Context trumps price action

Context is the thing. The financial markets are often seemingly bipolar. Why did it not do what we expected?

Many times we can find the answer from the bars to the left within our timeframe.

Context example

The chart below shows AUD/USD hourly bars. Bar 4 is a definite trend bar short and an excellent bar to take. Why did it not work?

Many websites overly concentrate on price action. That is the shape of the single entry bar. Often this will work if it has the power of a trend behind it, but not in this case.

A single bar is secondary to context. All the bars to the left. To take advantage of this, we need to understand the market cycle as this changes how we trade.

In our example, bars 1 and 2, not apparent at the time, are a breakout.  It is after we get all the bars between bar 2 and 3 can we see a channel; a channel that measures the same price difference as the combination of the breakout bars.

Bar 4

What has this got to do with bar 4? We know that more often than not on the achievement of a measured move of a channel price regresses to the end of the breakout point. From there it usually develops into a trading range.

Therefore the probability at the close of bar 4, even though it is a trend bar, is not for a continuation of the trend but a pullback to the top of the channel and a possible trading range.

Market cycle

The problem with not taking market cycle, the context or the bars to the left into consideration, is that a mistake here would have resulted in a hefty loss.

Most stops would have been positioned slightly above bar 3, and the market provided no pullback breakeven opportunity.

Context is king.
Context overrules price action

Another example below this time shows the US 500 SPTRD. Again we have the breakout bars followed by a channel that extends to a similar distance to the sum of the breakout bars.

As before we have a dramatic pullback to the start of the channel. The pullback will put many traders in to go short. But those traders that read the context will know that the probability is for the price to reverse and form a trading range.

In this case, the development of the trading range was interrupted by the weekend.

A context example of breakout, channel and pullback.
A context for US 500

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