There are many small tips and tricks that a day trader can use to filter their trade entries, but one that is often overlooked by traders is the signal bar. This article is going to explain how to use the signal bar to filter price action trades. First, we like to use Japanese candlesticks for our bar types when charting, because price action trading is mostly visual, and Japanese candlesticks are a very visual way to see the bars and help read the price action. If you color code the bars, which most all charting software does these days, you can tell the trend direction, or even the lack of trend direction of every bar at only a quick cursory glance. With normal open and close bars, you must spend a little more time when looking at the bars to recognize if there is a trend within the bar, and anything that distracts you too long can actually affect your trading in a negative way. So, by using candlesticks, we reduce the time it takes to determine what each bar is doing.
Now that we have explained why candlesticks can really aid you in determining the trend direction of a price bar, let’s discuss what a signal bar is and how we combine this information with candlesticks to help filter our trade entries. A signal bar is simply a single candlestick or bar within a pattern that signals to us as traders that a trade entry is likely setting up. A signal bar must complete and close before it can be a signal bar, so this part is really important. Once your signal bar has completed and closed, the trade will not actually trigger unless there is a break or movement in prices that go above our signal bar if looking for a long entry, or a break or movement of prices below our signal bar if looking for a short entry. As you can see, there are some specific parameters to our trade entry, and while they may seem trivial, they are key steps that must be followed properly in order to help us filter out bad trades. As with anything in trading, nothing is 100%, but these filters have been tried and tested, so we know that they work and that they work well in helping improve our win/loss ratios.
I have seen many great price action set ups or patterns that generate really good signal bars, only to never get the trade trigger as described above, followed by prices that just continue to go in the opposite direction, so that’s why the trigger is so important. Until you get that trigger, the trade is suspect and there is no reason to enter it. I’ve also seen many bars that appear as if they are going to set up to be great signal bars, only to see those bars change rapidly just before they close and then not turn out to be a good signal bar, so these are all reasons why we never guess about a signal bar and attempt to enter early. By guessing and entering early, we become gamblers, which is not what we want to do as day traders. We want to be profitable traders, and profitable traders only take trades in which the odds are stacked in their favor, so we follow our entry rules, and we are very strict about them.
We have now discussed that we like Japanese candlesticks, and we should also understand the importance of waiting on a completed signal bar, along with the proper trade entry triggers, which is a break above or below the signal bar depending on entry direction. Without each of these pieces occurring, we have no valid trade entry, thus we are heavily filtering our trades. Now let’s talk about the actual signal bar and how we use it to further filter our trades. If we are looking to buy or go long, we want what I call a trend bar or a reversal type bar that closes in the direction of our trade entry. Preferably our signal bar will close on or very close to the high of the candle if we are looking to buy, and at or very close to the lows of the candle if we are looking to sell short. If this doesn’t happen, then it’s not a great signal bar, and we may consider skipping the trade entry. In essence, this helps ensure that if we are going long, prices are already proving that they are heading in that direction before we enter, or if we are looking to go short, that prices are already moving in that direction before selling. The movement past our signal bar also shows additional strength in our desired entry direction, as it takes buying pressure to break above a previous bar or selling pressure to break below a previous bar.
If you are familiar with price charts then you probably already clearly understand what we mean when we say your entry bar must be a trend bar in your desired entry direction, but I will include a video at the end of this article that will show you some examples of what a good trend bar or good signal bar will look like. Even with all of these filters and a perfect pattern, you will still encounter trades that will trigger on occasion, yet still fail. This is part of trading, and it comes with the territory, but if you can learn all of our price action rules and truly learn how to read a price chart while incorporating our trade entry filters, you can get as high as an 80 to 90 percent win rate for at least scalping 4 ticks on each trade. This may seem impossible to many traders, but I can assure you it is a very real and obtainable goal once you can truly read or understand a price chart. Trading for a living, like anything worth learning and that pays very well, takes time, effort and hard work, which most people are not willing to commit.
We hope that this information on how to use the signal bar to filter price action trades will help improve your trading. Be sure to watch the included video just below to see some examples of what a good signal bar will look like. If you would like to learn all of our price action trading rules and strategies that we use to make money every day in the markets, then you will want to check out the additional information on our price action trading manual at http://priceactiontradingsystem.com/pats-price-action-trading-manual.