In Price Action Trading Strategy

As we are all well aware and logic dictates, the positions of smaller traders comprise an very small percentage of the total trading population. As individuals working for ourselves, we have to recognize what the majority of traders are thinking in relation to the next move. What we think does not matter. What the consensus thinks is the only thing that does.

Traders at major institutions are responsible for controlling the bulk of day-to-day movement in the foreign exchange market. They have goals or outcomes that need to be achieved on a daily basis. Because they don’t all work for the same bank and are scattered all over the globe, what we must do is make a basic assessment as to what could be going on behind the scenes where momentum is shifting and very large positions are coming into the market.

In thinking in the most basic terms of logic and reasoning, for many of them, momentum is the key that unlocks the gate to making the most profits. They, too, need to be on the same page as everyone else, and understanding what or why price is behaving in the manner that it is leads us to the most probable outcomes for success.

But they also have other goals, many that come in the form of derivatives, intraday offsetting of positions etc., that need to be achieved as well. This information can change very rapidly, and price levels can get decimated as market movers look to achieve certain goals, so we have to be on our toes and decide whether or not we like a certain scenario in order to continue taking part in it.

The horizontal support and resistance levels discussed all over this site are simply stated, reactionary levels that everyone can see. That’s why they work so well. If everyone can see them, everyone can be on the same page, and everyone with influence is able to turn a profit. We don’t prefer to use exponential indicators, because although they might be giving us a signal to go long, that long position could be about to crash into a very heavily monitored resistance level, where influence is looking to go short. The same is true for certain trend channels and other methods.

But here is the situation we are in: we don’t know what all of these goals are, and we cannot see the bulk of intraday positions, so what do we use as a meter in terms of what to expect next? The answer is that we use our edge, which is comprised of the following:

·Knowing what the majority of traders are looking at and what crucial areas will provide certain profitable outcomes.

·Knowing that these conditions can change rapidly and all the time, and we must be ready for when they do.

·Knowing that we have certain goals we wish to attain, but reality might not allow those goals to be met if we are not on the same page as everyone else.

In trading, acting surprised about price behaving a certain way is not a good thing. We want to forecast what’s going on, and we want to be right about it all of the time. But this is impossible. There is no way to know what’s going to happen at the very next turning point without listening in to every trader across the globe taking on a position.

So we have to look at the information we have in order to gauge what most people care about at any given point in time. Last week we saw EUR/USD take a substantial hit due to several fundamental factors coming out at the same time. Levels that would normally cause a reaction were taken out, one at a time, by arms of influence looking for a major selloff. What we did know was that much of the information was triggered by news surrounding interest rates. There are few catalysts stronger than this one in terms of currency market movement. Intraday fundamental data releases can be easy money, as we know from the wide range of news traders out there take advantage of this situation. But again they are doing nothing more than being on the same page as everyone else, as the numbers are obvious and hardly lie.

The levels we look to play bounces off of are usually very heavily-concentrated upon areas for market movers and they command a lot of attention. When people see that these levels have been hit, they seek to continue the price reaction in the form of a reversal, which could last for several hundred pips if overall market conditions are in alignment.

We turn to chart below. Here we have the last few days of activity for USD/JPY. On this chart alone, we have several different scenarios which are presented to us, almost all of which we have the ability to make money from. Let’s walk through these motions step-by-step.

Point A: We have a new level that gets formed. We’re looking for a price reaction the next time it gets seen.

Point B: Price exceeds the level by more than a comfortable amount (we’re looking for it to hit it exactly and reverse). Additionally, we have an up close on the 1hr bar that is almost right on top of the level. We close our new short position with only a couple pips of profit. Price exceeds the level, and then uses it as support. We open a long right on the level when we see this.

Point C: Price reaches major resistance, so we go short, expecting a sizable move

Point D: Price uses the high of point B as support and retraces about 25 pips, where we could have made some profits on a long; we know that major resistance is just above us, so our expectations are low for continuation.

Point E: Price uses the previous support level at point D now as resistance. We go short.

