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intraday tactics on forex - applicable to all markets

UNDERSTANDING
PRICE ACTION
Practical Analysis of
the
5-Minute Time Frame

Bob Volman

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Copyright © 2014 by Bob Volrnan. All rights reserved.

Published by: Light Tower Publishing

ISBN 978-90-822786-0-6

ProRealTime charts used with permission ofwww.ProRealTime.com

No part of this publication may be reproduced, distributed, or transmitted in any form or by any means,
'including photocopying, recording, or other electronic or mechanical methods, without the prior written
permission of the author, except in the case of brief quotations embodied in critical reviews and certain
other noncommercial uses permitted by copyright law. For permission requests, write to the author
at the address below.

[email protected]

Excerpts of the book can be downloaded from:

www.upabook.wordpress.com

Disclaimer: This publication is solely designed for the purposes of information and education. Neither
the publisher nor author shall be liable for any loss, claims or damage incurred by any person as a
consequence of the use of, or reliance on, the contents herein.

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Table of Contents

Preface ............. . ..... ....... .... ...... ........... . ......... ........... .... .......... . ........ ... ... ......................... ........ In

Part 1: Practical Analysis

Chapter 1: A Time to Trade and a Time to Study .................. .. ............... 3

Chapter 2: Price Action Principles-Theory .... ................... ..... .... ............ 5 Dou ble

pressure .......... ..... ..... ..... ... . . .......... ..... ... ............. ....... .... ..... 6 Support
and resistance ................... ... ...................... .... ....... ....... 8 False breaks, tease
breaks and proper breaks False highs and ... ...... I I

lows .............. ... ........................ .... ....... ........... .. I

6 Pullbacks reversals ... .............................................. .... ................ 20 Ceiling

test ........ ... . ........... . . ...... .... ........... .... ................... ... ... .... ......... 25 Round
number effect . ......................... . . . . .......... ........... ..... . . . .. . . .. 30

Chapter 3: Price Action Principles-Practice . . ..... ....... .... ............ ......... 33

Chapter 4: Orders, Target and Stop ........... ...... .......... ..................... ........ . . .. 67

Chapter 5: Trade Setups ........... ........ ... . . ..... ..... . ... .... ... ................ ......... ..... . .... . ... 73

Pattern break . . . . .. . ..... .... ................. . . .......... ....... ........ ... ............ ....... 76

Pattern break pullback ....... . . ... ....... ..... ...... ......... ..... ..... ... ... ..... 97 Pattern
break combi ....... ...... . . . . . ........ .............. .......... ......... ..... 108

Pullback reversal ..... .... . . . .... ...... ... ....... . ... ........... ...... ....... ....... 125

Chapter 6: Manual Exits ... ... . ............. .... .... ........... .... ...... . ....... ... ............. .... 143 News report

exit ......................... . .... ..... .... ..... .. .. ..................... ... 144 Resistance exit
.... . . .......... ..... ..... ........ ......... ........................ ......... 148

Reversal exit .... ..... . . ..... . . ........ ......... . . .... . ....... ......... ... .... . ........... 156

Chapter 7: Skipping Trades and Trading Breaks for Failure . .... 177

........ .. ............................ .... . .......... ...................... ....... 211

Chapter 8: Recap Part 1

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Part 2: Evaluation and Management

Chapter 9: Consecutive Intraday Charts .............. ...... .......... ...... ........... 245
March ...................................... .......................................................... 250

April ... ................ ......... ..... ...... .......................... .................. ... ............. 272
May ........ .......................... ............... ................ ........................ ............ 293
June ............................ ........................................................ ............... 3 16

July ........................ ............ .............. ................... ......... ............ .......... 337

August .................. ................ ................ ..................... ........ ........ ....... 359

Chapter 1 0: Trade Size-Compounding ............ ....................................... 383

Chapter 11: Adapting to Low Volatility ...... .................................... ........... 39 1

Chapter 1 2: Final Words ......... ... ........................... .

... ....... .................... .............. 421

About the Author .......... ......... ...... .......... ............. ................. ....... 422

Index ..... ........................... ...... ........... ........ ................... ... ......... ..... ..... 423

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Preface

In these modern times of high-tech trading devices, with all the latest gadgets at the push of a
button, price action traders may come off as somewhat old-school. With nothing in front of
them but the bars in the chart, there is little in their workspace that bears witness of the digital
wave. Are they mere relics from a fading past, soon to be extinct, or could it be that there is
merit in this seemingly stubborn defiance of trading evolution?

One way to answer this is to point out the actual benefits of every indicator craze that has
swept across the trading landscape for the past so many years. Not an easy chore by any
means. A simpler solu-tion, perhaps, is to focus attention on the price action trader instead
and see if we can come to appreciate his one and only tool, the naked chart.

With the latter idea in mind, Understanding Price Action is written not just to establish the
virtues of the price action method, but to serve as a practical guide on the matter. The core
premise within is that any dedicated student, before long, should be able to trade confidently
and profitably from a clean chart without ever feeling lost or otherwise deprived.

For the purpose of illustration, any price chart could basically do, but few are better suited
for the job than the 5-minute chart of the eur / usd currency pair. A true creature of habit, this
market has long since been the favorite of countless traders around the globe and it's hard to

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think of a more accessible platform for the technical discussions in the

chapters ahead.
When taking up the task of writing this guide, the objective was not
just to show a pallet of trading concepts on a number of cherry-picked
charts, but to give a fair impression also of their practical implementa-
tion on a day-to-day basis. For this purpose, the book has been split into
two parts.
Part I lays out the principles of price action and discusses entry and
exit techniques on a broad range of educational charts. In Part 2 we will
examine how these findings hold up on a more continuous basis. In-
cluded within is a series of six months of consecutive 5-minute sessions
of the eur / usd. Besides providing a massive amount of study material,
this series should leave little doubt behind as to the amazing continuity
and exploitability of price action themes from one session to the next.
One of the most common questions I rec.eived in response to my first
book, Forex Price Action Scalping, was if the principles and setups
pointed out on a fast scalping chart (70-tick) could also be applied to the
higher intraday frames, like the 2 or 5-minute, or even the hourly for that
matter. There can only be one answer to this question: price action
principles are transposable to any time frame of choice because they
bear within them the universal laws of supply and demand. This is not
bounded by the time in which it takes place, nor is it a prerogative of any
one market. From one instrument or time frame to another, subtle
adaptations may be called for, if only to accommodate for the differ-ences
in average range or motion; but the trading concepts of the price action
method are just as applicable to futures, indices, stocks, com-modities,
bonds, or what have you, as they are to the Forex markets.
As will be demonstrated also, price action principles are not only free
from the boundaries of market and frame, they stand above the nature of
the trading environment as well. To illustrate this point, a special section
is included on how to tackle a very persistent climate of low volatility by
slightly tweaking standard procedure to better suit the conditions at hand.
We will examine this adaptation process from the viewpoint of a faster
intraday frame on several currency pairs and some popular non-Forex
markets.

