Many day traders have the wrong idea about price action trading, and actually confuse price pattern trading with price action trading. Make sure that you do not confuse price action patterns with price action trading, because they are not one and the same thing. Now that we have made this statement, you might be wondering what is the difference between these two phrases? The difference is that you will see some of the price patterns we use at many places on a price chart, yet they are not good trade entry points. You must take the entire structure of the market and the surrounding price action and consider what is occurring within that price structure to help determine if a price pattern is one in which a good trade entry will actually be triggered. I understand that this is a rather broad statement, and it may not be completely clear to many traders as to what we mean, so I will try and go into what we are describing in more details so that maybe you will be further enlightened as to the benefits and successes that price action trading actually offers.
First of all I want to make it clear that there are several price patterns that we prefer and look for when searching for solid trade entries from which winning trades will be triggered. These patterns include two-legged pullbacks in a trending market, second entries, breakout pullback entries, failed breaks out of congestion or trading ranges. We also like to see bounces or reversals off of strong support and resistance areas, along with what I describe as traps, where large numbers of unsuspecting traders get trapped in and out of trades simultaneously. Understand that just seeing these patterns or set ups is not enough to trigger a good trade entry. What you want is to see these patterns or set ups form or print at what I call “key entry points” on our trading charts. In other words, a price pattern will only trigger a trade entry if and when the pattern forms at these key areas. In addition, you will see these patterns set up often, but never trigger, so there are triggers that need to occur along with the pattern occurring at specific locations on our price charts.
We won’t talk much more about the patterns themselves or the triggers, as there will not be room for that here. Our main intent today is to help you to understand where to look for these patterns in order to help increase your winning trade percentages. Let’s take a two-legged correction as an example. A two-legged correction is one of the easiest price patterns to spot and it is also a price pattern with a very high win rate. It is actually so simple and so profitable that many traders never really understand it’s importance. However, if this pattern does not occur at the right place, and preferably within a trending market, then we may want to skip taking a trade just because we see a nice two-legged correction pattern. If the market is trending strongly and there has not yet been a trend line break, then a two legged pullback or correction that reverses off of the EMA or trend line is in most cases, a very high probability trade entry. This is actually one of the most profitable patterns we know of, and it’s very easy to spot and trade.
However, if there is a tight range and prices are not trending, this same two-legged correction pattern will often fail miserably, trapping a trader into the wrong side of the market and quickly end up as a losing trade. Hopefully you see what we mean when we say that our preferred price patterns must form at key entry points in order to be good trade opportunities. We called these preferred trade entry locations our key entry points earlier, so now I will try and describe where these key entry points are actually found on a price chart. The key entry points on a price chart are nothing more than strong support and resistance. While most people understand what I mean by strong support and resistance, I think this still needs further discussion, because not everyone understands that strong support and resistance can be angled areas, as well as flat or horizontal areas on a chart.
What exactly do I mean by angled support and resistance and how can that be strong support and resistance? I’m guessing that if you know anything about trading, then you know what a trend line is and how to find one in the basic sense of trend lines. However, in almost all cases of a trending market, you can copy your trend line and then move it to the opposite side of the trend and find a channel in which prices move up and down, bouncing off both sides of the channel. In other words, if the market is trending upwards, each time prices come back to the trend line, they will normally turn upwards with the trend at that point and continue to trend upwards until they reach or find resistance off of the upper matching line that forms the channel. Upon reaching the upper line or what I call the trend channel line, prices will then move back down and test the trend line again, continually repeating this process until the trend ends. So indeed, trend lines are nothing more than strong support and resistance lines that form on an angle. Below is an example of this from a live trading chart.
Lastly, we like to use a 21 bar EMA on our trading chart, as it too will act like a strong support line in an upward trending market and a strong resistance line in a downward trending market. We won’t go into why we choose to use the 21 bar EMA, but trust me when I tell you that you will find some of your best trade entries during a two-legged correction or pullback to a 21 bar EMA in a trending market. It’s almost free money in most cases, assuming that prices haven’t just bounced off of a trend channel line and be on their way back to a trend line that is much higher than the EMA in a down trend, or lower than the EMA in an uptrend. In that case, it’s the one time this price pattern is not a very high probability set up.
I am hoping that you now understand why you do not confuse price action patterns with price action trading. The two phrases are very similar and they do actually go hand in hand, but in the end, they are not one and the same as we have discussed in this trading article. Make sure that you do not get suckered into price pattern trading and enter a good price pattern at the wrong location. By waiting on your patterns to form at the key entry points as we discussed, you will be fooled and trapped on the wrong side of the market much less often, and in return, your trading results will improve immensely. In addition, you will be forced to be patient and wait on your trade entries, helping to cure over trading, which can be a very costly mistake that many new or unprofitable traders almost always seem to make. If you would like to learn more about how we trade with price action and how you can learn to trade price action like a professional, you can find that information at http://priceactiontradingsystem.com/pats-price-action-trading-manual.