Trading “Tough” Days – Pay Attention to Tendency and Price Action

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Trading “Tough” Days – Pay Attention to Tendency and Price Action

Not every day is going to be easy to trade–some days are, some days aren’t. Depending on trading style, a tough day for one trader may be a glorious for another, but the fact remains every trader faces tough market conditions.

Since I don’t start trading the EUR/USD until well into the European session, nearer to the US open, I can already see what the day is like. If it appears to be tough conditions for the strategies I use–which are typically trend following strategies–I’ll either stay away or will be very patient with entries and exits.

On November 5 the EUR/USD showed a tendency to move sharply and then consolidate in complex formations, then move sharply, and so on. By realizing the tendency of the day, and being patient for opportunities, even a trending strategy could be employed. Patience is key though, because getting impatient and expecting a big move while complex consolidations are occurring can mean a lot of false signals and thus losing trades.

Picking out Tendency

Each day has a slightly different tendency. Some days we see sharp moves, followed by sharp pullbacks, or slow choppy trends followed by sharp or slow pullbacks, or no real trends at all.

By paying close attention to how the market is moving overall, we are better able to pick the times when our strategy should be applied.

Figure 1 shows some of the European session (bright yellow) and the start of the US session (pale yellow), and highlights this overall tendency.

Figure 1. EUR/USD 1 Minute Chart

Looking closely there are several additional tendencies which pop out, aside from the sharp moves followed by a complex consolidation.

Each of the consolidations has multiple false breaks out before the eventual move. The overall trend is down, so we want to be especially cautious about upside breakouts, because on this time frame, those breaks higher are likely to be false.

The next tendency is that in the small price swings just before the break lower, the price starts making lower highs, indicating a buildup in selling pressure.

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The following chart highlights how these tendencies could be used to pick a high probability trade.

Figure 2. Short Trade Based on Tendencies

While the tendency of the day is used to help isolate entry and exit points, we can’t abandon other methods for determining strength.

Incorporate Price Action Analysis

Following the first consolidation the drop is very steep and long. After the second consolidation, the drop is steep, but is much shorter than the last drop. This indicates the trend is still down, but that it is weakening. We still watch to see if the market follows the same tendency, but is now possible that a break higher could also occur.

Figure 3 shows the third consolidation and the break higher that followed it.

Figure 3. Same Tendency, Opposite Direction

This consolidation has similar tendencies to the prior ones, except in the opposite direction. On the third consolidation there is a break lower followed by higher lows–the opposite of the other consolidations. Combined with the possibility of a reversal based on the weakening downtrend, we want to look for a long position.

The EUR/USD makes a new high and once again a new low which is the area we want to enter long (marked on chart). As per the daily tendency a very sharp move ensues and we look for an exit as soon as the price starts to consolidate.

A forth consolidation is also marked, but at no point do we get the higher lows which should occur in order for us to take a long trade. This consolidation did not align with the tendency of the day.

On a day when many traders could have easily lost money trading within the consolidation, and completely missing the big moves because they were frustrated with the choppy price action, by paying attention to daily tendency and overall price action you could have grabbed two profitable trades and stayed out of the losers–not bad a for a tough day. It is important to stick to the strategies you have laid out for yourself, but it’s also important to pay attention to the price action and tendencies of the day so you can pick which times are best to employ that strategy.

Price Action Trading Strategies (Beyond Price Patterns)

Most price action trading strategies revolve around price action patterns like Pin Bar, Inside Bar and Engulfing Pattern. As a result, many traders equate price action trading strategies with price action patterns. The truth is that price action patterns merely form a subset of price action trading strategies.

For instance, a Pin Bar is simply a price pattern. A Pin Bar trading strategy must define the market condition for trading Pin Bars, the entry setup, and the exit method. Buying and selling every Pin Bar you see is a recipe for disaster.

Price action trading strategies go beyond price patterns.

A price action trading strategy must answer the following questions.

  • How do we determine the market bias?
  • What is our trading setup?
  • How do we exit the trade?

In this article, we will explore each question to find out what is it that really makes price action trading strategies tick. (Hint: It is not the price patterns.)