WE

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Preface

In regard to the absolute novice, it should be noted that to keep the

fo-cus at all times directed towards analysis, it is chosen not to disturb
the pace of this book with endless pages of introductory fluff that is readily
available either online or in more generic trading books. From a techni-
cal perspective, however, Understanding Price Action is written for both
the novice and the experienced trader, and for all who have taken inter-
est in exploring the benefits and possibilities of the price action method.

Free excerpts of the book can be downloaded from:

www.upabook.wordpress.com

VII
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Part 1

Practical Analysis

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Chapter 1

A Time to Trade and a Time to Study

While the indicator hype has far from run its course, more and more traders are coming to see
the virtues of the "less is more" philosophy.
And with reason. There is something strikingly serene about a chart stripped down to the bare
essentials. There are no riddles to decipher, no conflicting signals to evade, there is nothing
cluttering up the screen.
It's all about facts-and they are out in the open. The bars in the chart hold nothing back, nor
will their message ever lag behind. With these benefits in mind, the price action trader adheres
to a very simple prem-ise: if a high-odds trade cannot be spotted straight off the chart, it is
just no! there.

Still and all, without a proper understanding of market mechanics, no trader of any kind is
likely to escape the notorious lessons of the market and the costly fees that come with it. The
journey through the learning stages is never an easy process and there will be pain and
hardship along the way. Chances are, quite a few will never surpass this dreaded stage of
initiation. On the good side, there is a lot a trader can do to increase his chances of survival,
and at little cost to boot: in a nutshell, he needs to educate himself properly.

Bear in mind, this is not to suggest that all can be taught from the drawing board; it merely
serves to stress the importance of preparation.
If the goal is indeed to survive in a field where so many others have per-ished before their
time, how can it not pay to enter well prepared from the outset.

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Understanding Price Aaion

It is up to the student how long to commit to the safety of the side-

lines. For some it may take several months of reviewing the same old
principles over and over again, for others the light may turn green much
sooner than that. But even when all the concepts and techniques are
starting to make perfect sense, aspiring traders are well advised not to
delve into the markets without a solid plan in place. Lessons need to be
learned, but there is little point in allowing one's auditions to be un-
necessarily costly or self-defeating.
Next to jumping in headfirst, hurriedly adopting a third party meth-od,
just to get going, is another popular practice among many new entrants.
But when applied as a mere shortcut to education, this ap-proach, too,
is not likely to hold up in the line of duty, particularly when the current
market environment proves unfavorable to the chosen method in question.
The preferable route, by far, is to always put ample time and effort into
constructing a personal methodology, suited for all seasons, and devoid
of the vagaries and whims of third party discretion.
Although a fully functional and standalone method will be offered in
the chapters ahead, and referred to as "our" methodology, please un-
derstand that this is done so for practical purposes and not to suggest
that the reader should obligingly apply whatever is put forth. The con-
cepts and techniques, of course, can serve as a structural groundwork for
any customized method.
It may take some time and experimenting to find out what style of
trading suits a trader best. But regardless of personal preference, all
techniques should at least harbor the same objective, which is to ex-ploit
repetition. The first task, therefore, for any student, is to build up a mental
database of price action principles in action. In the following two chapters
we will have a close look at these essentials, from both a theoretical and
practical point of view. From there on, our focus will be on the finer
subtleties of trading the 5-minute chart.

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Chapter 2

Price Action Principles-Theory

Price action principles form the basic ingredients of all sound trading
techniques. While their variations in appearance are practically infinite, as
are the ways they can be implemented into a plan of attack, all will find
footing in a small set of elementary concepts that repeat over and over again
in any technical chart. The core principles relate to:

Double pressure.
Support and resistance.
False breaks, tease breaks and proper breaks.
False highs and lows.
Pullback reversals.
Ceiling test.
Round number effect.

Figure 2.1 provides a schematic impression of the principles in action; if

presented in regular bars this may very well have been a typical 5-
minute chart of the eurjusd pair meandering in a 50 pip range over the
course of a session--or any other chart, for that matter.
Rather than delving into these price charts straightaway, let us es-tab;ish
a solid foundation for all our further studies by exploring each of the seven
principles from a theoretical viewpoint first.

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Understanding Price Action

double top lower top pre breakout tension ,-:::: ÿ=ÿ-=ÿÿ------: ÿ

(buildup)

pullback

'
double pressure Ceiling test
""-
pre-breakout tension
(buildup)
higher bottom
triple bottom

Figure 2.1. Schematic illustration of the core principles of price action.

Double Pressure

Since no trader can take his own trades to target, we are all dependent on the actions and
reactions of our fellow traders in the field. Does this

mean we are mere puppets hanging from the market's fickle strings? Far from it. But we
need to play our game cleverly. Before putting capital at risk on any one trading idea there is
an important concept to take into account: for prices to follow through in substantial fashion,
we need as-sistance from both sides of the market. Should we aim to take position on, say,
the bull side, it may not suffice to only find companions in the bullish camp. Preferably, we
would like to see a decent number of bears quickly bail out to protect themselves from the
very rising market we are trying to exploit. The more bears forced to buy back their shorts,
the better the odds for our trade to reach its destination before the situation

sees chance to reverse.

When both bull and bear temporarily join forces on the same side of the market-not with
similar enthusiasm, we can imagine-we have what we can refer to as a double-pressure
situation. Considering the many seesaw motions in any chart, these imbalances between
supply and demand are far from unique; but it is fair to suggest also that they sooner tend to
self-correct than blossom into anything substantial. In a certain set of conditions, however,
double pressure could start to feed on itself, and this could really set the wheels in motion.
Should we see

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prices head out one way much more than the other, this is generally referred to as follow-
through Rather than responding to
its presence, arguably a more promising way to take advantage of follow-through is to
anticipate its origin so as to take position in its primary stage. This implies that these events
do not always appear out of the blue. Indeed, it can safely be stated that in any session of
any market sooner or later the price action will build up to a boiling point from where the
pressure is likely to escape in double-pressure manner. To detect these "sweetspots" in the
chart, the crucial boundaries between attack and defense, is essentially what a breakout
method is all about.

While most traders will find merit in the double-pressure concept, many may not
sympathize with the idea of trading breaks. Some will even argue that in today's tight
markets the failure rate of the average breakout (of whatever kind) is so high that this once
much-appreciated strategy is now a poor proposition at best. This critique is not entirely out
of place. Many breaks indeed fail to follow through, and not seldom by design. Yet if we
learn to make distinctions between the high and low-odds varieties there is no need for
pessimism on the part of trading breaks, quite the contrary. In the chapters ahead, we will
see hundreds of examples of breakouts that should leave little room for argument as to their
tradability with high odds attached.

