Trading Price Action Trends

Technical Analysis of Price Charts Bar by Bar for the Serious Trader

Al Brooks

• Publisher: Wiley
• Year: 2011
• Print ISBN: 9781394378104, 9781118066515
• eBook ISBN: 9781118166253
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

A practical guide to profiting from institutional trading trends

The key to being a successful trader is finding a system that works and sticking with it. Author Al Brooks has done just that. By simplifying his trading system and trading only 5-minute price charts he's found a way to capture profits regardless of market direction or economic climate. His first book, Reading Price Charts Bar by Bar, offered an informative examination of his system, but it didn't allow him to get into the real nuts and bolts of the approach. Now, with this new series of books, Brooks takes you step by step through the entire process.

By breaking down his trading system into its simplest pieces: institutional piggybacking or trend trading (the topic of this particular book in the series), trading ranges, and transitions or reversals, this three book series offers access to Brooks' successful methodology. Price Action Trends Bar by Bar describes in detail what individual bars and combinations of bars can tell a trader about what institutions are doing. This is critical because the key to making money in trading is to piggyback institutions and you cannot do that unless you understand what the charts are telling you about their behavior. This book will allow you to see what type of trend is unfolding, so can use techniques that are specific to that type of trend to place the right trades.

• Discusses how to profit from institutional trading trends using technical analysis
• Outlines a detailed and original trading approach developed over the author's successful career as an independent trader
• Other books in the series include Price Action Trading Ranges Bar by Bar and Price Action Reversals Bar by Bar

If you're looking to make the most of your time in today's markets the trading insights found in Price Action Trends Bar by Bar will help you achieve this goal.

Part I

Price Action

The most useful definition of price action for a trader is also the simplest: it is any change in price on any type of chart or time frame. The smallest unit of change is the tick, which has a different value for each market. Incidentally, a tick has two meanings. It is the smallest unit of change in price that a market can make, which for most stocks is a penny. It is also every trade that takes place during the day, so each entry on a time and sales table is a tick, even if it is at the same price as the prior trade. Every time the price changes, that change is an example of price action. There is no universally accepted definition of price action, and since you always need to try to be aware of even the seemingly least significant piece of information that the market is offering, you must have a very broad definition. You cannot dismiss anything, because very often something that initially appears minor leads to a great trade.

The definition alone does not tell you anything about placing a trade, because every bar is a potential signal both for a short and for a long trade. There are traders out there who will be looking to short the next tick because they believe that the market won't go one tick higher and others who will buy it believing that the market will likely not go one tick lower. They might be looking at the same chart and one trader sees a bullish pattern and the other thinks there is a bearish pattern that is stronger. They might be relying on fundamental data or any of a thousand other reasons for their opinions. One side will be right and the other will be wrong. If the buyers are wrong and the market goes one tick lower and then another and then another, they will begin to entertain the prospect that their belief is wrong. At some point, they will have to sell their positions at a loss, making them new sellers and no longer buyers, and this will drive the market down further. Sellers will continue to enter the market either as new shorts or as longs forced to liquidate until some point when more buyers start coming in. These buyers will be a combination of new buyers, profit-taking shorts, and new shorts who now have a loss and will have to buy to cover their positions. The market will continue up until the process reverses once again.

For traders, the fundamental issue that confronts them repeatedly throughout the day is the decision about whether the market is trending or not trending. Even if they are looking at a single bar, they are deciding if the market is trending or not trending during that bar. Is that bar a trend bar, opening near one end and closing near the other, or is it a trading range bar with a small body and one or two large tails? If they are looking at a collection of bars, they are trying to decide if the market is trending or it is in a trading range. For example, if it is trending up, they will look to buy high or low, even on a breakout of the top of the move, whereas if it is in a trading range, they are only looking to buy at the bottom of the range and they want to sell instead of buy at the top of the range. If it is in any traditional pattern like a triangle or a head and shoulders top or bottom, it is in a trading range. Calling it one of those terms is not helpful because all that matters is whether the market is trending, and not whether they can spot some common pattern and give it a label. Their goal is to make money, and the single most important piece of information that they can discern is whether the market is trending. If it is trending, they assume that the trend will continue and they will look to enter in the direction of the trend (with trend). If it is not trending, they will look to enter in the opposite direction of the most recent move (fade or countertrend). A trend can be as short as a single bar (on a smaller time frame, there can be a strong trend contained within that bar) or, on a 5 minute chart, it can last a day or more. How do they make this decision? They do so by reading the price action on the chart in front of them.

