Today’s update will be a little different, instead of the normal stuff we’re going to solely focus on trading, price action, and price action patterns.
Trading repeated price action patterns:
The topic of price patterns and probabilities came up in our chat today and a few traders asked me to expand on what I was saying and explaining. I want to use today’s update to cover some actual aspects of trading and trading techniques that I use, specifically the price pattern aspect. Time and space will not allow me to get too in-depth on this stuff but I want to cover some of the basics here for the benefit of those traders who really want to learn for themselves.
On a trade day like today with the various ECB rhetoric, better than expected Eurozone and UK data, and then the plunge on Wall St., the Forex market ran wild from as soon as London opened right through the mid-afternoon NY session. The beautiful thing about today was the irrationality and emotions of market participants contributed to a strong degree of volatility and larger price swings which allowed for several tradeable price actions to form.
Before we cover an actual price action pattern that played out today and that was used for trading, I want to lay the ground work by explaining a few personal theories and philosophies on price action, patterns, and how they all connect together.
Price action–
The term price action has been growing in popularity in the trading world in recent months and everybody seems to have their own definition and application for the term. In my view price action is not an activity but a cause-and-effect event that occurs in the market at any given moment, and this cause-and-effect event is just the sum of its individual components. These components are:
- Velocity
- Momentum
- Speed
- Degree
- Direction
- Path of least and or most resistance
Combine all six of those components and what you get is an event which enables price to change, move, and flow at any given moment, in any given direction and at any given time. When I’m trading and watching the price action what I am really doing is using those six components to deconstruct the changes, movements, and flow of price in order to help me formulate an opinion to make a trading decision in the future.
What sets this cause-and-effect event into motion are humans and their emotions. You, I, and millions of others just like us are the ones responsible to set the event of price action into motion at any given moment of the trade day. As long as a living, breathing, and feeling human being has access to the buy and sell button, the price action event will occur to one degree or another. To the degree at which this event occurs, price action will then define itself by the velocity, momentum, speed, direction, and path of least/most resistance, set in motion by the collective buying or selling power of humans who are ultimately driven to make decisions based on two things:
- The opportunity for gain
- The fear of loss
Price action and price fluctuations–
Price is never wrong and price is the only honesty you will ever get in this market because the market itself is never wrong, it cannot be wrong. If the market says the price of the EUR/USD at 1.3594 is too low, is a good value, and should be valued and priced higher, a larger degree of the market will attempt to buy the euro at 1.3594 than what supply would be available to buy at that exact moment in time. More humans believe they can gain by purchasing the euro at that price as opposed to the amount of humans who fear the risk of loss. Conversely, there may be almost just as many humans who believe they can gain by selling the euro at the price of 1.3594. Both sides might be correct, but only the future holds the answer to that question and this is where the two emotions of fear and greed control the decision making once the trade has been made and must be managed by the human who decided to participate at the price of 1.3594.
When the supply of available contracts at the price of 1.3594 cannot meet the demand of bidders who want to buy the available supply at 1.3594, the price changes, it goes up and forces those who wanted it at 1.3594 but didn’t get it at 1.3594 to pay more to get what they want. As long as more humans demand to buy the euro than there is supply at any given price, price will have to go higher, it cannot work any other way. Now this doesn’t mean those humans who thought the dollar was a better value when the euro was at the price of 1.3594 are ultimately wrong, it just means there were more humans who wanted something that was in greater demand but had lesser supply at that given moment in time.
Price exhaustion–
So everything we’ve discussed thus far is what leads up to how tradeable price action patterns develop and are formed. One of my philosophies on price action says that the price of any market, including currencies, will always over-extend and over-exhaust itself to the upside or downside. How this applies specifically to the spot Forex market stems from my belief that a larger degree of retail traders will buy or sell into the final 5% of a market move. The bulk of the buying power that propelled price from the “lift-off” point has either stopped buying or has begun the profit-taking process. Therefore, the demand is lacking to force price higher and lack of demand is one of the main contributing factors leading to price failing to continue higher or lower.