But in all cases, conditions are king. Even a break in line with the dominant pressure
runs a high risk of failure if poorly set within the technical picture. Always more telling than
its mere occurrence is the way a break is built up. By and large, the best opportunities stem
from a visible fight over the breakout level in question-a number of alternat-ing bars in which
bulls and bears battle it out in a relatively tight vertical span. These tug-o-wars can
materialize in any number of ways, but not seldom only a handful of bars are needed to
recognize the sweetspot in the chart, and with it, the potential for a serious pop. We can
refer to these cluster progressions as buildup or pre-breakout tension.

Figure 2.2 shows a random series of very common buildup situa-tions that often
precede a breakout of sorts. In a regular chart, these sideways progressions may be a little
less straightforward (not neces-

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sarily), but the element of buildup is never hard to detect: prices keep pushing at and
bouncing off a level of interest, until either the defend-ers or the attackers throw in the towel.

1\ buildup
/

e---- ZÿVV\Mÿ\I I ÿI

Figure 2.2. Double-pressure pops after buildup.

While each buildup cluster has a bull and a bear side, in the vast ma-jority of tradable cases
only one will qualify for trading purposes. It is interesting to note also that this side is generally
the most defined, which stands to build up the pre-breakout tension even more. At the "non-
break" side, however, the price action can still send out very telling signals and this, too, can
play a role in the timing of the break.

When it comes to taking position, the break of a specific bar in a buildup progression
could trigger an entry in the market, but this is never a standalone event; there are always
more parameters to take into account. To judge any situation in its proper light, a solid
understand-ing of price action principles is essential.

Support and Resistance

In mainstream Technical Analysis, the concept of support and resis-tance is by far the
granddaddy of all price technical phenomena. The general idea is that the levels in the chart
from where prices previously bounced may prove their resilience again at a later stage, but
will be broken at some point. It takes little charting experience to find merit within this
observation.

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An interesting side-effect of support and resistance is that when these

"barrier levels" are eventually overcome, their earlier significance is not
necessarily lost. Once broken, these levels often reverse their ini-tial roles,
meaning that former support may now turn into resistance when touched from
below, and resistance, once broken topside, may act as support when touched
from above. This, too, is a highly visible technical phenomenon and it is not
hard to imagine how countless strategies are solely designed to exploit it.

Despite their prominent role in the price action, however, it is best to

entertain a neutral view on all these peaks and troughs and use them mainly
as a source of information. The novice in particular is not recommended to
adopt the aggressive contrarian approach of shorting former highs and buying
former lows in anticipation of these levels to hold up; nor is he advised to
blindly long new highs or short new lows in anticipation of these breaks to
follow through.
Rather than acting on support and resistance straightaway, whether for a
break or a bounce, the conservative practice is to first monitor how the market
handles itself in and around these levels, and then take it from there. For
example, the perforation of a former high is likely to have more of an impact
when the level gets taken out as a result of a tug-o-war progression beneath
it (buildup). Much less so when prices come up from lower levels and then go
straight on to clear the former high-these type of breaks are known to backfire
quite painfully. As to the latter, it is vital to realize that there are numerous
parties in the market whose favorite game is not to trade but to counter the
break, particularly those set poorly.

Support and resistance levels can serve many purposes, but their biggest
virtue is that we can derive from their presence an idea on the dominant party
in the chart. This is valuable information; not only will it point us in the proper
direction for our trades, it will tell us also which side of the market to shun. For
we shouldn't trade against dominance.
A very effective way to identify the dominant party is to simply follow the
overall slope of the market. When a chart is dominated by the bulls, even
modestly, prices will make new highs on the whole and the bearish corrections
along the way will have a hard time surpassing former lows.

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And even when prices start to falter in the higher region of the chart, bulls
are technically still in control as long as they manage to keep the market
up in levels higher than or equal to a former significant low.
Inevitably, at some point the ruling party will run out of ammo and as a
result they may no longer be able to recoup so well from whatever
setbacks they are forced to incur. This could be a sign of a power shift
ahead. But the stronger the earlier dominance, the less likely the mar-ket
will turn on any first reversal attempt.

\
situation 2

Figure 2.3. It takes time for a market to roll over. All else equal, the break at point c
provides better odds for bearish follow-through than the one at point a.

Compare the two situations in Figure 2.3. Up until point b, both charts are
identical. The failed bear attack at point a serves to illustrate the danger
of accepting an otherwise reasonable break that is technical-ly still set
against the dominant pressure. Since this break followed a "classic"
topping progression (double top plus lower top), eager bears may have
been tricked into thinking that a turn was at hand. But they traded in
defiance of the bullish dominance, which so far had only shown signs of
waning momentum.
The bear break at point c, in Situation 2, already stands a much better
chance of finding follow-through. The premise behind the better odds is
found in progression b-c, which shows a failure of the bulls to undo the
bear break at a, which, in terms of probability, is now more likely to inspire
bears to play short and bulls to bail out (double pres-sure). And not
unimportant either, contrarians will probably be less keen on defying this
break.
Of course, in the bigger scheme of things, and depending on what-
ever parameters are taken into account, both the break at a and c could

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be unfavorable; and even the break at a may have been playable, why not: but when
compared among themselves, trading the break at point c is definitely the better bet, simply
because there is now more informa-tion available that favors the bearish cause.

Identifying the dominant pressure correctly is paramount in any breakout method. Aspiring
traders in particular should either trade in line with this pressure, or take position from a
neutral base whose break is likely to promote a new dominant order; but they are well ad-
vised not to defy whatever dominance is in place.

This is not to suggest that trading against dominance is considered an inferior proposition,
most certainly not. But before going this more aggressive, contrarian route, it really is
recommended to learn to trade confidently and profitably in line with the pressure first.

Contrarian tactics do deserve our utmost attention, though, if only for the fact that the
extent of counterpressure will play a crucial role in the failure or success of a breakout. The
more we come to understand

the favorite game of our opponents, the sooner we will be able to recog-nize a poisonous
break on offer. All this will be taken up as we march along. Some of these counterbreak
tactics may even strike a pleasant chord with the reader, and they can always be implemented
at some future point.

False Breaks, Tease Breaks and Proper Breaks

Even when set in line with the current dominant pressure, there are basically three ways for
the market to go about a break: terribly, poorly or properly. Before we take up the differences,
allow me to once again stress that one crucial concept that is so vital to grasp: as much as
trading breakouts is a favorite pastime among many participants in the market, equally
popular is the contrarian game, which harbors within it the exact opposite line of thought:
contrarians take pride in position-ing themselves against the event. At first this may seem
odd; out of all the possible places to take a counter position, why pick a break and risk
getting trampled on by a potential double-pressure stampede? The

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answer is not hard to guess: the contrarian anticipates the breakout to fail.