It is important to understand that most of the time there is a 50 percent chance that the next tick will be up and a 50 percent chance that it will be down. In fact, during most of the trading day, you can expect that the market has a 50–50 chance of moving up X points before falling X points. The odds drift to maybe 60–40 at times during the day, and these brief times offer good trading opportunities. However, the market then quickly gets back to uncertainty and a 50–50 market where the bulls and bears are mostly in balance.

With so many traders trading and using countless approaches, the market is very efficient. For example, if you bought at the market at any point during the day without even looking at a chart, and placed a profit target 10 ticks higher and a one cancels the other (OCO) protective stop 10 ticks lower, you have a 50 percent chance of making a profit. If instead you sold originally and again used a 10-tick stop and profit target, you would still have a 50–50 chance of making 10 ticks on your short before losing 10 ticks on your protective stop. The odds are the same if you picked 20 or 30 ticks or any value for X. There are obvious exceptions, like if you pick a very large value for X, but if your value for X is reasonable based on the recent price action, the rule is fairly accurate.

During the spike phase of a strong trend, the probability may be 70 percent or more that the trend will continue over the next few bars, but this happens only briefly and rarely more than once or twice a day. In general, as a strong breakout trend move is forming, if you choose a value for X that is less than the height of the current breakout, the probability is 60 percent or better that you will be able to exit with X ticks’ profit before a protective stop X ticks away is hit. So if a bull breakout has gone four points (16 ticks) so far and is very strong and you pick a value of eight for X, then you probably have about a 60 percent chance of being able to exit with eight ticks’ profit before an eight-tick protective stop is hit.

Because of the inherent high level of uncertainty, I often use words like usually, likely, and probably to describe what I think will follow in at least 60 percent of cases. This can be frustrating to readers, but if you are going to make a living as a trader, this is as good as it gets. Nothing is ever close to certain, and you are always operating in a gray fog. The best trades that you will ever see will always be described by uncertain words like these because they are the most accurate descriptions of the reality that traders face.

Everything is relative and everything can change to the exact opposite in an instant, even without any movement in price. It might be that you suddenly see a trend line seven ticks above the high of the current bar and instead of looking to short, you now are looking to buy for a test of the trend line. Trading through the rearview mirror is a sure way to lose money. You have to keep looking ahead, not worrying about the mistakes you just made. They have absolutely no bearing on the next tick, so you must ignore them and just keep reassessing the price action and not your profit and loss (P&L) on the day.

Each tick changes the price action of every time frame chart, from a tick chart or 1 minute chart through a monthly chart, and on all other types of charts, whether the chart is based on time, volume, the number of ticks, point and figure, or anything else. Obviously, a single tick move is usually meaningless on a monthly chart (unless, for example, it is a one-tick breakout of some chart point that immediately reverses), but it becomes increasingly more useful on smaller time frame charts. This is obviously true because if the average bar on a 1 minute Emini chart is three ticks tall, then a one-tick move is 33 percent of the size of the average bar, and that can represent a significant move.

The most useful aspect of price action is what happens after the market moves beyond (breaks out beyond) prior bars or trend lines on the chart. For example, if the market goes above a significant prior high and each subsequent bar forms a low that is above the prior bar's low and a high that is above the prior bar's high, then this price action indicates that the market will likely be higher on some subsequent bar, even if it pulls back for a few bars in the near term. However, if the market breaks out to the upside and then the next bar is a small inside bar (its high is not higher than that of the large breakout bar) and then the following bar has a low that is below this small bar, the odds of a failed breakout and a reversal back down increase considerably.

