Trading Key Levels with Price Action

Bare bones trading is the simplest way to trade in the Forex market. So what is bare bones in Forex trading? I believe all that's needed is a Daily chart with price action and no indicators. The question now is how do I identify a valid trade setup with entry and exit points? This is where Horizontal or Key levels come in, which is the“core” component of my trading strategy. In this article I will be discussing how to identify these levels and why it should be a fundamental part of any trading strategy. I will not discuss signals at this point in time as there will be other articles  elaborating on this.

There are two types of horizontal levels, these are know as support and resistance. Support levels are usually below the current price. Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. Support does not always hold and a break below support signals a new willingness to sell. Once support is broken, another support level will have to be established at a lower level. Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further. Resistance levels are usually above the current price. Resistance does not always hold and a break above resistance signals shows a new willingness to buy. To draw these lines you will have to connect all the highest highs to establish a resistance level and all the lowest lows for support levels (This is a very basic explanation in how to establish support and resistance levels, further research maybe needed to learn how to identify these levels correctly).

Why do I trade off these horizontal levels? Everything starts with horizontal levels and all traders pay attention to these key levels in the market, because they know that these levels are significant and can thus have a strong impact on the direction of price. Below are some of the reasons why and how I could use horizontal levels:

• Helps me define my risk by giving me a price level to place my stop loss 
• Provide me with confluence or confirmation level to trade from
• Helps me define my profit target

How are these Horizontal levels formed? The more I study charts the more I see that price never moves in a straight line. Let me illustrate this through the diagram below, here we can see price is in an upward trend and as it makes new highs it also creates resistance when it falls away from these highs, then as it pulls back the previous high / resistance actually turns into support. Old resistance becomes new support in an uptrend, and in a down trend old support becomes new resistance, also known as swing points.

 

 The way that I take advantage of these horizontal level swing points, is to watch for price action signals forming near them as the market pulls back. Look at the yellow circles in the illustration above, these are the swing points at which I want to watch for obvious price action signals to form. By doing this I'm trading from a point where various confirming signals can be seen within a trending market.

It seems that I can also trade horizontal lines in a range-bound market with price action, this is also known as channels. This normally occurs when the market has not found a upward or downward trend but finds itself in a range where price  often swing between support and resistance. In the illustration below we can see an example of what a range-bound market might look like. When price is obviously bouncing back and forth between a horizontal support and resistance level, we can wait for price to hit one of the boundaries of the range and then wait for price action signals to form there.

 Trading with channels as seen above gives me obvious levels to define my risk and reward. Risk is defined just beyond the trading range high or low from the boundary I'm entering near, and reward is defined near the opposite end of the trading range.

In conclusion horizontal levels are very important in the market, and by combining them with a price action signal allows me to have a very effective trading strategy. Price Action signals will be discussed in future articles.

Forex Money Management

What does a stop loss, limit, profit target, spread, margin, have in common? They are all related to money management, these are systems which are put in place to make sure I make money and try not give it back to the market. The course material goes into detail explaining the above terms in how and when to use them.

The main function of money management is to help  me manage my emotions. It seems that I need to take a logical approach in my decision making knowing that every trade setup taken there is a calculated risk. By doing that I have now taken an unknown variable and replaced it with some certainty, which can help me remove the emotional side to trading. The course states that many begging traders are largely unaware of some or most of the basic concepts of effective Forex money management, and this is a major reason why so many traders fail to make money over the long-term in the markets. 

How much should I risk on a trade?

The question should be how much money do I have as disposable income that I can realistically afford to lose? This approach does seem to be subjective, but through the course they have supplied me with a few tools to help me gauge how large or small my position size should be, and it also helps me calculate how much money I potentially could loose. I also learned that I should never risk any money in the markets that is not truly disposable, doing this will start me on an “even” emotional playing field, because I will have no emotional attachment to my trading money.

Risk Reward

It seems that proper implementation of risk reward is how professional traders make money, but many traders take the wrong approach to risk reward by worrying first about the potential reward and last about the potential risk. I need to first calculate the risk involved in any potential trade setup AFTER I've determine the most logical place to put my stop loss. Once I've done this, I then can determine what the potential reward is.e.g. If I risked £100 on a trade, I ideally want to aim for a reward of at least £200 or more; the R:R would be 1:2. The idea is that if I can make at least 2 times my risk on all my winning trades, I will, over a series of trades, offset my losers to the point of turning a decent profit.

Position sizing

Position sizing allows me to risk the same amount of money no matter what trading strategy I trade or how large or small my stop loss distance is. Having a wider stop loss on a trade doesn't mean I'm risking more money or that by having a smaller stop loss on a trade I'm risking less money, therefore I can adjust my position size up or down to meet the necessary stop loss distance. Once again logical place to start is with my stop loss on a trade setup, after I've figuring out where to place my stop loss, I THEN calculate the number of lots I can trade to maintain my pre-determined risk amount. Thankfully once again Forex Training Worldwide has supplied me with tools to easily work this out.

If I don't logically manage my risk on every single trade it will be impossible for me to manage my emotions. The better I manage my risk and money in the Forex markets with a trading strategy, the easier it becomes to manage my emotions, if I know exactly how much I can lose, and exactly how much I can make on every single time I enter a trade I'm unlikely to become emotional.

Keep you posted Happy pipping!!