Contrarian tactics are certainly not for everyone, for the dangers within them are evident.
However, we can rest assured that there are many parties in the market who have mastered
the art of the counter-strike to perfection. It is what they do all day long. And it is not just the
typical break they tend to bully; with equal pleasure they take their shots at a rising or falling
market by shorting or buying whatever comes towards them.

With powerful enemies always on the prowl, we cannot afford to only concentrate on the
bright side of our trading ideas-the likelihood of opposition demands equal attention. But let
us not forget that the con-trarian, too, needs to carefully weigh his prospects before taking
his chances on defying a break, for no party can ever have his way with the market
unchallenged. As we can see, the breakout trader and the con-trarian may entertain opposing
views, their task is essentially the same: to determine the nature of the break.

If a break is not built up "properly", chances are it will have a hard time convincing the
bulk of breakout traders that the event is for real.
Not seldom, a lack of participation immediately becomes evident when the same bar that
caused the break instantly reverses-a nasty little oops-moment for all those who traded it. At
other times, we may see prices follow through a bit, only to then peter out and undo the break
after all. Regardless of how these things play out in the situation at hand, a poorly set break
stands a high chance of failure simply because many breakout traders will not deem the odds
good enough to trade the event for continuation, while at the same time plenty of contrarians
may be tempted to trade the break for failure.

Also, when confronted with a faltering break, parties positioned in line with it, from
whatever earlier level, may decide to exchange their holdings for the safety of the sidelines,
thereby further increasing the pressure against the break-and with it, the odds for its failure.
Of course, not always will a poor break resolve itself in favor of the contrar-ian cause, or we
might as well become contrarians ourselves. But any chart will show that the dreaded false
break is not a rarity by any means.

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Chapter 2 Price Action Principles-Theory

Before we go on to examine the favorable scenario, it may help to first

look at some situations to avoid. There are two type of breakouts that should
at least come across as highly suspect. The most obvious one we will refer
to as the false break trap; the second type, less malign but still very much to
shun, we can look upon as the tease break trap. Bear in mind, it is never
the outcome that determines these labels, it is the way the breaks are set
when they occur. In other words, it is very well possible that an excellent
break will find no follow-through whatsoever, whereas a terrible break might
take off and never look back. In terms of probability, the outcomes are
sooner reversed.
Whether or not to take position on a break is always a function of how
well the technical credentials of the chart back up the prospects for follow-
through. At least three things demand examination in all situa-tions: (a) is
the break set in line with the dominant pressure or against it; (b) is the
market ranging or trending; (c) are there obstacles overhead or underfoot
that could possibly obstruct an advance or decline.
While these are the core essentials that will determine whether the
chart conditions speak favorably of the venture (we will discuss their
particulars in more detail along the way), they do not warrant participa-tion
by themselves. Always a mandatory routine before taking position on any
type of break is to assess the way the market behaved just prior to the event.
If we don't find buildup there, the offer is best declined.
Consider the three situations in Figure 2.4. All else equal and as-suming
the short entries at e were all technically sound in regard to the dominant
pressure, these situations perfectly illustrate the principle of the false break
trap, the tease break trap and the proper break respec-tively.

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stoP?

In'\ I ÿj l

situation 1
'eJ jÿ

situation 2 situation 3 \

Figure 2.4. Difference in buildup prior to a breakout not only affects the likelihood of follow-through, but the level for protection as well.

Earlier on we stressed the importance of buildup and how it tends to play

a determining role in the success or failure of a break. The premise behind
this principle is not hard to grasp: the stronger we see a level defended
before it yields, the more dominance displayed by the ultimate victors. But
there is another good reason why the absence of buildup tends to
compromise the follow-through potential on a break. It con-cerns the
placement of the protective stop.
On any wager, the level for protection plays a major part in the total
concept of a trade. You simply cannot enter the market without a sound
idea of when to get out in case prices fail to follow through. In all cases,
there is a point of no return beyond which a trade has lost validity and
needs to be scratched. Obviously, there are no hard and fast rules on the
matter and all will depend on strategy specifics and a trader's per-sonal
perception of the situation at hand. But let us try to shed some light on the
entry/stop issue by examining a very common technique that should not
raise too many eyebrows as to its technical merit; in case of a short
position, it is to place the stop somewhere above the last distinctive high
prior to entry.
If we apply this tactic to the three situations in Figure 2.4, the dif-
ferences are evident. All entries were taken at point e, but the levels for
protection ranged from wide to tight.
Without discarding the benefits of a "wide" stop per se, we can gen-
erally state the following: the wider a stop needs to be placed to find
technical justification, the less attractive the breakout becomes from a
continuation perspective, and the more attractive when seen through
contrarian eyes. (Situation 1).

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For further explanation, let us examine the tease break scenario in

Situation 2. Here the bears were offered a somewhat better entry and a
better technical level to protect themselves also. Still, the buildup left a lot
to be desired since it did not really take place at the bottom bar-rier of the
range progression; the level for protection, too, resided quite some distance
away from entry. This type of break is likely to attract more sideline bears
than the one on the left, but it still provides decent opportunity from a
contrarian point of view.
On balance, breaks of the tease break variety (and we will see many of
them) do stand a pretty good chance to follow through, but they may not do
so straightaway. Hence the idea of a tease. As seen in Situation 2, a typical
response of the market is to first counter the break in an attempt to undo it;
but as prices move back inside the range, they may then hit upon the lows
of whatever buildup lies higher up. From such an area of resistance (former
support), prices may edge down again and even go on to break the bottom
barrier successfully second time around.
All of this could play out in any number of ways and in some situa-tions
a stop may get hit and in others, it may survive. The point is that the tease
breakout, despite being less premature than the very poor break, still poses
a big threat to anyone playing the market with a tight stop. Since a tight stop
will be a key feature within our operating tactics, to be discussed in Chapter
5, our focus is best directed towards the breakouts of top-notch qUality.

An excellent way to play a break is shown in Situation 3. Now we can

truly see the virtues of proper buildup. Not only did this break stem from a
bamer fight, with bears coming out on top, a breakout trader could now
place a stop tightly above the buildup progression. The breakout may still
fail soon after, but technically seen, this is the more
favorable scenario.
Pleasant here also is that the principle of support and resistance may
help out once again should prices at some point travel back up to challenge
the broken barrier from below (common practice). Now rep-resenting both
the bottom of the broken range and the bottom of the latest buildup, the
barrier stands a much better chance to fend off the contrarian bulls on
impact; furthermore, bulls in position could grab

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the opportunity to quickly sell out, while empty-handed bears could make
excellent use of the pullback to hop on the bandwagon in second instance.
That implies double pressure on the sell side again.
As we can see, a breakout not only involves a broken level, there are quite
a few variables, forces and perceptions at work and all need to be taken into
account when assessing the odds. The most important mes-sage to take
away from the above is to simply avoid all breaks that are not built up solidly.

