TRADING PRICE ACTION

            Identifying support and resistance is only half the battle; to make money,
                                     you have to be able to trade them. There are a couple of tactics I prefer to
trade price action along support and resistance levels, and you will learn
those tactics in this section. You will see these tactics in action when we
discuss actual trading methodologies in Chapters 6 through 9. To trade

price action successfully, you need to be clear on one critical concept
about support and resistance: It isn’t a perfect line in the sand. Occasionally,
a price will be struck that causes an instant and obvious market reaction,
but support and resistance barriers are normally established in a
range between a high and a low price. This range represents the support
or resistance zone where buyers and sellers are momentarily in balance.
The relative balance between buyers and sellers may last a few minutes or
a few years, depending on what timeframe you are trading, but the range
should be clear. This range is where traders should look to enter a low-risk,
high-probability trade along support and resistance.

Identifying Support and Resistance Zones

Locating a support or resistance zone is done by finding the price range immediately
preceding a turn that takes price in a new direction. The range
could be near a round number, at a daily or weekly range, or preceding a
major breakout in price. Once located, the zone becomes the focus point
for a bargain-hunting support and resistance trader to place orders. Figure
3.14 illustrates support and resistance zones using a GBP/USD hourly
chart. In this example, the market is approaching a support zone identified
between a high price of $1.6025 and a low price of $1.5975. It is worth noting
that the psychological round number of $1.6000 sits in the middle of
this support zone, making it attractive for traders to consider taking a long
position if the zone holds support.
Lower timeframes are often used to identify support and resistance
zones. Most of the trading strategies taught in this book use lower timeframes
to plan support- and resistance-based entries after identifying a
trade opportunity on the daily chart. Spend some time identifying support
and resistance zones using historical data and get a feel for the way that
price moves in and out of these zones; it will be worth your time.

Identifying Strong Rejections

Occasionally the market will touch a price that generates a tremendous
amount of interest. When this occurs, the market is often rejected strongly

from that price, creating a pattern, which I so creatively refer to as a strong
rejection. There are a number of names associated with single bar or candle
patterns that are well known, such as pin bars or hammers, but don’t
confuse strong rejections with traditional candle patterns. Candle patterns
and pin bars have restrictions that qualify their patterns as trading signals.
Strong rejections are focused on analyzing the strength of a support or resistance
zone and are not trading signals on their own.
Strong rejections are often seen as a single bar or candlestick; however,
a series of strong rejections only adds further evidence that the support
or resistance level you are looking at is genuine. Candlesticks display
strong rejections with a very long wick or tail. The size of the body
doesn’t matter; this is about observing order flow, not spotting a candle
pattern. Bar charts display a strong rejection with a long bar whose open
and close ticks are close together. Figure 3.15 illustrates what a strong rejection
looks like in both candlestick and bar chart format.
Strong rejections occur when the market hits a price that triggers a
massive amount of selling or buying interest and serves as a warning to
traders that a demand level may be forming. This example shows a strong
objection with a bias to sell because the wicks are higher than the body.

Reversing this pattern would indicate a strong objection with a bias to buy.
Seeing a strong rejection should serve as a warning shot to traders that a
good support and resistance trade may occur near the source of the strong
rejection.
Strong rejections are visual tools to support the idea that a strong support
or resistance level may have formed near the price that was the source
of the rejection. You should always analyze the surrounding landscape to
ensure that any strong objection has some teeth; otherwise, you will enter
a trade without merit. Strong rejections that occur near round numbers are
usually very good signs that the round number has developed support or
resistance and will hold. Strong rejections are also potent clues that support
or resistance is strong when they appear near the open of a major
trading session or following the release of major fundamental data, such as
the nonfarm payroll report.
Strong rejections occur on every currency pair and any timeframe. The
longer the timeframe, the more attention a strong rejection should receive.
It takes a tremendous amount of activity to push a daily or weekly candle
around, so when price is rejected on a longer timeframe, take note.
Figure 3.16 illustrates how a cluster of strong rejections combined with
a round number created a buying opportunity on USD/JPY in July 2009.
USD/JPY had tested support at $92.00 twice and was strongly rejected;
on the third test the market reversed and moved higher. Using an entry
order to buy the USD/JPY below the round number at $91.90, a bargain
hunter could have taken advantage of this low-risk, high-probability
support trade.

Identifying Turnabouts

Turnabouts are a very conservative technique to identify support and resistance
trades. Using a turnabout, the trader essentially waits for confirmation
that a suspected support or resistance level will hold price before

taking action with a trade. When you make a mistake trading, there are no
money-back guarantees, but waiting for a turnabout is probably the closest
thing you’ll find to a guarantee in the world of support and resistance trading.
The market must turn in order to trade—hence the name turnabout.
The downside to a turnabout trade is missing out on other valid support
and resistance opportunities.
When traders aggressively enter on support and resistance, they will
get into a trade well before a turnabout trader does. In some cases the market
will move away from the support or resistance level with such force
that waiting for the turn may keep a turnabout trader sidelined while the
aggressive trader is in the money. Although waiting for the turn will reduce
the number of trades taken, the trades that are taken may offer a higher
probability of success. Turnabout traders are not guessing whether support
and resistance will hold because they waited for the turn. Turnabouts
also take the guesswork out of placing protective stop orders. During the
turnabout, the market will make a high or low price, depending on whether
you are trading support or resistance. This high price mark gives traders an
excellent place to put a protective stop order on their position, should the
trade turn out to be a loser.

