Trading “Tough” Days – Pay Attention to Tendency and Price Action

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Trading “Tough” Days – Pay Attention to Tendency and Price Action

Not every day is going to be easy to trade–some days are, some days aren’t. Depending on trading style, a tough day for one trader may be a glorious for another, but the fact remains every trader faces tough market conditions.

Since I don’t start trading the EUR/USD until well into the European session, nearer to the US open, I can already see what the day is like. If it appears to be tough conditions for the strategies I use–which are typically trend following strategies–I’ll either stay away or will be very patient with entries and exits.

On November 5 the EUR/USD showed a tendency to move sharply and then consolidate in complex formations, then move sharply, and so on. By realizing the tendency of the day, and being patient for opportunities, even a trending strategy could be employed. Patience is key though, because getting impatient and expecting a big move while complex consolidations are occurring can mean a lot of false signals and thus losing trades.

Picking out Tendency

Each day has a slightly different tendency. Some days we see sharp moves, followed by sharp pullbacks, or slow choppy trends followed by sharp or slow pullbacks, or no real trends at all.

By paying close attention to how the market is moving overall, we are better able to pick the times when our strategy should be applied.

Figure 1 shows some of the European session (bright yellow) and the start of the US session (pale yellow), and highlights this overall tendency.

Figure 1. EUR/USD 1 Minute Chart

Looking closely there are several additional tendencies which pop out, aside from the sharp moves followed by a complex consolidation.

Each of the consolidations has multiple false breaks out before the eventual move. The overall trend is down, so we want to be especially cautious about upside breakouts, because on this time frame, those breaks higher are likely to be false.

The next tendency is that in the small price swings just before the break lower, the price starts making lower highs, indicating a buildup in selling pressure.

The following chart highlights how these tendencies could be used to pick a high probability trade.

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Figure 2. Short Trade Based on Tendencies

While the tendency of the day is used to help isolate entry and exit points, we can’t abandon other methods for determining strength.

Incorporate Price Action Analysis

Following the first consolidation the drop is very steep and long. After the second consolidation, the drop is steep, but is much shorter than the last drop. This indicates the trend is still down, but that it is weakening. We still watch to see if the market follows the same tendency, but is now possible that a break higher could also occur.

Figure 3 shows the third consolidation and the break higher that followed it.

Figure 3. Same Tendency, Opposite Direction

This consolidation has similar tendencies to the prior ones, except in the opposite direction. On the third consolidation there is a break lower followed by higher lows–the opposite of the other consolidations. Combined with the possibility of a reversal based on the weakening downtrend, we want to look for a long position.

The EUR/USD makes a new high and once again a new low which is the area we want to enter long (marked on chart). As per the daily tendency a very sharp move ensues and we look for an exit as soon as the price starts to consolidate.

A forth consolidation is also marked, but at no point do we get the higher lows which should occur in order for us to take a long trade. This consolidation did not align with the tendency of the day.

On a day when many traders could have easily lost money trading within the consolidation, and completely missing the big moves because they were frustrated with the choppy price action, by paying attention to daily tendency and overall price action you could have grabbed two profitable trades and stayed out of the losers–not bad a for a tough day. It is important to stick to the strategies you have laid out for yourself, but it’s also important to pay attention to the price action and tendencies of the day so you can pick which times are best to employ that strategy.

Price Action Definition

What is Price Action?

Price action is the movement of a security’s price plotted over time. Price action forms the basis for all technical analysis of a stock, commodity or other asset chart. Many short-term traders rely exclusively on price action and the formations and trends extrapolated from it to make trading decisions. Technical analysis as a practice is a derivative of price action since it uses past prices in calculations that can then be used to inform trading decisions.

Key Takeaways

  • Price action generally refers to the up and down movement of a security’s price when it is plotted over time.
  • Different looks can be applied to a chart to make trends in price action more obvious for traders.
  • Technical analysis formations and chart patterns are derived from price action. Technical analysis tools like moving averages are calculated from price action and projected into the future to inform trades.

What Does Price Action Tell You?

Price action can be seen and interpreted using charts that plot prices over time. Traders use different chart compositions to improve their ability to spot and interpret trends, breakouts and reversals. Many traders use candlestick charts since they help better visualize price movements by displaying the open, high, low, and close values in the context of up or down sessions.

