for a few hours before falling again, resulting in a
loss.

This losing trade has a stark difference with the winning instance. The losing
instance’s re-entry occurred below the moving average. It was a hint that the
market bias was no longer bullish. On the other hand, the winning example’s re-
entry setup bar had the support of the moving average.

Moreover, the market has hit a target projected from a triangle chart
pattern (orange lines). Since the original setup took place with the break-out of
the triangle, the projected target held sway. After the projected target was hit,
some traders took their profits and closed their long positions. It follows that
when the market fell down, fewer traders were stopped out and trapped out.
Hence, the re-entry approach was not ideal in this case.

REVIEW – FOREX PRICE ACTION RE-ENTRY TRADING STRATEGY

The re-entry trading strategy is a simple method to enhance the probability of

any price action pattern. Generally, good re-entries occur soon after the original
setup.

The re-entry trading strategy is versatile as you can use any price pattern as its
basis. Thus, it is easy to look for re-entry trading setups using the price action
patterns you are already familiar with. All it takes is patience. Skip the original
entry and wait for the re-entry.

Like many other trading methods, it is not mechanical. It is a discretionary

approach to trading that focuses on prudence and patience. Always consider the
market bias before using the re-entry trading strategy. It is not meant for use in
isolation.

Using a re-entry trading strategy in forex trading has its trade-offs. The main
drawback is fewer trading opportunities. At times, the market takes off without
offering a re-entry opportunity. In such cases, we miss out on the profits. This is
a necessary sacrifice for better forex trading odds.
HOW TO MANAGE GAP RISK IN SWING TRADING
A hallmark of a consistent trader is risk focus. A paradox of trading is that
thinking more about risk instead of profits, results in more profits in the long
run. For a swing trader holding a position overnight, gap risk is the most
challenging risk to manage.

Gaps occur when the market opens away from the closing price of the previous
session. It happens because while the market is closed, it continues to discount
new material information. Company earnings is a classic example.

Gaps cause a trader to lose control over trade risk in two ways.

 Gap past stop-loss order

 Gap past intended entry price

Let’s discuss them separately and see how you can deal with them.

GAP PAST STOP-LOSS ORDER

With a stop-loss order, you know how much you stand to lose for each position.
You know the market heat to expect. This is important for position sizing and to
manage your emotions.

But with gaps, your stop-loss order is no longer meaningful. The market can gap
across your stop-loss order and result in a loss larger than what you expected.
The chart below illustrates this scenario.
WAYS TO DEAL WITH GAP RISK

1. AVOID HOLDING POSITIONS BEFORE COMPANY EARNINGS

Earnings are usually announced outside market hours and are certainly material
information. Hence, they are a major cause of gaps in stocks.

Unless you are trading your earnings expectations, avoid holding positions just
before company earnings. This is a simple step to avoid gap risk.

On Zacks Earnings, there is an “Earnings by Symbol” section. Simply key in the

symbol of the stock you intend to swing trade to check if its next earnings date is
too close for you.

2. USE SOUND POSITION-SIZING AND DIVERSIFY

Gap risk represent the possibility that you might lose far more than you
expected. (Slippage might also cause you to lose more than expected, but the
extent is small compared to gaps.)

Hence, it is critical to size your trading positions conservatively. And never put all
your eggs in one basket. No matter how confident you are in a single swing
trade, do not devote too much of your trading capital to it. Impose a limit on
your trading size in any one trade position.

3. AIM FOR A HIGHER REWARD-TO-RISK RATIO

When the market gaps against you, your trade risk is larger. Your reward-to-risk
ratio suffers immediately. But if you take trades with higher reward-to-risk ratio,
the enlarged trade risk is less of a problem.

For a trade to enjoy positive expectancy, the following must be true.

Reward-to-Risk Ratio > (1 – W) / W

 W – Winning Probability

For instance, your reward-to-risk ratio is 1. A gap against you causes your risk to
double. Your reward-to-risk ratio becomes 0.5. This ratio is too low for positive
expectancy unless your trading strategy has an extremely high win rate.

On the other hand, consider a reward-to-risk ratio of 5. In the event that your
risk doubles, the ratio falls to 2.5, which requires only a win rate of above 29% to
produce positive expectancy.

Hence, trading setups with higher reward-to-risk ratio give us a larger cushion to
deal with gap risk.

(To estimate your trade reward, you need to have a method for setting trade
targets.)

4. POST-ENTRY DAMAGE CONTROL

If the market gaps past your stop-loss order, it triggers your order at the opening
price of the session. There is not much you can do in those cases.

However, some traders do not use real stop-loss orders. Instead, they have a
mental stop-loss which they will enforce manually. If this is how you trade, you
can consider the following risk management techniques after a strong gap
against you.

Exit part of your position to cut risk. (Never add to your position.)

You sized your position with your initial expectation of trade risk. Now that the
gap against you has increased your trade risk, you should exit immediately or at
least cut your position size.
Place or tighten your stop-loss based on post-gap price action. This method
is ideal for an exhaustion gap. The chart below shows this concept.

5. BUY OPTIONS TO LIMIT YOUR GAP RISK

There are two ways to control gap risk with options.

The first method is to buy an option as an insurance.

If you are in a long position and want to hedge against a bearish gap, buy a put
option. If you are in a short position and are afraid of a bullish gap, buy a call
option.

In the event of an unfavourable gap, your earnings from the option contract will
make up for the loss from the underlying stock. However, the extent of this
hedge depends on your choice of the options (expiry and strike).

The second method is to buy a deep in-the-money option contract instead

of taking an outright stock position.

Deep in-the-money options offer a way to gain leverage while limiting your risk.

Short-term traders need leverage to amplify trading gains. Most swing traders
use margin trading for leverage. They borrow money from their brokers to buy
stocks. This means that they might lose more than their trading capital when the
market gaps strongly against them.
However, if you swing trade with options, while you enjoy leverage, your loss is
also limited to your initial cash outlay.

Sounds too good. What’s the catch?

Unlike stocks, options expire. And when they do expire, they expire worthless.
Hence, if you use options for swing trading, you must get both the timing and
direction of the stock right. You must choose the right strike and expiry. You also
need to pay extra for the time value built into an option contract. Moreover, not
all stocks have a liquid options market.

In a nutshell, it’s not easy.

Using options is the surest way to limit your gap risk, as you can only lose the
premium you paid despite enjoying leverage. However, it is potentially costly
and is more sophisticated. If you want to learn more, start with these books.

 Options for Swing Trading: Leverage and Low Risk to Maximize Short-Term
Trading
 The Options Playbook, Expanded 2nd Edition: Featuring 40 strategies for
bulls, bears, rookies, all-stars and everyone in between.

6. TRADE MARKETS THAT OPEN ROUND THE CLOCK

A gap is the price difference between a session’s closing price and the next
session’s opening. If a market does not close, it trades continuously and will not
have significant price gaps. Hence, if you swing trade a market that trades round
the clock, you avoid gap risk.

