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Price action means simply the movement of the market – how far did price move, how fast did it move, did it oscillate wildly or did it progress smoothly from one level to another? Price action can occur in an infinite variety of ways. Some claim price action lies in the domain of technical analysis or charting, but actually one doesn’t even need a chart to get a feel for price action. It is enough to follow the ticker. Price action traders define and quantify price action in many ways, and this article goes into detail about some of their methods.
Some say price action also includes volume and the level 2 “top-of-book”, and many price action traders will include indicators such as moving averages in their analysis, and others again will also depend on price patterns such as Japanese Candlestick or Edwards & Magee formations. Some traders who would not class themselves as price action traders often use price action to complement their main tools.
While price action has existed since the first market opened, and early traders on the stock exchanges who read the tape obviously used price action to help make their trading decisions – read chapter 1 of the Jesse Livermore book referred to below – there isn’t that much literature detailing profitable trading strategies based on price action, except the Al Brooks books (also see below).
In brief, a successful price action trader will study the market intensively and internalise the meaning and weight of a selected subset of price action in terms of its likely effect on future price movement. A certain type of price action behaviour will trigger bearishness or bullishness. That price action might be made of multiple small signals, or just one very glaringly obvious big one.
To define the exact methodology a trader uses is just as impossible as it is to describe how an art expert knows how to judge a real Old Master from a fake, or how a firefighter knows to get out of a burning building seconds before the roof collapses. The trader might not even be conciously aware of some of the input. This is learnt by experience from the market. Commonly quoted advice states that a trader requires five thousand hours of experience to become an expert.
It is notoriously difficult to define and categorise a list of price action behaviours. Since this is a wiki which can be easily edited, the rest of the article will lay out, in whatever order makes itself apparent, a series of examples of price action illustrating the principles involved and where possible an explanation in terms of other market participants (i.e. the bulls and the bears), their decisions, order flow and supply and demand.
[top] Price Action Analysis
Normally in the face of ever-fluctuating supply and demand, a trend will move in a series of pushes seperated by pull-backs.
Although price action traders generally assume that nothing can be strictly defined, this doesn’t prevent them from giving it their best shot. The primary method for defining a trend is through the turning points or swings, referred to as “swing highs” and “swing lows”, or higher highs “HHs” and lower lows “LLs”. A bull trend will have alternating higher swing highs and higher swing lows – HH’s and HL’s (higher lows) – and a bear trend will have lower swing highs and lower swing lows – LH’s and LL’s (LH = lower highs).
Swing points (high or low) can be defined in their own way in varying fashion. A swing high is a high price preceeded by a certain minimum length of time and followed by a certain minimum length of time. A swing low is analogous. For example on a bar chart, a swing high could be any bar with 2 adjacent bars to the left whose highs are lower than the swing bar’s high, and similarly 2 adjacent and lower bars to the right. It could be 3 or 5 or any number of bars instead of 2, but the more bars used for the definition, the fewer the swing points created.
Virtually every trend will often ‘break’ its swing count as this one does at 12:30 by putting in a lower low rather than a higher low. After a break like that, this time the trend carried on, making a new HH. Otherwise the trader would start to reconsider the predicted direction. This is illustrated in the chart “counting swings”.
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Lance Beggs of YTC (see link below) defines a mechanical rule to determine a break of the trend or the swing count as the point at which the market makes – e.g. in a bull trend – a lower low than the HL (higher low) that led to the current HH. And vice-versa for bear trends.
Sticking rigidly to the definition is something that can be done by a computer. Indicators can be programmed to place the chart mark-up at each swing point. However smaller breaks occur e.g. at 12:30 on this chart where the market makes a lower high. A human trader can ignore such a little anomaly and keep the count going – a computer can’t, or at least would require a lot more lines of code and processing power.
Here are some of the chief characteristics of different types of trend:
- perfect sine-wave trends with regular pull-backs – this rarely happens – the chart “counting swings” is an example of something that comes as close to that as it gets (at least for forex). Not only is the swing count fairly extended with few breaks, the reversals into and out of pull-backs will be nicely symetrical, the bars on the chart will show few tails except at reversals, there won’t be any chop and any acceleration or deceleration of the trend will be smooth and regular at the start and the end.
- strong trends are characterised by big bars and brief pull-backs and rarely fit entirely onto one chart screen. A strong trend can commence through acceleration as the trend builds or straight off from a break-out. The adjacent chart “strong trend” is typical. It may often end in a “blow-off top” or “climactic top” where all market participants thinking with-trend are drawn into the market in a final surge and the trend ends as the last traders enter and no more with-trend pressure is left, resulting in either consolidation or a reversal.
- weak trends are best defined as markets where there has been a visible movement, i.e. opening and closing prices are far apart, but where all other definitions fail – the swing count is broken, there is too much choppy action, there are too many bars with tails, smaller child trends accelerate and decelerate, pull-backs are large and long-lasting, etc.
- accelerating trends become stronger and stronger as in the adjacent chart (“Accelerating trend”).
