Where to draw Horizontal Lines and why? Part 3

Using reaction at price levels to determine price direction.

Support and Resistance Trading.  Part 3.  

Part 1 of this case study showed how I choose support and resistance price levels using red horizontal lines.  Part 2 of the case study I discussed how I can use the levels to determine trading direction, where to enter, place limits and stops.  Here in part 3, I will continue to discuss the clues provided by price action for USDCAD during Q1 2013.

Once price chooses a direction, I must remain focused and watch closely for clues suggesting the move will continue, stop and or reverse.  Stop and or stalling, at a level, in itself, is not enough to suggest the move is over.  The clues of continuation or reversals come from price behaviour at structure levels: making or failing to make new HH or LL, putting in new HL or LH.  All of this helps to define the trend direction and it’s strengths.  In addition, I like to use Fibonacci retracement and extension levels. 

Note: 1.00000 is a psychological big number, it can be expected to see natural resistance around it.  So too is 1.01000 but to a lesser extent.  Careful with trading at these levels and be wary of false breaks though once a side is chosen the moves can be significant.

The chart below brings in my use of Fibonacci retracement levels when they align with horizontal lines. 

The second chart brings in EMA lines, I like to look at the charts in this order.  First identify levels, then bring in Fibonacci levels and then EMA lines. 

 

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Where to draw Horizontal Lines and why? Part 2

Identifying Support and Resistance Levels.

Case Study: USDCAD 2013 Q1.

PART 2.

How I draw, qualify and use horizontal lines.  USDCAD Case Study Jan 2013, Q1.

To begin, I will identify the key horizontal lines from October – December 2012, Q4.  Then use these to read and understand why price moved as it did during January to March 2013.  Here, I am using quarterly segments as forex trading requires patience in regards to time.

  • The first chart identifies 4 lines: the periods high, low, and it’s structure high and low.
  • Chart 1 summary:
    • High 1.00582  Low .97364.
    • Early in the quarter structure high (SH) resistance is about .98800 which then becomes the structure low (SL) support in early November.
      • This suggest below the line sellers are stronger than buyers and therefore affect price more.  When price level .98800 is broken, to the upside, it suggest sellers no longer find this price level attractive and sell less, if at all.
      • After price broke above .98800 it suggest buyers are outnumbering sellers.
      • After trading above .98800 price then came back down to  it, again.  It would be highly probable to expect buyers to outnumbered sellers here and price should move back up.  That is exactly what happened and a new HH was set in Middle of November.
    • Later in the quarter, early December, the SL at .98800 is broken, as price came back to it, buyers were not liking this price level and therefore price continued further down establishing a new structure low at about .98200

I will now use these identified levels from chart 1 to read and interpret Q1 2013, chart 2.

  • Chart 2 has two red horizontal red lines which were the highs and lows as identified on chart 1.  Now, in this case, I need to read price action to see how Q4 high was reached instead of the Q4 low.
  • The end of December had put in a new structure low at .98200 and this level held throughout January as price moved sideways early on.  If price was going to the Q4’s low of .97364 then it would need to break the structure low if .98200, this did not happen as price broke out of the sideways box, up.
  • The green box labelled Rotation Bullish; when I see a price pattern like this, I view it as possibly market movers switching sides.  In this case switching from sellers to buyers.  They are buying USDCAD.
  • The early part of January gave clues suggesting price may move up towards the Q4 high.  First, the structure low at .98200 held.  Second, a bullish price rotation pattern emerged, and price moved up outside of it.
  • If price does not move towards the next key support level then chances are it will move to the opposite next key resistance level.

All of the above tells me sellers are selling less and less at these price levels.  When sellers are selling less it means price will move higher.  Or, I can say: buyers are buying more and more, and as their demand to buy more grows price will move up.

Either way the behaviour of price is suggesting taking long position should have a higher probability of being right than taking short positions.