The closest market that trades round the clock is the spot forex market. But
even the forex market closes for weekends, and gaps are possible when it
reopens on Monday. The same goes for futures that trade almost around the
clock like ES and NQ.

In these markets, gaps are still possible but the odds are much lower. Hence,
gap risk is limited.

GAP PAST INTENDED ENTRY PRICE

You might have planned to buy when the market hits a certain price. That’s your
intended entry price. What happens if the market gaps past your entry price?
This chart shows what happens. Your trade risk increases.

WAY TO DEAL WITH GAP RISK

1. REDUCE YOUR POSITION SIZE

When the market gaps past your intended entry price, you can still enter the
market. But you must first cut your position size.

As the gap has increased your trade risk, your initial position sizing is invalid. You
need to resize your position and enter the market with a smaller amount.

2. TIGHTEN YOUR STOP-LOSS ORDER

You can also tighten your stop-loss order after the gap. Instead of sticking to the
original stop-loss level, you can trail your stop-loss order with the market to limit
your risk.

3. SKIP THE TRADE

The first two methods rely on the same criteria.

 Your trading premise/setup must still be valid.

 You can reduce your trade risk to an acceptable level.

If these conditions are not met, do not force a trade. Just skip it and wait for
another setup.
RECOGNIZE GAP RISK TO MANAGE IT
You need to accept gap risk if you decide to hold positions overnight.

Both swing traders and long-term investors hold positions overnight. Investors
look at a longer horizon and gaps are blips for them. However, for swing traders,
a gap might skew the reward-to-risk ratio of a position and cause expectancy to
suffer. Hence, it is critical to manage it.

Many traders are exhilarated when the market gaps in their favor to produce a

windfall profit. Yet, they are in denial about what gaps can do when it goes
against them.

Recognize gap risk and use the methods discussed above to manage it.

TRADING CONTINUATION WITH RUNAWAY GAPS

Gaps represent prices that the market did not trade at. They are pockets of
vacuum. For this reason, gaps intrigue traders. Hence, it is not surprising that
there are various gap trading strategies. The trading strategy depends on the
type of gap. (For e.g. exhaustion gap and runaway gap.)

Runaway gaps occur in the middle of a trend. It shows the urgency of the market
to join the fast-moving trend. Runaway gaps propel the trend. Hence, they offer
opportunities to join the trend as it continues.

Another useful feature of a runaway gap is that it tends to form in the middle of
a trend. This means that you can use the price movement before the gap to
project price targets. For this reason, a runaway gap is also known as
a measuring gap.

TRADING RULES – RUNAWAY GAPS BULLISH RUNAWAY GAP

1. Sharp rising price action in a bull trend followed by a gap.

2. A lack of pullback trade opportunities. (Indicating urgency)
3. Gap has average or slightly increased volume. (High volume might point to
an exhaustion gap.)
4. Buy on close of gap day. BEARISH RUNAWAY GAP

1. Sharp falling price action in a bear trend followed by a gap.

2. A lack of pullback trade opportunities. (Indicating urgency)
 3. Gap should have average or slightly increased volume. (High volume might
point to an exhaustion gap.)
4. Sell on close of gap day.

TRADING EXAMPLES – RUNAWAY GAPS

In the charts below, there are a few useful indicators/markers.

 20 Period EMA (orange line) – To highlight sharp price movements

 Blue Boxes – To mark out Gaps or Windows (candlestick term)
 Volume Panel with Upper Bollinger Band (brown line) – To avoid extreme
volume

WINNING TRADE – JPM DAILY

1. The market trended upwards with only minor pullbacks. In fact, after
crossing above the EMA, price has remained above it.
2. This gap was not a huge one. However, as it occurred right after strong
bullish action, it might be a runaway gap.
3. The gap volume was not high. (Far below the Upper Bollinger Band line)
4. With patience, the trade ran its course and hit the projected target.

LOSING TRADE – AXP DAILY

 1. AXP rose sharply above the EMA and hovered above it.
2. After such bullish price action, a gap presented itself.
3. The gap volume increased a little but was not high.
4. The market failed to hit the projected target. Instead, the gap was filled
within eight trading sessions.

The urgency (of the bulls) is clearer in the JPM example, where price rose without
much sideways action. In contrast, AXP went sideways for around two weeks
before resuming its way up. For runaway gaps, the urgency is an important clue
to success.

REVIEW – RUNAWAY GAPS

Swing traders cannot avoid dealing with price gaps. While gaps present risk that
requires mitigation, they are also profit opportunities.

Runaway gaps are ideal for gap traders for the following reasons.

They are, by definition, on the side of the market trend. Trading exhaustion

gaps goes against the trend; trading runaway gaps goes with the trend.

Runaway gaps also offer price objectives for logical profit taking. But don’t use
the projected target without observing the market structure. Major support or
resistance might cause the market to stall before hitting the target. In such
cases, target with caution.
A runaway gap seldom fills before reaching its target. Use this knowledge to
guide your stop placement. For a bullish runaway gap, place your stop-loss just
below the gap. For a bearish gap, place your stop-loss just above the gap.

INTRADAY TREND TRADING WITH PRICE ACTION (TRADE PRICE)

Trade price (Sho) is a member of the Forexfactory forum, where he shared his
trading method in the thread “Intraday Trend Trading with Price Action“.

He trades price action with Keltner Channel and price action patterns including

pin bars, inside bars and outside bars. This trading method is not a trading
system with hard and fast rules.

However, Sho pointed out a couple of rules that produces high quality trades (A+
+ trades). The trading rules below combine his golden rules and my application
of his trading approach.

TRADING RULES – INTRADAY TREND TRADING

LONG TREND TRADING

1. Strong impulse move above upper Keltner band (10,1)

2. 50% retracement to a support level
3. Rejection from Keltner bands
4. Buy on close of pin bar

SHORT TREND TRADING

1. Strong impulse move below lower Keltner band (10,1)

2. 50% retracement to a resistance level
3. Rejection from Keltner bands
4. Sell on close of pin bar

INTRADAY TREND TRADING WITH PRICE ACTION TRADE EXAMPLE

WINNING TRADE – BULLISH TREND
This is a 15-minute chart of 6A futures contract (AUD/USD). The only indicator on
the chart is the Keltner bands which comprises a 10-period moving average and
two bands displaced 1 ATR away from the moving average.

1. There was a clear bullish move out above the upper Keltner band.
2. Prices pulled back and stalled at the 50% retracement level of the bullish
move. The level coincided with the low of an earlier outside bar which
acted as support in this case. Furthermore, the chart printed a pin bar that
tested these levels before closing above the moving average.
3. We bought at the close of the pin bar and placed a stop at its low for a
profitable trade.

LOSING TRADE – BEARISH TREND

We continued looking for A++ trades in the 15-minute chart of 6A. This chart
shows a trading setup that failed.

1. There was a strong down move beyond the Keltner bands.

2. Price started to pull back up and we saw two strong bull bars with shaved
bottom which implied eager buying. (Not good for a short trade.)
3. The pullback up ended with a pin bar that got rejected from
several resistance levels including the upper Keltner band, the 50%
retracement level and a previous swing high (dotted line).