- decelerating trends are usually dying trends, where any strength in the trend tails off with each push and each push gets successively shorter to the point where it becomes obvious the trend has become sideways or even reversed.
- choppy trends: typically have a lot of pull-backs, a constantly breaking swing high / swing low count, lots of tails, a mix of sharp reversals and rounded turn-arounds. This chart “Choppy trend” shows a choppy sell-off that made 100 points.
Many traders pay close attention to the number of pushes and pull-backs in a trend, especially day traders observing a child trend during the day. Pushes, or the push and the subsequent pull-back, are also called legs, and a trader may come to expect a particular number of legs depending on the market, especially 2 or 3 legs, before the trend finishes and goes into consolidation or retrace mode.
[top] Ranges and Consolidation
Strong moves often result in a subsequent period with very little movement, as seen on this chart (“Ranging market”) in EUR/USD after several days of strong rally.
EUR/USD only moved 80 points all day, despite volatility at the 3min timeframe.
The trader who already has a bias for the future direction can use the stall as a low risk entry point – it’s low risk because the protective stop can be placed really close on the opposite side of the stall to the predicted direction.
The stall doesn’t have to be a tiny range, it can be a bit bigger and looks like a solid block of bars on the chart, either all heavily overlapping range bars (as at 08:00 on the next chart – “More stalls”) or overlapping dojis (as at 08:30).
Depending on the market, a few, several or practically half of all moves will be immediately preceeded by an attempt to go the other way which fails.
This example shows the EURUSD interacting with resistance at 1.2800. The preceeding strong bull market decelerated massively into the 1.2790s and then proceeded to make higher lows, with big spikes in-between deomonstrating good supply above 1.2800 which repeatedly drove price back down – although each time a new high was made.
Just as the new higher low looks like it’s about to be made just under 1.2800, the market breaks and the bears look like they have surprisingly won the battle – but after stalling, it turns around and powers through the resistance after all.
The last chart shows EUR/USD in European trading breaking out of the range set in the Asian session. It tries both directions and fails each way before making a successful break-out.
Tails are an artefact of the bar chart or candlestick chart and are the top from the higher of either the bar open or close to the high of the bar, or the lower tail, from the lower of either the open or the close to the low of the bar. When a tail is significantly larger than average, e.g. the lower tail, it is evidence that demand is pushing price back to the open of the bar and is generally bearish. A sequence of bars with lower tails is stronger evidence, and a sequence of bars with tails breaking support or resistance levels is sign that the market does not accept price being on the other side of that level. When the level of supply or demand begins to decline, the tails reduce and any S/R level will become fragile. EURUSD3MinTails.jpg
When a period of trading shows bars with large numbers of tails in both directions, it’s referred to as chop. Where there are several overlapping Dojis, especially InsideBars, in sequence, it is referred to as Barb Wire.
Supply and demand fluctuate as market participants go about their business with the result that even at the highest time frame, price in a free market will oscillate irregularly backwards and forwards. Each point where the market changes direction is technically a reversal. EURUSD3MinReversalBar.jpg We already have definitions of swing points, SwingHigh and SwingLow and swing points can take various forms on a spectrum between a perfect V shape with one bar only penetrating alone many points away from the market before and after, to a regular U shape which displays a smooth curving change of direction over many bars. [wikiimage]EURUSD3MinUturn.jpg|160px|thumb|border|right|Sweeping turn-around[/wiki]
When the market puts in a symmetrical formation at either end of that spectrum, e.g. a perfect one bar reversal with a long tail or a long sweeping turn-around, then traders feel safe making their predictions of that to carry on. In reality what we usually see is something in-between.
[top] Inside Bar Break-outs
A well-known entry trigger is the inside bar break-out strategy. A small InsideBar which appears at the top or bottom of very large bar is unexpected – the market has just experienced great volatility and has surged in one direction, but now with the inside bar, demonstrates indecision as the market participants collectively pause to make a decision whether this large move should continue or reverse. Whichever way the market moves, it is likely to continue with similar momentum shown in the previous bar. EURUSD3MinInsideBarBreakout.jpg
It may fail, and the market might come straight back after moving only a short way in one direction, but it is mostly just as good a risk to take the loss and go with the opposite break-out.
[top] Basic Price Action Reading
Reading price action seems easy enough to understand – read what price is doing on a chart at any given time. Is it going up, is it going down or is it going sideways? So what advantage is there to this and why would you want to do it? Well simply put you’re looking for opportunity. You’re looking for an edge to make a profit.
Price action reading in hindsight, meaning after the fact, is relatively easy to master – even seconds after the fact. But, you do not profit this way as you cannot trade this way. You need to attain an understanding or a feel for what is occurring in the now, understand what potentially is causing the price action to unfold as it is before your eyes and doing so sub-consciously. The goal is to read price action as you would the words in a book. Reading words, sub-consciously you form understanding and ideas; the goal is to think this same way when reading price action.