Small patterns evolve into larger patterns that can lead to trades in the same or opposite direction. For example, it is common for the market to break out of a small flag to reach a scalper's profit and then pull back, and the pattern then evolves into a larger flag. This larger flag might also break out in the same direction, but it might instead break out in the opposite direction. Also, a pattern often can be seen to be several different things at the same time. For example, a small lower high might be the second lower high of a larger triangle, and a second right shoulder of an even larger head and shoulders top. The name that you apply is irrelevant since the direction of the subsequent move will be the same if you read the bars correctly. In trading ranges, it is common to see opposite patterns setting up at the same time, like a small bear flag and a larger bull flag. It does not matter which pattern you trade or what name you use to describe it. All that matters is your read of the price action, and if you read well, you will trade well. You will take the setup that makes the most sense, and if you are not fairly certain, you will wait until you are.

Over time, fundamentals control the price of a stock, and that price is set by institutional traders, who are by far the biggest volume players among the traders who are trading for the long term; high-frequency trading (HFT) firms trade larger volume but are intraday scalpers and probably do not significantly affect the direction on the daily charts. Price action is the movement that takes place along the way as institutions probe for value. The high of every bar on every time frame is at some resistance level; the low of every bar is at support; and the close is where it is and not one tick higher or lower, because computers put it there for a reason. The support and resistance may not be obvious, but since computers control everything and they use logic, everything has to make sense, even if it is often difficult to understand. Short-term computer algorithms and the news determine the path and speed, but the fundamentals determine the destination, and an increasing amount of the fundamental analysis is being done by computers as well. When the institutions feel that the price is too high, they will exit or short, and when they feel it is too low (a good value), they will buy. Although conspiracy theorists will never believe it, institutions do not have secret meetings to vote on what the price should be in an attempt to steal money from unsuspecting, well-intentioned individual traders. Their voting is essentially independent and secret and comes in the form of their buying and selling, but the results are displayed on price charts. They can never hide what they are doing. For example, if enough of them are buying, you will see the market going up, and you should look for ways to get long. In the short run, an institution can manipulate the price of a stock, especially if it is thinly traded. However, institutions would make much less money doing that compared to what they could make in other forms of trading, and they don't want to waste their time on small profits. This makes the concern of manipulation of negligible importance, especially in stocks and markets where huge volume is traded, like the Eminis, major stocks, debt instruments, and currencies.

Each institution is operating independently of the others, and none knows what any other is doing. In fact, large institutions have many traders competing against one another; often they are on different sides of a trade without realizing it, and they don't care. Each trader is following his own system and is not interested in what some guy on the ninth floor is doing. Also, every move on the chart is a composite based on the total dollars traded; each trader is motivated by different factors, and there are traders trading on every time frame. Many traders are not even using charts and instead are trading off fundamentals. When I say that the market does something for a reason, it never does something for only one reason. Whatever reason I am giving is just one of the countless reasons behind the move, and I point to that one reason to give some insight into what some of the major traders are doing. For example, if the market gaps up a little on the open, falls quickly to the moving average, and then rallies for the rest of the day, I might say that the institutions wanted to buy lower and were on the sidelines until the market fell to an area of support and then they believed it was likely not to go lower. At that point, they bought heavily. In fact, that might be the logic used by some institutional traders, but others will have countless other reasons for buying at that price level and many of those reasons will have nothing to do with the chart in front of you.

When I look at a chart, I am constantly thinking about the bullish case and the bearish case with every tick, every bar, and every swing. During most of the day, the chance of making a certain number of ticks on a trade is just about the same as the chance of losing the same number. This is because the market is always searching for value and balance and spends most of the day with both bulls and bears feeling comfortable taking positions. Sometimes the odds might be 60–40 in favor of one direction, and in very strong trends the odds can briefly be 80–20 or even higher, but after most ticks during the day, the odds are about 50–50 and uncertainty, value, and balance prevail. Alan Greenspan said that as Fed chairman he was right about 70 percent of the time. This is very revealing because he had so much influence over whether he was right, yet he could only get his winning percentage up to 70. If you make money on 70 percent of your trades where you can never trade large enough volume to increase your chances of success, you are doing extremely well.

Whenever a pund...

Table of contents

• Cover
• Series
• Title Page
• Copyright
• Dedication
• Acknowledgments
• List of Terms Used in This Book
• Introduction
• Part I: Price Action
• Part II: Trend Lines and Channels
• Part III: Trends
• Part IV: Common Trend Patterns
• About the Author
• About the Website
• Index
• End User License Agreement