The pin bar led us into a losing trade as we got stopped out by the outside bar
that appeared two bars after our entry.

REVIEW – INTRADAY TREND TRADING WITH PRICE ACTION

This is an excellent price action trading method. It emphasizes a simple principle,

which is to follow the momentum.

Finding the momentum is truly the key to trading intraday trends successfully.

Look out for bars that are completely beyond the Keltner Channel to find strong
momentum. (This is similar to the moving average channel method by Jake
Bernstein.)

Combining strong momentum with a pin bar rejected by a support or resistance

level produces a high probability trade. If you add 50% retracement and Keltner
bounce to the formula, you get what Sho calls a A++ trade.
I find that for long trades, rejection from the lower Keltner band is not as
reliable. Focus on rejection from the top Keltner band (for very strong trends),
and from the moving average itself. (The reverse is true for short trades.)

Remember that this is a trading approach and not a rigid system. The

trading rules above are simply one formulation of this method.

DAY TRADING WITH ONLY THE 20-PERIOD MOVING AVERAGE

Day trading is a fast game with many factors. It is best to keep your trading
method simple for effective trading.

For traders looking for simplicity, using only a 20-period moving average to day
trade is a great option.

20 is not a magical number or the best kept secret in day trading. Basically, any
intermediate period is useful for day trading. A long 200-period moving average
lags too much and does not help day traders. A short 3-period moving average is
almost like price itself and is mostly redundant.

As for the choice of moving average type, we are using exponential. But a simple
moving average will work fine too. The key is consistency and do not keep
changing the period or type of your moving average.

1. USING MOVING AVERAGE FOR MARKET CONTEXT ANALYSIS

Determining the price action context, whether the market is trending or in a

range, requires discretion and experience. A moving average can help to clarify
the price action.

These are some questions to help you clarify the context using a moving
average.

1. Are prices above or below the moving average now?

2. How did prices get there?
3. Have prices been overlapping with the moving average?
4. What is the slope of the moving average?
5. Has the slope been changing often?

The answers to these questions cannot be interpreted in isolation. We need to

integrate them to form an analysis.
EXAMPLE OF USING MOVING AVERAGE FOR PRICE ACTION CONTEXT

The is an example with a 5-minute chart of NQ futures. It shows the first 20 bars
of the session.

Let’s
try to answer the guiding questions above.

1. Price is now above the moving average.

2. It got there after a bounce off the moving average. However, it has not
exceeded the last swing high.
3. 7 out of the past 20 bars overlapped with the moving average. The bars
that overlapped mainly had long bottom tails. The bars that did not overlap
the moving average were all above it.
4. The slope of the moving average is positive but not overly steep.
5. The slope of the moving average turned down momentarily at two
instances.

INTEGRATION AND ANALYSIS OF TRADING CONTEXT

Prices were mostly above the moving average and bounced from the moving
average. These signs show that the day has been bullish.

However, the slope of the moving average is not steep and had turned negative
at two instances. So, despite the bullishness, the market is not in a strong
trend.

WHAT ARE THE IMPLICATIONS OF OUR ANALYSIS ON OUR DAY

TRADING?We should only take long trades until there are bearish signs. But
due to the lack of a strong trend, we should aim for nearer targets.
2. MOVING AVERAGE DAY TRADING SETUPS
After analyzing the market context, we have to look for trade setups and the
moving average is again a useful tool.

In a bull trend, buy when prices retrace to the 20-period moving average. In a
bear trend, sell when prices pullback up to the 20-period moving average.

This chart shows the price action after our price context analysis.

T
he two-bar reversal at the moving average was a buy signal. As the context was
bullish, we took the trade. However, as implied by our context analysis, we
should not press for large gains.

We can also use candlestick patterns with the moving average to pinpoint

entries.

3. TRADE MANAGEMENT
Although not applicable in the same example, the moving average is also a
natural tool for placing trailing stops. The moving average follows the price trend
but lags behind it.

Hence, a trailing stop based on a moving average locks in profit and at the same
time gives enough room for whipsaw action.

CONCLUSION: DAY TRADING WITH MOVING AVERAGE

Day trading with a moving average is a simple approach to capturing intra-day
trends.
It is a valuable tool for traders learning price action. This because a moving
average plots on the price chart itself and interacts with price itself. When we
look at a moving average, we have to look at price as well.

Open a chart now and put on a 20-period moving average. If you practice
enough, a 20-period moving average is possibly the only indicator you need

PINOCCHIO BAR TRADE SETUP (PIN BAR)

The Pinocchio bar (pin bar) is a very popular price pattern among active traders.
In Martin Pring’s “Technical Analysis Explained”, he called the pattern Pinocchio
because it lies.

It lies about the market direction. And its long nose exposes the lie.

So we expose the pin bar below.

The
concept behind pin bars explains its efficacy. Traders place their entry orders
and stop orders at support and resistance levels. Pin bars, by making a short-
lived break of the levels, give false hope to traders in the wrong direction. As the
pin bar closes back within the support or resistance, prices make a run for the
other direction.

RULES FOR LONGBar opens above support

1. Bar trades below support for most of the range of the bar
2. Bar closes above support

RULES FOR SHORTBar opens below resistance

 1. Bar trades above resistance for most of the range of the bar
2. Bar closes below support

WINNING TRADE

Thi
s daily chart of AT&T shows a pin bar that began a swift down trend.

1. There was an existing up trend followed by a cup and handle pattern that

signaled the bull trend to continue.
2. However, the cup and handle formation failed quickly with a pin bar that
poked above the “cup rim” before closing below the resistance.
3. After the pin bar triggered a short entry, prices tried to move up but could
not gain momentum despite several tries. In fact, it was better to wait and
enter after the failed attempts to move up.

LOSING TRADE
 This is a 5-
minute chart of E-mini futures on NASDAQ 100. We included part of the previous
and next trading sessions to highlight the context of the trade.

1. After a prolong congestion, prices broke down strongly and stopped at

yesterday’s low with a two-bar reversal pattern.
2. The pin bar was the second test of the low of yesterday’s session. Given
that it was the second test of yesterday’s low, it was a good trade. However,
we got stopped out quickly.
3. After a final thrust down, prices drifted up and gapped up the next day to
continue its way up. Indeed, there was buying pressure below the support
tested by the pin bar. However, the pin bar was not the ideal entry point in
this case.

REVIEW – PINOCCHIO BAR TRADE SETUP (PIN BAR)

A pin bar is a unique price pattern because it is not defined by one, two, or
even three bars. It is defined by the entire market structure.

We can only label a pin bar after looking at support or resistance levels that it
penetrated.

Given the right context, the pin bar offers a reliable point of entry. Focus on pin
bars that penetrate major support or resistance. Then, find confirmation from
other indicators or chart patterns, and you have a high probability trade.

When confirmation is lacking, it is a good idea to delay your entry. Let more price
action unfold after the pin bar and enter if it confirms the pin bar.
Need help find the pin bar on your charts? Get an indicator for five price action
patterns including pin bar here.