Trading is easy, push the go long or go short button, see if you make a profit, if not exit. You could just enter at any location, but that would be more in line with gambling – lay your money down and see what happens. That approach is doomed to failure. If you have no idea of a stop loss-profit target (risk reward ratio), no judgment as to what is occurring in the market, no insight into who is in control – you really have no chance for success.
Reading price action and understanding market context go hand in hand. As for example with news releases, the market context typically includes exceptionally wide and volatile swings. Review the ES or 6E futures charts at 10:00EST and notice how volatile that time of day can be. Scheduled reports are routinely released at that time. The close of a market is also another crazy time to trade. If you cannot hold overnight you must exit your position before the market close. Those who can hold over night will be glad to help you exit your positions. Successful traders have a firm grasp of market context. Major and minor swings, number of traders in the market, type of traders in the market, time of day, time of week, time of month, time of year , trending or trade range, – all of these and more make up market context.
The best entries have obvious risk and reward price points which can be used as stop loss and profit targets. Look back on any chart and identify these locations. You know the ones, where you say, If I had entered here and had a stop loose there, look how far this trade would have run. Once identified, study the bars just before the obvious entry location – those are the price action patterns you want to learn to identify allowing you to prepare for the entry. Also with the prior bars, pay particular attention to the potential obvious stop loss and profit target areas. Keep these locations in mind should the market should prove you right and warrant an entry. Plan your trade and trade your plan.
Validating entry locations includes understanding the trade’s risk:reward ratio. Subconsciously learn how to calculate the risk:reward ratio. Many trading methods use this value as an entry guideline– why risk more than you can be rewarded by? One rule of thumb is a 1:3 minimum. Not all approaches follow this rule so regimentally. With trading, things are very dependent on market context. Some methods I have studied use stop losses as catastrophic stop loses and such stop losses are hit only in extremely rare occurrence the market does something crazy. Using a catastrophic stop loss, the trade is managed once initiated, but a profit target is always known/set in advance. Scaling in/out can also be incorporated allowing you to fund a “free” runner trade. For example, once you make profit to cover your initial risk, you exit a portion and let the remainder run with the market while managing the trade stop loss accordingly.
By reading price action, you learn to understand where such entry locations are likely to begin and why. It is absolutely impossible to always be correct in your read; nothing works every time because the market context is never the same. More importantly anything can happen at any given moment. There will be times when the absolute best setup simply does not work out. There will also be times when the market takes off for no reason what so ever. A fine line exists between the prediction of market movement (which is impossible in my opinion) and reacting expediently to what is unfolding before you (if the market is behaving in line with how you are reading it). Reading price action and reacting as needed requires extreme confidence in one’s self.
It is critically important to have an opinion on is who is in control. Why, because it provides a base from which to measure. Is this a bull market or a bear market or a trading range? In review of charts, it is easy to see who was in control, but as already stated you do not trade in hindsight. The sooner you establish who is in control the sooner you can trade on the “right” side of the market. Examples of the right side of the market are: going long at the end of a pullback in an uptrend, going short at the end of a rally in a down trend or buying low and selling high in a trading range.
The standard candle stick bar provides insight as to who was/is in control for the period of the bar. A candle stick bars has a high, low, open and close value. If the close is above the open, the bar is an up bar. If the close is below the open, it is a down bar. Looking at a common 5 minute chart, a large bar that has no tails or wicks is obviously bullish if it is an up bar and bearish if it is a down bar. This fact alone provides insight into who was in control for the duration of the bar.
The tails of the bars provide valuable information as well. If the distance from the high of the bar to the open or close of the bar is significantly larger than the body ( the body is the distance between the open and close) , the top of the candle will have a top tail or wick. I use the term tail and wick interchangeably; it just means there is a line that extends from the top, bottom or both sides of the candle. A large top wick means the bulls pushed price up to the high, but then the bears took control and pushed the price back down. Conversely if the bar has a relatively large bottom tail it signifies the bears pushed price down to the low only to have the bears gain control and push price back up. Now consider a bar that has a relatively large bottom tail, no top wick and is an up bar – this bar is very bullish. Conversely if a bar has a relative tall top tail and is a down bar, it is very bearish. Knowing how to interpret the orientation of candle stick bars aids tremendously in determining who is in control. Some say the tale is in the tails – long bottom tails indicate buyers, long top tails (wicks) means sellers. But again, you must understand market context. For example given two bars, if the previous bar has a large top tail and the current bar has the large bottom tail – are the bulls in control?
Understanding how the market works greatly aids in determining who is in control. The market utilizes two basic types of orders – booked orders (such as limit orders) and market orders (filled when they arrive at the exchange). Yes there are variations, but at a basic level there are orders on the book and orders filled when placed. Why is this important to know? Booked orders cannot be filled by other booked orders. Booked orders can only be filled by market orders. Thus, traders placing market orders can be readily and correctly identified as the aggressive traders.