On the good side, plenty of breaks are set so poorly that they are easy to
dodge by anyone with just a basic understanding of break play tactics. A non-
buildup break as discussed in Situation 1, for example,
is one such event that is best left alone. As to the line between a tease
break variant and a proper break, in all fairness, it can be rather thin at times.
We best take up these differences in more detail once we start to do our
analysis on the 5-minute charts.

False Highs and Lows

When a bar takes out a high or low of a neighboring bar, we can refer to the
current bar as a breakout bar. If a subsequent bar takes out the breakout bar
in the same direction, this new bar is now the break-out bar, and so on.
Always more interesting than the mere occurrence of a break, though, is to
find out how the market handles the event.
For example, a bull break followed by bull break is a sign of follow-through
and thus an indication of bullish enthusiasm, for as long as it lasts. Should we
see the market respond to a bull break with a bearish bar and this bar then
gets broken at the bottom by another, that gives us valuable information also:
technically seen, we are dealing with a false high. It is considered false
because the bull break failed to follow through and was followed by a bear
break in turn.
When compared to the failed breakout of a carefully built up pattern, the
failed breakout of a single bar is usually of less significance-but it is a false
break nonetheless. To minimize confusion, in most cases we will refer to the
pattern break failures as false breaks (usually more

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bars involved) and to the single bar failures, or failures of a broken top or
bottom, as either a false high or false low.
A false high or low in a trending swing may only reflect a minor hic-
cup in the dominant pressure and as such may have little impact on the
current directional consensus. But when situated at a crucial spot, say, in
a buildup cluster, a false high or low could be a major tell as to the most
likely outcome of the skirmish at hand. Seeing the break at their end fail,
the parties affected adversely may no longer feel so confident re-maining
in position. Should more counterpressure come forth, they may even
decide to bail out of their holdings. So in this respect, a false high or low
could be a harbinger of (double) pressure in the other direction.
To see how this information can be useful, imagine a situation in which
we are anticipating the market to turn bullishly around in an area of
support, and so the idea is to participate in a break on the buy side; if the
price action is currently forming a little cluster of bars going sideways in a
tight span (buildup), wouldn't it be nice to see the bears first put in a break
at the bottom of this cluster, only to get reprimanded by the bulls. This
serves a couple of purposes that may prove beneficial to the prospects of
a bullish turn: (a) seeing the bear break fail, sidelines bears may take
heed and thus decide to stay where they are-out of the market; (b) bears
in position may get the message also and their idea could be to bail out, if
not immediately then possibly on the first bull break to come along
(confinnation of the false low event); (c) at the same time, a number of
sideline bulls will like what they see and their deci-sion could be to act on
the first bull break as well; (d) bulls in position, some of whom may have
been on the brink of selling out their longs, may now breathe a little easier
again (no selling pressure yet from these parties).

The more we can imagine these favorable forces to work in concert,

the stronger the upside potential.
Understandably, false highs and lows gain in relevance when they
show up at crucial levels in the chart. A false low in support will not eas-
ily go unnoticed, nor will a false high in resistance. To get a better idea on
the mechanics in play, let us explore some hypothetical, yet pretty common
chart situations, as depicted in Figure 2.5.

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situation 1 situation 2

Figure 2.5. False highs and lows can have a strong demoralizing effect and often serve to announce a
reversal of sorts.

In situation 1, we can regard the market as bullish (higher highs and higher lows on the
whole) and for that reason the failed break at point 1 can be classified as a false high in line
with the current directional pressure. Since all price swings at some point need to correct, a
false high in a top doesn't necessarily portend the end of the bullish envi-ronment, but it is
an indication of waning momentum. From it we can deduce that there is reluctance among
the bulls to buy high up; or at least we can say that their eagerness is temporarily outmatched
by the volume in the other direction, that of bulls taking profits and bears tak-ing shorts. In
other words, supply is currently toppling demand. But given the overall bullish conditions,
bulls might very well return on the scene with renewed elan once prices have retraced to
more "attractive" levels. Therefore, the false high at point 1 shows us valuable informa-tion
regarding momentum, but it is not an indication of a major shift in dominance.

Note: It is essential to grasp that a break in line with dominance is hardly a guarantee for
follow-through. In fact, in many an instance it produces the exact opposite effect. Savvy
contrarians possess excellent understanding of pressure and momentum and their typical
ploy is to counter whenever they feel a certain move has run its course. But not seldom they
will deliberately refrain from action until the market has set a new break first-then they will
counter. And they will be even more happy to do so when the break in question is set with
little to no buildup (think false break trap).

As already stated, it is not always the contrarian who comes out on top in the tricky battle
between failure and follow-through. The degree

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of double pressure on a break may very well have been underestimated and as a result,
the contrarian may see his own stop triggered in turn.
As a simple rule of thumb: the more extended the foregoing move and the poorer the
break is set at the end of it, the bigger the chance the event will be countered with
success, if only temporarily.
Let us now consider the false low at point 2. With the overall pres-sure still up and
prices in an area of a former low, we can imagine plenty of sideline bulls to be on the
lookout to position themselves for another leg up. Aggressive individuals may already fire
long straight into the level of the former low in the hopes of an immediate bounce, but
such eagerness is not devoid of danger, particularly when coming in with a tight stop.
From where we stand, the preferred route is to moni-tor how the market handles itself in
the level first. This not only buys us extra time in assessing the situation, our fellow
traders can benefit from the extra information also. Always remember that we want both
bull and bear to cooperate in our game and for this we need a certain degree of
consensus.

Stalling action in the lows of a pullback in a level of support will surely strike attention
among many participants. If nothing else, it pro-vides a visible indication that sellers are
no longer on top of the buyers and this could portend a revival of the bullish dominance
anytime soon.
But caution is still king because the skirmishes in the turn of a pull-back can be quite
choppy and in them a tight stop is easily found.
A development that could possibly work as a catalyst for the situa-tion to resolve in
favor of the bulls is when a bear break fails to extend

the pullback and is then followed by a bull break soon after. After all, if the bears cannot
follow up on their own break, and then suffer an up-side break as thanks for their efforts,
that provides a telling clue as to who is calling the shots in the turn.

While false highs and lows can indeed offer valuable information, by themselves they
are no reason to act. In Situation 1, a good example of how to have incorporated a false
low incident into a trading decision is to have entered long on the break of level 3. In this
setup, the false low at 2 functioned as an excellent marker of an upcoming turn, but it was
the subsequent buildup that provided the base for the actual trade.

