Price Action based Trading Strategies that goes beyond Price Patterns
I am sure you have come across Price Action-based trading strategies that go over patterns like Doji bar, Inside Candlestick, and Bullish Engulfing etc. As a result, most of the traders think that price action trading strategies equals Price Patterns. However, the appropriate statement is that price patterns are only a part of these trading strategies.
As an example, let us take Doji Bar pattern…..
A Doji Bar trading strategy should define the right market conditions for the pattern, the strict entry rules, and of course the exit criteria. Buying and Selling every Doji Bar pattern without the proper context and action plan is a recipe for failure.
The important point is that price action trading strategies go beyond price patterns. Any successful price action strategy should b able to answer the following questions:
- How is the Market Bias determined?
- What does your Trading setup look like? In simple terms, how, and when do we enter? What is your entry trigger?
- How do we exit the trade?
Let us try to get in details around each of these points to find out what makes price action strategies effective.
Market Bias: Price Action based Context
Market bias means market’s tendency to move in a particular direction, either up or down. Some traders call it market trend. I strongly believe that Market bias is what gives anyone their edge. It has a strong impact on the success of our trading results, far more than any price pattern by itself.
Like always, the best way to illustrate the points above is by going through few examples. We will look at how different patterns perform within a given market context. The 3 charts below show the same set of price bars (4 hourly #TSLA chart). You can clearly see the Down trend (Bearish bias). Now let us mark different price action based patterns on this chart of #TSLA.
Arrows point out the Inside Days that offered an entry during this bearish trend.
Second chart highlights the Pin Bars and how they performed in this market.
The last chart shows the Two-bar reversals.
You can clearly see that most of the bearish signals or triggers did well for all three patterns, and most of the Bullish patterns failed. You can observe how the last chart is indicative of how strong the down trend was. More traders look for two-bar reversals with strong bars in both directions or for second bar to completely engulf the first bar. You can also observe that there were bearish bars followed by a bullish bars, but it failed to see any significant upside follow through.
In other words, the quality does not lie that much with the pattern but with the Bearish market bias. So once we get the market bias right, almost any pattern can produce results. Of course, there will be fake outs, but they will not be fatal in nature as we will always practice reasonable method to control our trade risk.
So devote your time to figure out the market bias. Here are some market bias concepts you have utilize in real time.
Market Structure: The market never moves in a straight line. It moves in wave-like pattern with swing high and swing lows.
Higher highs and higher lows point that the market is trending up (as shown above). And Lower highs and lower lows point that that market is moving downward.
Trend Lines: An upward sloping trend lines indicate that the market is in a Bullish mode. And opposite is true for the bearish market. Therefore look for a decisive breakout of the break line to see if the new opposing trend has started.
Multiple Time-Frames: One way to analyzing charts is to go through multiple times frames to confirm your market bias. For example, looking at the chart in higher time frame (such as daily or weekly), and figuring out what the market bias is — and then drilling down into lower time frame to look for pull backs as entries. The same approach and methodology can be applied to market structure and Support/Resistance as well.
Price Action based Trading Setups
Strictly speaking, Trading setup is defined as specific set of market circumstances or criteria that you want to see to be able to consider a trade.
So looking for price patterns within the price action trading strategies is the smart way to do it. Examples of Price patterns include Inside Bar, Reversal setup, or Candlestick pattens like Dark Cloud Cover, Inverse Head and Shoulder, Engulfing etc.
But what if we just figure out what the market bias and go with it. Is that not what is needed for us to have a trading edge?
The reason is because timing an entry will dictate your Profit and loss. The chart can remain Bullish or Bearish but still Stop you out if your entry is not optimal. Plus to define your chart-based stop-loss and target, you need some context. Moreover controlling risk is number one priority as a trader.
Risk control is the most important point.
Here are couple of examples of Pattern-based stop points. Of course you can place a stop-loss anywhere you want, but the natural and logical stop-loss level would be above or below the pattern.
#AMZN daily chart shows how the Dark Cloud cover pattern formed at the resistance level. And then clearly the next day we can see the stock sell off. The initial stop-loss would be the high of the pattern.
Here is a intraday 2-min chart of #TSLA from June 28th, 2022. Clearly market bias was bearish. So looking for bearish patterns made sense. I have highlighted intraday bear flag patterns and their pattern-based stop-losses. Entry could have been at the top end of those flags or at the time of breakout of that bear flag.
Trade Exit Plan based on the chart
There are always different ways to get out of a trade. But there are always two scenarios that one should plan out for:
- Exit when you are wrong
- Exit when you are right
So as the stop-loss should depends on your entry pattern, the two ways you can plan for your exit are:-
- Support and Resistance
- Measured Move
Support and Resistance
For a short position, naturally the nearest support level is the highest probability target. And then depending on which time frame you consider, there can be multiple targets. Example shown below.
Further you aim from your target, the probability of the trade hitting your target goes lower. That is how it works. Moreover, there will be some pull backs along the way.
The support and resistance levels are derived from historical price structure. But if the market moves into area where we don’t have price ranges or other defined support and resistance levels, then the concept of measured move provides a valuable concept.
Below example shows a Bear flag being played out and a measured move target is the 100$ projection for the pole of the flag.
It all comes down to finding a methodology that suits your skills, routine, and mindset. Manage your Risk, and take the setups. No one made profits with fear. Taking calculated, well-defined risks with proper risk-to-reward is the only answer to your survival and long-term success.
All the best !!!
UC & Ainee