Candlestick patterns such as the Harami cross, engulfing pattern and three white soldiers are all examples of visually interpreted price action. There are many more candlestick formations that are generated off price action to set up an expectation of what will come next. These same formations can apply to other types of charts, including point and figure charts, box charts, box plot and so on.

In addition to the visual formations on the chart, many technical analysts use price action data when calculating technical indicators. The goal is to find order in the sometimes seemingly random movement of price. For example, an ascending triangle pattern formed by applying trendlines to a price action chart may be used to predict a potential breakout since the price action indicates that bulls have attempted a breakout on several occasions and have gained momentum each time.

How to Use Price Action

Price action is not generally seen as a trading tool like an indicator, but rather the data source off which all the tools are built. Swing traders and trend traders tend to work most closely with price action, eschewing any fundamental analysis in favor of focusing solely on support and resistance levels to predict breakouts and consolidation. Even these traders must pay some attention to additional factors beyond the current price, as the volume of trading and the time periods being used to establish levels all have an impact on the likelihood of their interpretations being accurate.

Limitations of Price Action

Interpreting price action is very subjective. It’s common for two traders to arrive at different conclusions when analyzing the same price action. One trader may see a bearish downtrend and another might believe that the price action shows a potential near-term turnaround. Of course, the time period being used also has a huge influence on what traders see as a stock can have many intraday downtrends while maintaining a month over month uptrend. The important thing to remember is that trading predictions made using price action on any time scale are speculative. The more tools you can apply to your trading prediction to confirm it, the better. In the end, however, the past price action of a security is no guarantee of future price action. High probability trades are still speculative trades, which means traders take on the risks to get access to the potential rewards.

Forex Market Size And Liquidity

Unlike other financial markets like the New York Stock Exchange (NYSE) or London Stock Exchange (LSE), the forex market has neither a physical location nor a central exchange.

The forex market is considered an Over-the-Counter (OTC), or “interbank” market due to the fact that the entire market is run electronically, within a network of banks, continuously over a 24-hour period.

The forex OTC market is by far the biggest and most popular financial market in the world, traded globally by a large number of individuals and organizations.

In an OTC market, participants determine who they want to trade with depending on trading conditions, the attractiveness of prices, and the reputation of the trading counterparty.

The chart below shows the seven most actively traded currencies.

*Because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200% instead of 100%

The dollar is the most traded currency, taking up 84.9% of all transactions.

The euro’s share is second at 39.1%, while that of the yen is third at 19.0%.

As you can see, most of the major currencies are hogging the top spots on this list!

The Dollar is King in the Forex Market

You’ve probably noticed how often we keep mentioning the U.S. dollar (USD).

In fact, according to the International Monetary Fund (IMF), the U.S. dollar comprises roughly 64% of the world’s official foreign exchange reserves! Because almost every investor, business, and central bank own it, they pay attention to the U.S. dollar.

There are also other significant reasons why the U.S. dollar plays a central role in the forex market:

  • The United States economy is the LARGEST economy in the world.
  • The U.S. dollar is the reserve currency of the world.
  • The United States has the largest and most liquid financial markets in the world.
  • The United States has a stable political system.
  • The United States is the world’s sole military superpower.
  • The U.S. dollar is the medium of exchange for many cross-border transactions. For example, oil is priced in U.S. dollars. Also called “petrodollars.” So if Mexico wants to buy oil from Saudi Arabia, it can only be bought with U.S. dollar. If Mexico doesn’t have any dollars, it has to sell its pesos first and buy U.S. dollars.

Speculation in the Forex Market

One important thing to note about the forex market is that while commercial and financial transactions are part of the trading volume, most currency trading is based on speculation.

In other words, most of the trading volume comes from traders that buy and sell based on intraday price movements.

The trading volume brought about by speculators is estimated to be more than 90%!

The scale of the forex market means that liquidity – the amount of buying and selling volume happening at any given time – is extremely high.

This makes it very easy for anyone to buy and sell currencies.

From the perspective of a trader, liquidity is very important because it determines how easily price can change over a given time period.

While the forex market is relatively very liquid, the market depth could change depending on the currency pair and time of day.

In our forex trading sessions part of the school, we’ll tell you how the time of your trades can affect the pair you’re trading.

In the meantime, here are a few tricks on how you can trade currencies in gazillion ways. We even narrowed it down to four!

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