Commander in Pips: So, we’ve learned the basics of all these lines – support, resistance, trend lines and channel, now it’s time to talk about their application in practice…
Pipruit: At last – practice… This word makes my heart tremble with joy.
Commander in Pips: As we already know any line can provide either support or resistance initially. Hence there are only two major price behaviors are possible after it has reached the line – bouncing from it or breaking it. But first, memorize this very important notice:
Notice:
We strongly do not recommend that you use any line types as a single context for trading. You should use lines as an additional tool in an overall trading plan and trading context.
This will become clearer, when we will study all the other tools and provide an algorithm on how to create a trading plan and what parts it should contain. But currently just remember, that it is better not to make trades that are based only on lines.
Pipruit: Ok, thanks
Commander in Pips: So, as we’ve said market can pull back from the line or break it, so let’s take a look at these possibilities closely:
Pullback or Bounce
As you understand, this kind of scenario assumes that the line will not be broken and will hold the price action. But who knows this ahead of time? Yes, you see the line, and know about the price level, but will it hold or not? – nobody knows in advance. So, what do you prefer? – enter to the trade right from the line without knowing – will it hold or not, or wait some confirmation of strength?
Pipruit: I think to wait a confirmation is safer. But will the enter price for both scenarios be the same?
Commander in Pips: No, they will not. Confirmation suggests that you enter the trade after the bounce from the line with worse price, but with higher probability of profit.
Pipruit: Once we’ve pointed that trading should be made in terms of probability. The first entry – without confirmation reminds me of a slice & dice game, but entering after the bounce is a logical entry. Besides, the fact that I’ve entered with a bit worse price does not mean that I will take a loss. So, I choose the second way – after confirmation.
Commander in Pips: You’re absolutely right. Entering after confirmation is much safer and has more chances of success, than entering ahead of the market. Do not ever try to predict the market – wait for when the market itself will show you what it intends to do. There is a proverb – “it is unwise to run ahead of a train”. In this meaning entering before a confirmation is equal to catching the falling knife. And this is really more gambling than trading. Trading is a business – not a gamble.
Take a look at the #1 chart – this is 60-min EUR/USD. Here we clearly see a support line, and let’s assume that we want to buy here. I’ve marked two ways of possible entering. The first way – is to enter without confirmation (short blue line) and the correct entry is the green line. The stop loss order is marked by red line. So, you can see that let’s call it as “gamble entry” has some advantage in price level, compared to “Proper entry” – but both positions will make profit from this trade.
Pipruit: Well, Commander, your speech is confusing me – once we’ve said that we should not enter without confirmation, and here you show that this position has advantages in price level – because “Gamble entry” got in at a lower price, hence the profit will be greater than from “Proper entry”.
#1 EUR/USD 60-min
Commander in Pips: Hold on, son – I’ll show you. Now take a look at the #2 chart. In fact, this is the same chart, but let suppose, that we intend to sell from resistance. See – “Gamble entry” has taken place and very quickly turns to loss, because the market has hit the stop-loss order. The “Proper entry” hasn’t taken place at all – there was no bouncing, i.e. confirmation of this trend line, so you just did not entered into this trade and saved your money!
Commander in Pips: And now just imagine these two ways of entering with multiple times – who do you think, who will gain more – a trader that uses “proper entry” or “gambling trader”?
Commander in Pips: Delighted!
Commander in Pips: Well, later we will learn more tools and how to use them to increase our confidence around support and resistance levels. Second – use the rules that we’ve discussed in previous chapters about different line types. Third – the probability of a breakout always exists. Remember this one – “The market is always right”. It means that although our tools are significantly increase our chances of success, still there could be failures and losses not because you’ve done something wrong, but because this is a probability. Losing trades is a part of this business.
A good trader is the person who makes less mistakes but not the person who never makes mistakes at all.
Ok, as a summary to our discussion of possible entry at bouncing we have to say:
The major task at of any trade – is to shift the probability in our favor. Second – always remember that trading is not gambling. If you do something – you have to have a context and logical basis to do it. No trade should ever be done for an adrenaline rush.
So, using the confirmation and “proper entry” after the bouncing is a tool of shifting the probability in our favor. The point is that the market itself shows us the strength of some line, with price bouncing from it. You should open a position after the bouncing – with this approach you avoid loss in numerous situations when the market falls like a stone and breaks the lines. If you will not follow to our advice – you can get really hurt by catching the falling knife.
Breakout of the Lines
As you understand nothing lasts forever, even lines. They have a tendency to be broken by the market price action… very often.
So, here we will discuss how we can act in this scenario.