  • Taking a long trade once price moved out of identified bullish rotation box, in this case, paid nicely.  Though price stalled a little above the rotation box it did not show any signs of reversing down.
    • Possible signs of reversing down would be price moving back into the box.  Or breaking below and closing below the impulse bar that moved price out of the box.
  • From the slow down above the green breakout box, price then moved up and through SH quickly hitting limit 1 target.
  • The closes above the structure high (SH) formed a bullish flag pattern further suggesting the Q4 high is in play and reachable.  Once price took off up, again, it quickly reached Q4 high hitting limit target 2.  There was nothing in price action suggesting sellers had any fight or interest in slowing down the buyers.
  • Above the Q4 high additional highs were not made suggesting sellers liked this price and started selling preventing price from moving further up,  and or buyers were unloading their longs, and or fewer new long contracts were being added at this level.
  • As price moves down from this level, I need to look for clues to answer is price reversing the long-term trend or is the current up trend just pulling back?
    • From this new high, above the Q4 high, price retraced down to the previous structure high (SH), around .99700 finding support.  Once a bottom was found and price resumed up it can be safe to say a new higher low (hl) has been put in and price is not reversing but just pulling back.
  • Once the steam of the bulls ran out and sellers entered the market a double top was set in early March and priced moved down from there finishing out Q1 2013.  This will be where I pick up for Part 3.

Conclusion

I can use previous significant, in this case the quarterly, highs and lows to identify support and resistance levels to gain insights for future price action.  At these price points, I can draw horizontal lines then wait for when price reaches them again.  If price does not move to one and then aligns to move to the opposite level then, I can look for trades in that direction to that level. Once the level is reached, I should continue to read the price clues, left behind by buyers and sellers, to see where price may go next.

I can further draw in and use structure highs and lows to gain insight to which level price may move to and how to evaluate it once it gets there.  The key is to read and see who is winning the battle, buyers or sellers.  If buyers are winning then price will move to resistance levels.  Once it reaches the level another battle will occur between buyers and sellers.  If at resistance levels buyers are winning the battle then price will break that resistance level and move further up.  Often when a significant high or low is broken price may come back and test it. These are ideal areas to join the longer term trend but entry signals must provide high probability with low risk.

Where to draw Horizontal Lines and why? Part 1

The Art of drawing horizontal lines and how to evaluate their strength. 

Identifying Support and Resistance Levels.

This case study is to assist me in better choosing where to place horizontal lines and how to evaluate their usefulness.  I will select obvious highs and lows from recent price action to draw horizontal lines, for this I will use red lines.  I will determine these horizontal lines from past price action but their usefulness is in the future.  Well chosen price levels to draw horizontal lines can serve as boundaries to where price may move to and or reverse from, in the future.  In between these obvious support and resistance levels will be other valid points to draw horizontal lines,  I call these levels structure high or low, and will use blue lines to highlight them.

This case study will only identify horizontal lines and look to see when they come into play again.  I will focus on the battle between buyers and sellers before price return to a line, again.  Once price returns to an earlier identified level, I must continue to read the battle between buyers and sellers at the lines.  This is a significant battle to understand and to know who is winning, as it will give valuable insights towards whether the line will hold or be broken through.  If sentiments are correctly read based on price action at these levels it can help prevent taking low probability bad trades in the wrong direction.  Reaction at these key significant levels can be excellent guides towards the medium to long-term trend direction and strength.

Clues towards who is winning the battle, at key price levels, identified by horizontal lines, may come from structure levels and or when higher lows (HL) and or lower highs (LH) are set.  When higher lows are being made it suggest buyers are greater than sellers and in control of the overall up trend.  When lower highs are being made it suggest sellers are greater than buyers, at the key levels, and will move price down.

Using my combination of support / resistance levels with structure highs and lows has help me avoid a lot of bad trades with low probability of success.  Understanding it more and combining it with a few other price action tools should help me identify higher probability trade set ups, and then entries with protective stops and realistic limits.

Here is the EURUSD daily chart with key significant highs and lows identified by red horizontal lines and in between structure highs and lows with blue lines.  Below the picture is a definition of how I may use these lines.

