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Price pattern trading
Accounting and finance
Kyambogo University
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Introduction
Trading is hard.
The act of trading is simple.
But putting it all together in a consistent manner will take effort, drive, and success will only come to those who put in the work.
Methods to analyse your charts are also simple but humans enjoy complexity yet that does not guarantee success.
Common theories such as moving averages act as support and resistance is flawed. When you start to look at the usual teachings with a critical eye and ask “why”, the theory starts to unravel and leaves the trader confused.
Simple works.
I'm not asking you to trust me. I'd rather you not.
What I am asking is that you approach the information with an open mind and be critical - prove it to yourself.
You are going to lose.
There is no “sure-fire” trading strategy or system that will let you book 100% win rates or let you off the hook without a string of losses.
Your wins and losses will come in a random distribution and your job is to consistently execute your trading plan and let your edge bring you back on the right side of the winners circle.
INTRODUCTION TO PRICE ACTION
Open up any chart and look at what price is doing.
Is it going up? Going down? Going sideways?
Whatever direction it is going, what is causing price to move?
The demand and quantity for whatever you are tracking is based on how valuable it is.
If an item is deemed valuable, if there are plenty of them, and if it’s a fair price, we can expect subtle fluctuations in price but nothing to be concerned about.
Once the supply of the item is running out, the value of that item will increase as long as there is sufficient demand for it.
The more demand for it, the faster it sells, and the higher price climbs.
What if people start to return the item because it’s poor quality?
Supply starts to increase and because word got out that the item is not very good, the demand starts to dwindle.
Soon, the supply is so great that price drops to entice buyers. The more the demand falls and supply increases, price will fall.
That movement in price, is the action of price and as price action traders, how it moves and how fast it moves is vitally important.
When traders make trading decisions based on repeated price patterns that have formed, they indicate to the trader what direction the market is most likely to move.
3 Reasons Why You Should Trade Price Action
- Price action represents collective human behavior. Human behavior in the market creates some specific patterns on the charts.
Price action trading is really about understanding the psychology of the market using those patterns.
That’s why you see price hits support levels and bounces back up.
That’s why you see price hits resistance levels and heads down.
Why? Because of collective human reaction!
Price action forms structure to the market. You can’t predict with 100% accuracy where the market will go next but structure can help reduce uncertainty and show you the probable next move of the market.
Price action helps reduce market “noise” and false signals. If you are trading with stochastic or any indicator, they tend to give false signals.
Price action is not immune to false signals (think failed breakouts) but it is a much better option than using indicators as your prime trading tool as indicators because they are derived from the raw price data.
Why You Should Care About The 4 Market Stages
Markets do not move in a straight line up, down, or sideways. There is an alternation of movement that forms that basis of not only of an increase or decrease in price, but also of the overall market direction.
Stage One: Accumulation phase
This is the phase preceding a bull run that comes after a sell off where you can start to position before the move begins. This is the zone where informed traders start to accumulate positions and the market is virtually ignored by other traders.
This accumulation must be done in a way as to not get on the radar of other traders. Bigger traders are attempting to build a position at low price and any not draw attention.
More buyers could rapidly increase the price and this is not what you want to happen when attempting to gain a position.
This phase is not easy to spot as it could simply be a consolidation before another leg down.
You can increase your chance of labelling these price areas:
● Support holding with small probes below ● Strong upthrusts at resistance designed to entice longs, stop out the longs, and price drives lower = cheaper buy points ● Exhaustion thrusts in the same direction of the down move.
Stage Two: Markup (participation) phase
This phase is when the average trader begins to take notice and begins to “trade the trend”.
It’s even possible that the probes below support and then bought up are bigger players supporting price to entice more longs to enter.
Larger players can then unload at higher prices.
Make no mistake, you are in this business with professionals who have the capital to move price to cause other traders to do certain things - like buy when the market is about to fall.
Stage Four: Mark Down Phase
The bear market begins and price action was showing you the probability that it could happen while in stage three.
This is the opposite of stage two in that traders are now dumping their holdings.
In Forex, things are a little different when thinking about the mark down phase. You have replaced what you believe was a strong
currency and have now flipped camps believing the second currency (the quote currency) will be stronger than the base currency.
Why Are We Covering The Bigger Picture?
We can consider this the natural evolution of price. These four stages can be identified on the earliest charts ever plotted.
