In our chart below, price action suggests probability but is context more important?

Trading Range

The hourly bar chart below shows a trading range (TR) and a possible breakout.

Bar 2 was a consideration for an entry short. If we look to the bars to the left, we see that the close of bar 2 was at or above the TR base (shown by a yellow arrow). Therefore, although bar 2 was prominent, engulfing the prior three bull bars, it did not, to our mind, qualify as an entry bar.

If we had taken the entry short at bar 2 our stop would have been twice the width of the TR, putting it marginally above the spike of bar 3. Weak traders had their stops taken by the peak of bar 3.

Price action, bar 3

Bar 3 provided a reasonable price action. The close of bar 3 was below the TR (the yellow arrow). However, most breakouts from a TR fail. Moreover, bar 3 was possibly the final push of a wedge, in this instance three drives short.

That provides us with a dilemma. We have a wedge and a prominent trend long. However, the price action (that is the shape of bar 3) provided an acceptable probability of a measured short against the trend.

How to measure our target. Unusually we measured the whole of bar 3, wick included and got a measured target some 92 pips below. The trade was exited with 36 pips of profit and at the 21st bar since entry. We try not to let a deal go beyond 21 bars.

Traders equation

Context overrides price action, nearly every time. In this instance, a 30 pip measured move for a scalp of the body of bar 3 may have been the more intelligent trade. The issue with that is the stop would have been three times further away than the target, therefore not a traders equation.

On that point, at least we took a planned 1R trade (that is reward/risk were equal). Our actual trader’s equation, the pullback against bar 3 and our entry, was 11R. In other words, our gain was eleven times more than our ‘actual’ risk.