Figure 3.17 illustrates an example of waiting for the market to turn
before assuming that the resistance level will hold. In this example, the
USD/CAD rallied to test a resistance level at $1.2670 and was rejected
again. Traders who waited for the market to close below the resistance
level used the turnabout effectively to short sell this resistance level. The
small line above the high price during the turnabout represents a potential
stop order level to protect a short position.

Identifying a Bargain Day

Bargain days are a recurring theme you will see in almost every trading
methodology I use. Traders often jump into trends at a price that doesn’t
represent the best possible value for their trade. This is usually referred to
as chasing a breakout or entering at the top of a rally or selloff. Bargain
days represent an opportunity to join an existing trend at a much cheaper
price. They are often referred to as pullbacks and are formed when the
market has moved against the prevailing price action or trend.
The idea is simple and is rooted in the theory of how supply and demand
drive prices higher or lower. Within the context of any trend therecomes a point where the traders who are driving the trend lose interest
and the trend slows. This pause allows the other side to gain control and
push the market in the opposite direction of the prevailing trend. Eventually
the participants in the original trend notice the cheaper prices and
begin to enter the market again. When the prevailing trend has paused and
the market is on sale, a bargain day is usually close by.
Selecting the Best Bargain Days Each methodology taught in this
book will explain how to identify a bargain day for that specific trading
strategy, because the rules do vary. Regardless of a strategy’s nuances, all
bargain days are represented by a pullback against the prevailing price action
or trend. Figure 3.18 illustrates several bargain days in uptrends and
downtrends using a USD/CAD daily chart from 2009. Bargain days fit with
the bargain-hunting principle, never pay full price. Looking for a bargain
day will help reduce the risk you must take to join an existing trend and

increase profits by avoiding entries at the top of a selloff or rally. You will
see bargain days in action in Chapters 6 though 9.
Wicks and Tails Are Important A good bargain day will have either a wick
or a tail, depending on which way the trend is expected to continue. The
length of the wick or tail is not as important as simply having one, although
the longer it is, the more support or resistance may be present. The importance
of a wick or a tail lies in the level of support or resistance provided as
the bargain day came to a close. Without it there is little evidence through
price action analysis that the market actually found traders willing to stop
the direction of the bargain day, and the market may move further on the
next trading day. If you are looking to sell a currency pair, the bargain
day should have closed above the indicator and have a visible wick on the
candle. If you are looking to buy the currency, the daily or weekly candle
should have closed below the indicator and have a visible tail.
Always Consider Support and Resistance When you consider a potential
bargain day, do not do it in vacuum. Even if the bargain day has a decentsized
wick or tail, that doesn’t mean that the market isn’t done moving
against the trend. You can see that clearly demonstrated in Figure 3.18,
which shows that not every bargain day is one you should trade. The bargain
day alone is not a signal to trade; it is a signal that there may be a
support-and-resistance opportunity coming soon. When you see a bargain
day, you should look for a support-and-resistance opportunity to join the
existing trend at a bargain price. Use everything you have learned about
support and resistance to determine whether there is an opportunity to
trade. If you don’t see obvious opportunities, move on, because not every
bargain day will yield a trading opportunity.
Wait for the New York Close Daily candles tend to be slightly different
from chart to chart, depending on your data feed and the time at which
your software considers the end of a trading day. I prefer charts that close
daily candles at 5:00 P.M. Eastern Time. This ensures that the daily candle
on your chart accounts for the full range of trading that occurred during
the London and the New York trading sessions that day. For most traders
this won’t be an issue, but if your daily candles close at another time, you
might consider changing your settings or switching software.

Learning to Place Effective Entry Orders

Trading long-term support and resistance opportunities allows you to manage
how you enter trades using entry orders. You do not need to be present
when the support or resistance opportunity is executed. Learning to placenot present to execute the trade, takes some practice, but it is not difficult
to master. Placing an entry order depends on the kind of opportunity you
are trying to take advantage of. Round numbers should have entry orders
placed at least 10 pips above or below the round number, depending on
your desire to be long or short. Support and resistance trades should take
advantage of a defined support or resistance zone near the desired entry
price. Support trades should place an entry order along the top of a support
zone. Resistance trades should place an entry order along the bottom
of the resistance zone. This practice ensures that your entry order will be
executed as the market enters the outer boundaries of the support or resistance
zone being traded. These techniques are demonstrated in Chapters 6
through 9.