Trading Guides

Contextualizing The Levels To Trade From

Whenever we trade, an important differentiation we need to make includes, whereabouts in the chart are we looking to enter a trade? Making this important distinction is yet again, another virtue that as a serious trader, you must possess if you are to approach the markets in a consistent cohesive manner.

As an analogy, just as in the case of a football’s elite player, they do specialize in taking free-kicks from a particular spot on the pitch with the aim to score a goal, as a trader, you must be able to always ask yourself, under what context the location of my entry falls under? Have you ever considered this question before, or are you simply led to enter the market based on a mechanical process based on a moving average, divergence, etc with no regard to the area the trade is executed?

Below, I break down some of the most critical areas in the chart for you, so hopefully it can stimulate your critical thinking and help you further define the context under which your trade is taken:

Extremes Of A Range

This is a very common patte, especially in the forex market. Did you know that studies have shown forex pairs tend to range-bound ⅔ of the time, delimited by the dailies average true range. True directional movements or trends from a daily standpoint, only occur when participants are incentivized to support a particular direction for a substantial period of time. Since the forex market is going through a period of very low volatility regime, with Central Bank all paddling their boats (read monetary policy settings) in the same direction, the absence of diverging policies has only strengthened the notion of trading currencies within a range context, which can be narrower or wider, depending on what timeframe one uses to trade the markets. It is therefore important to make this first distinction by contextualizing if your trade is looking to exploit the edges or extremes of an established range. This is what would constitute the 1st category of where a trade can be taken from. For your own sanity and risk reduction,unless you are a professional trader who knows what is doing, I’d personally recommend to minimize the times in which you engage in a range, other than trading at the extremes for what’s without a doubt, the area that can offer the best risk reward prospects.

Retest Of A Broken Range

Another context in which to take a trade would include the retest of a broken range. The rationale behind this trade, depending on the individual conditions affecting a particular market, is that not only you are joining the dominant momentum as reflected by the side that managed to take control of the range, but whenever a range is retested, by default, it tends to cause opposing pressure in favor of trend followers as weak-handed players trapped wrong-sided look to bail from their positions for minimal damage. In the case of the example below, once we see a resolution of the range to the downside, those buyers caught wrong-sided by buying at the bottom of the range, if they haven’t been stopped out already, will be incentivized to close their positions once the range gets retested.

100% Projection Level

This is a concept that orbits around market symmetry and the harmonious behaviours that exist. Grab the fibonacci tool, calculate where the 100% projection resides from the previous swing through the breakout point, or in the case of a range, calculate the range distance and apply a 1:1 measured move, and that’s where you will find a cluster of bids/offers that you may consider to capitalize on. These areas tend to be reactionary in nature due to the side in control of the dominant trend takes profits off the table, counter-trend positions are added by contrarian players, but importantly, these are price points where limit orders and initiated activity is executed by market-makers. I made a video talking at length about this concept, showing dozens of examples in varies forex pairs.

Right Shoulder Patte

An area in the chart that I find it to be one of my favorites to look for trades, especially if the market context is in my favor such as entering with the underlying trend, is what I’d call the ‘right shoulder patte’. In a way, this is like a hybrid or twisted version of the Head and Shoulder patte, but with the added benefit that the reward potential it offers far exceeds the well-defined risk you can determine in order to find out whether or not the trade is going to work out in your favour. I’ve written extensively about why trading under this patte is so powerful. The best case scenario is for the ‘Head’ to break through the ‘Left Shoulder’ in an impulsive fashion, with a decent magnitude move. Once this sequence is established, then you want to be fixated in looking for trading opportunities at the area of support or resistance (example below shows support) as a reference to re-engage. If you think about it, the rationale behind the trade is quite clear, with buyers achieving a major successful rotation, hence it is expected that when the price retus to the most influential area, from a technical perspective, it is likely to be perceived as a value area to enter trades. Trading based on the expectation that the 2nd shoulder will be formed, you place yourself, from a risk-reward standpoint, in a far better position.

