Stage 3: Distribution phase
Distribution usually occurs after a rise in prices and looks like a consolidation period.
Characteristics of distribution phase:
- It usually occurs when prices have risenover the last 6 months or more
- It looks like long period of consolidation during an uptrend
- The 200-day moving average tends to flatten out after a price decline
- Price tends to whip back and forth around the 200-day moving average
It looks something like this:
Stage 4: Declining phase
After price breaks down of the distribution phase, it goes into a declining phase (a downtrend) and consists of lower highs and lows.
This is the stage where traders who do not cut their loss become long-term investors.
Characteristics of declining phase:
- It usually occurs afterprice breaks out of distribution phase
- Price formsa series of lower highs and lower lows
- Short term moving averages are belowlong term moving averages (e.g. 50 below 200-day ma)
- The 200-day moving average is pointing lower
- Price is belowthe 200-day moving average
It looks something like this…
So, you’ve learnt what are the 4 stages of the market, and the key characteristics to look out for.
Now, let’s move onto the next section…
How to tell when the market is trending
There’s a famous Wall Street saying that goes like this…
Question: What is the trend of the market?
Answer: What is your time frame?
What does it mean?
This means there are trends on different time frames. You can have a downtrend on 5 minutes chart and an uptrend on a daily chart.
Here’s an example…
So, you’ve understood that trends can exist in different time frames.
Now… let’s learn how to define a trend objectively.
There are two ways you can go about it:
- Structure of the markets
- Moving average
Structure of the markets
The market is in an uptrend when there’s series of higher highs and higher lows.
Likewise, in a downtrend, there’s a series of lower highs and lower lows.
Alternatively, you can use a moving average to define the trend.
Here’s how you can do it:
- 20 ema – Short term trend
- 50 ema – Medium-term trend
- 200 ema – Long term trend
If 20 ema is pointing higher, and the price is above it, then the short term trend is up.
If 50 ema is pointing higher, and the price is above it, then the medium-term trend is up.
If 200 ema is pointing higher, and the price is above it, then the long-term trend is up.
Let’s look at a few examples:
Now, let’s learn how to identify a range market…
How to tell when the market is ranging
A range market is contained between Support & Resistance.
A textbook example looks something like this:
Now, before the light bulb in your head goes off with “buy low and sell high”, I want you to see the reality of trade range markets.
Because in the real world, you get variations like:
- Range expansion
- Range contraction
This occurs when the market does a false breakout and trades back into the range. Thus expanding the “space” between Support & Resistance.
Selling at resistance would get you stopped out, as price breaks above the resistance, only to trade back into the range.
This occurs when the market enters a period of low volatility, usually due to an impending major news release.
Looking to “buy low sell high” would put you on the sidelines as the markets went into a tighter consolidation.
Here’s what I mean:
Personally, I find range expansion and contraction one of the hardest markets to trade, and I usually stay out of it.
Now, let’s move onto something interesting…
How to read the price action of any markets (and determine the strength and weakness of it)
Here are the things I look out for:
- Slopeof impulse moves getting flatter
- Candlestick bodiesgetting smaller on impulse move
- Slopeof corrective move getting steeper
- Candlestick bodiesgetting larger on corrective move
Slope of impulse moves getting flatter
Candlestick bodies getting smaller on impulse move
Slope of corrective move getting steeper
Candlestick bodies getting larger on corrective move
Here’re a few examples to walk you through…
A-Start of the move downward, look at the slope and length of the move
B-Corrective move called as retracement
C-A move downward, but candle size getting smaller compared to the previous impulsive more
D-A very small correction, signalling a move to support is imminent
E-Price moved to the support with this impulsive move and formed a dozi(I will explain it later)
F-Correction is almost 100%, signalling that move is almost done but we might retest the support, which often is the case
G-Tried to moved down, but failed, as bulls are getting stronger
H-Tasted the high of F
I-Very slow move to the support, you can see there are small corrective move and impulsive move within this down move, which is the indication of bears losing momentum.
