The Importance Of Levels

Finally back to posting after so long! Well I've been real occupied with a lot of deep diving into the James16 material, and honestly I'm getting more and more impressed. The quality of the material and members is truly incredible and unbelievable. It is hard to imagine another better place to learn price action. One could just pay USD 129 to get access for a month and walk away with material which in my opinion is worth 10k or more. And no, I'm just a satisfied customer and is in no way affiliated with them :)

So anyway, I want to blog about something that has been on my mind a lot lately. It is about levels. I read this in a forum thread recently and it really got me thinking:

Now that is not to say that trading candlesticks is not a viable strategy. I still use them (particularly on the daily time frame) to gauge potential market direction.

However, after discussions with other successful traders, I began to distrust them in terms of entries one side and stops the other. 

Let's look at this in a little more detail.

A bullish pin, by way of example, simply shows that demand has come in at a level. However, the fact that buyers came in does NOT mean that buyers will continue bidding prices up. I started to think of a candlestick pattern in the same way I thought of an indicator: it lags.

If you think of the market moves as having a cause and effect relationship, the cause of a move is the market participants that interact at the areas of perceived value (or lack of it), the effect is the resulting candlestick. 

Now I would sit there waiting for setups and I would say to the other traders: "I'm waiting for confirmation" but what I didn't realise is that by trading the effect and not the cause, you are always one step behind the market. 

So, the aim became to pinpoint an entry at an area that will cause other traders to follow you which can then create the effect of favourable momentum, meaning that still more traders join later and the momentum continues.

There are a few other important points to make about candlestick patterns.

Firstly, if price trades into a significant technical level, the probability shifts in favour of a reaction as the limit orders get hit from those traders entering and exiting the market. However, the duration of that reaction is unknown. Or to put it in laymans terms: it's one thing to accept that price will react to a key support level but it's another thing entirely when you have to work out how far it will travel in your favour. The simple fact is: if you enter at the source of the move rather than after the reaction, you have more options in the event there is no follow through from the other market participants.

This leads me onto my second point. The "entry" of the pin itself is usually at a random price. This then poses a problem for those traders that love to get their stops to "break even" because the majority of the time, their break even price means absolutely nothing to the market. 

This loosely leads me onto my third point. Candlesticks have an open and a close. The forex market does not. All candlesticks do, is break the market movement down into convenient "slices" of time but it is important to realise that the market does not stop moving. This therefore means that a "setup" can be dependent on a completely arbitrary concept such as the time your broker considers to be the "close". 

Perhaps worse than this, is the fact that you can miss a level that price has an extremely high probability of bouncing at simply because you failed to get a pretty candlestick that has just the right length wick and just the right size body to tuck it nicely within the previous candle within the window of time that you chose.

Now that is something that is really deep. While the author is trying to substantiate his trading style, what spoke to me was the importance of levels. Here is in my opinion how price action (PA) traders should progress:

1. New traders start off being focused on PA setups like pin bars or engulfing bars. They trade them all over the charts, into trouble areas, against the trend, and inevitably gets burned.
2. Once they realize the mistakes they're making, they become more picky and only trade setups at strong confluence levels with nice big PA bars and good space.
3. After years of experience, these traders have become so proficient at identifying key support/resistance levels that they do not even require PA setups at these levels. They can take touch trades off them or simply drop down to a lower time frame to refine their entries.

Now this is very powerful because touch trades allow one to get in before PA traders do with the benefit of a very tight stop. Obviously, new traders will get killed trying to trade like this because of their inability to identify true significant levels. However, whats there to stop experienced traders from doing so? It is too much to go in depth into such a trading style, one could study Jarroo from the public James16 thread. I've spent the past few days studying his material (lots of videos from the private group) and I must say it is truly ingenious and pure.

Personally, I'm still going to trade PA setups until I've achieved substantial success with them. However, I'll be paying a lot more attention to key levels and how prices behave around them. In fact, I'll strive to only take PA setups off these levels.