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Discover the Power of Placing Your Stop Guided by a Long Wick

Discover the Power of Placing Your Stop Guided by a Long Wick

2012-04-06 03:00:00
Richard Krivo, Trading Instructor

Many newer traders will tend to decide on where they will place their stop based on the amount of pips that they are comfortable losing. Maybe that number is 10, 50, 100, 200, or whatever. The point is that the number is arbitrary and, most likely, bears no relationship whatsoever to the price action that we see on a chart.

A more effective way to decide where to place your stop is to look for levels of support in a buy or levels of resistance in a sell. When buying the stop would go below a level of support and when selling the stop would go above a level of resistance.

(Of course the placement of these stops must comply with the 5% rule of Money Management.)

To take this one step further and fine tune it even more, a better guide for stop placement is to bring long wicks, if they are present, into the analysis.

Take a look at the 1 hour chart of the GBPJPY below for a visual…

Discover_the_Power_of_Placing_Your_Stop_Guided_by_a_Long_Wick_body_Long_Wicks_4_5.png, Discover the Power of Placing Your Stop Guided by a Long Wick

Note the rectangles that are highlighting some of the longer wicks on this chart. Also note that after a long wick makes an appearance, oftentimes price will move in the opposite direction of the long wick for a time.

In other words, if the longer wick is below the body of the candle, price has a tendency to move up. Conversely, if the longer wick is above the body of the candle, price has tendency to move down.

These extended wicks, those that are longer relative to other wicks that are around them on the chart, have a story to tell.

A long wick at the bottom of the candle signifies that sellers were able to push the price down significantlythat is one aspect of what creates the long wick.

However, the seller’s numbers were not great enough to keep the price at that low level. The buyers were able to push price back up from that low level thereby showing strength. (That is the second aspect of what creates the long wick.)

Since the buyers triumphed in that sense, there exists the potential that their strength will carry forward and given that strength the price may rise.

(In the case of long wicks above the body of a candle, the opposite scenario would be true and price may fall.)

So how can a trader use this in their trading?

As always, we must first take note of the daily trend. If the trend is down, as it is on the chart above, seeing a candle (or several candles for that matter would even be better), with long wicks on the top, would point toward a stronger potential for price to move down in the direction that the market has been taking the pair.

So, to continue with the downtrend example, if the pair retraces…that is, against the trend…and stalls at a level of resistance or a Fib level, I am going to be looking for long wicks at the tops of the candles forming along that resistance line for two reasons.

  1. Those long wicks indicate the potential for the pair to trade to the downside back in the direction of the Daily trend.
  1. The top of that extended wick provides an excellent guide for a trader to place their stop. The rationale for that stop placement is that buyers pushed price to the top of that wick but could not push it beyond that point. As such, placing the stop just above that wick is a level that has a much lower likelihood of getting hit.

Bottom Line: Taking note of long wicks forming at levels of support or resistance, especially when they signal potential movement in the direction of the daily trend, can create a beneficial “edge” for the trader especially in regard to stop placement.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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