Why it pays to keep things simple…
Today I’d like to tell you a little bit more about the trading strategies I personally use to trade the markets.
For me, simplicity is key…
I don’t like to mess around with fancy indicators or over complex theories – after all, why make life difficult for yourself when you don’t need to?
I have two main strategies for finding trades, based solely on price action and volume…
The first strategy is the most simple, and is based entirely on the idea of support and resistance.
Support and resistance on a price chart is simply a representation of supply and demand in the markets. Supply and demand are what makes all markets move and the financial markets are no different.
For example, if there’s a high demand for the Euro, the price of it will increase. That leads to a greater supply (as holders sell into the higher price) – that is, until supply becomes so great (more sellers than buyers in the market) that the price starts to fall again.
Support is essentially the price level where buyers push price up – the price is ‘supported’ by demand. Conversely, the price at which sellers step in, and start forcing the price back down, is known as resistance.
As the price moves in its normal flows, the majority of orders will build up around these support and resistance levels – as you can see on the following chart of AUDUSD (Australian Dollar vs the US Dollar).
Note the price level I’ve highlighted by the shaded box…
You can see in the area to the left that this price level acted as support (1). You can then see the price returned to here to the right side, but eventually broke through (2). It then tested this previous support level, but this time as resistance (3).
Opportunities where the price breaks through a previously strong level (support or resistance) are THE best.
You simply wait for the retest and buy or sell back with the new direction.
Here is another example to show you how it works:
I’ve drawn a price level on the chart (in red), and you can see to the left of the chart that the price tests this level as resistance (1) and then makes a strong move down.
It then returns to that key resistance level before breaking through (2). The market then uses this previous resistance level as support. You’d have bought here at this level, and you can see the price rises swiftly up after (3).
And just to prove how broken levels act like magnets…
This occurs time and time again and doesn’t require some funny indicator to spot. It’s merely price and market mechanics.
Playing the market’s structure…
Yesterday I briefly mentioned how the work of Richard Wyckoff, and later Tom Williams (author of ‘The Undeclared Secrets That Drive the Stock Market’), have been the main influences on how I profitably trade the markets.
In particular their volume spread analysis method – which I use frequently in my trading.
Take a look at the following chart – I’m going to guide you through how I view the market structure when looking to take a trade, and what is occurring with specific market participants for this method to work…
We start off with a steep fall in price (1). The price moves down because at this point there is more selling pressure (supply) than buying pressure (demand).
The price at which support (2) is found will be key, since this is where buyers will have stepped into the market, and found the price to be significant enough to show interest.
The price support being created gives me the first few inklings of there being a possible trade in the pipeline.
My interest is definitely piqued when that strong area of support is broken (3). This is the first price signal that I look for.
To make sense of the next few stages of this strategy, it’s important you first understand how the market works on a micro level…
Think of price as a ladder – as orders enter the market, they’ll push the price up or down, depending on the level of participation at each price level.
Large banks or hedge funds have access to what is known as the ‘interbank market’ – where institutions deal directly with each other. Using this they can see buying or selling occurring as it happens in actual numbers, not just via a chart.
As the support level is broken, the large players can see that people are rushing in to sell the broken support, as they believe price will keep falling.
Now, if you are a large institution with a lot of money, and you buy when everyone else is buying, then you’ll push the price up heavily and put you further away from your desired entry price.
Therefore, bigger players want to buy into a rush of panic selling. We want to be doing the same.
Ok, back to our chart above…
As you can see (4), price is pushed down (note the long ‘wick’ off the candle body) but then heavy buying occurs into this hysteria of selling.
Price is pushed back up and we have a significant rally. What we’re looking for here is higher than usual volume, occurring alongside the break of support and the long candlestick, to have your second price signal. However, we still do not have a valid price signal to buy.
In trading, the market is always looking to take out the weakest hands. Patience is a trader’s number one friend, and it’s something that not many have. When you have a key area of price, there could be two or three attempts to shake out weaker players.
With every trade you have a predetermined risk price – which you are willing to get out of the trade at..
This is known as the stop loss and is a pending order that reverses your trade. So if your stop loss is hit, the platform will automatically execute a sell order, which will net your position to £0. You’ll then incur a loss of whatever your stop size is multiplied by what your £-per-point risk is).
It’s likely that market participants will put their stop losses below the open of the bullish candle, where the long wick is (5).
If you note the pink line, you’ll see that price returns to this level and rallies off hard. This is due to finding newer buyers and probably more ‘in the know’ buyers (who may be following this method too).
As you can see on the chart, the red shaded area below my entry (6) represents my stop loss level, and the green shaded area represents my target level.
You target a return to previous large supply if buying (7), and previous large demand if selling. The reason being is that levels of large market participation act as magnets for price to bounce to and from.
When market interest changes at these levels, they are broken and tested on the other side.
The above trade is actually a real trade I called on Twitter back on 10th August (you can see my tweet here).
And with a little help from an inflation miss, I hit my target and made 2.52 times the amount I risked.
So that’s two of the key strategies I use to formulate trade ideas…
If you have any questions about them or there are any aspects you want explaining further, please let me know.
Just hit reply, send me your question and I’ll answer it in a future issue of The Trading Point.
Tomorrow I’ll be sending you a free gift – one which will help your trading no end.
I’ll also be explaining probably the most key aspect of trading – and a different way to view wins versus losses…
Keep an eye on your inbox for that.