Chapter 2: Price Action Trading Strategies
#1 - Outside Bar at Support or Resistance
For those unfamiliar with an outside bar, an example of a bullish outside bar is when the low of the current day exceeds the previous day's low, but the stock rallies and closes above the previous day's high. The bearish example of this would be the same setup, just the opposite price action.
outside down day
Therefore, it's not just about finding an outside candlestick and placing a trade. As you can see in the above chart of Cambrex (CBM), it's best to find an outside day after a major break of a trend. In the CBM example, there was an uptrend for almost 3 hours on a 5-minute chart prior to the start of the break down.
After the break, CBM experienced an outside down day, which then led to a nice sell off into the early afternoon.
A spring is when a stock tests the low of a range, only to quickly come back into the trading zone and kickoff a new trend. I like to use volume when confirming a spring; however, the focus of this article is to explore price action strategies, so we will zone in on the candlesticks.
The one common misinterpretation of springs is traders wait for the last swing low to be breached. Just to be clear, a spring can occur if the stock comes within 1% to 2% of the swing low.
Trading setups rarely fit your exact requirement, so there is no point in obsessing a few cents. To illustrate this point, please have a look at the below example of a spring setup.
Spring Example
Notice how the previous low was never breached, but you could tell from the price action the stock reversed nicely off the low and a long trade was in play
#3 - Inside Bars after a Breakout
Inside bars are when you have many candlesticks clumped together as the price action starts to coil at resistance or support. The candlesticks will fit inside of the high and low of a recent swing point as the dominant traders suppress the stock to accumulate more shares.
To illustrate a series of inside bars after a breakout, please take a look at the following chart.
Inside Bars
This chart of Neonode is truly unique, because the stock had a breakout after the fourth attempt at busting the high. Then there were two inside bars that refused to give back any of the breakout gains. NEON then went on to rally almost 20% in one trading day.
Please note inside bars can also occur prior to a breakout, which strengthens the odds the stock will eventually breakthrough resistance.
#4 - Long Wick Candles
Long Wick 1
Long Wick 2
Are you able to see the consistent price action in these charts? If not, were you able to read the title of the setup or the caption in both images?
Just having a little fun here, don't get sensitive.
The long wick candlestick is one of my favorite day trading setups. The setup consists of a major gap up or down in the morning, followed by a significant push, which then retreats. This price action produces a long wick and for us seasoned traders, we know that this price action is likely to be tested again.
Reason being, a ton of traders entered these positions late, which leaves them all holding the bag. The counter pressure will be weak comparatively, so what can't go down must go up again. This leads to a push back to the high on a retest.
That may have been a little tough to follow, so let's illustrate this point through the charts.
Long Wick 3
Notice after the long wick, CDEP had many inside bars before breaking the low of the wick. After this break, the stock proceeded lower throughout the day.
#5 - Measure Length of Previous Swings
Measure Previous Swings
Have you ever heard the phrase history has a habit of repeating itself? Well, trading is no different.
As a trader, you can let your emotions and more specifically hope take over your sense of logic. You will look at a price chart and see riches right before your eyes.
Well, that my friend is not reality. Did you know in stocks there are often dominant players that consistently trade specific securities?
These traders live and breathe their favorite stock. Given the right level of capitalization, these select traders can also control the price movement of these securities.
What you can do to better understand the price action is to measure previous price swings.
As you perform your analysis, you will notice common percentage moves will appear right on the chart. For example, you may notice that the last 5 moves of a stock were all 5% to 6%.
If you are swing trading, you may see a range of 18% to 20%. Bottom line, you shouldn't expect stocks to all of a sudden double or triple the size of their previous swings.
I fully understand the market is limitless; however, it's better to play the odds with the greatest chance versus swinging for the fences. Over the long haul, slow and steady always wins the race.
To further illustrate this point, let's go to the charts.
Measure the Swings
Notice how FTR over a 10-month period experienced many swings. However, each swing was on average 60 to 80 cents. While this is a daily view of FTR, you will see the same relationship of price on any time frame.
As a trader, do you think it would make sense to expect $2, $3, or $4 dollars of profit on a swing trade? At some point, the stock will make that sort of run, but there will be a more 60 to 80 cent moves before that occur.
Just on this one chart, I can count 6 or 7 swings of 60 to 80 cents. If you can trade each of these swings successfully, you in essence get the same effect of landing that home run trade without all the risk and headache.
#6 - Little to No Price Retracement
No Price Retracement
Not to get too caught up on Fibonacci, because I know for some traders this may cross into the hokey pokey analysis zone. However, at its simplest form, less retracement is proof positive the primary trend is strong and likely to continue.
little retracement