Market Bias – Price Action Context

Market bias refers to the market’s tendency to move in a certain direction, either up and down. It is also known as the market trend or price action context.

The market bias is what gives us our edge. It has a strong influence on the success of our trades, far more than any one, two or three-bar price pattern.

To prove this point, we will look at how different patterns do within a given market context.

We marked out the ID/NR4 patterns on the ES chart below.

We also observed how Pin Bars performed in this market.

This last chart marks out the two-bar reversals.

For all three patterns, most of the bearish signals did well, and most of the bullish patterns failed.

The last chart is extremely telling. Usually, traders would look out for two-bar reversals that have strong bars in both directions or for the second bar to reverse the first bar completely. However, for our example, we did not impose any more criteria to “enhance the pattern”.

We simply marked all two-bar combinations with opposing direction (i.e. a bullish bar followed by a bearish bar, or a bearish bar followed by a bullish bar). As it turned out, this simple pattern did extremely well. The merit does not lie with the pattern. It lies with the bearish market bias.

The point here is that once we get the market bias right, almost any pattern will produce results. There might be some whipsaws, but they are not fatal as long as our trade risk is under control.

Hence, we should spend more time figuring out the market bias instead of searching constantly for price patterns.

However, this is easier said than done. We selected the bullish market above by looking back in time. Any one can do that.

The difficult part is in evaluating the market bias in real-time.

In price action trading strategies, there are several simple but effective tools to help us decipher the market bias.

Multiple Time-Frames

Some price action trading strategies pay attention to price action in a higher time-frame as a way to find the bias in a lower time-frame.

Market Structure

The market never moves in a straight line. It moves in wave-like market swings, creating swing highs and lows. Most price action trading strategies are sensitive to the market structure built by these swing pivot points.

Higher highs and higher lows point up. Lower highs and lower lows point down.

Trend Lines

Upwards sloping trend lines track bullish markets, and downwards sloping trend line follow bearish markets.

In price action trading strategies, a decisive break of trend lines signals the beginning of a new opposing trend.

Our example strategy in a Template for a Simple Day Trading Strategy uses a trend line to define the market bias.

Support And Resistance Areas

In a bullish market, support levels are likely to hold up. In a bearish market, resistance areas tend to keep the market down.

By paying attention to how the market reacts at major support and resistance areas, we can get a glimpse at the true bias of the market.

Volume

Many price action trading strategies include volume analysis.

Along the path of least resistance, the market should move with increasing volume. On the other hand, when it is moving against the market bias, volume tends to dry up.

Hence, when implementing price action trading strategies, traders should use these tools and integrate their observations to find out which direction is the market is more likely to head in. This is the first step in all price action trading strategies.

The importance of market bias also underlies the rise of global macro trading and trend following strategies. While the former uses fundamental data and the latter employs technical methods, both strategies seek to align themselves with the market bias, without over-emphasizing the exact timing of their entries.

Price Action Trading Setup

A trading setup is a specific set of market circumstances we want to see before we consider a trade.

In price action trading strategies, it involves a price pattern. Examples of short-term price patterns include an inside bar, reversal bar, or any candlestick pattern like Engulfing or Morning Star. Some price action trading setups focus on longer term chart patterns like Head and Shoulders and Double Top.

Didn’t we just argue that the market bias provides us with the trading edge? Then why can’t we just figure out the market bias and jump right into the market?

Why do we need a trading setup?

In theory, we can simply enter a trading position once we form our opinion on the market bias. Once we change our bias, we exit and reverse the position.

However, this way of trading demands deep pockets. This is because the adverse price change between the time we enter, and the time we realize that our market bias has changed, can be huge. Since retail traders do not have deep pockets (if you do, you are an institutional trader), we need to control our risk with little pockets of money each time.

This leads us into the purpose of a trading setup, which is risk control.

By timing our entries with a setup, we are able to pinpoint a stop-loss point in our price action trading strategies. This is especially true for price action trading setups which have a natural and logical pattern stop point. This is usually the lowest point of a bullish pattern or the highest point of a bearish pattern.

Pattern Stop

This chart shows the natural stop-loss level of a bearish Pin Bar pattern.