If price is dropping that means trades are occurring at the bid (the price someone is willing to buy at, yes buy at). The aggressor is the seller in this case, the initiator of the trade is a seller. Conversely if price is rising, trading is occurring at the ask (the price someone is willing to sell at). Aggressive traders sell at the bid and buy at the ask. You can test this – during a slow time, to avoid slippage, and in simulation mode, place a market buy order and see what price you get filled at (note what the bid and ask are when you enter) and conversely do the same with a sell. Another way to think of it, if you want to enter the market long and don’t care about price, are you going to get the lower or higher price? If you don’t care and you go long, you’re going to pay the higher price. The ask is higher than the bid. Aggressive traders, traders who initiate a trade, sell at the bid and buy at the ask. This fact provides the basis for a tangible metric to aid in determining who is in control.
If price thrusts downward who is in control? You might say well dah, the sellers are. But guess what, at the start of a large down move and a large reversal, the charts will look exactly the same – a thrust downward. Force yourself to determine/pick who is in control, based on what you read from the chart – this judgment needs to become a habit. Always have an opinion of who is in control. So what If you’re proven wrong, when proven wrong you still end up knowing who is in control.
There can be and many times is a difference between the aggressor and who is in control.
I have come to think of the heard as the aggressor. The herd is the vast majority who are trading. Think of stampeding cattle. What gets them all aggressive and moving in one direction? Who controls the heard? There are stories of getting the heard all fired up, running full steam ahead only to fall off a cliff to their death. So if the heard are the aggressors, who is it that is in control? More importantly how can you determine the sentiment of who is in control?
Many times more than not, the aggressor is not in control. Many times the aggressor represents the laggards – always late to the party and rushing in chasing the market.
Take for example a price drop that plummets 10 ticks in seconds on high volume. Imagine all the trades that must have occurred, all the orders filled for this to occur. Then you see price stop at a value it has stopped at before, to the exact tick. The exact same price point hit, just a few minutes ago. Ask yourself, with heavy volume and the thousands of traders in the market – how is it that price stopped to that exact tick? Is this a random occurrence? Look back to the left of a chart to aid in what is occurring on the right hand side of the chart. Review your charts to see what happens the majority of the time when you get a double bottom (DB matching lows) or double tops (DT matching highs). Who is in control on these locations? This type of action appears almost magical, price tries to move past some value but the move/attempt is repeatedly rejected. On a 5 minute bar you can see the intra-bar movement repeatedly hitting that low, but it simply will not pass that value. In this example down thrust, someone sells and someone immediately buys. No matter how much selling volume there is, all the sell orders are instantly bought up. No way is this random. Knowing how the market works, the aggressors are trying to go lower, but for some reason the market won’t go down. The heard is being re-directed by the controllers.
And with that said, also consider the vastness of the market, so many traders with their own agenda. Recall it was stated that nothing works all the time. In review of charts, take note of what happens when a DT or DB location fails to hold.
You have undoubtedly have heard “the trend is your friend”. Well who is in control in a trend? You want to be on their side and you want to be in control too.
- You read price action to ascertain who is in control
- You read price action to learn where the laggards are as they become “trapped traders”
Have you ever been in a trade only to have the market immediately go against you? How do you feel? If you’re smart what do you do? You exit the market. It is also very true that at every trade there is an initiator and the remaining trader. If you initiate an exit due the above scenario (for example exit a short entry), someone else needs to pick up the other side of your trade in order for it to be filled. Ask yourself, if you’re exiting because you’re feeling pain – who in their right mind is entering? In this example/context, the ones who are in control, the bulls, the buyers, that’s who is making so you can exit safely. How nice of them…
Imagine price is moving strongly downward. An aggressive trader jumps on the bandwagon and enters short. They are an above average trader and place a stop order just above the entry bar. They place an “obvious” profit target at a respectable risk:reward ratio. Price now starts to move in their direction, volume increases meaning others are jumping on the bandwagon. But all of a sudden price stalls – it just will not go lower and is just shy of an “obvious” risk:reward ratio profit target. Price then starts heading upward towards the obvious stop loss exit, but it does not hit the exit either. Time moves on and magically price starts moving downward again. The aggressive trader’s emotions are going crazy – at first they were elated as it seems they were on their way to an easy profit. Then all of a sudden they almost got stopped out – whew what a close call. And now price is coming down again, yes this trade is going to work. Then it happens – price stops to the tick of the previous thrust, it just refuses to go down any further. The bulls, who are in control, are again rejecting again the 2nd attempt down of the bears – and to the tick. The laggard trader is trapped. What to do? Indecision ensues, do I exit now with partial profit, but my rules say never ever change my targets, what to do what to do what to do, panic sets in…. Price now races back to the stop loss. What happens next? What happens when those exists are hit? What happens if they exit with partial profit? If we are in a down move, those exits are buy orders. So now we have the bulls that are in control having defended the low a second time (double bottom). We also have the trapped trader exits that turn into more buy orders. Demand is building and supply is gone signified by the fact that price would not go down. What’s gona happen to price?
Enter the market to ease the pain of trapped traders in the direction of observed control (trend).