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When compared to the false high at point 1, the false high at point 4 in
Situation 2 is likely to have a bigger impact on the bullish morale.
The sideways buildup prior to the upside break indicates that this time the bulls
had put a lot more effort into setting their break, only to see it fail soon after. Not
a promising prospect. If prices cannot make much headway even after breaking
out successfully from a buildup situation, then maybe there is more danger on
the boil. The event may not neces-sarily portend a complete market turnaround,
but it is a sign of trouble for the bulls and thus a good reason for all parties to
monitor the fol-lowing action with close attention for detail. Should prices fail to
recoup from the false high incident and instead face another bear break, as was
the case below the level of 5, the market is sending out an even stronger

message.
To summarize on these theoretical yet very common examples, we could say
that (a) a false break at the end of a swing in line with the dominant pressure
could trigger a temporary correction (point 1); (b) a false break at the end of a
correction could be a harbinger of the domi-nant pressure to soon resurface
(point 2); and (c) a break that is built up properly by the current dominant parties
but fails anyway could be an indication of a more serious power shift ahead (point
4).

Pullback Reversals

Should we conduct a survey among technical traders to get an idea of the most
popular setups around, then any variant of the pull:back reversal will probably
rank high on the list. It is not hard to grasp the attraction if we consider how often
this setup is glorified in trading lit-erature and how easy it is to cherry-pick perfect
examples from virtually any chart. But how rightfully earned is this reputation,
really?
Before we try to answer this, let us examine the characteristics of the pullback
first. In its most classic definition, it is a corrective price swing that travels
somewhat diagonally against the prevailing trend. True as that is, there are many
more variations of the pullback and probably the majority of them have very little
to do with countering a "trend". The

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ranging market, for example, is flooded with seesaw motions and half of them are pullbacks,
whichever way you look at it. And then there are the so-called "corrections in time" that
hardly retrace in price at all, yet are pullbacks nonetheless. Furthermore, since the idea of
superior and inferior moves is a matter of perception to begin with and highly depen-dent
on the time frame of choice, we may rightfully ask ourselves who is actually countering
who at any moment in time in the bigger scheme of things.

Naturally, it is always best to establish a view on these matters from one's own
perspective and a trader's first task, therefore, is to recognize the line of least resistance in
his chart. If there is dominance to be de-

tected in the current technical picture, any decent retracement within it is worthy of attention.
But there is always a tricky issue to solve: just when exactly have prices retraced far enough
to "safely" anticipate a favorable turn?

In our discussion on the false highs and lows, we already touched upon a reversal
technique, which was to trade the break from a small buildup progression in the anticipated
lows of a corrective swing (Figure 2.5, Situation 1, entry above 3). In the following
paragraphs, we will dig a bit deeper into the practice of turning point recognition.

In the wide array of pullback reversal tactics, two popular strate-gies stand out, both
contillning elements that can be implemented in our own plan of attack. The most universal
approach is to measure the length of the dominant move and then wait for the pullback to
retrace a certain percentage of it. If the trending move is, say, 10 points tall, many traders
will wait to deploy their reversal positions until they have seen a retracement of about 4 to
6 points, so in essence the conven-tional retracement levels of 40, 50 and 60 percent.

Regardless of how this technique holds up statistically, it is easy to point out its most
apparent drawback: with no further discretion built in, it needs a relatively wide stop to
survive all corrections deeper than anticipated.

To counter the element of uncertainty to some degree, another popu-lar tactic is to wait
for the pullback to first reach an area of support or resistance within the trending swing-
preferably residing at a cor-

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rection level of 40 to 60 percent-and then fire in it, in anticipation of a favorable bounce. This
technique can be referred to as waiting for a technical test. Since most trending swings will
show some form of sideways activity on the way up or down, and not seldom halfway or
thereabouts, corrections back to these levels are highly anticipated and can make for great
bounce candidates indeed.

For a technical test to earn attention, there is no need for a classic trend/pullback
situation. Any kind of correction that hits upon a for-mer level of support or resistance,
major or minor, can be referred to as a technical test and thus harbors within it a potential
for a bounce.
Should one insist on playing a reversal without waiting for buildup, fir-ing into a technical
test is certainly superior over firing into a void. But there is still a large degree of aggression
involved.
A more conservative route, and the one we will explore in more detail later on, is not to
buy or sell straight into a retracement spot, technical test or not, but to monitor how prices
handle themselves in the poten-tial reversal area first. This wait -and -see tactic is based
on the premise that most pullbacks will not turn on a dime. On our 5-minute frame we often
get to see at least one or two, if not many more bars that reflect a little bull/bear skirmish
right in the anticipated end of the correction.

This not only allows for extra time to assess the likelihood of the rever-sal itself, it builds
up the required tension prior to it, and at the same time it tends to offer a better view on the
exact level of the break.

Obviously, this is not to suggest that by showing a little more patience we will never get
stopped out or tricked into a premature entry-or fully miss our ride, for that matter; but if we
aim to play reversals with a tight stop, this more conservative route definitely deserves
preference over blindly buying and selling into the market without waiting for prices to stall
first. Let us examine some textbook examples to get an idea of how these tactics can be
put into practice.

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d a

situation 1
a d

Figure 2.6. Pullback reversals are often initiated from a key level of support or re-
sistance. Rather than trading into these levels straightaway in anticipation of an
immediate bounce (both at point e), it may pay to allow the market a little extra time
to set up the turn in buildup fashion.

In Situation 1 in Figure 2.6, pullback d-e represents a classic technical

test in the level of b, which was a function of the earlier sideways activ-ity
within bull trend a-d.
It can safely be stated that the level of b plays a crucial role in this
chart: (1) it built up pressure towards another leg in the trend; (2) it worked
as a technical magnet for the pullback later on; (3) it provided a level for a
technical test in a 40/50 percent correction; (4) it offered a platform for
bulls and bears to fight it out in order to determine the "definitive" lows of
the correction, thereby setting up a pullback reversal in buildup fashion (e-
j).
As already hinted, by waiting for buildup, it is inevitable to occasion-
ally miss a turn. In fact, it is quite a frequent occurrence. But it will save us
also from many a quick shake. On balance, patience will prove a much
better ally than eagerness, as countless chart examples will aim to
demonstrate in the chapters ahead. In Situation 1, the buildup between e
and fis a very common development, and a favorable one at that. It resided
pleasantly in technical support of b, while building up tension below the
level off Should the pressure escape on the bull side, this is very likely to
trigger a double-pressure response.
Regardless of entry preference, however, it is important to note that the
higher entry above f does not necessarily compare unfavorably to the
more economical entry at e. First of all, the buildup below f shows more
confirmation on the likelihood of the reversal, which is already a plUS. But
there is another issue to take into account that will affect the

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clinical odds on both wagers. It regards the levels for protection and tar-get in relation to the
level of entry. If we assume both the bounce trade at e and the break trade above I to have
been protected "technically" with a stop below the last distinctive low prior to entry, there are
some interesting things to point out.