J-Again a doji and start of the upmove begins, slope of the corrective move is more than 45 degree.
K-Very small correction, bears have died and bulls are coming strongly.
L-Very close to the previous high of corrective move F,
M-Same as K.
N-Broke the previous high of corrective move F, Bulls are in full control
The downtrend is getting weak. Support comes in around 230 which is a strong line of defence for the bulls.
I will look to long or stay on the sidelines. No shorting at this point.
With the retest of support and formation of doji confirms that Bulls are gaining control and an upmove is imminent.
A-Corrective move after an strong impulsive move.
B-Price couldn’t travel much higher compared to previous impulsive move.
C-50% correction of the move B
D-Look at the slope, it seems like flattening out, but we can’t say bulls are done yet, as high is still higher the previous swing high.
E-Almost 60% correction, signalling bearish pressure is getting weaker.
F-Very flat move and into the resistance and topped by a doji, showing strong downward pressure.Bears are getting ready and can pounce anytime.
G-Look at the candle size, bears have come and want to take price down.
H-Last attempt by bulls to take price higher but they failed and now bears are in full control.
Bulls were in full control upto the resistance area, as the price reached resistance area bears pounced, I will go short at swing high after corrective move H.
For further readings, I would recommend the works of Lance Beggs.
Now, let’s move onto the topic of candlesticks…
Stop memorising candlestick patterns, you only need to know these 4 things
- Length of the wick
- Size of thebody
- Close of thecandle
The wick of the candle represents price rejection. If you see a longer wick, it represents greater price rejection.
Here’s what I mean:
Length of the wick
When you see wicks “flying” all over your charts, you’re probably in a “choppy” condition (usually in a range market).
And when you get little to no wicks, you’re probably in a “cleaner” condition (usually in a strong trending market).
Size of the candle
The easiest way to identify momentum in the markets is, to look at the size of the body.
A large body shows greater momentum, and a small body shows a lack of momentum.
Close of the body
To identify who’s currently in control, you’d want to see where the candle closes.
If it closes near the highs, the bulls are in control.
If it closes near the middle, the market is undecided.
If it closes near the lows, the bears are in control.
So, are you pumped right now?
Because you’re going to learn something really cool…
Advanced candlestick knowledge (that nobody talks about)
I used to get excited when I spot a candlestick pattern that I memorised.
“Look, a shooting star! The market is heading lower for sure!”
And it rallied 30 points.
Instead of “copy-pasting” what individual candlestick means, I’ll go deeper into it.
I’ll explain to you how not to trade them, how to trade them, and other variations of it.
Here’s what you”ll learn:
- Inside bar
- Rising three method
- Wide range candles
- Narrow range candles
A Pinbar is a reversal pattern, which was first introduced by Victor Sperandeo, in his book, Trader Vic: Methods of a Wall Street Master.
The key takeaway about this pattern is price rejection.
Bullish Pinbar – A small bodied candle with a long lower wick, showing rejection of lower prices.
Bearish Pinbar – A small bodied candle with a long upper wick, showing rejection of higher prices.
Just because you see a bearish Pinbar, doesn’t mean price is going to trade lower.
In fact, it’s usually just a retracement within a trend.
Here’s what I mean:
Do not “blindly” go short when you see a bearish Pinbar or go long when you see a bullish Pinbar.
Chances are, it’s a retracement within a trend.
Here’s what you should do instead:
- In an uptrend, only trade bullish Pinbar at an area of support
- In a downtrend, only trade bearish Pinbar at an area of resistance
Following these simple rules, you’ll greatly increase the odds of your trade working out.
Look at this:
The Pinbar shows price rejection on the charts.
But, there are more than one ways to show price rejection, and it may not come in the form of Pinbar.
…if you’re only focusing on Pinbar trading setups, then you’ll miss trading opportunities like these…
Another variation of Pinbar is the Engulfing pattern.
If you think about it, Pinbar is actually an Engulfing pattern on a lower time frame.