  • A support horizontal line is drawn at the lowest low for a chosen time period.  The support level will hold if buyers like this price more than sellers and enter the market taking long positions.  The absence of sellers at this level will move price higher until sellers see a level they like and enter the market.  How do I know, from price action, that buyers are greater than sellers?
    • Knowing that a level has held is not an immediate result.  When price approaches and reach a support level, depending on the time line being used, the first challenge would be to wait for the bar to close, this is where patience and focus is greatly needed.  Once the bar closes, I need to look where it closed.  If price moved and closes below the support level, then this may suggest the level is broken.  This would happen if buyers did not come in and buy at the support level or if they were outnumbered by sellers.  More clues are need to assist in correctly evaluating.  For example, after closing below support, if price moves back up and puts in a new lower high then moving back down to the support level this may suggest the level is broken and price should move further down.
    • If price bounce off the support line and move higher up breaking structure highs and lower-highs then it suggest the level held.  Setting higher lows above the support level is another clue support has held.  Further, indicator tools should become aligned bullish.  If these fail to happen then the support level may become weak and price may break through it when reached again.
  • A resistance horizontal line is drawn at the highest high for a chosen time period.  As price approaches and reaches the resistance level, it will hold when sellers are selling more than buyers are willing to buy, here.  If more people are selling than buying at a resistance level then it should hold and price move down (of course, if this does not happen then buyers are stronger and price moves up, sometimes it is not what happened but what did not happen that can help read price action).
    The further down price moves without significant rallies up shows the strength of sellers over buyers.  If price cannot break and close above the resistance level and then proceed down breaking structure support levels with rallies only producing lower highs, this all suggest sellers are in control and price is likely to move further down.  When this is happening all indicators should read bearish.  If at any time this is no longer true then it may suggest sellers are losing control and buyers may be coming into the market in greater numbers.  This is why patience, focus, and discipline is needed to win at forex; when all three of these are being used it can help to prevent bad wrong trades with low probability.

In Part 2, I will review and discuss the above as it played out in USDCAD Q1, 2013.  I believe this simple tool of drawing horizontal lines and then reading price reaction at them can be used on any trading instrument and on any time frame.  Though, dentifying these levels, especially on higher time frame charts (4-hr to weekly) will aid in analyzing the reliability and limits of price action tools and indicators on lower time frames, 1-hour to 15-minute charts.

NZDUSD Case Study

Price Action Case Study: NZDUSD

June 25th, 2013

The key to synthesizing all of the clues given by price action, from the various time interval charts, is not to focus on the live bar or the recent bars, but to look at what did and did not happen. When all of it is taken into consideration then the fractal harmony between time lines begins to present itself.

In hindsight, I can look at a chart and give a detailed explanation of why and where to take an entry, where to exit, and when not to do something.  With in the explanation, I can give understandable reason to take entries, set limits, where to place stops and how to adjust them accordingly.  The goal is to anticipate these explanations live and execute them as real-time trades.

The difficulty of hindsight analysis is translating the actual time into “real-time.”  When I look at a chart in hindsight and explain what happened, I can do it in a short time, but live is much longer.  Every 1-hour bar has four 15-minute bars, every 4-hour bars has four 1-hour bars and sixteen 15-minute bars.  This takes time to unfold.

It’s easy to say wait until the bar closes but that takes time and patience.  It further takes focus to see if the set up or pattern or trend direction is still valid at the close of the bar.

The purpose of this case study is to learn to read price action and become more aware of why price moves in the big picture.  I am hoping it will serve to help me see and understand the rhythm and purpose of price levels and who is effecting price more, buyers or sellers.

One of the goals is to help develop and train my reticular activating system (RAS).  If I can train my RAS, I can become more efficient at looking at the charts.  I need a systematic approach in defining what to look for and then determining what to do.  I need to learn to identify and see repeatable reliable price behaviour and when they presents themselves.  A well-trained RAS looking for high probability low risk opportunity will improve my understanding of when to trade and how to manage it.

