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Here's How to Reduce the Risk of Having a "False Entry"

Here's How to Reduce the Risk of Having a "False Entry"

2012-04-12 03:00:00
Richard Krivo, Trading Instructor

Oftentimes a currency pair will give us a valid signal to enter a trade, we take the entry, and a few minutes or hours later we find that things are not working out according to our trading plan. The pair is moving in the opposite direction of our entry!

While there is absolutely no way to know what might happen going forward in the market with any amount of certainty, there is a way to reduce the likelihood of taking a false entry signal.

Let’s take a look at the Daily chart of the EURUSD pair below…

Heres_How_to_Reduce_the_Risk_of_Having_a_False_Entry_body_false_entry_4_11.png, Here's How to Reduce the Risk of Having a "False Entry"

We know this pair is in a downtrend since price is below the 200 Simple Moving Average (SMA) and, at the time of this chart, the EUR was weak and the USD was strong. As such, we would only be looking for opportunities to sell the pair. Such an opportunity would present itself when price takes out a previous low. We have two such examples on the chart above labeled #1 and #2.

In the second example we can see that the price traded below the prior low but the candle did not “close” below the previous low…it merely wicked below it. After generating that short entry signal, price then moved smartly to the upside. Therefore our entry signal, even though it was valid as it broke through support, turned out to be a false entry.

In the first example we can see that this time the candle closed below the previous low as opposed to merely wicking below it as it did in the second example. Even though both these entry signals are valid, the first example is the more compelling of the two. The reason for this is because a close below the previous low would show that the sellers were strong enough not only to take out the prior low, but also to maintain that strength through the close of the trading day.

So when taking an entry, a closed candle below our entry level (support) in a downtrend or above our entry level (resistance) in an uptrend is preferable to price merely wicking above/below our designated point of entering the trade.

Keep in mind that the chance of a false entry can be reduced by the above tactic, but it can never entirely be eliminated.

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

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