Image from Tradciety
Price rejection can come in many forms. You should focus on price, not the pattern.
It can be both a continuation and reversal pattern (I’ll focus on continuation pattern).
The key takeaway about this pattern is low volatility. Thus, you can get an entry with tight stops on this pattern (and improve your risk to reward).
Inside bar – Small candle contained within the previous bar highs and lows
How not to trade it?
Most traders would trade the break of the Inside bar, hoping to capture a quick profit.
In a choppy market, the lack of momentum usually results in many losses (so it’s best to avoid choppy markets).
Here’s an example:
The best Inside bar setups occur when:
- Price breaks out of a range with strong momentum
- It’s a strong trending market
- Trading in the direction of the trend
Here’s what I mean…
Another variation of the Inside bar is coined the “Fakey”, by Nial Fuller.
It’s when the Inside bar breaks out in one direction, only to reverse and close in the opposite direction (otherwise known as a false breakout).
Here’re a couple of examples:
Look how Fakey setsup perfectly in the downtrend, it broke on the wrong side and into support turned resistance, perfect way to go short on the break of the inside bar on the downside.
Price action patterns — Rising three method
This pattern was first introduced by Steve Nison, in his book, Japanese Candlestick Charting Techniques.
The main idea of this pattern is trend continuation.
Rising three method – This is a bullish trend continuation move, with three bearish candles as a retracement in an existing trend. Then a bearish candle closes lower, signalling the bears are back in control.
Falling three method – This is a bearish trend continuation move, with three bullish candles as a retracement in an existing trend. Then a bullish candle closes higher, signalling the bulls are back in control.
Here’s the thing:
By waiting for this precise pattern to occur, you’ll not get many trading setups (following an exact 3 candles pullback).
So… what other patterns can you trade?
If you think about it, another variation of this pattern is the flag or pennant formation.
Here’s what I mean:
Price action patterns — Wide range candles
A wide range candle is formed due to an imbalance of buying/selling pressure.
This represents “hidden” Support & Resistance in the markets (known as Supply & Demand by Sam Seiden)
Here’s what I mean:
There are traders who swear by Supply & Demand, and some who do just fine, with Support & Resistance.
Here’s the thing…
You don’t want to trade them in isolation, but use them with other technical tools, that add confluence to your trades.
Price action patterns — Narrow range candles
If there is a sudden range expansion in a market that has been trading narrowly, human nature is to try and fade that price move.
When you get range expansion, the market is sending you a very loud, clear signal that the market is getting ready to move in the direction of that expansion. – Paul Tudor Jones
What does it mean?
Simply put, when you get series of narrow range candles (volatility contraction), get ready for an explosive move. (These findings can be validated by the works of Adam Grimes, Tony Crabel, and Mark Minervini.)
Here’re a few examples:
So, what’s the best way to enter such trades?
You can look to trade the initial breakout or the pullback after the breakout.
The last thing you’d want to do is trade against the breakout.
Let’s move on…
A price action trading strategy that works
Here’s what you need to do:
- Mark your areas of Support & Resistance (SR)
- Wait for a directional move into SR
- Wait for price rejection at SR
- Enter on the next candle with stop loss beyond the swing high/low
- Take profits at the swing high/low
Here’s an example…
Mark your area of Support & Resistance
Wait for a directional move into Support or Resistance area
Wait for price rejection at Support or Resistance area
Enter on next candle with stop loss below the swing low
Take profits at the swing high
You can consider taking half your position off at the nearest swing high, and the remaining at the further swing high.
This depends on your trade management.
This is important…
You must understand the trading strategy isn’t the holy grail.
In fact, you’re going to have both winners and losers. And the only thing that will keep you in this game is proper risk management. My advice is to risk no more than 1% of your account on each trade.
Here are more examples of the price action trading strategy:
So, what’s next?
You’ve just learned what price action trading is all about, and how you can use it and to get a “feel” for the markets.
If you learn it well, it will improve your entries, exits and trade management.
Now… it’s time to put these techniques into practice.