Those market participants who pile into the last 5% of a market move lead price to exhaust itself in addition to the contributing factor of stop loss triggering. When you combine exhausted price and the effect of stop loss triggering, you get an over-extended price that will struggle and then ultimately fail to move beyond a certain point at that given moment in time. Then comes the addition of market participants who believe price is over-valued and the collective buying power of this group of participants contributes to price failing to continue and price will falter and begin to reverse.
Price action pattern formation–
Here’s where another personal philosophy of trading comes into play… I do not believe price action in the currency market actually goes up and down, rather I believe it just goes in a continuous circle. I think the way price is displayed on a candle or bar chart is completely wrong and inaccurate because on a chart price is displayed as moving in an up and down motion which gives the false idea that price has a true starting and stopping point, a top or bottom, or a beginning and ending point.
I believe the price of a currency has no top, bottom, beginning, or end. If a currency did have those things that would mean there’s a starting and ending point, a place where price could ultimately be unable to increase or decline in value; a final resting place. There cannot be an absolute price for any currency purely on the nature of how they are paired together. There is no such thing as a single currency that stands alone, so there cannot be an absolute price because each currency is valued against another.
Just because the EUR/USD went to 1.6048 last July and has not returned there since does not mean the EUR/USD will never go to 1.6049 and beyond. Price is continuously in a state of repeated replication. During today’s trading the EUR/USD hovered roughly between the 1.3550 and 1.3700 level. In 2008 at a certain moment in time it hovered at the same exact levels. In 2007 at a certain point in time it hovered at the same exact levels.
In other words, price has completed a circle of replication and this is exactly where I find price action patterns that have been repeated in the past. Pattern recognition is nothing more than observing the past, analyzing the data from the past, and connecting the past to the present to get a probability on the future when price is in the replication process.
I’m running out of space to continue this commentary but hopefully this gives you some more insight to how I utilize this aspect of trading. I want to finish up by giving you a beautiful price action pattern for the GBP/JPY that formed this morning. This pattern formed today, it’s formed in the past, and based on what the market did every time this exact pattern sequence formed, I was able to make a trading decision with a probability, knowing exactly what to expect because price had replicated itself which gave me a look into the future…
GBP/JPY price action pattern–
As you know my strategy with price action says when the GBP/JPY completes a pattern sequence of at least seven consecutive higher opens or lower opens over seven consecutive 30-minute time frames, there is a high probability the market has exhausted and over-extended itself and I will then play the market against itself, against all those traders who do not understand these concepts and will pile into the last 5% of the market’s move which puts them on the wrong side of the market, ultimately either stopping them out or causing them to take a loss.
Here’s the pattern sequence:
0300 EST – 4718 pip differential of +37
0330 EST – 4773 pip differential of +55
0400 EST – 4840 pip differential of +67
0430 EST – 4862 pip differential of +22
0500 EST – 4887 pip differential of +25
0530 EST – 4905 pip differential of +18
0600 EST – 4920 pip differential of +15
So here we have seven consecutive higher opens and based on this pattern sequence, my trading strategy called for me to take a GBP/JPY short position at the price of the seventh higher open which was 149.20 targeting no less than 80-pips profit. The GJ’s high of the day was around 149.48 if I recall, so what my strategy was showing me the market has exhausted and over-extended by the 0600 EST time frame and any move in price beyond the 149.20 level would only up the probability of a reversal, not a continuation because price would only further exhaust itself.
By 0736 EST the price pattern paid the 80-pips profit and should the trade have been held longer it would have been paid in excess of 250-pips from entry to the low price of the trade day. That pattern sequence above has formed in the past and it will form again in the future because the market will complete the circle of price replication again in the future and when it does, I will get the same exact results unless an unforeseen geo-political event occurs to alter the emotions of humans and their decision making. But even if I did not know this was a replicated price pattern, just based on the sequence and the pip differentials alone I would know it’s time to short, not to buy… but the geo-political factor is a whole other aspect of price action we’ll need to save for another time.
That’s all the time and space I have for now. Don’t forget tomorrow is a huge fundamental day and I expect more volatility and price swings in the market. Key levels will be posted in the morning before Wall St. opens. If you have any questions based on this commentary feel free to ask, whether in the chat or via email, I’m glad to help if I can.
-David
