Eventually novice traders begin the laborious task of stripping their charts back to their initial, naked, vanilla appearance. This generally occurs after they’ve experimented with many individual indicators and clusters of indicators in search of a winning formula which could form part of an edge. It takes time to realise how risk and probability will underpin your trading success over and above the use of technical indicators, you’d only need a marginally successful 52:48 win-loss ratio to take continual and considerable profits out of the market place, if you control your risk per trade and ensure your trading costs are under control.
However, the majority of novice and intermediate level traders become too focused on discovering a strategy and edge that has a far greater win-loss ratio. There’s a reason for this and it’s based on the psychological evidence that losses impact emotionally far more than wins. Traders experience far more hurt with losses than they enjoy the pleasure of gains. Therefore, traders often become embroiled in a fruitless search for strategies that have impossible winning odds such as 80:20. Whilst you might develop a system that predicts initial direction correctly 8 times out of 10 you’ll never make the strategy work, unless you control risk and calculate the probabilities.
As traders begin to strip back their charts to the vanilla options, while the impact of risk and probability affecting their trading outcomes becomes apparent, they’ll begin to familiarise themselves with the concept of price-action in all its various manifestations. Price-action concentrates on the now, it’s not a lagging indicator, it reveals what price is doing at any given moment in the market-place. As such it’s the ideal mechanism to create a longer-lasting, reliable strategy that traders can build a regular income from.
There shouldn’t be any misinterpretation that price-action is 100% reliable because it isn’t. But it will reveal what price (at any given time) is more likely to do next. This is where probabilities and your risk control comes into play because if you predict direction correctly 75% of the time it won’t translate into a 75:25 win ratio, you’ll only obtain a ratio close to this level by ensuring your actual losses are minimised on losing trades.
Many novice traders fear price-action analysis as it offers up no crutches. It’s easy to place three technical indicators on your one hour chart and if they align and chime you then take the trade, you can also automate such a process through your MetaTrader platform. Price-action analysis on lower time-frames requires visual skills and quick thinking, for that reason it’s favoured by many successful day-traders. Swing-traders can also use price action analysis on an end of day basis as they look at the closing candles and price over the previous days’ sessions, in order to make their decisions.
You’ll come across many phrases attributed to price-action and the various patterns associated with the phenomenon. Candle formations such as the shooting star, hammer and doji are commonly used as are phrases such as bearish and bullish-engulfing. One of the simplest concepts of price-action to understand and then implement involves the identification of lower-lows and higher-highs. They’re simple theories to understand and put to practice, because the phrases reveal precisely how price of the security is reacting to market sentiment. If the market price is making higher-highs then the market is bullish, if it’s making lower-highs then it might be time to consider banking the profit on an individual trade.
It’s worth walking through how identifying higher-highs as a day-trader, when working off a 1hr time-frame in order to establish continued bullish sentiment, might potentially work for traders of all levels of experience and success. Firstly, can you identify if the market is bullish on a daily basis? A simple judgement could be made that if price is trading above the daily pivot point and perhaps above or threatening to breach the first level of resistance, then the market is likely to be exhibiting bullish sentiment. Then you simply and calmly look to see if you can identify higher highs through the 1hr candles which have developed or are developing.
Such a pattern of behaviour could indicate that the current direction will continue if you’ve analysed the pattern correctly and you’ve got your timing right. The higher-high process of analysis using the 1hr candles should also include the search for closed candles, which can also provide an indication of continual direction.
This stress free, calm method of price-action analysis is one of the simplest and time honoured processes by which traders can identify and attempt to profit from market behaviour. Free of the classic technical indicators and clutter on your charts, you only require the daily pivot points and candles, in either standard or Heikin-Ashi formation, to make valued and judicious decisions.