You should refer to Martin Pring’s solid work on technical analysis to learn more
about the pin bar and other bar patterns.

You can also take a look at the Thee-Bar Inside Bar Pattern, which is another
great bar pattern to use in your trading.

3 PRACTICAL DAY TRADING INDICATORS

With the tons of trading indicators out there, it is a Herculean task to go
through them one by one. Hence, many of our readers have asked for
recommendations of day trading indicators.

(Yes, you ask. And we deliver, if we can. Tell us what you want here.)

To get you started with day trading, we suggest these three trading indicators.

1. Donchian Channel
2. Moving Average
3. Stochastic Oscillator

They are simple, easy to understand, and useful for day trading. No, they are not
perfect. But they form a nice package to start with.
This chart shows how the three indicators add value to day trading.
1. DONCHIAN CHANNEL (BLUE)

Richard Donchian, the pioneer of trend following, invented the Donchian

Channel. The channel plots the highest high and lowest low of a specified time
period. An average of the two values is also calculated and plotted as the mid-
line.

Donchian Channel shows you where the market is now, compared to its past, in
a direct and visual way.

The Donchian Channel is useful for day trading as you can use it to keep on
eye on the larger time frame. Use a 100-period Donchian Channel to keep you
with the longer term trend.

2. MOVING AVERAGE (ORANGE)

A x-period moving average is the average of the past x number of  price closes.
As new price bars close, the moving average will move along, dropping the
oldest close and including the newest close in its calculation.

The direction of the moving average highlights price trend, and the space
between price and the moving average highlights momentum. This simple
indicator packs a punch if you know how to use it.
While there are dozens of moving average flavors, start with the simple or
exponential moving average with a 20-period setting for day trading.

3. STOCHASTIC OSCILLATOR (LOWER PANEL)

The stochastic oscillator is a popular day trading indicator.

Its working logic is like that of Donchian Channel, in the sense that it measures
the current market position relative to the market’s past trading range. However,
it assumes that the market is in a trading range and turns that measurement
into an oscillator that moves between 0 to 100.

It is useful for finding day trade entries as it is sensitive and

responsive. (Use %K-5, %D-3, Smooth-3 for your settings.)

For a multiple time-frame day trading method using stochastic, take a look
at Kane’s %K Hooks strategy.

DAY TRADING INDICATORS – A WORD OF CAUTION

You get three indicators. Now it’s time for three warnings against them.

1. Indicators are not perfect, understand when and how to use them.
2. Don’t neglect price action when trading with indicators. Consider using
price action patterns to improve your analysis. (Like this simple failure
pattern, or the Hikkake pattern.)
3. Do not overwhelm yourself with indicators. Consider the value of every
single indicator you add to your chart. Does it add value? Remember
to trade simply.

TRADING THE IMPULSE SYSTEM BY ELDER

Alexander Elder is the author of two bestselling trading books, Trading for a
Living and Come into my Trading Room. He is also known for many trading
tactics including the Triple Screen Trading and the Impulse System.

I have come across many recommendations of his books for beginning traders
once and again. And I would personally recommend them as well.

Being a trader with a background in psychology, he gives unique insights into

the world of trading in a concise and readable way.
Without further ado, let’s introduce the Impulse System by Alexander Elder. This
system combines a relatively short EMA with the standard MACD to find market
momentum. When the two indicators align, they show an impulse move.

Alexander Elder advised that we should use the Impulse System on a higher
time-frame to enhance the trading setup.

TRADING RULES – IMPULSE SYSTEM

LONG TRADING SETUP 13-period EMA rising

1. MACD(12,26,9) histogram rising

SHORT TRADING SETUP 13-period EMA falling

1. MACD(12,26,9) histogram falling

IMPULSE SYSTEM EXAMPLE TRADES

WINNING TRADE – IMPULSE SYSTEM

This 6J chart is in need of explanation. Bars with positive impulse are green. Bars
with negative impulse are red. Blue bars mean that EMA and MACD are
disagreeing. (I must thank Wessel on Ninjatrader forum for sharing this
indicator.)

I also coded a separate indicator for the background color to show the Impulse
System on a higher time-frame. Our trading time-frame is 20-minute. Alexander
Elder recommends a factor of five. So the background reflects the impulse on
the 100-minute time-frame.
 1. EMA and MACD on the higher time-frame were both rising.
2. There were multiple buy signals in our trading time-frame from the
Impulse System.
3. For this example, we are focusing on the signal marked by the green arrow.
That trading setup had a high chance of success because it tested the
previous swing low, but did not affect the momentum on the higher time-
frame.

LOSING TRADE – IMPULSE SYSTEM

This is a daily chart of Hewlett-Packard. The higher time-frame uses weekly bars.

1. A bearish triple top foreshadowed this trade.

2. However, prices stalled at the last swing low. This might have contributed
to the failure of the short signal from the Impulse System.
3. As shown by the blue bar, price lost momentum right after entry. Given
that the Impulse System is a momentum trade, we should take that as a
signal to exit earlier and limit our loss.

REVIEW – TRADING THE IMPULSE SYSTEM

Combining multiple time-frame analysis with the Impulse System produces

a solid momentum trading strategy.

However, some trading platforms are not friendly to multiple time-frame

analysis. In that case, you can pay attention to pullbacks that do not overlap with
the EMA.
For instance, price bars are above the EMA and they start to retrace down.
However, throughout the pullback, price bars stay above the EMA. It means that
the bullish momentum is strong. Given that context, it is likely that the higher
time-frame supports the bullish impulse.

To improve on this trading strategy, you can seek confirmation from support
and resistance like our examples above

A SIMPLE INSIDE BAR DAY TRADING STRATEGY

USING YM FUTURES
To day trade successfully, we need a market that is volatile and liquid. S&P 500
E-mini (ES) and NASDAQ-100 E-mini (NQ) futures are popular day trading
markets. Beyond them, the E-mini DOW (YM) futures contract is also a great
choice. Among equity index futures, the trading volume of YM futures ranks
right after ES and NQ futures.

Like ES and NQ, YM futures is also an electronically traded contract. Its

underlying is the Dow Jones Industrial Index. For a one-point movement in the
index, its value changes by $5.

If you are completely new to futures, you should spend some time
browsing CME’s website.

Read on for a simple inside bar day trading strategy with examples from the YM
futures market.

TIME-FRAME FOR DAY TRADING YM FUTURES

The 5-minute time-frame is a common choice among day traders. But that is just
a convention.

Instead, I use the Price Action Time-frame Index (PATI) to find time-frames that
are tradeable. It finds the smallest time-frame that is tradeable for a price action
trader. As long as you are trading above the minimum tradeable time-frame
(MTT), price action analysis is possible. But note that the MTT changes over time
as market price action changes.
For the YM futures market, its current MTT is the 4-minute time-frame. Trading
using the MTT offers the highest number of trading setups. Hence, we will be
using the 4-minute time-frame.

If you prefer fewer setups or longer intervals for ongoing analysis, increase your
time-frame.

(The concepts of PATI and MTT are explained in my course – “Day Trading with
Price Action“.)