Limits, fractals and abstract thinking are applicable to price action reading. Here is one way to understand what thinking at the limit means. Stand facing a wall, 4feet or so from it. Now take a step half way to the wall, then repeat, again and again and again. Will you ever hit the wall? Fractals and limit thinking are an interesting combination when applied to trading. As an example of the fractal nature of trading consider a 1 minute, 5 minute and 10 minute chart. If a high is made on the 10 minute chart, that same high is also made on the 5 minute and 1 minute chart. Price action reading is fractal in nature – price is simply represented or printed in finer or more course detail on charts. On the 1 minute chart you will see pull backs whereas on the 10 minute chart you will only that action as intra bar movement. Both will end with the same high/low extreme, it’s just that one illustrates with more detail. The detail may provide you, or better stated, you may perceive opportunity in the detail where as another trade will call it noise. There is no right or wrong here, just what you perceive, how you react and how you trade (your style). Just remember the smaller the time frame, the smaller the opportunity. If you take this concept to the limit, to the single tick, the same principles still apply. With this said, there are always easier ways of doing things – you could fly to California or you could walk, one is just easier. Al Brooks advocates the 5 minute chart for Price Action Reading, but it will work on any highly liquid market with any periodic measure.
In keeping with the microscopic view (at the limit if you will) , at every price point traded there is a potential trapped trader because for every buyer there is a seller and for every seller there is a buyer. The higher the density of trades, the higher the probability of a trapped trader whose pain you can “help” ease. Trapped traders will gladly allow your fill with their stops. Based on this does it not make sense to look for these highly probable, highly dense trade areas on the chart?
This is why looking back to the left becomes important. Those previous peaks and valleys represent high probability locations of prior traders. I know of many methods that use closes of bars and just as many that use highs and lows of bars. Many methods use previous session highs and lows. Common trading methods, widely accepted methods serve up (more like T up) these highly probable locations on a silver platter. Patterns form and methods work, not due to magic, but due in part to being self-fulfilling in nature. If the majority of current traders within the heard believes the EMA20 price cross method, guess what the high likely hood of price action within the market (at that moment in time) will be when the setup occurs. And for every buyer there is a seller, so someone is always left holding the bag if you will. You need to understand the market you trade in; you need to get a feel for the way it behaves. Don’t chase the market, rather like in chess, think ahead of the next move and be prepared to take action when your thoughts are proven right. Don’t be greedy – but do be profitable.
You’re seeking to be on the side of control, you want to remain in control of your trade. If you’re in the market and not proven right – do not hesitate to exit. There is no hoping involved in trading – you are either proven right or you exit. Don’t let the market make that decision for you. You need to be in control of your trading, not the market. Lean to read where the high likely hood of trading will occur – you can easily identify these locations by reviewing your charts. Look for the locations where you say If I had entered here look what opportunity was available. Then consider what the market looked like just prior to that and look for that “setup” when reading price action in real time. Look for control, remain in control and trade in the direction of control.
I have recently started taking screen shots of moves that I believe are great setups. When trading live I take the screen shot as soon as I recognize it forming. I store these in a folder with a name based on the name I give the setup (for example 1st pull back). I periodically review the folders of images, sort of a flash card type approach to teaching my brain what to look for. I want to build my sub conscious mind to recognize this image as it forms just as I teach my mind to read what is going on – who is in control and where are the trapped traders I can help. Trading is very much mental – it needs to become second nature.
The mechanics of trading are not difficult. What is difficult is remaining in and maintaining mental control. Excitement and frustration are hard emotions to keep in check. Remaining in the “zone” focused on what is unfolding as told by price action is challenging and hard to do. It is extremely difficult to sit on your hands when you see the market accelerate and you’re not in the market. It is equally difficult to remain in the market when you are proven right and everything is indicating continued movement in the identified direction. And it is most challenging to exit when you are not proven correct. One way to remain in mental control is ensuring you are making your trading decisions. You can only control yourself, you cannot control the market. If you decide to get out of the market make sure it is because you decide to do so meaning exit before you catastrophic stop loss is hit. It’s akin to seeing an eighteen wheel semi speeding down the road directly towards you; as soon as you identify this situation does it not make sense to get out of the way? Letting the market take you out by hitting your stops become mentally challenging. Learn to listen to yourself. Learn to distinguish between the inner voice that is all excited about seeing a market thrust and the inner voice that identifies opportunity and trapped traders.
Reading price action is tool to aid in successful trading. Understanding how to read the market will provide you with the reasons why a DT or a DB works. It defines why the BPB (breakout pullback) works. Patterns and methods are valid in trading, but reading price action provides reasons why they work and provides you an edge before they print. At first you may think your anticipating the move, but remember you cannot predict the unpredictable. You are reacting to the provided information you are receiving in real time that then leads to the pattern.