On the trade above f, the last low of significance prior to entry re-sided at the level of b.
A stop, therefore, could have been placed a little below the latter.

On the bounce trade at e, a technical stop may have been placed below the first low on
the left, below point c. Let us further assume that both traders had the high of d as a technical
target in mind. Should it have been met, the aggressive trader, since his entry was lower in
the chart, may have scored more pip on reaching target, but not necessarily more profit in
terms of percentage. To examine this, we have to consider the ratio between risk and reward.
For example, should the stop level on the bounce trade have resided at, say, 16 pip away
from entry and the target at 32, then this particular venture would have yielded a ratio between
risk and reward of 1 :2. It is not unthinkable, however, that the conservative trader, despite
his entry higher up, could also have applied a ratio quite similar to this. The distance from Ito
the target level of d may now only have been about, say, 24 pip, but the stop below b was set
at a smaller distance also. Should it have resided at about 12 pip away from entry, then this
too would have yielded a ratio of 1 :2.

Even when adhering to a "more conservative" mode of operation, it can be a fine line
between acting prematurely and acting too late; the market is certainly not always so kind as
to grant us the most effec-tive entry if only we be patient. There is little point also in arguing
over which approach is the statistically more viable, for all is a matter of perception within the
situation at hand. From where we stand, we can generally label an entry more aggressive than
conservative when there is relatively little buildup involved prior to the break.

Situation 2 in Figure 2.6 nicely demonstrates what exactly it is that we aim to avoid when
waiting for buildup. The downtrend a-d is basi-cally a mirror image of the earlier bull trend in
Situation 1, but this time the pullback reversal played itself out a little differently. Techni-

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cally seen, the level of b once again presented itself as the most likely candidate for a possible
turnaround (a 50/60 percent retracement in an area of former support, now resistance), but
an immediate short at point e would have put an aggressive bull in serious trouble before the
actual turn set in.

Take note of the fact that in this situation, prices once again put in a technical test before
reversing, but instead of using a former level of support to bounce away from (b), the market
opted for a former level of resistance to turn around in if matches c). Both e and f are valid
technical tests and equally common in occurrence. But since we have no way of knowing
beforehand which level the market will pick in any one situation, the idea is to remain on the
sidelines until more clarity comes along. Not always will the market offer us this extra
information, but it will do so often enough to consider patience a vital ingredient in operating
tactics.

As to the conservative short in Situation 2, an entry below the level of g and a tight stop
above the level of f will certainly have suited many bears just fine.

Ceiling Test

In our discussions on the pullback reversal, we came to appreciate the technical test as a
potential base for a bounce should prices hit upon it (bounce effect) . Equally intriguing,
however, is this level's ability, and tendency, to initiate the correction in the first place (magnet
effect).
To see the logic in the magnet and bounce principles going hand in hand, let's imagine a
bullish price move from A to B, some stalling in B and then another move up to C. If we were
on the sidelines with bullish views on this market and then saw prices come down from the
high of C, what would be a defensible play? Of course, we can only answer this in general
terms, but it is fair to suggest that waiting for prices to hit upon the level of B makes for a
decent tactic. This implies that we deem the level of B a "safer" zone to operate from, than
say, a little above B, with the level yet to be hit. The point is, if we see reason within this

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approach, based on technical grounds, then so will many other players with us, and they
too may postpone their purchases until the level of B is hit. As a logical consequence, this
unanimous absence of buying enthusiasm is exactly what may cause the correction to carry
on until the magnet in question is hit.

Needless to mention, this is not to say that the magnet will be tested, it merely suggests
the potential; yet in the marketplace, the mere likeli-hood of an event often plays a major
role in the development of it. Such can be the self-fulfilling nature of price action.

Observation has it that this magnet-and-bounce principle is not just the prerogative of
the typical trend/pullback situation, it is basically present within any seesaw motion in the
chart, even within in the tini-est of technical shapes. This then leaves us to discuss how we
can put these mechanics to our benefit in regard to future operating tactics. For this purpose,
let's have a look at the technical test's more subtle cousin, the ceiling test.

A good way to introduce its workings is to explore the ceiling test principle from the
perspective of a range breakout situation. The reader may remember the three qualifications
used to rank the likelihood of follow-through on these type of events: a terribly, poorly or
properly built up break. Another way to describe these distinctions is to regard a break as
either very premature, slightly premature or ready-to-go.

Evidently, our purposes are best served by the latter, since this type will show the desired
buildup prior to breaking out. The very premature break, however, is not likely to cause
much problems either; this one is so devoid of buildup that we will simply decline it without
much further thought. With this in mind, the trickiest situation usually regards the slightly
premature break, which may show just enough promise to trap a trader into the market a
little too soon.

When confronted with a break of this kind (a potential tease break trap), the best course
of action, from where we stand, is to decline the offer; but we shouldn't take our eyes off the
situation just yet-quite the contrary. Should prices indeed fail to follow through on the initial
break, but not fully retreat either, we may soon see the attacking par-ties give it another shot.
If so, an element that could play a telling role

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in whether or not we should participate in the subsequent breakout is the presence or

absence of a ceiling test. Let's explore some examples.

Figure 2.7. Principle of the ceiling test at work in a ranging market (both at 5).

First off, to grasp the concept of a ceiling, picture an arch-shaped for-mation in the chart and
then zoom in on the series of bars that make up its top. In Figure 2.7, in Situation 1,
progression 1 -2-4 depicts a bear-ish arch. By definition, any arch, before rolling over from
the highs to the lows, will show a little sideways progression in the top, even if it is made up
of one single bar (pointy arch) .
The highs of it, obviously, form an
intermediate top in the chart, but at the same time, the lows of this topping progression form
a ceiling, basically a small level of support (3) .
Naturally, in a bullish arch, a U or V-shaped formation, this "ceiling" level would reside at the
top of a bottoming progression (floor). For ease of use, we will refer to a floor as a ceiling,
too.
By extending the level of 3 to the right, we can see how at some point a pullback came to
test this mini barrier from below (5) . This is a

textbook example of a ceiling test following a tease breakout, and it is a highly anticipated
event. In fact, the mere ceiling test potential is one of the core reasons why the breakout at 4
is regarded premature.
But tease break traders may not be the only parties at risk by the adverse magnet of the
ceiling. Sideline bears who declined the initial breakout may get into trouble also should they
too eagerly decide to take their chances on the first pullback to hit the range barrier from
below (circle) . This approach defies a price technical concept that is best not taken lightly
when playing with tight stops: rather than turning around in the most obvious level of former
support (resistance of the bottom barrier), a bullish pullback is known to gun for the last level
of former support, even when less prominent within the bigger picture (the level of