TRADING RULES – SIMPLE INSIDE BAR DAY TRADING

These rules attempt to capture the first low-risk pullback in a new trend using an
inside bar. We define the trend with the help of a 21-period simple moving
average (SMA).

BULLISH INSIDE BAR TRADING SETUP

1. From below the SMA, the market rises completely above it. A price bar
must clear above the SMA.
2. Wait for the first bullish inside bar.
3. Place a buy stop order a tick above it.

(Why use a stop order to enter the market?)

BEARISH INSIDE BAR TRADING SETUP

1. From above the SMA, the market falls completely below it. A price bar must
clear below the SMA.
2. Wait for the first bearish inside bar.
3. Place a sell stop order a tick below it.

SIMPLE INSIDE BAR DAY TRADING EXAMPLES

The charts below show the YM futures market using 4-minute candlesticks. The
orange line is a 21-period SMA.

WINNING TRADE – YM FUTURES BEARISH INSIDE BAR

 1. The market was above the SMA.
2. This bar went below the SMA and signaled a change in trend. We started
looking out for bearish inside bars.
3. After YM pushed below the SMA, it did not prompt any significant bullish
response. None of the candlesticks manage to test the SMA above it.
4. At the end of its third attempt to rise towards the SMA, a bearish inside bar
formed. We sold a tick below it.

There are many options for exiting. As we expected the trend to continue, the
most conservative target is at the last extreme low. (horizontal dotted line)

Even with this conservative target, this trading setup gave us a 2:1 reward-to-risk
ratio. Hence, it was a setup of high positive expectancy.

LOSING TRADE – YM FUTURES BULLISH INSIDE BAR

The first bar on this chart is also the first bar of the session.

1. This session started below the SMA.

2. Within half an hour, YM managed to clear above the SMA.
3. The SMA rejected the first test by the market from above, giving hope to
bullish sentiments.
4. However, as the market made a new session high, it started congesting.
The candle bodies contracted and prices moved sideways.
5. Within this congestion, a bullish inside bar formed. We bought above this
bar and got stopped out immediately.

REVIEW – SIMPLE INSIDE BAR DAY TRADING STRATEGY

In an active market, using the right time-frame, inside bars offer great trading
windows. It is a tool to control our risk and time our entries in a trending market.

While we used YM futures in this example, you can use this strategy in

other liquid and volatile markets.

This trading strategy is simple as you only need a SMA and knowledge of inside
bars. But there are two points to take note of when employing this trading
strategy.

First, look for new trends. This is because retracement trades early in a trend

has higher chance of success and more room for profit.
Second, avoid congestion areas. This is crucial for inside bar trading. This is
because inside bars are often found in congestion patterns. The trick here is to
distinguish between an inside bar in congestion and one that is not. You will
suffer whipsaws if you assume that the trend will continue when the market is
actually in congestion.

Look at the two examples again. In the winning example, YM was clearly drifting
upwards and the top shadows were more prominent. It was not congesting. But
in the losing example, the price bars were meandering sideways with both top
and bottom shadows. It was definitely forming a congestion pattern. Hence, we
should have avoided trading the bullish inside bar.

With regards to target placement, you should at least aim for the last extreme of
the trend. When the momentum is clear, you can aim further. You can
use support/resistance areas projected using past swing pivots and price
thrusts. Another good option is the high or low of the last trading session.

THE 15-MINUTE OPENING RANGE SCALP TRADE

The 15-minute opening range scalp trade is among the 10 scalping trade setups
shared by Kevin Ho, a floor trader and a member of the Singapore Exchange, in
his article in Chartpoint. It is a time-sensitive trade for the market opening of
the S&P.

This opening range scalp trade is an excellent option for part-time day

traders who can only afford limited time to watch the market.

RULES FOR LONG SCALP TRADE

1. Wait for the first 15-minute range to form
2. Place buy order 2 ticks above the high of the range
3. Exit with a 1-point loss or 1-point profit (or if trade is still open after 1
minute)

RULES FOR SHORT SCALP TRADE

1. Wait for the first 15-minute range to form
2. Place sell order 2 ticks below the low of the range
3. Exit with a 1-point loss or 1-point profit (or if trade is still open after 1
minute)
WINNING TRADE – OPENING RANGE SCALP TRADE

Although this opening range scalp trade uses the 15-minute range, we used the
1-minute chart in our example to account for any whipsaw. In this case, the finer
chart also gave us a sense of how quickly prices hit our the target. The black
lines mark out the 15-minute opening range.

1. Within the first 15 minutes, prices drifted up before a strong bear

thrust took over.
2. Almost immediately after the range formed, prices made a weak attempt
to move up.
3. The failure of the weak bull swing triggered our sell stop order placed 2
ticks away from bottom of the opening range. In this case, placing the
order 2 ticks below the range made all the difference. If we had placed the
order 1 tick below the range, we would have shorted earlier and scratched
the trade after a minute.

LOSING TRADE – OPENING RANGE SCALP TRADE

Another opening of S&P E-mini futures shown using a 1-minute chart. While this
opening range scalp trade was hardly profitable, the 1 minute time stop rule
coupled with good execution would have helped us to exit at break-even,
incurring only the commission.

1. Within the opening range, there are many small bars and dojis, which are
signs of a trading session with contracted range.
2. The buy order was triggered 2 ticks above the range but scratched after 1
minute. Not a bad outcome for a losing trade.
3. Having a time stop was fortunate as the following congestion was terrible
and might subject the anxious scalper to an emotional roller coaster.

REVIEW – 15-MINUTE OPENING RANGE SCALP TRADE

This opening range scalp trade is extremely simple and requires at most 16
minutes of your time.

As a scalping trade setup, its genius lies in having a fixed target and stop,
coupled with a time stop.

In the losing example, we managed to minimized our loss by using the time stop.
For scalping strategies, the risk to reward ratio is not fantastic. Hence, a time
stop is essential.

To put the odds in your favor, you can also pay attention the price action
within the opening range to glimpse clues of the odds of a successful break-
out.

We should bear in mind that the suggested target and stop, and the 2 ticks
buffer between the range extreme and our entry, might need revision. Kevin
Ho’s article gave examples from 2003. Scalpers should adjust them according
to current market volatility.

Due to the time-sensitivity and high volatility of the market during its opening,
you will need a decent trading platform to execute this trade setup accurately.

Minimally, you must use bracket orders when placing your trades. Ideally, your
trading platform should place the time stop automatically as well.

MOVING AVERAGE CHANNEL DAY TRADE

This day trading setup by Jake Bernstein uses a moving average channel to
figure out trend and key support and resistance levels. For our review, we will
build a moving average channel with a 20-period SMA of highs and lows.