Another way to understand price action involves supply and demand. Why does price go up? Why does price go down – supply and demand or the lack there of. High demand means the supply is low and conversely high supply means demand is low. When the availability of an item to buy is low, what happens to its price? It rises. Think about gold, it is rare with a supply lower than the demand so its price is relatively high. Conversely, the supply of dirt in the world is higher than that of gold and thusly the price of dirt is less than the price of gold.
So how do you measure supply and demand? With trading, I don’t think you adequately measure it. The reason being you are not provided the reasons why someone is buying or selling. You do not know if they are selling to exit with profit, selling to exit with loss, or selling to enter the market. All you know is that trades occurred at a location. But I know you can react to supply and demand changes when identified.
There are millions of possible reasons why supply or demand change. I recall something I read one time about this techno-wizard showing a very wealthy old crony beans trader, his latest and greatest Holy Grail indicator. The techno wizard says all excited to the old crony – see this arrow this is a strong highly probable buy signal that works 95% of the time. The old crony says really, grabs the phone and places an order to sell 1000 bean contracts at the market. Just as the market starts to raise a few ticks, it almost instantly drops 10 tics. The old crony then says to the techno wizards, thanks. The point is you never know what is occurring. You can be assured that supply and demand will change. Large institutions always have orders to sell or buy – because that’s what they do. The High Frequency Trading (HFT) computers may have just been programed with a new algorithm and it is being tried out for the first time. Some episodic news related item (Japan Earth quake) may have just occurred without warning. Some rouge trader may have just pushed the sell button. There are endless possibilities and all can and do affect supply and demand. But what can be recognized are areas where prices has hard time moving through, areas of support and resistance. You can also watch intra bar and get a feel for what rejection and continuation looks like within the market your trade. Remember the fractal nature of the market, intrabar on the 30 minute can be a significant trend on the 1 minute.
When demand increases, price increases. When supply increases, price falls. In a trending market, when demand increases, supply falls and when supply falls, demand increases. Demand could be increasing, and then profit taking could occur causing a monetary drop in price, only to take back off upward again. That’s what a first pull back looks like in a trend.
Price has found equilibrium where demand and supply are in check. Price seeks equilibrium.
Equilibrium is identified on the chart as congestion – overlapping bars or barbed wire as Al Brooks calls it. Demand and supply for the moment are equal. When either side gains control, price moves again, and continues on a path seeking equilibrium. Again, you are looking for control. Is supply in control or is demand in control.
At the end of it all, what really causes price movement is greed and fear of human beings. Greed brings you into the market and fear takes you out. You enter because you observe an opportunity to profit. You exit for two possible reasons. If you exit with a profit, your fear is not so hard to accept, the fear of losing the profit potential you have. If you exit for a loss, your fear is more profound, the fear of losing more than you started with.
Price Action reading provides the ability to define an edge. It provides a measure you can use in any liquid market. It is as close to the Holy Grail of trading that you will ever find and you will still need to apply discretion. It offers you a way to understand and explain market movement and allows you a repeatable way to determine who is in control. Being in control and on the side of control is a definite advantage in trading. At its essence price action reading is the basis of all trading methods.
How to Build a Trading Risk Management Strategy
In this step by step guide, we’re going to discuss how to build a trading risk management strategy to create a risk-adjusted performance. This risk management trading PDF can create an unprecedented opportunity for growing your trading account in an optimal way.
Risk management is widely recognized among professional traders to be the most important aspect of your trading plan. Our team at Trading Strategy Guides has created this risk management trading PDF that explains the key components of a good money management strategy. Also, read bankers way of trading in the forex market.
Risk management is the absolute most important thing that you can learn.
We’re going to teach you how to stay in the game. Staying in the game and making money on a consistent basis it’s all we care about. We’re not in this to make a one hit home run trade because anyone in the Forex market who has been long enough know that’s not possible.
All of our market strategies have a trading risk-reward ratio of at least 1:2.
There are many different ways to manage your risk and to manage your own money but in the end, it’s all about your risk tolerance and preferences. However, you need to have some sort of risk management system to make money in the FX trading.
Moving forward, we’re going to introduce you into the world of how hedge fund manager really looks at trading the markets.
What is Risk Management? – Risk management trading PDF
Risk management is the process used to mitigate or protect your personal trading account from the danger of losing all your account balance. The risk is defined as the likeliness a loss will occur. If you manage the risk you have an excellent opportunity of making money in the Forex market.
Basically, risk management it’s just a method to control risk exposure when trading.
Risk management it’s like the foundation of a house. When you build a house you first start with the foundation layers and only then you start building the walls and the roof and everything else. On that note, risk management is the foundation of a successful trading plan.
We can basically break risk management foundation into 3 layers:
- Risk Planning
- Trading Risk Reward ratio
- Position Sizing
Moving forward, we’re going to explore how one can use these risk parameters to generate superior risk reward ratios for your trades.
Risk Planning – Trading Risk Reward Ratio
Planning your risk will help you maintain consistency with the risk we take trading the markets. Becoming a consistent trader is one of the biggest hurdles that you need to conquer and it can only be done right from day one if you plan your risk exposure.