Follow-Through Rotation

This location in the chart is what I call a follow through rotation or you might also call it a swing continuation. Regardless, the idea here is predicated on the fact that we have the pre-conditions of a market experiencing a strong momentum. If that’s the case, which you can obviously measure based on your own set of indicators, combined with intermarket flows as I always suggest, then what we want to look for is the successful rotation of a market auction, with the subsequent retest of the previous swing low or high (in the example below it shows the ‘low’) being rejected. Note, the stronger the breakout through the breakout point (swing low), the more conviction should exist for sellers to re-engage in line with the ongoing momentum in the market. Always pay attention to the symmetrical components as well, as an elongated breakout is likely to distort this patte in the first place. There needs to be the right harmony and rhythm in these patte for the market to interpret them as valid.

Test Of The PoC

Remember, the PoC stands for the Point of Control, in other words, it refers to the area in the chart with the most traded volume activity. This is by far the most relevant area you want to monitor as it can help to define the placement of your stops or the areas in the chart where you might find the most pristine entry levels. The highest concentrated area of volume for a particular period of time we will call it PoC or Point of Control and you will be surprised how many times it acts as a wall on a retest. Traders tend to factor this in as an area of support or resistance. I’ve written a lengthy article about the use of volume profile when it comes to trading, with the POC at the absolute epicenter as the true determiner of what side happens to be in control of the constant market auctions.

3rd Touch Of A Trendline

It’s all about picking the right battles to fight, right? That’s exactly what I wrote in this guide on identifying areas of high interest and why I want to emphasize yet another location that I am constantly monitoring to enter trades under the right conditions. I am talking about entering a trade around the intersection of a trendline, once we’ve been able to gather enough evidence that the market structure is evolving in a conducive manner, that is, we need to be able to connect the trendline through 2 initial peaks or bottoms, which could then lead to a response once the market is testing that trendline for a 3rd time. If you are then able to combine this trendline with a level of horizontal support or resistance, what you’ll get is a lot more eyes paying attention to that level, which would then increase the confluence, in other words, the overlapping or cluster of different key levels around the same area.

Origin Demand/Supply Imbalance

If you take a look at the chart below, what do the 3 highlighted rectangles have in common? Firstly, it marks the onset of a strong impulsive departure by price due to either an imbalance of demand or supply. Secondly, each time the explosive move occurs, at a micro or macro level, it achieves the breakout of its prior swing high/low. If these two pre-conditions are present, and conditioned to market conditions, be aware that these represent areas in the chart where market participants will be using as a reference to potentially add positions. The major spike away from these levels can only occur if the market goes thru a major re-evaluation of what it perceives to be fair value, therefore, under the right conditions, a retest of these areas leaves a clear trail to anticipate a cluster of orders.

50% Fibonacci Retracement

When it comes to the selection of your levels, we cannot ignore the power behind the popular tool fibonacci retracements, even if my sole focus in this article is going to be on arguably the one measure that I’ve perceived to be respected in the majority of cases. I am referring to the 50% retrace. Whenever the market breaks into new highs/lows in an impulsive manner as the sequence of multiple lows exhibited below demonstrate, looking to reinstate position at the midpoint of the distance between the prior swing high and the newly found swing low carries technical value. Note, the 50% retracement level is not even a Fibonacci ratio to start with, but it is introduced due to the tendency for an asset to resume its directional move whenever the 50% retracement has completed.

Test Of Moving Averages

As you must know by now, I don’t really lean against moving averages as supporting technical evidence when tested, but rather, I use the slope as a foreteller of a change in trend. However, certain moving average, such as the 100 or 200-period tend to be widely popular amongst the trading community, that’s why the tests of these intersections in the chart can also act as a psychological area in the chart from where a cluster of liquidity is likely to create some type of response.

Round Numbers & Mid-Rond Numbers

Another location where liquidity tends to be rich, simply because of the psychological nature it has on people’s perception, include round numbers and to a lesser extent the mid-round numbers. Whenever price tests these levels, more often than not, a response is expected as the chart below illustrates.

Confluence – The Pinnacle Of Levels Selection

By far, the most powerful approach that you can take to pick the areas on the chart where you expect a reaction in line with your directional play is to constantly find confluences. If the 50% fib retracement alone is on its own a technically relevant area, how much more critical an area can become if we notice that the POC and a trendline come around the same intersection point? Think about it, the more the confluence, the more participants are potentially ready to step in and react.