The first way to trade it is simply enter the market after a breakout when the price has moved through the level for a solid distance. Here is an example - this is the same chart as #2, but for our purpose here we want to buy if upper breakout of resistance line will take place:
Commander in Pips: Well a lot of blurring details, such as:
1. How much should be a “Solid move” after breakout?
2. When the market just explodes as on chart #3 – you will have to jump onto a running train. The stop order has been placed too far – this is a significant risk.
3. Remember what we’ve talked about Wash&Rinse patterns – in fact, failure breakouts happen much more often than real breakouts.
Take a look at chart #4 - you will understand it fast:
Commander in Pips: First of all, remember the rules of breaking support and resistance levels – application of close price and the 3-period rule. These rules are absolutely suitable for estimation of breakout reality.
Commander in Pips: Yes, second – as we said, appearing of a Wash & Rinse pattern tells us that the market is ready for move in the opposite direction. We should not sell here, but buy. W&R confirms the strength of the line! We’ve talked about it in detail in previous chapters.
Commander in Pips: Well, in fact you may. Some traders call this type of breakout trading as “Aggressive”, but we can’t agree with it. Because this type of breakout trading has not impressive probability to success and too far stop orders, that lead to much greater risk. This combination seems to us as “Not logical”, so our preferred way to trade the breakouts is the next one as on chart #5:
1. You do not need to guess about “solid move after breakout”
2. You have a confirmation from the market by failure to return right back above the line
3. You have a better opportunity to place your stop loss order and your stop loss order is tighter to significantly reduce risk.
4. Very often your entry level will be better compared to entering with the initial breakout (try to find entry level according to the first type entering – and you’ll see. Besides, there is a probability that with first type of entering your stop loss could be triggered precisely during the pullback. So you could be stopped out at the moment where you have to enter the trade and not to exit...)
5. All you need to succeed in this kind of trades – is a bit patience to wait the right moment to enter the market.
Commander in Pips: Yep, this is it! Also, here you can see how a support trend line becomes a resistance line after breakout…
Commander in Pips: Ok, what do you want – trade all trades that you can ever find or to make money?
Commander in Pips: So, what is the question then, son? If the risk is too much – just skip the trade and calm down – your money is still with you and you always can find another possibility to trade, but with better initial conditions.
Remember this excellent proverb by the famous trader Joe DiNapoli:
1. Again, we do not recommend to trade breakouts as on chart #3. If you will trade it in such manner still – do it only with stop loss order in place. A stop loss order is a must here. And strictly apply money management rules that we will learn later.
2. Our preferable way to trade breakouts is as on picture #5. Take a note, the market does not always behave like that – sometimes it can just run through the level without any pullback. So, here you have the chance of safer trades but with a risk to not be filled if market will not return back to the line. Other words, you can miss this trade, and it can happen very often.
3. But we think that this is OK, due to very good market philosophy: “Loss of opportunity is preferable to loss of capital!” Because you enter the market not just to trade, but to make profit.
4. Needless to say that here a stop loss order is also a must.
Commander in Pips: Hold on, son – I’ll show you. Now take a look at the #2 chart. In fact, this is the same chart, but let suppose, that we intend to sell from resistance. See – “Gamble entry” has taken place and very quickly turns to loss, because the market has hit the stop-loss order. The “Proper entry” hasn’t taken place at all – there was no bouncing, i.e. confirmation of this trend line, so you just did not entered into this trade and saved your money!
Pipruit: Cool stuff. I see.
Commander in Pips: And now just imagine these two ways of entering with multiple times – who do you think, who will gain more – a trader that uses “proper entry” or “gambling trader”?
Pipruit: Ok, I’ve got it, Sir. Now, I’m sure that I have to rely on “Proper entry” and “Gamble entry” will be beyond the law for me. Please hit my hands, if I’ll break this rule.
Commander in Pips: Delighted!
#2 EUR/USD 60-min
Pipruit: But only one question, Sir – even when we see the bounce and confirmation with close price after it, how we could be sure that this is a true bounce and that the market will not return to the downside again?
Commander in Pips: Well, later we will learn more tools and how to use them to increase our confidence around support and resistance levels. Second – use the rules that we’ve discussed in previous chapters about different line types. Third – the probability of a breakout always exists. Remember this one – “The market is always right”. It means that although our tools are significantly increase our chances of success, still there could be failures and losses not because you’ve done something wrong, but because this is a probability. Losing trades is a part of this business.
A good trader is the person who makes less mistakes but not the person who never makes mistakes at all.
Ok, as a summary to our discussion of possible entry at bouncing we have to say:
The major task at of any trade – is to shift the probability in our favor. Second – always remember that trading is not gambling. If you do something – you have to have a context and logical basis to do it. No trade should ever be done for an adrenaline rush.