(Read: Displaced Moving Average Channel Trading Strategy)

TRADING RULES – MOVING AVERAGE CHANNEL DAY TRADE

LONG DAY TRADE

1. Wait for two consecutive bars to move entirely above the high of the
channel
2. Buy as price tests the 20 SMA of lows (more aggressive traders can buy on
test of 20 SMA of highs)

SHORT DAY TRADE

1. Wait for two consecutive bars to move entirely below the low of the
channel
2. Short as price tests the 20 SMA of highs (more aggressive traders can sell
on test of 20 SMA of lows)

TRADING EXAMPLES – MOVING AVERAGE CHANNEL DAY TRADE

WINNING TRADE
This chart shows a 5-minute chart of ES, the E-mini S&P futures. The two circled
bars went completely below the moving average channel and confirmed the
down trend.

For a conservative trade, we placed a sell limit order at the top of the channel. As
prices spiked up to hit the channel top, we entered a short position at 1347.25.
Prices continued down until 1338 and gave a profit potential of 9.25 points,
while risking almost nothing as the trade went in our direction immediately after
we entered.

In this example, the moving average channel highlighted the strong bear spike
as price moved beyond the channel. The top channel line gave excellent
resistance and minimized our risk. Even if we entered as the bearish outside bar
broke the low of the previous bar, it was still a good entry with little adverse
movement.

LOSING TRADE
Here, similarly, we had two bars entirely below the channel to confirm the down
trend. We then shorted with a limit order at around 1356.75. However, the trade
went against us almost immediately and forced out any reasonable stop-loss
order.

There were warning signs against taking this trade.

First, the two circled bars were not exactly in free fall with the first bar being a
doji and the second bar with a long bottom tail.

Next, right after channel break-out, there was a classic double bottom followed
by four consecutive bullish bars. Following that, you could notice that each
bearish bar was followed by either a doji or a bullish bar, suggesting that the
bears were giving up the fight.

Given this bullish context, we should not take a short trade simply because of
the rigid trading rules.

REVIEW – MOVING AVERAGE CHANNEL DAY TRADE

This trade setup gives the traditional moving average a useful twist. Using the
highs and lows to form moving averages is a sound concept as they are the
natural support and resistance levels of each bar. Hence, it behaves nicely
as support and resistance.

Requiring two bars to go beyond the channel helps to find spikes and avoid
ranging conditions.
A potential pitfall of using this trading setup is over-reliance on the moving
average channel for support and resistance. This may cause traders to overlook
the real price action unfolding before them.

DISPLACED MOVING AVERAGE CHANNEL TRADING STRATEGY

Displacing a moving average means shifting the moving average to the right.
With two displaced moving averages (DMA), we can form a channel trading
strategy.

This displaced moving average channel trading strategy comes from Paul Ciana’s
book, New Frontiers in Technical Analysis: Effective Tools and Strategies for
Trading and Investing. Paul Ciana is a Chartered Market Technician working for
Bloomberg. He is very active in engaging technical analysts to improve
Bloomberg’s technical analysis offerings.

The displaced moving average channel consists of two moving averages:

 6-period simple moving average of bar highs displaced to the right by 4

periods
 6-period simple moving average of bar lows displaced to the right by 4
periods

TRADING RULES – DISPLACED MOVING AVERAGE CHANNEL

The rules below are our adaptation of the DMA channel for trading.

LONG TRADING STRATEGY

1. Price is above the DMA channel on a higher time-frame

2. Prices are within the DMA channel on trading time-frame
3. Place buy stop order at a tick above the bar that closed above the DMA
channel on trading time-frame

SHORT TRADING STRATEGY

1. Price is below the DMA channel on a higher time-frame

2. Prices are within the DMA channel on trading time-frame
3. Place sell stop order at a tick below the bar that closed below the DMA
channel on trading time-frame

DISPLACED MOVING AVERAGE CHANNEL TRADE EXAMPLES

WINNING TRADE – LONG DMA CHANNEL TRADE

For this example, we looked at the daily chart of The Procter and Gamble
Company. The lower panel shows the weekly chart which is our higher time-
frame.

1. Prices moved above the channel and our market bias became bullish.
2. The low of price bars rose and remained above the DMA channel,
confirming the bullish bias.
3. This bar closed above the channel but the next bar did not trigger our buy
stop order. Around a week later, we had a second signal bar (green arrow).
We bought the next day and participated in a solid up trend.

LOSING TRADE – SHORT DMA CHANNEL TRADE

This chart shows the price movement of DBS Group Holdings Limited listed on
the Singapore Exchange.

1. Prices moved below the channel, implying the start of a bear trend.
2. Following our trading rules, there were two profitable swing trades.
However, our focus for this example is on the last trade setup that failed
(red arrow).
3. Before the trading setup, the lows of the candlesticks on the daily chart
went above the DMA channel. This bullish momentum hinted that this
trading setup might not succeed like the earlier ones.

The three consecutive dojis after our short entry gave an early warning of the
failure of this trade.

REVIEW – DISPLACED MOVING AVERAGE CHANNEL

Using the displaced moving average channel on dual time-frame is a sound

trading approach.

Moving average channels are useful trading tools because they highlight
strong trend movements. Look out for bars that move completely beyond the
DMA channel. They highlight powerful moves that you can further analyze for
hints of market strength.

YOUR FIRST GUIDE TO VOLUME SPREAD ANALYSIS (VSA)

You have heard of Volume Spread Analysis and the value it might add to your
analysis. But it sounds like a convoluted trading method with uncommon terms
like “No Demand Bar” and “Stopping Volume”. Is VSA really that inaccessible?
Together, let’s take the first step to understanding VSA. With this guide, you will
find that VSA is an intuitive method after all.

WHAT IS VOLUME SPREAD ANALYSIS (VSA)?

VSA is the study of the relationship between volume and price to predict market
direction.

In particular, it pays attention to:

 Volume
 Range/Spread (Difference between high and close)
 Closing Price Relative to Range (Is the closing price near the top or the
bottom of the price bar?)

WHO INVENTED VSA?

There are three big names in VSA’s development.

 Jesse Livermore
 Richard Wyckoff
 Tom Williams

Jesse Livermore spoke of a theory based on market manipulation. He also

worked his theory in his legendary trading career. However, he did not pass
down concrete trading methods. His legacy is that of a trader and not an
educator.
Jesse Livermore’s Methods of Trading in Stocks by Richard Wyckoff
Richard Wyckoff was much more interested in education. To find methods that
work in the markets, he interviewed top traders including Jesse Livermore.
Wyckoff proposed the idea of a “Composite Trader” that embodies the entire
market. He used the “Composite Trader” to explain the market phases
of accumulation, markup, distribution, and markdown.

Neither Jesse Livermore nor Richard Wyckoff used the term “Volume Spread
Analysis”. It was Tom Williams who used the term to describe the methods he
built based on the Richard Wyckoff’s ideas. Tom Williams’ books and software
has helped to propel the concepts of VSA among traders.

WHY DOES VSA WORK?

The basic idea is that the public can only make money from the markets if we
understand what the professional traders are doing. And professional traders
are not small players. They play big.

Hence, they leave their footprints in volume data. When the professionals are
active, the market shows high trading volume. Conversely, when the market
volume is low, the professionals might be holding their horses.

It follows that in order to get a sense of what the big guys are up to, looking at
just price action is not enough. We need to look at price together with volume.

DOES VSA WORK IN ALL MARKETS?

