Context price action

Trade opportunities have been in earnest so far in September. Somewhat odd to those trading the higher timeframes such as the daily or weekly scale of things. Where nothing much has occurred, but dig under the surface to the 4 hours, one hour and maybe occasionally the 5 minute and price movement has been identifiable.

A couple of examples from my recent trading log:

The setup above is a short entry in AUD/JPY using the 5-minute chart. A live screenshot with the left-hand edge of the blue line depicting my entry position. My target is the lower red horizontal line, a goal that is reached later that day.

The entry and exit on the trade above started on the 12th September and concluded four days later. A double-entry with each short shown by the red arrow at the top of the chart. Exit for both entries was at the green diamond and slightly before my target depicted by the lower red horizontal line. Holding to the goal would have been a good thing to do, but we achieved a trade that provided nearly six times of reward to risk (6R).

Price action and the context of multiple timeframe charts gives me an early insight into the sentiment of the market and, importantly, the probable market flow of the big players. Technically the trade has to make sense and has to be incorporated with a setup that provides me with a clear reward to risk calculation. The deal has to make sense also on a reasonable timeframe above my entry chart, which provides the essential strategic or fundamental agreement (the macro).

When you explain what type of financial trader you are, it will often fit into one of the following broad explanations:

Sentiment
Flow
Technical
Macro

As a context, price action trader who reviews multiple time frames, I consider that in one way or another, I have a preview into all four disciplines.

Here’s a trade that I exited almost on the bell of the weekend market close last night at 20:59.

The above setup started at the higher horizontal black arrow and concluded successfully at the lower similar mark. Fortunately, the price reached the target as the market was closing for the weekend.

The entry was over two days and as you can see from the picture price took its time to move determinedly lower. When it did, it made the hold all worthwhile.

Below is a sentiment notice that the dollar was likely to weaken. Interesting how context price action identified this sentiment some 24 hours earlier!

Media sentiment regarding USD/PY.

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

Chess and trading bars

Trading can be compared more easily to chess than to poker. That is because, as with chess, we enter trades with all the previous moves in clear view.

Also, as in chess, all previous moves when trading have a certain degree of relevance and effect –

Moreover, each trading bar has a particular characteristic, a specific force, an individual power; as do individual chess pieces – the pawn versus the queen for example. The chart below asks: are there similarities to chess?

Snip20151211_30

Trading bars don’t, of course, have nice horse’s heads on them, to let us easily differentiate between the knight and the less capable pawn. However, each trading bar is, in its way, just as distinctive as the carved chess piece.

When we know these trading bar distinctions, we have a chance at winning. But, as in chess, a game is not won by just knowing the capabilities of individual chess pieces. We need, more importantly, to understand how the different parts (or bars in trading) support each other – the context – the confluence.