Trading systematically is reading what has happened then being able to anticipate what may happen next.  Anticipating what happens next may be done through “if then, do this” statements.  Given that this has happened then price may go there and when it gets there expect a result.  The expected result is taking a trade in that direction.

Charts taken Wednesday June 26th:


Explaining the chart images:

Chart 1 is the plain 15-minute chart for NZDUSD.  Included is the 21 EMA and the grey shaded area is 1 full day of trading showing the previous days high and low.  Inside the grey shaded area the horizontal line shows the daily opening price level.

Chart 2 shows how I mark up the chart to read what has and has not happened and what it may mean.  Insightful clues can be gained from knowing what has happened and how it happened.  Reading single events in isolation is not enough to see what is happening.  Each event is a piece of a puzzle, forming a pattern, and they must all be read together for potential clarity in price direction.

I will review what has happened going from left to right:

  • At the extreme left, a channel is formed.  While the channel was live there were very little to suggest which way price would break.  In this case, price broke to the downside closing both below and the channel and the 21 ema.  This leg down also closed below structure indicated by the blue line (BSD, break structure down).
  • From the channel break, I could conclude the bears are in control and therefore look for short trade entries.
  • After trading and closing below the recent structure level it rallied back up to the 21 ema leaving a bearish pin bar right on the 21 ema line.
  • Bringing in all of this together presented a high probability low risk short trading opportunity.  That is, price broke down outside of the channel, close below structure low and all below the 21 ema.  This suggest that sellers are stronger than buyers and price needs to drop further down before buyers become interested in buying.  It’s low risk as stops would go above the channel high but early clues to exit and adjust would be if and when price broke above and closed above the identified pin bar on the 21 ema line.
  • Off this initial entry price drops sharply 30 pips before rallying back up to the 21 ema, again.
  • At the second rally to the 21 ema price touches the line 3 times without going to far above it or even closing above it before dropping 50 + pips.
  • The termination of this down moves ends at a perfect Fibonacci 1.618 extension drawn from bear pin bar down to the bottom of the 30 pip drop and back up to the pin bar high.  The termination point also leaves a bullish pin bar but this is not the defining signal that the down move is over as price is still below the 21 ema and in a down channel.
  • Insightful clues that the down leg is over starts to present itself when price bounces off the 21 ema but cannot produce a new LL.
  • After the higher low is put in price rallies quickly with a small size impulse bar (IB) and closes above the 21 ema.  It then drops down but failing to close below the small IB and produce a new HL.  Still there is not a clue to take a long entry.
  • The signal for a long entry does not come until after the big impulse bar that moves price all the way up above the earlier channel starting off these swings, the drawn in upper red horizontal line at 0.77826.
  • An aggressive entry could have been after seeing a close above the 21 ema or on the big IB bar as it starts to move up into an area it should not be if sellers were still in control.
  • A safe systematic entry could be seeing the big IB move, drawing in fib retracement and then waiting for price to show bullish tendencies at either the .382 or .618 levels.
  • In this case the bullish buy signal came at the .618 level.  It is a little tricky to see but this is where patience, focus, discipline, belief, and confidence is important.  At the .618 level price break below the 21 ema but cannot produce a new LL or get down below the IB bar.  When it break back above the 21 ema it suggest that the retrace is over and will continue back up.  Stops would go below the cluster at the .618 level or below the IB bar.  Target would be back up for a double top where the strong resistance boundary is.  Trade to boundaries!
  • The second half of the chart shows very similar pattern as the first, like a pattern repeating itself-fractal!
  • Quickly: from the resistance boundary price retrace and puts in a structure low moving up but failing to break the previous high leaving a LH.
    • From the LH price moves down and breaks the recent structure put in place and closing below the 21 ema.  Price then rallies back to the 21 ema which is aligned with structure.  It then drops 40 pips down putting in a HL failing to establish a new LL.
    • From the HL it moves up breaking and closing above the 21 ema then moving back up to the resistance boundary high.
    • This time price closes above the HH but on the 15 minute chart.  A fractal pattern may be presenting it self between the 15-minute and the 1-hour charts.  After setting this HH and breaking structure up price sharply drops down to the previous higher low (HL).
    • Again, do not trade at boundaries until they have been clearly been broken and in sync on a couple of time lines.