VSA focuses on price and volume and seeks to find the actions of professional
traders. Hence, as long as a market has a group of professionals and offers
reliable price and volume data, the trading premise of VSA holds.

Almost all financial markets (stocks, futures, forex) seem to fit the bill.

However, in the spot forex market, volume is a tricky concept. You will not get
actual traded volume. You get tick volume which measures the times the price
ticks up or down. If you intend to use VSA methods for trading spot forex, you
need to decide if your source of tick volume is a reliable proxy for actual volume.
(Need help deciding? The ForexFactory forum has a discussion on trading forex
with VSA.)
HOW DO WE USE VSA TO TRADE?

I will not sugar-coat the fact that VSA is difficult to master. This is because
traders have interpreted various VSA concepts differently. To trade well with VSA
requires years of practice and market observation. (Consider how much time
Jesse Livermore, Richard Wyckoff, and Tom Williams spent studying the
markets.)

Nonetheless, we can still improve our trading with basic VSA concepts that are
easy to understand. Hence, in this first guide, we will look at two simple VSA
concepts.

1. No Demand
2. No Selling Pressure

VSA BASIC CONCEPTS

(The following definitions are based on Tom Williams’ book on VSA – Master the
Markets.)

1. NO DEMAND ON UP BAR
If the market rises with contracting spread and volume, the market is not
showing demand. Without demand, it is not likely to continue rising.

To find “No Demand” bars:

1. Price closed higher than the previous bar.

2. Volume is lower than past two bars.
3. Spreads (Range) are narrow.

2. NO SELLING PRESSURE ON DOWN BAR

If the market falls with decreasing spread and volume, the market is not
interested in selling. Thus, it is not likely that the market will continue to fall.

To find “No Selling Pressure” bars:

1. Price closed lower than the previous bar.

2. Volume is lower than past two bars.
3. Spreads (Range) are narrow.
VSA TRADING EXAMPLES

In the two examples below, we will use a 20-period simple moving average as
our trend indicator. Our aim is to use the concepts of “No Demand” and “No
Selling Pressure” to find trend retracement trades.

In the charts below, I have marked the “No Demand” bars with red arrows and
the “No Selling Pressure” bars with green arrows. (Click on the images to zoom.)

1. NO DEMAND BAR – POTENTIAL SHORT TRADE

This chart shows the daily bars of Deere & Company (DE).

1. This bar punched below the SMA and hinted at an impending bear trend.
2. These three consecutive “No Demand” bars confirmed the lack of market
interest to resume the bullish run.
3. Hence, we had a great context for considering a short trade.

2. NO SELLING PRESSURE – POTENTIAL LONG TRADE

This chart shows the daily bars of The Proctor & Gamble Company (PG).

1. The market was in a strong bull trend and remained above the SMA.
2. In this sideways pullback, we observed three “No Selling Pressure” bars.
They hinted that the bears are not forthcoming, and the stage for a bullish
retracement trade was set.
3. This bullish Pin Bar offered the ideal setup bar.

WHERE CAN WE LEARN MORE ABOUT VSA?

VSA is gaining in popularity, and there is no lack of resources to advance your
understanding.

BOOKS ON VSA

 Master the Markets

 Trading In the Shadow of the Smart Money
 Trades About to Happen: A Modern Adaptation of the Wyckoff Method

FORUM DISCUSSIONS ON VSA

There are great discussions on VSA on Traders Laboratory and Forex Factory. To

find information on VSA in popular trading forums with a click, try our Trading
Forums Search Engine.

VSA TRADING SOFTWARE

There are many software that claim to use VSA techniques to help you trade
better. I would not comment on their efficacy as I have not used them.

But I am sure that no software will bring you trading success unless you truly
understand the VSA principles. Hence, you should definitely learn as much as
you can about VSA, before relying on a software for your analysis. This approach
will make sure that you do not use the software blindly, if you do buy one.

RELATED VOLUME STRATEGIES

These are not classic VSA methods, but they will help you understand the
interaction between price and volume.

 Low Volume Pullback

 Low Volume Pullback (Expanded)
 Anchor Bars
 On-Balance Volume

CONCLUSION – VSA
Volume is valuable because it offers another market dimension for analysis.
Volume is also dangerous because it confuses those who do not understand it.

Take one step at a time. Pick up VSA concepts steadily and use them in your
trading prudently. Once volume starts to make sense to you, you will see
progress but improvements will not come overnight.

. WHAT IS STOPPING VOLUME IN VOLUME SPREAD ANALYSIS (VSA)?

Stopping volume is a concept in volume spread analysis. It refers to an increase

in volume that stops the market from falling further.

The assumption here is that the market is falling. Then, it experiences a surge in
volume bullish enough to halt the fall. This is the theory.

In practice, how do you look for it?

CHARACTERISTICS OF STOPPING VOLUME DAY

 Down-day. (closes lower than the day before)
  Very high volume. (I explained my method to find high volume in this
article.)
 Closing near the high of the day.

(Based on Tom William’s Master the Markets .)

STOPPING VOLUME AND PRICE ACTION

At its best, stopping volume catches the exact low of a bear trend (start of a bull
trend). This is what attracts Holy Grail seekers to this VSA concept. However,
more often, stopping volume just pushes the market into a trading range
instead of reversing it.

This volume signal is not a common sight. When you spot it, it deserves a closer
look.

THREE STOPPING VOLUME EXAMPLES

1. SIDEWAYS PRICE ACTION

The chart above shows the daily price bars of Campbell Soup Company (CPB).

1. The market was in a bear trend.

2. Price was rejected from a new trend low with stopping volume.
3. CPB did not reverse into a bull trend. Instead, prices went into a trading
range.
 4. After a sharp false break-out upwards, another stopping volume day
formed. However, stopping volume makes sense only in the context of
falling prices. Thus, this second signal held less weight on our analysis.

2. DEEP RETRACEMENT

This is a daily chart of Expedia Inc (EXPE).

1. Again, the price action context was bearish.

2. After a tight trading range, the market moved lower and met increased
volume that stopped it.
3. The stopping volume here was more potent than the CPB example. It led to
a bullish trend that almost erased the earlier market plunge.
4. Then, the market continued to fall. (I used the label of “deep retracement”
with the benefit of hindsight. In real-time, I would have called it a reversal.)

3. SHARP REVERSAL
This chart shows the recent price action of the S&P 500 ETF (SPY).

1. The market fell fast and prompted fear.

2. At the end of the sell-off, there were two consecutive days with stopping
volume.
3. Immediately after this rare formation, prices reversed and rose sharply.

USING STOPPING VOLUME TO YOUR TRADING ADVANTAGE

The last example shows stopping volume catching the exact start of a bull trend.
Such textbook examples are not common. So don’t try to catch reversals with an
isolated signal.

Combine volume signals with other technical tools for a safer reversal trade.

If you are in a short position, covering when there’s stopping volume is a good
idea. It may not be the perfect exit. But even if you expect the bear trend to
continue, you can likely short again at a higher/better price.

High volume formations are often key turning points or support/resistance.