Trade Exit Plan

In price action trading strategies, as mentioned above, our stop-loss depends on our entry setup.

As for setting targets, there are two common price-based methods.

Support/Resistance

Support and resistance levels provide logical points for exiting.

For a long position, the nearest resistance level is the highest probability target. For a short position, the closest support level is the highest probability target.

If we aim for levels that are further away from the market, we need to accept a lower chance of the market hitting our target and some pullbacks along the way.

Measured Move

What if the market is breaking new ground? It is moving into price ranges that it has not been to recently.

In such cases, the measured move concept is useful for projecting targets.

The measured move takes the length of a previous impulse swing and project it by the same amount.

It is a specific instance of Fibonacci extension using 100% for the projection. Using a smaller percentage gives more conservative targets.

For best results, base your projection on a strong and clear impulse wave.

Creating Your Own Price Action Trading Strategies

Ultimately, trading boils down to finding a method that is suitable for your skills and temperament.

Hence, instead of blindly following price action trading strategies of (purportedly) successful traders, learn from them what makes sense to you.

Focus on picking up methods and knowledge that answer the three questions revolving around price action trading strategies. Then, combine them to create complete price action trading strategies that tick for you.

Remember that price action trading strategies go way beyond just price patterns.

Checklist for While I am Trading

You have a plan of attack for the market, called your trading plan, and it should lay out the strategies you’ll use, how you’ll manage your money, position size as well as some rules and guidelines for your trading. But no two days are exactly alike, while we do our best to prepare, there may be subtle changes in the market each day that may affect our strategies. I am not a fan of blindly following a strategy and trying to fit it to every market condition. As primarily a trend trader I only want to execute my strategies in trending markets, therefore I have developed a little checklist which helps me focus on if the market is trending, in which direction and what I can expect from the day.

The checklist items work together to help confirm or deny trading opportunities.

  • What is the long-term and short-term trend: For me long-term is basically the overnight session, maybe a bit of a prior day and the new session. Short-term is the last 30 minutes to an hour or so. Ideally, I like trades where there is a shift in momentum on the short-term that aligns with the long-term. The question to ask is, what is the overall expectation, and what is the immediate expectation? I take trades based on immediate expectations, but if that goes against the overall expectation then I am much quicker to bail on the trade at any sign of trouble. If I am trading with the overall expectation, I am more inclined to give the trade some room.
  • Is the market exhibiting some sort of pattern? What may look like trend may just be a piece of a larger wedge pattern or range. Drawing lines on the chart along highs and lows will help isolate if there is are any patterns present. Pay attention to these.
  • Is there strong support or resistance anywhere? These are areas that have caused the price to shift very strongly in the opposite direction. Be care of strong bounces off these levels.
  • In which direction are the strong and weak moves? If all the really strong sharp moves are up, and all the weak moves are down, probably best to be trading on the long side until that changes (see: How to Trade the Trend and Spot Reversals).
  • How volatile is it? On a very slow day your profit expectations will likely be less than on a very volatile day. Base your targets and stops on the price action you have seen so far. You can only trade what the market is willing to give.
  • Would the strategy have worked already? If a few signals already occurred before you started trading, would those have worked out? If the market doesn’t seem to be respecting your strategy parameters, wait till it does. This may mean missing one trade, but it is better than trying to impose a strategy on a non-complying market.
  • Are there repeating tendencies? This one takes quite a bit of focus because you need to realize it in real-time, but are there repeating price movements? For example, the price moves higher, stalls, and then makes three attempts to move higher before finally breaking out. Next time the price moves higher, the same thing starts occurring. Finding certain tendencies can give you a little extra confidence for a trade, but don’t expect them to last for long. They may repeat 2, 3, maybe 4 times and then disappear. Use them for information while you can, but don’t rely on them too heavily (see: Pay Attention to Tendency and Price Action).

I go through this checklist while I am trading to make sure my own expectations align with what the market is offering. It helps tailor my expectations to the market, and stay focused on the immediate and overall outlook. Based on your strategies, you may choose to create your own checklist which will help you determine when you should be trading, when you shouldn’t be, and when it is time to trade in the other direction.

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