Chart 3.  Combing the 15-minute chart with the 1-hour chart begins to show fractal harmony and boundaries of moves.

  • Displays the same price action from the 15-minute chart but in 1-hour candlestick format.
  • The important key here is to see the down channel suggesting a down trend is in play and remains in play.
  • The second key is to see the range trading developing, possible trades at boundaries.  Long trades at the bottom of the box and short trades at the top.
  • No trend reversal, to the upside, until price breaks above and out of the box.

Structure support / resistance, 21 EMA

Using structure support and resistance levels to determine if break of 21 ema indicates a trend change

Thursday, USDJPY, Update:

  • No Lower highs has been broken and price is trading below the 21 ema.  A new LL has been set.
  • Price had a .382 retrace up but nearing a near perfect .382 AB=CD completion.

Tuesday, USDJPY, 2-hour chart

  • USDJPY has been on bullish upward trend since October 2012.  However, the last three weeks or so price has been moving down almost an 800 pip drop.   When will the fall stop, turn around, and head back up?
usdjpy 2 hour chart 21 ema
Trend Trading using the 21 EMA
  • One the chart above, I can see price moving down and the 21 ema is following behind it.  A few times price has broken above the 21 ema line but only to resume its bear trend further down.

Why?  How to determine when a 21 EMA break signals a trend turn around?

  • The best answer is to look at structure support and resistance as defined by LH and LL, in this case.
  • When price break above the 21 EMA, I need to ask: “did it also break an earlier lower low resistance and or a LH.”

So, from the above chart

  • at the blue line labelled structure res 1, as price broke above the 21 ema it did not also move up past the structure res 1 level.  For a signal to be valid that price is going to turn around and head further up this level needs to be broken, as well.  It did not, the structure res 1 held, and price moved further down with the 21 ema nicely behind it all the way.
  • Similar scenario at structure res 2.  Priced moved down further pulled back up and closed above the 21 ema line but could not break the previous LL support now turning resistance.  For price to have pulled further back up this level would need to be broken.
  • Again, the same pattern played out at structure res 3.  Priced moved further down setting a new LL then pulling back up and breaking the 21 ema line and trading above it until it reached the previous LL support now turn resistance.

This pattern will continue until the 21 ema is broken along with a previous support turn resistance and Lower High all have break and close above.

Yes, one may say there were pips to be gained after price broke the 21 ema.  This would be true but that would be counter trend with bigger riskier stops.  The higher probability lower risk trade may be taking trend continuation trades at the resistance level.  And, I prefer to have multiple reasons to take a trade.  Breaking the 21 ema is not enough by itself.

Trade Levels Not Individual Bars or Price

Interpret Price at Key Reference Levels Not at Tick-by-Tick Price.

Identifying key identified price levels in advance will help me understand the direction price wants to go.  When looking at a chart to see what is happening or not happening I must have a frame of reference.  The live bar is only useful in relation to established significant qualified levels, is price moving towards or away from a level.  Chances are if it’s not going towards one level then it’s going to the other.  Those levels can be support or resistance areas, higher highs, lower highs, lower lows, higher lows, and or Fibonacci retracements or extension areas.

Things to identify on a chart:

  • Current and recent impulse legs. Ideal impulse leg is from a LH to a LL and HL to HH with stong bars majority being of the same colour.
  • Fib retracement levels of impulse legs and adjusted as the leg lengthens.
  • Fib extension levels, drawn once a strong key fib retrace level has been hit, especially, .382 and .618, or  a full retracement has occurred.
  • Horizontal lines at support and resistance levels.