Hence, expect to find them with anchor bars and exhaustion gaps. In fact, these
concepts are not mutually exclusive.
For more volume spread analysis concepts like “No Demand Bar”, take a look at
this guide to VSA

RELIABLE SUPPORT AND RESISTANCE ZONES WITH

HIGH VOLUME SIGNALS
Price never moves in a straight line. Price action bounces up and down between
support and resistance levels. In fact, when skilled price action traders analyse a
chart, they are just looking for support and resistance zones.

We look at major support and resistance for market bias. We also make use of
minor support and resistance for timing purposes.

Support and resistance is a key price action trading concept. Hence, it is not
surprising to find a myriad of techniques for projecting support and resistance.

Traders seem to buy in areas of support and sell in areas of resistance. But they
do not react to support and resistance because of magic. They do because they
are interested in those price levels.

The best way to gauge market interest is by observing volume. When a

price zone gets the interest of the market, the market trades. Volume
surges.

Hence, by paying attention to volume clues, we can find reliable support and
resistance areas. The easiest way to find volume-based support and resistance is
to focus on climatic volume signals. While they do not occur often, you cannot
miss them when they do.

What are climatic volume signals? How high is high?

Here, I will use the volume benchmark that I applied to find Anchor

Bars and Exhaustion Gaps.

The benchmark is the upper Bollinger Band with a look-back setting of 233 and a
displacement of 3 standard deviations. If a price bar shows volume higher than
this benchmark, we will zoom in and analyse it as a potential support or
resistance area.
First, find a high volume price bar, Then, mark its high and low prices. The area
between is the potential support or resistance area.

Let’s take a look at the two examples below.

HIGH VOLUME SUPPORT/RESISTANCE – SPY ETF

The top panel shows the daily price bars of SPY. The lower panel shows the
volume of each day. The orange line is the Bollinger Band benchmark as
described above. Look out for instances when the volume rises above the
orange line.

1. These two consecutive high volume bars caught our attention.

2. Using the highest and lowest traded price of these two days, we drew a
price zone.
3. As the market rose, the price zone became a potential support zone.
4. At the end of the first deep pullback down, the price zone offered perfect
support to halt the market descent.

This is a textbook example. Buying when the market dipped into the support
zone was a great trade with almost no adverse movement.
The next example will show that price action around a support zone is not
always as neat.

HIGH VOLUME SUPPORT/RESISTANCE – LEN

This chart shows the daily price bars of Lennar Corporation (LEN on NYSE).

1. We spotted this clear surge in volume.

2. Using the high and low of the high volume bar, we marked out a potential
support/resistance zone.
3. After rising above the price zone, the market tested the support zone for
five times before leaving it alone. The fourth test was the strongest and
shook most weak bulls out of their positions.

The tests of the support zone were of varying strengths. Such market movement
made it difficult to make use of the support zone for trade entries. Thus, blindly
buying a bounce off the support zone was not ideal. It was essential to use more
specific trading setups to define our risk and reward.

TRADING WITH HIGH VOLUME SUPPORT AND RESISTANCE ZONES

When trading with any form of support/resistance, always look out for
support/resistance zones that have failed.

Generally, if the market falls sharply through a support area, it becomes invalid
as a support. (You can still observe it for flip trades as the support switches into
a potential resistance zone.) The same logic applies for a market rising through a
resistance area with clear momentum.

A tip for day traders: fine tune your support and resistance levels with range
bars instead of time-based charts. Range bars with high volume are effective
intraday support and resistance levels.

High volume price zones are potential support and resistance areas. Potential is
the key word here. They do not always work. Hence, you must not trade them
blindly.

While looking out for high volume price zones is great for mapping the market
structure, it is not a complete trading method. You should always use
other trading methods to time your entry.

4 WAYS TO TRADE A CHANNEL

Do you trade with a channel? There are dozens of channel for trading
including linear regression channel, moving average channel, and trend line
channel.

Regardless of your favorite channel tool, there are 4 ways to trade them. Let’s
learn about them to make the most out of your trading channel.

TRADING TRENDS WITH CHANNELS

This is a trend trading strategy. To use this trading method, you must have a
channel that is sloping at a healthy angle to confirm that the market is trending.

A trend line channel is the perfect tool for this trading method.
Let’s go through this channel trading example.

1. We drew a trend line with two swing highs. The trend line was sloping
downwards.
2. Then, we drew a parallel line starting with the swing low to complete the
channel.
3. Prices went up to test the trend line, which is also at the level of a previous
congestion area. Hence, the context was excellent for a bear trade, so we
went short with the bearish inside bar.
4. The channel trend line provided the perfect price target for this trend
trade.

We could have taken the short trade using only the trend line. However, having
the channel gave us a clear exit point for this trade.

To learn more about trading trends with trend line channels, read Channel
Surfing: Riding the Waves of Channels to Profitable Trading .

TRADING REVERSALS WITH CHANNELS

When price exceeds the channel trend line, it could be a climatic move, implying
that the trend has exhausted itself. We can then look out for reversal trades like
the one below.
Reversal trades are usually low probability trades so we must select only the
best trades. Follow these rules to find the best reversal trades.

 Ensure that the channel is going against the trend of the higher time-
frame. Effectively, you are looking for a retracement of a larger, more
powerful trend.
 Trade reversals with steep channels. Steep channels are unsustainable.
 Strong rejection of break-out of channel trend line. (like the outside bar in
the example above)

TRADING RANGES WITH CHANNELS

Channels are not just for trending markets. They are also useful in highlighting
range-bound trades.

In horizontal channels, we can trade without directional bias. We can sell short at
the top of the channel and buy at the bottom.

The Gimmee bar trading setup is an example of trading ranges with channels.
However, in the Gimmee bar strategy, the Bollinger Bands acted as the channel.
Read our review of the Gimmee bar trading setup to learn more.

TRADING BREAK-OUTS WITH CHANNELS

The earlier strategies assume that the channel will contain price action and seek
to buy low, sell high. What if this assumption fail?

Then, we might have a break-out trading setup that often offers quick profits.
However, judging which break-outs are valid is an art that is hard to master.

 Pay attention to volume. Valid breakouts are strong with increased volume.

 Look out for break-out bars with above average bar range. (Read Yum-Yum
continuation pattern.)

For trading strategies that finds break-outs with channels, take a look at:

 Quick Trade using Linear Regression Channel – A classic example of a

break-out trade.
 A Simple Day Trading Strategy – It uses MACD to confirm the breakout of
Bollinger Bands.

MAKE THE MOST OUT OF TRADING CHANNELS

Channels are powerful trading tools that highlight trading opportunities for all 4
types of basic trade setups.

However, for some traders, having too much trading options is a drawback. They
look for trading setups everywhere. They take a retracement trade, and then a
reversal trade, and then think that a break-out is impending. All these within a
few minutes. They are overtrading.

A solution is to draw a larger channel to analyze the larger price context and only
take trades in its direction. For indicator-type channels, you can increase both
the look-back period setting and the deviation setting to create a larger channel
to contain long-term price action.