So, when it comes down to planning your risk we need to be able to answer one simple question: How much are you willing to risk per trade?
Well, ultimately, the answer to this question is a personal preference and it comes down to your risk tolerance. However, professional money managers recommend not risking more than 2% on any particular trading idea.
The main advantage of the 2% risk rule is that you’ll be able to take more trades at any particular time. Conversely, the more risk per trade you take intuitively you’ll be prone to make fewer trades.
The risk per trade is something that you’ll probably begin to refine over time, but don’t try to ramp it up too fast until you’ve got some good trading experience behind you.
How to determine the risk-dollar amount is simple:
Risk Dollar Amount = Account size * %Risk
For example, if your account balance is $5,000 and your risk tolerance is 2% your dollar risk amount is $100 per trade.
Risk Dollar Amount = $5,000 * 2% = $100
By calculating the risk-dollar amount we can ascertain how much we’re going to lose if the trade goes against us. In our particular case, the maximum loss would be $100.
Risk planning will help you better control the mental part of trading because you already know in advance how much you’re going to make if the trade goes in your favor or how much you’re going to lose if the trade goes against you.
Trading Risk Reward Ratio
The trading risk-reward ratio simply determines the potential loss versus the potential profit on any given trade.
How to measure the risk-reward ratio?
The risk is simply defined as the price distance between your entry and your stop loss.
The reward is simply defined as the price distance between your entry and your take profit.
In essence, in order to calculate the risk-reward ratio you only need three components:
In order to determine the risk to reward ratio, you simply need to divide the potential “Total Risk” to the potential “Total Reward:”
Risk Reward Ratio = Total Risk / Total Reward
In order to figure out your total risk, you need to apply this simple formula:
Total Risk = Pip Value X (Entry Price – Stop Loss Price)
In order to figure out your total reward, you need to apply this simple formula:
Total Reward = Pip Value X (Entry Price – Take Profit Price)
As an example, if you’re planning to enter a long position on EUR/USD at 1.2200 with a stop loss at 1.2150 and a profit target at 1.2300 you’re basically having a risk reward ratio of 1:2.
Risk Reward Ratio = $1 x (1.2200 – 1.2150) / $1 x (1.2200 – 1.2300) = 50 / 100 = 1 / 2
We want to have a strategy with a higher trading risk reward ratio as this will ensure our profitability in the long term.
For example, if your risk to reward ratio is 1:2, it means your win rate has to be above 33% to make money in the long-term (see Figure below).
Position sizing answers another important question, namely: How big a particular trade should be?
Is it arbitrary?
Or should you always be buying 5 lots or 1 lot?
There are several ways you can determine how big that position should be. It’s entirely under your control to determine how big your position should be.
In order to be able to calculate our position sizing we need to know three things:
- Account size.
- How much of that account you want to risk – percentage-wise. We have examined this under the Risk planning section.
- Stop Loss.
The basic formula for calculating your position size is:
Position size= (Account size * % Risk per Trade) / Stop Loss
Let’s imagine the following scenario where we have a fictional account size of $10,000. We have a risk tolerance of 2% per trade and based on our analysis, we figure out that we need 50 pips to stop loss.
Applying the above formula, it results that our position size should be 4 mini lots.
Moving forward we’re going to discuss two of the most popular risk management strategies:
- Fixed Fractional Money Management Strategy
- Fixed Ratio Money Management Strategy
Fixed Fractional Money Management Strategy
Using a fixed fractional money management strategy means only risking a percentage of your trading account on each trade typically 2%.
Each trade you take, you can’t risk more than 2%.
The advantage of a fixed fractional strategy is that as your account grows, you’re increasing your position size with the growth of your account. So, you’re getting the same kind of results as you would be if your account is $10k or $50k and so on.
However, the disadvantage is that if your account has a drawdown all of a sudden your risk of ruin increases. By using a fixed ratio strategy you can tackle this disadvantage.
Fixed Ratio Money Management Strategy
The fixed ratio strategy uses a specific position size that increases and decreases with your account balance.
Let’s consider the following scenario:
You’re having an account balance of $5, 000 and your fixed position size is $10 per pip. The next step a trader will follow when applying a fixed ratio money management strategy is to decide when to increase your position size. Of course, this all comes down to your preferences and risk tolerance.
For example, you can double your position size after you have made another $5000 then your position size will increase to $20 per pip. This concept is known as DELTA.
In fixed ratio money management, the delta represents the number of profits you need to make until you increase your position size. In other words, you’re using the delta as a benchmark to increase your position size.
You can break down your Delta in different increments to better suit your risk profile. For example, you can use a position size of $1 per pip for every $1000 in your account. So obviously if you’ve got a $5,000 account, your position size will be $5 per pip. Once your account dollar grows to $6,000 after you’ve made an additional $1000 profit your position size will now grow to $6 per pip.
You’re basically using that ratio of increase depending on your initial capital.
Risk management is the absolute most important thing that you can learn. In our next section, we’ll present all the factors why is having good risk management so important.