So, using the confirmation and “proper entry” after the bouncing is a tool of shifting the probability in our favor. The point is that the market itself shows us the strength of some line, with price bouncing from it. You should open a position after the bouncing – with this approach you avoid loss in numerous situations when the market falls like a stone and breaks the lines. If you will not follow to our advice – you can get really hurt by catching the falling knife.
Breakout of the Lines
So, here we will discuss how we can act in this scenario.
The first way to trade it is simply enter the market after a breakout when the price has moved through the level for a solid distance. Here is an example - this is the same chart as #2, but for our purpose here we want to buy if upper breakout of resistance line will take place:
#3 EUR/USD 60-min
See – after the breakout, the market never returns back to the trend line and particular this trade has finished with a profit. Sometimes this happens, but this way of breakout trading is not our favorite one…Pipruit: And what’s wrong with it?
Commander in Pips: Well a lot of blurring details, such as:
1. How much should be a “Solid move” after breakout?
2. When the market just explodes as on chart #3 – you will have to jump onto a running train. The stop order has been placed too far – this is a significant risk.
3. Remember what we’ve talked about Wash&Rinse patterns – in fact, failure breakouts happen much more often than real breakouts.
Take a look at chart #4 - you will understand it fast:
#4 EUR/USD 60-min
Pipruit: Ok, I’ve got it. So what we should to do then, how to trade breakouts?
Commander in Pips: First of all, remember the rules of breaking support and resistance levels – application of close price and the 3-period rule. These rules are absolutely suitable for estimation of breakout reality.
Pipruit: Yes, I think that will help. Applying the 3-period rule I do not enter the trade on chart #4, because the market shows only 1close below the trend line.
Commander in Pips: Yes, second – as we said, appearing of a Wash & Rinse pattern tells us that the market is ready for move in the opposite direction. We should not sell here, but buy. W&R confirms the strength of the line! We’ve talked about it in detail in previous chapters.
Pipruit: So, should I never trade breakouts in this way, or what?
#5 GBP/USD Weekly
Here you can see how after the breakout, the market retests broken support of the up channel. When you see that the market confirms it failing to return right back (above the support) and capitulates – you enter short (i.e. Sell). Here you have some major advantages compared to the first way of breakout trading:1. You do not need to guess about “solid move after breakout”
2. You have a confirmation from the market by failure to return right back above the line
3. You have a better opportunity to place your stop loss order and your stop loss order is tighter to significantly reduce risk.
4. Very often your entry level will be better compared to entering with the initial breakout (try to find entry level according to the first type entering – and you’ll see. Besides, there is a probability that with first type of entering your stop loss could be triggered precisely during the pullback. So you could be stopped out at the moment where you have to enter the trade and not to exit...)
5. All you need to succeed in this kind of trades – is a bit patience to wait the right moment to enter the market.
Pipruit: Looks like this is what you are named as “Kiss goodbye”?
Commander in Pips: Yep, this is it! Also, here you can see how a support trend line becomes a resistance line after breakout…
Pipruit: But, Commander, the market does not behave in such a way all the time. What will happen if it will not retest this line and just continue its move to the downside, like on chart #3?
#3 EUR/USD 60-min
Commander in Pips: You’re right in this case you will skip this trade – because you will not have an area and reason to enter. Definitely speaking, your entering order will not be filled, because the market will not reach it.Pipruit: But I don’t want to skip trades!
Commander in Pips: Ok, what do you want – trade all trades that you can ever find or to make money?
Pipruit: Make money…
Commander in Pips: So, what is the question then, son? If the risk is too much – just skip the trade and calm down – your money is still with you and you always can find another possibility to trade, but with better initial conditions.
Remember this excellent proverb by the famous trader Joe DiNapoli:
“Loss of opportunity is preferable to loss of capital!”
Commander in Pips: Ok, as a summary to trading of breakouts I want to note follows things that are exceptionally important, to my mind:
1. Again, we do not recommend to trade breakouts as on chart #3. If you will trade it in such manner still – do it only with stop loss order in place. A stop loss order is a must here. And strictly apply money management rules that we will learn later.
2. Our preferable way to trade breakouts is as on picture #5. Take a note, the market does not always behave like that – sometimes it can just run through the level without any pullback. So, here you have the chance of safer trades but with a risk to not be filled if market will not return back to the line. Other words, you can miss this trade, and it can happen very often.
3. But we think that this is OK, due to very good market philosophy: “Loss of opportunity is preferable to loss of capital!” Because you enter the market not just to trade, but to make profit.
4. Needless to say that here a stop loss order is also a must.
:):):)