Point F: We attempt to go long at the support level created at point B. The level is taken out, and we get an hourly close below it. Price retraces back up to the level, and uses it as resistance. We go short.

Point G: We go long when price hits a previous support level on the last wave up, which ends up coming off of it hard

Point H: Our support level created at point B is hit yet again, but because it failed the last time, it is now weaker. Additionally, the hourly close is very strong, and in the upper portion of the bar. We take partial profits on our trade and hold off on any new action.

Point I: News comes out, and other levels are taken out. Before the news was released, we closed the rest of our long.

In this example alone, there were many opportunities to make money in both directions. But you need to be on your toes, and most importantly execute or get out of these trades when you see these events occurring. By “dicing” up the chart in this way you are able to see what the majority of traders are looking at and where each money making opportunity arises.

Now lets discuss where most traders go wrong. Its very easy to look at the chart below, make an analysis of it after all of the trades have happened and say what it is we should have done. This is how most of us learn, and we’re used to being conditioned. We post trades before they occur here because I find little value in stating something that has already happened. That premise alone completely ignores the biggest component of our jobs as traders: to forecast.

All over forums, nlogs, etc., the greatest majority of threads started and posts concern means of entering trades only. Very few of these, or books written on FX trading in general, concern themselves about how to manage a trade once they are in it or when to take profits. This is where traders begin to fail, and fail miserably, as their emotions kick in and blind clues staring them right in the face get replaced by our overwhelming desire not to ever fail. Call it anxiety, call it fear, but in the way we are conditioned in society in regards to all other facets of life we bring to the trading platform and causes us to do damage to our accounts.

Going back to the examples above, how do you think you would have reacted to putting on a short position at point B, or putting on a long position at point F? Would you have reversed the position as the market was telling you to do? Or would you have stayed in it and waited for the trades to turn green again so that you didn’t take a loss? Minor damage leads to greater damage, and your emotions will go nuts if you don’t listen to the market, and cause you to take greater losses. For example, at point F, clearly the level was broken. Price is not going up, but you stay in the long position in hopes of it turning green again. Price then dropped about 50 pips, at which point your small intraday trade (which you could have and should have reversed for some very good profit) begins to turn into a major loss. Seeing that things are getting out of control, you might have closed the trade deep in the red, suffering an unnecessary loss for the day.

In his book, The Alchemy of Finance, one of the first things discussed by George Soros is a concept which he refers to as reflexivity. Simply stated, this is a concept which refers to the reality of a situation versus a desired outcome. This concept, among others, stands true across a wide range of markets and is in great contrast to hypothesis of market efficiency and other very widely known or accepted economic theories. He explains that many of the “bubbles” caused in the markets are driven by human action replacing fundamental theorem, as they are not explained in any other way.

Without reverberating the concepts of Soros in great detail, we can understand it on a personal level (in our own trading) as well as on a macro scale (the entire market). Seeing the reality of the situation (price moving in a certain direction, and for a certain cause) contrasts against our innate desire to achieve a certain outcome. We need to realize what is happening, and most importantly, react to it, in order to achieve this desire. But we say the path to the ultimate goal is not the same in trading as it is everywhere else, but is this really the case? Setbacks and roadblocks are found in every single business and in every single aspect of life. But when we look at a setback in trading (taking a minor loss), we see concrete dollars and cents going down the drain, which many of us refuse to let go of. This is a natural function of life, and we have to realize this in order to succeed.

Ultimately, the same clues we use in loss prevention are the same ones that bring us profits, and our reaction to these clues absolutely need to get executed in order for us to profit. As day traders, we need to react in the form of buying and selling, sometimes with little warning, quickly and without haste to make the most out of what we do. Realize the obvious, react quickly, use your edge, and the rest will follow.

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Showing 2 comments
  • Saiyanhead2001

    Wow this explanation is simply awesome, though as usual a part of me thinks that author has made it up after all has happened and trying to explain things in a very pleasant and good way.
    Anyway if I compare whether i learned something here or not, i definitely say  that this post was freaking awesome, i was about to skip this but glad i did not do this.

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