Why is Having Good Risk Management so Important?
While Forex trading can be fun, it does come with an inherent risk that you need to understand.
Having a trading risk management strategy is probably the most important aspect of your trading process because it will guarantee long-term survival throughout the ups and downs of your trading career.
Your number one priority as a trader should be capital protection because profits do care of themselves.
Applying risk control into your Forex strategy will enable you to be in control of your emotions because you already determined how much you’re going to lose before jumping into a trade.
Risk management is going to permit you to trade in a smart way and give you the flexibility to choose how much you want to risk per trade in a way that will allow you to maximize your profits and minimize your losses.
If you apply the risk management principles taught through this guide you’ll have a much greater chance to survive in this Forex business. However, not following any money management rules has the potential to break your trading career.
The good news is that this risk management trading PDF is easy to grasp as there is nothing complicated about money management.
Conclusion – Trading Risk Management Strategy
Not having a trading risk management strategy we’re basically risking the entire trading capital and risk of getting a margin call. Smart trading also means that you need to have a trading risk-reward ratio of minimum 1:2 in order to survive in the long term.
Money management has proven many times to turn a losing strategy into a winning one. So to overcome the limitations of your trading strategy you should focus on your trading risk management strategy. Be sure to read about our guide for the best trading strategies!
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Top 5 Things to Know in the Market on Friday, March 27th
Investing.com | Mar 27, 2020 07:13AM ET
By Geoffrey Smith
Investing.com — The U.S. overtakes China (but not yet Europe) in having the most cases of Covid-19. The Senate’s $2.2 trillion economic support bill should pass the House of Representatives on Friday, although isolated rumblings of opposition suggest it’s not a done deal yet. The dollar is on course for its worst week since 2009 as confidence returns to global funding markets, while the euro zone failed to agree on common bonds to fight the economic fallout and the U.K. suspended its housing market. Here’s what you need to know in financial markets on Friday, March 27th.
1. U.S. overtakes China in Covid-19 cases
The U.S. has now overtaken China in the total number of confirmed cases, with nearly 86,000, despite having only one quarter of the population. The U.S. death toll approached 1,200, still well behind the likes of China and Italy.
In a press conference on Thursday, President Donald Trump said the figures were a credit to U.S. testing and repeated his priority of restoring activity as quickly as possible, saying that “people want to get back to work.”
Separately, the Washington Post reported that the G7 had been unable to agree on a joint communique due to the U.S.’s insistence of calling the Covid-19 virus the “Wuhan virus”.
2. Senate support package due for House vote
The House of Representatives is expected to vote on the $2.2 trillion package passed earlier this week by the Senate, despite rumblings of resistance from individual lawmakers.
Republican Rep. Thomas Massie of Kentucky told a local radio station on Thursday he would oppose allowing the bill to pass by voice vote, effectively forcing a physical vote in Washington for which it would be difficult to gather a quorum.
However, the effect of the bill and of measures taken by the Federal Reserve continues to course through global funding markets, driving the dollar index below 100 and putting it on course for its biggest weekly drop since 2009.
3. Stocks set to open lower as profit-taking kicks in
U.S. stocks are set to open lower on Friday after a breathless rally over the last three days that meets the technical definition of a new bull market.
By 7:10 AM ET (1110 GMT), the Dow Jones 30 futures contract was down 470 points or 2.1%, while the S&P 500 contract was down 2.1% and the Nasdaq 100 futures contract was down 1.8%.
The Chinese CSI 300 had earlier fallen 0.5%, not helped by a 38% drop in industrial profits over the first two months of the year, while Europe’s Stoxx 600 fell 2.7%.
4. Europe struggles, medically and financially
Europe continues to struggle with the Coronavirus, both medically and financially.
Spain reported its deadliest day of the outbreak so far with 769 deaths on Thursday, while Italy also broke a three-day sequence in which new infections and deaths had slowed. The deterioration in Italy’s figures appear due to the virus spreading further beyond the region of Lombardy in the north.
A teleconference among EU leaders on Thursday, meanwhile, produced no further progress on coordinating the bloc’s response to the outbreak, due to a dispute over proposals to issue joint debt, led by France, Spain and Italy.
Elsewhere in Europe, the U.K. government effectively suspended the housing market due to public health concerns, a measure that rippled through the shares of realtors, banks and builders on Friday.
5. Russia keeps pressure on oil; U.S. Senators up in arms
Crude oil prices turned lower as the rally in other risk assets ran out of steam, leaving participants to focus on a mind-blowing level of oversupply in the near term. By 7:10, U.S. crude futures were down 0.1% at $22.55, while Brent was down 1.2% at $26.02
Additionally, Russia’s deputy energy minister was quoted by newswires as saying that Russia thought a fair price for oil is between $45 and $55 a barrel. That’s somewhat below the level that many western oil companies have used for their baselines in recent years, and also below what many shale producers would need to breakeven, at least in the current environment of sky-high borrowing costs.
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