 

To test this idea, below I have placed the 4-hr chart for AUDUSD, USDCHF and GBPUSD with identified levels and marked areas for possible trades.  I will update each of these charts after the close on Friday or if levels achieved before then.

Identifying levels and key structure areas should help the worry and uncertainty of trading, but more importantly give me defined things to look for on a chart.

AUDUSD

AUDUSD 4 HOUR CHART
AUDUSD after rate decision, which sounded bearish, price has been dropping sharply after the pre rate announcement rally. Nearing ABCD completion at Fib Extension levels and approaching Key support from Oct 2011

USDCHF

usdchf 4 hr
USDCHF possible short trade at resistance region or long if it drops down to 1.618 which also align with structure support.

GBPUSD

GBPUSD
At .618 level which aligns with a structure Lower High. Look for reversal signal to short

——————————————————————————————————————

UPDATE

AUDUSD Update

Trade levels not bars
Was looking for buy signal at Fibonacci extension confluence.  Buy entry could have been on 1.414, 1.272 confluence but the safer entry would have been on the break above the down pin bar.  Targets could be .382, .618 and or the 21 EMA which is not shown on the chart.  It looks like price has more to rally up.  I don’t expect .618 to hold if retested.  Looking now for a double top to .97931 but must wait for up rally continuation signal on lower time line (1 hour chart).

USDCHF Update

Fib Extension confluence did not hold
USDCHF. In this case Fib extension confluence did not hold BUT price did not rally up to the identified Resistance level suggesting it had more down side to go.  It went down to a double bottom on the previous HL that produced the most recent HH for a full retrace.  This may still have more to go down but both Long and Shorts should be considered closely with patience until near term structure levels have been broken.

GBPUSD Update

GBPUSD 4 hr chart
GBPUSD has had a nice stair step rally up to a previous HH breaking and closing above it.  The entire move up has not had a structure level broken or tested to the down side.  This rally may have more to go.  Look for possible entries on the immediate leg .382 retrace but up signals must present on lower time lines.  If price does retrace further down a better entry might be at a .382 / .618 confluence lining up with a previous LH level.  Both the 21 EMA and Ichimoku is strong Bullishly aligned.

Counter trend trade below BIG support area, high confluence zone

Since the beginning of May AUDUSD has been dropping almost vertically about 800+ pips.  On the most recent down leg, after seeing a pullback wave up to the .618 level I drew a few Fibonacci expansion points using a couple of different levels.  This presented an excellent reversal entry zone to trade up, counter trend.

Intraday price moved below the strong support of .95821 however price stalled at a couple Fibonacci extensions levels.  I drew a Fib inversion from C to B and back up to C plus an fib extension of A to B then back up to A.  Using both extension and inversion created a confluence area of a possible rally up.

Confluence zone counter trend trade
Confluence zone for counter trend trade & Structure break entry
  • The were several entry areas.  The aggressive low risk entry was the 1.618 inversion of the C-B points as priced rally sharply from there.  The 1.618 was just above the A-B extension point of 1.414
  • On the Hourly chart there was a loose 3-drive step down to get to the 1.618 inversion.
  • Another possibly more safe entry could have been the open after the hourly bar closed which touched the 1.618 level.
  • Another entry would have been to wait for recent structure levels to be broken (closed above) then look for an ideal entry.  This is safe but presented a bigger stop value as stops would need to go below the days lowest low, about 65 pips away.
  • Target would be a .618 retrace of the recent down leg.

NOTES

  • I identified and drew the possible reversal zones around 5pm EST.  Therefore, it took 9 one-hour bars before the lowest low was reached.  Further, once price moved into the fib extension regions, below 1.272 level, it took 7 one-hour bars before the 1.618 level was touched.
  • This is important to know, when trading live as Forex trading is all about waiting and knowing what is going on.  The key is patience, focus and discipline.
  • This is easy after the fact but, live, the .382 level look liked a good resistance level as it was aligned with a former support area, point B.
  • It is important to see that the structure level was taken out on the 4am EST bar, it closed above the previous 8 one-hour bar highs.