Bar

Tick scalpers cause prices to pop up and down a few ticks and their net impact on the direction of the market is neutral. Generally speaking, tick traders will exit their positions when the market moves in their favor a few ticks. Other tick traders expect this and will fade such moves causing any move to pullback just a bit. These two groups of traders are tick chasers and tick faders respectively.

When the market activity is dominated by the above kinds of traders, bars tend to have small bodies and have tails on both ends (dojis). When many successive bars are dojis, any trend trading is likely to be lower probability. Occasionally, the move out of this area is strong enough to result in a trend in either direction.

When traders take positions and stand their ground and tick traders are unable to create tails at the ends of the bars, the likelihood of a strong entry bar and a sustained move are higher. Therefore bars like b12 and b9 are likely to be winning setups, i.e., respect stops and go at least as far as the signal bar before.

A strong close therefore is a very good indicator of a good with-trend setup given the market is at a good location and has a tradable pattern.

Note the exceptions to this rule: 

• A large overlap (b22,23) is likely to invite faders. You should treat the OL like a TR and take a BP or fBO of the overlap
• Inside bars, especially large inside bars are also overlaps and their breakout is likely to fail or at least require a large stop. Small inside bars (smaller than your stop) are usually OK. Inside bars that setup a fade of a much larger overlap are often OK (b9, b24)
• When the market enters a channel (b37-66), all signal bars are likely to be poor but the move can be protracted.

Pattern

One of the most interesting problems in day trading is early determination of a trend. An early determination is a decision before there are obvious HH and HL or LL and LH. One simple way to address this is to state that any sustained move from the open is a trend (b1-4) and any sustained move against such an opening trend (b5-8) is a possibly a first reversal (1Rev). Any move that is not sustained is simply a 1PB. The balance between a 1Rev and a deep 1PB is subtle. In the absence of a 3 push move and reversal, I generally err on the side of a 1PB (with some notable exceptions).

Once you have a trend, even if its simply an early determination, you can look for with-trend trades.

Among the with-trend setups, I'm most liberal about the first pullback (#1, #4). If the pullback is deep (#1) or has a strong signal bar (#4), I will often take it since it can lead to gains far larger than the risk. A first pullback made of a one leg or poor bar is not a higher probability trade, but when it does succeed, the gains can be large. Sometimes, a failed deep 1PB in the old direction is a 1PB in the new direction (#2,#3). Usually, I prefer to skip the reversal itself (b14) and take the 1PB after it (#4).

A first move against the current trend (#5,6) is likely to require you to exit on the entry bar, regardless of how good the signal bar may be.

Multi-leg pullbacks such as b54 have the highest probability of a strong entry bar and least adverse excursion after entry. When a multi-leg move is basically a micro-channel (#9), chances of a failed first attempt to break the channel are high.

Location

In an earlier post, I outlined how you could trade both directions as long as you exit on the close of the entry bar. So the question becomes, why would I ever want to only trade with-trend? Why do I insist on taking only a few good trades and let most trades go by?

What is the point in taking only a small number of trades? Isn't it better to also add those little trades to pad my profit? Won't all those small trades add up?

Today's action illustrates why all those little trades do little or nothing to your bottom line for most traders. For example, today I added five counter-trend trades at reasonable setups:

#2: Multi-leg fBO with strong signal bar
#7: TCL OS
#10: Strong signal bar
#11: small trend entry bar (occasionally these are followed by BO bar)
#12 possible W

Even with the express intention of exiting on the entry bar, three of the five trades were losers.

In contrast, only one with-trend trade, #3 was a loser. This was a news related experimental trade. Trade #9 was a scratch and was an accident.

The important take away here is that if I only took #1 and #5, my cumulative profit would have been larger.

A second observation is that the longer you trade on a given day, the worse your performance gets. For example, My peak profit was after trade #6. I gained nothing by trading for an additional hour.

So what's special about #1 and #5? They were clearly at the trendline. Their superior location is obvious even without drawing an explicit trendline.

Building blocks

Price action trading has so many angles and components that it can be overwhelming. An average trader is unlikely to be able to recall every single aspect of price action and make the correct call most of the time. In contrast to simpler indicator based approach where everything boils down to a buy/sell, price action concepts reflect the complexity of the market and the trader needs to weigh opposing readings and make the right call.

To be able to absorb and build up one's knowledge and expertise and then practice and apply it in daily trading is no simple matter. To do it with every single bit of price action knowledge is next to impossible.

I believe that the layers of knowledge and expertise need to be built up one by one. The first and foremost is directional correctness. The next is the right entry and the last is a target estimate.

Directional Correctness: A new trader should trade not with profit in mind but with the desire to hone his directional correctness. If a trader is able to take trades that eventually move in the direction of your trade, then they could theoretically be profitable with larger stops. A simple way to do this is to not bet on any reversal attempts. Instead let the reversal attempt actually succeed (take out a swing point) and then take the next pullback. With-trend entries enable directional correctness. The market needs to be trending  (higher highs/lows or lower lows/highs) and not in a chop. A simple way to ensure that you are entering with-trend is to always draw a trendline and ensure there has never been a trendline break (a sustained move beyond the trendline) or the trend has otherwise terminated (no HH/HL or LL/LH).

The right entry: A second requirement is to only enter at support. A test of the trendline or ema or HLC of the prior day are usually good choices for entry. A good location ensures that many more traders enter with you increasing the probability of success.  Two or three legged pullbacks have higher probability than a one legged pullback. The earlier the pullback, the weaker it can be, i.e., the first pullback can be one-legged with a poor bar if its deep. The second and subsequent pullbacks should be two legs and deep and should preferably have a good signal bar. Do not be tempted by one-legged shallow pullbacks after the first pullback. They are likely to fail and give a two-legged deep pullback. If you find that you are often stopped out and the price eventually moves in your direction, you need to develop patience and let the market develop better entries. Once you have mastered this for normal trends, you can make adjustment for hard and soft-trends. You would still need to be cautious after an extended move or third pushes since a retrace would need to be two or three legs.

A good way to distill the points above is to reduce them to location, pattern and bar. A good location is a pullback to a support in a trend move. A good pattern is a deep pullback, preferably two or three legged. A good bar is a strong close, non-overlapped signal bar (with adjustments for 2BR, oio, etc., where you would treat the entire pattern as one bar).

Estimating targets: Once you have mastered directional correctness and are generally successful taking the right entries, you can work on maximizing your profits. The most obvious choices are measured moves of a trading range and overshoot of TCL on third push. You should also look to exit near the recent extreme once a trend is broken.

Remember the order of mastery and take them up one by one. Until you have mastered directional correctness, your mind does not have the bandwidth to absorb the intricacies of the right pattern and entry. Until you can confidently take the right entry without fear of being stopped out, you will have no conviction to hold until your estimated target.

Once you have all the three, you have developed a framework into which other observations of the market fall naturally into place. After this point, your trading style develops sophistication and absorbs information from the market and other participants naturally.