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When the market is trending, it tends to mean revert towards the moving average.
Depending on the type of trend you’re in:
In a strong trend, the market tends mean revert to the 20 MA.
In a normal trend, the market tends to mean revert to the 100 MA
In a weak trend, the market tends to mean revert to 200 MA
Thus, the last thing you want to do is enter a trade when the market is far away from it’s moving average.
But the question is:
How do you define what’s low and what’s high?
Allow me to introduce to you…
Horizontal support & resistance
This is useful because it helps you identify areas of value on the chart.
Support – Area on the chart where you’re are looking to buy “low”
Resistance – Area on the chart where you’re looking to sell “high”
Dynamic support & resistance
These are Support & Resistance that moves along with the price.
Dynamic support occurs in an uptrend, and dynamic resistance in a downtrend.
They can be identified using moving averages. (I use 20 & 50 EMA).
If you enter trades in the middle of a range, it never gives you a favorable risk to reward (at best 1 to 1).
But…
If you enter trades at support & resistance, it would greatly improve your risk to reward.
If you notice the price has been ranging for a long time, you’re not alone.
Traders all around the world will be seeing the same charts as you.
Some will be queuing to short the resistance, and some will be trading the breakout.
If the price does trade above the resistance, shorts will get squeezed, and breakout traders will hop on the bandwagon.
That’s why price trend for a sustained period of time, due to the imbalance of buying/selling pressure.
You’ve learnt that the longer price range, the harder it’ll trend. Now, you can take this concept further and apply it to the range of candles (instead of time).
The thing you’re looking out for is… narrow range candles.
Why?
Because you can expect an explosive move to occur soon.
A wide range candle is formed due to an imbalance of buying/selling pressure.
This represents “hidden” Support & Resistance in the markets (known as Supply & Demand by Sam Seiden)
There are traders who swear by Supply & Demand, and some who do just fine, with Support & Resistance.
Here’s the thing…
You don’t want to trade them in isolation, but use them with other technical tools, that add confluence to your trades.
First, let me explain what is a false breakout.
I define false breakout when price breaks support or resistance, only to close back into the range.
Why is this one of the best times to enter a trade?
Because you’re taking advantage of traders who are being “trapped”.
Imagine:
A trader, called Michael, went long on the break of resistance because he expects a rally.
After a few candles, price traded against him and closed under resistance.
At this point…
Michael is “trapped”. And chances are, there are many traders like Michael, who took the same breakout trade and are “trapped”.
Now, a proficient trader can take advantage of this.
How?
By shorting the false breakout, with expectations that the “trapped” traders would cut their trade, and fuel further price decline.
And this my friend is the power of false breakout.
One of the best ways to improve your trading performance is, trading with the trend (and not against it).
This greatly increases the odds of your trade working out, and gives you a greater profit potential.
You may wonder:
What are continuation patterns?
They’re chart patterns such as flags, pennants, triangles etc.
And…
A big mistake traders make is, to trade these patterns in a range market.
These are 3 things I’ll look out for: