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A Simple, but Effective Price Action Tell

A Simple, but Effective Price Action Tell

2014-11-13 19:00:00
James Stanley, Strategist

Talking Points:

There are a lot of different ways to analyze markets: Technicals, fundamentals, sentiment, and even the position of the moon and the stars. Believe it or not, ‘financial astrology’ is really a ‘thing.’ (No offense meant to current or prospective financial astrologists).

There is just one problem with all of these types of analysis, and it’s this same problem that gets traders looking at off-beat systems in the first place: None of these methods will perfectly predict the future. All systems, all strategies, all forms of analysis in markets have periods where they simply won’t work. These methods are simply a way for a trader to look for an ‘edge’ in a market, even if that edge is just a slight probability in their favor.

So equally, if not more important to traders than analysis is risk management. Because as long as there is the risk that one ‘bad’ trade can snuff out the gains from numerous ‘good’ trades, the effectiveness of one’s analysis can be rendered rather moot. This is The Number One Mistake that Forex Traders Make; and it should be avoided as much as possible.

Price Action can bring a lot of value to this equation. Sure, it’s just another form of technical analysis; but it can help to strip out a lot of the superfluous factors that can often end up just misleading traders. Because no indicators are needed, traders can focus on the most pertinent factors impacting their trade(s); which is current price relative to past prices.

And further to this point – this clean, unadulterated information can help traders see areas where they might be able to look for risk-efficient entries. In this article, we’re going to examine one such phenomena that traders can look for on a multitude of time frames and setups in the effort to focus upon risk-efficient setups.

If you want to build more of a foundation with price action, we have quite a few materials available for you.

You’re also more than welcome to attend our Price Action Primer, via Brainshark. You can click on the link below and that will take you directly into the course so that you can begin learning the building blocks of price action analysis.

Price Action Primer via Brainshark

A Simple, but Effective Price Action Tell

And if you’d like something a little more advanced, The Forex Trader’s Guide to Price Action covers quite a bit of material as a capstone article on the topic. In each of the highlighted sections of that article, there are numerous ‘sub-articles’ that will explain that subject matter in much more granular detail.

The Cycle of Markets

One of the Price Action building blocks pertains specifically to trend analysis. And this relationship is very similar to many other things changing or evolving in the world around us.

When something changes, rarely does the entire change happen instantly without any counter-balance. There are often two sides to most changes, as we’ll usually see a system of ‘two steps forward, one step back.’

Trends in financial markets will often come in through a similar way. In up-trends, prices will take ‘two steps forward,’ often followed by ‘one step back.’ The movements are going to be relative, so the ‘one step back’ doesn’t always have to equal 50% of the two steps forward. But price action can help us see this as it takes place on a multitude of time frames.

In the chart below, looking at GBPUSD over the past 18 months can show us both types of trends on the daily chart. In the blue area, we can see an up-trend, accented with higher-highs, and higher-lows as the market gyrates higher. Notice that this isn’t perfect, nor is it predictable: But it does give the trader a way to observe and trade with the prevailing bias. In the red box, we can see a down-trend as accented with lower-lows and lower-highs: Two steps forward, one step back as this down-side bias gets priced into the chart.

Two Steps Forward, One Step Back in GBPUSD (Daily)

A Simple, but Effective Price Action Tell

Chart created with Marketscope 2.0; prepared by James Stanley

Notice that this chart, spanning nearly 18 months of price activity includes quite a few different ‘themes’ or events. The up-trend from the middle of 2013 leading into the middle of 2014 was taking place as the British recovery looked to become more and more entrenched. Was all of the news good? No, of course not.

But in an up-trending market, bad news has a tendency to be shrugged off while good news will usually be priced in very aggressively. That’s the nature of sentiment.

The best part about this is that you don’t need to look to the stars to try to predict this stuff, nor do you have to force yourself to read between the fine lines of every single data release. Price action will show you how much the market cares for a certain piece of data or news. Price Action can help traders see the forest from the trees, and can further help traders trade on the side of the prevailing bias.

But price action can also help traders accomplish the goal we discussed in the earlier portion of this article: To find risk-efficient entries in situations that may allow them to get the probabilities on their side.

The Tell’

‘TheTell’ is another part of this ‘two-steps forward, one step back’ relationship. As a market makes higher-highs and higher-lows, traders should look to enter shortly after a ‘higher-low’ was made, in the effort of controlling risk.

In an up-trending market, old resistance often becomes new support; meaning –previous ‘higher-highs’ will often be in the same vicinity or area of a chart as future ‘higher-lows.’ Once again, this isn’t perfect and it won’t usually happen with accuracy to the tenth of a pip; but support and resistance zones can allow traders to focus on these situations with which they may be able to buy before the continuation of an up-trend, or sell in front of the continuation of a down-trend.

Old Resistance Becoming New Support

A Simple, but Effective Price Action Tell

Chart created with Marketscope 2.0; prepared by James Stanley

When prices find support in the vicinity of a previous point-of-resistance, traders can begin looking for entries in the direction of the trend.

The point of this exercise is not to predict that prices have to move higher. It’s simply an opportunity, as any trade is, for the trader to look at and focus upon an observed theme in a market. But these types of opportunity can offer built-in risk management.

The trader can look to place their stop below the recently-inflected point of support so that should support not hold, the loss can be mitigated. But if the trend continues, the trader has the opportunity to look for an outsized gain relative to the risk taken on in the entry of the position. This is an opportunity to take that Number One Mistake that Forex Traders Make, and get it turned around.

In the chart below, I’ve identified additional patterns in the GBPUSD Daily chart; but this analysis can be implemented on shorter-term time frames or different markets such as EURUSD or even markets such as Gold, Oil, or the S&P 500.

Old Resistance as New Support & Old Support as New Resistance

A Simple, but Effective Price Action Tell

Chart created with Marketscope 2.0; prepared by James Stanley

--- Written by James Stanley

Before employing any of the mentioned methods, traders should first test on a demo account. The demo account is free; features live prices, and can be a phenomenal testing ground for new strategies and methods. Click here to sign up for a free demo account through FXCM.

James is available on Twitter @JStanleyFX

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