These four stages also occur on a smaller scale on all charts and all time frames.
This means you can build an entire price action trading plan around:
● price trending ● price consolidating
You can use what shapes price, the forces of mean reversion and momentum, in order to trade.
Why?
Because that is what markets have been doing since the beginning of time.
Note that these four stages can be difficult to see at times and generally only after the moves have started. The explanation of these four phases was to get you to see the different ways that markets move.
This will become valuable very soon.
While the formation of 1,2,3 candlesticks can produce a pattern, I have found no edge in the way these are generally traded.
Here are the main types of candlesticks I pay attention to depending on where they show up on the chart:
Lower shadow on a candlestick mean lower price rejection and may be of interest depending on location
Strong momentum candlesticks show conviction in the direction and in this example, it is to the downside.
This candlestick is “out of the ordinary” and often represents a climax in price. In this case, it could halt, at least temporarily, the down move in price.
The upper shadow indicates a probe into and a rejection of higher prices. Like the lower shadow, location is important.
We are putting the pieces together so take a moment and refer back to the four stages.
Swing Analysis - The Importance It Holds
Markets transition between ranges, trends, and that trends are more likely to continue in its direction than to stop trending.
There can be different directions between higher and lower time frames and what will be covered is not time frame dependant.
For clarity purposes, I will be using daily charts in the examples.
Given that trends persist, it makes sense that if the market is trending, that you find a way to get a position in the same direction.
The first thing you’d want to do is to determine the strength of that trend and that is where swing analysis takes over.
What I don’t want you to do is fire up some technical indicator or start looking for chart patterns. We want to see what the different aspects are between a trend and a range.
A market that is climbing higher will, of course, put in higher swing highs and higher swing lows.
That is the pattern in an uptrend and the reverse is a downtrend.
This is a clear uptrend and I have marked some areas that are of interest to a price action trader looking to take a position long.
We don’t want to see strong corrections against the trend like we do here. There is a consolidation at the end of the thrust which may work off the overbought condition of the market without needing another push down. Price resolved at support.
Another new high and push down in price. Momentum candlestick can’t break support which could mean buyers are stepping in to support price.
Price rises and a small pullback occurs with more of a consolidation. When price breaks the high and can’t continue with strength, this is a red flag for a long trade. When price broke down and failed to rally, a short trade could be justified with conservative profit targets until/if a new trend is established.
Price breaks support and regains over support within 3 candlesticks. That is a sign that bulls are back in business.
This is a special move. The trend is grinding higher with very little retrace or range. It may be counterintuitive but a low volatility move like this can point to at least a short term trend change. Why? It is loaded with longs. Loaded with traders just piling in. Think of shaking a closed soda bottle. You load that up and when it finally pops, it does with a bang.
Takeaways
● Trends in motion tend to stay in motion ● We want to see strong impulse moves in the direction of the overall trend direction ● Corrective moves should be less intense than the impulse ● Breaks of support for longs (resistance for shorts) does not mean the trend automatically changes ● Low volatility pushes in the trend direction often end with a bang, not a fizzle
Is this the beginning of a sideways consolidation?
That is one outcome. Another one is a complex correction.
Traders who position at the red line on a pullback usually get stopped out when the market pulls back in two waves.
Another issue is when price breaks the red line, we’ve put in a lower high and will be putting in a lower low.
That is a downtrend from a technical standpoint which may cause traders to go short but remember - trends generally don’t just reverse without a stage three - distribution.
After a strong run in price, you can look for complex pullbacks to occur and after one or more simple pullbacks.
Takeaways
● Longer corrective swings show some weakness in the market ● Break of low of a simple pullback does not mean trend change ● Complex pullbacks should be expected after strong impulse legs and after one or more simple pullback
Explosive Price Moves Can Be Dangerous
When trading a pullback, we want to see the prior swing show some momentum that can imply that the market is setting for another leg up.
Weak impulse moves, especially if divergence is seen, can be a warning sign that getting into a continuation trade is not the best play.
We want to see momentum - just not too much momentum.
Price breaks former resistance with momentum and you can see that these two candlesticks are much different than any in the swing up.
If the strong momentum didn’t put you on alert, the thrust above highs and immediate failure should have lowered your
Price pattern trading
Course: Accounting and finance
University: Kyambogo University
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