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3) . We could say this is to "fill up" the hollow space between the range
barrier and the ceiling test extension. This is essentially a function of the
magnet effect described above, and by no means a rare occurrence.
Where eager players run a risk of an adverse magnet to work against
them, patient traders stand excellent chance to benefit from it. Should
prices indeed bounce back from a ceiling test and then go on to attack
the range barrier second time around, this shows a persistence on the
part of the assailers not likely to go unnoticed. As a result, the defend-
ing parties may now prove more intimidated, and possibly more willing to
dump their holdings on a subsequent break.
Situation 2 in Figure 2.7 shows a variant of the very same principle.
The arch of interest in this picture is progression 1 -2-4. The range high
is broken at 4, but not from a buildup progression directly below the top
barrier; so that puts this break in the tease break category, too (regard-
less of outcome) .
By declining the offer at 4, bulls may have had their suspicions about
the potential for immediate follow-through, but not necessarily about the
bullish prospects in general. It is therefore not unthinkable that they are
actually hoping for this tease break to fail. After all, should prices indeed
be forced to retreat, their typical tendency is to be sucked towards a level
of support back inside the range (low of 5 put in a ceiling test with the
highs of 3). And that could serve as an excellent platform from which to
launch another upside attack.
Note that this particular "ceiling" (a floor in a V -shape) is not really
located in the deepest part of the 1 -2-4 arch; but since this level repre-
sents the last level of former resistance inside the range, it is the first
magnet of interest to qualify as potential support on the way back from
the tease breakout, and we can refer to this as a ceiling, too. Aggressive
parties may already buy straight into this level in anticipation of an im-
mediate bounce (5); more conservative players may want to see how the
market handles the test first, and take it from there; others may decide to
remain on the sidelines until they actually see the top barrier of the range
broken second time around (point 6).
None of the above is to suggest that tease breakouts are merely a
postponement of a superior break later on, but it is very common prac-

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tice, especially when the dominant pressure is working in favor of the breakout. In the total of
hints and clues with which to paint our view on the price technical picture, the ceiling test's
presence, or absence, can have a major say in whether or not to accept a break. (Entry
specifics are taken up in Chapter 5.)

Like most price action phenomena, the ceiling test principle is not limited to any particular
market environment. It is present in both rang-ing and trending markets and can play a role
in basically any type of reversal or break. Situation 1 in Figure 2.8 shows another textbook
eX?IDple of a ceiling test, when the low of 4 came to test the top of the bottoming cluster in
arch progression 1 -2-3.

situation 1 situation 2

Figure 2.8. Some more examples of the ceiling test principle (4 and 8).

Note: If you scan your charts for higher lows and lower highs, major or minor, you will often
find that plenty of turnarounds were initiated by a perfect ceiling test bounce. Especially when
the chart shows strong continuation prospects, say, bullish, a correction may not make it all
the way back to a former low, because bulls already buy the ceiling test level.

Another interesting variant of a ceiling test is shown in Situation 2.

In this chart, the bullish dominance came under pressure when the lows of 6 were broken.
As bulls fought back to undo the implications, a pullback emerged, which offered sideline
bears an opportunity to take position from higher up. The parties who already fired short at 7,
in the extension of the lows of 5, may have had good reasons to do so, but they did expose
themselves to the danger of a ceiling test at 8. Since the lows at 6 represented the last level
of former support, it was a more likely magnet for the pullback to gun for and possibly reverse
in (all this in terms of probability, of course) .

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Round Number Effect

The directional effort of any currency pair is a big players game. The volume
necessary to significantly move the currency markets is simply beyond the
realm of the average home office trader, even if he were to operate on a
scale that could be considered huge by whatever home trading standard.
Corporate banks, central banks, institutions and hedge funds are the typical
big parties competing heavily with one an-other in the Forex arena. There is
no point in trying to figure out these parties' motives for doing what they do
at any moment in time. They may be considering macro-economical releases,
fundamental outlooks, interest rate decisions, chart technicals, you name it.
Even if we knew what one big party was up to, most certainly there will be a
bunch of other big players doing the exact opposite. In all cases, we best
concen-trate on the chart. Mter all, whatever is bought and sold, it should
show up in the price action.

To complete the series of core price action principles, let us explore the
round number effect. One does not need to observe the charts for long to
find constant evidence of how the price action tends to work up to, and then
revolve around, a notable round number of interest.
Whatever causes these particulars, anything that shows up as a regular
occurrence is always worthy of examination.
What is a round number level in a currency chart? Most pairs have a four
digit quotation after the decimal mark (ignoring the pipette) and whenever the
last digit shows a 0, we can consider it a round number.
On a tiny scale, say a 1-minute time frame, a quote like 1 .2630 can be seen
as a relevant round number, and the next one in line would either be 1.2620
or 1 .2640. On a bigger intraday frame, say a 2 or 3-minute chart, the relevant
levels usually move up a notch and we often get to see the price action
zigzag between the so-called "20-levels" ( 1.2600, 1 .2620, 1.2640, and so
on) . But arguably the most notable round num-bers in any currency chart,
and the ones we will sharply monitor on our 5-minute frame, are the full and
half cent numbers, for example 1 .2600,
1 .2650 and 1 .2700. We will address them as the 00 and 50-levels.
In almost any session, sooner or later a 00 or 50-level will come into

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play. It is not uncommon to see the price action meander around these
numbers for many hours on end. Parties will come and attack them,
others will come and defend them. There is never any telling beforehand
how exactly these skirmishes will play out, but we can rest assured that
no trick or trap is shunned to fool and demoralize the opponent. particularly
in the early stages of a round number fight, it will certainly pay not to pick
sides too eagerly.
Like any other tug-o-war, round number battles at some point de-
mand a conclusion (not necessarily in our session, though) . From the
pleasant safety of the sidelines, it is our task to detect and assess the
various hints and clues that may point in favor of one side more than the
other, all of which will be covered as we go along.
Whether the direction of the market is indeed a result of superior
contestants throwing their weight around, or just a consequence of all
combined activity is basically irrelevant. For what it is worth, no party can
ever have his way with the market like a neighborhood bully. Even the big
players know very well that at any moment in time they might run into a
bigger bully themselves and get hurt in the process. On top of that, they
are only human and just as susceptible to follies, false per-ceptions and
tactical trading errors as any ordinary trader trading from his home.
Therefore, rather than being intimidated by these powerful parties, we
should welcome their presence, for without their volume, prices are not
likely to move substantially anytime soon.
A very interesting consequence of round number focus is that these
levels, too, tend to work like technical magnets. If a trade sets up prop-
erly, in line with the dominant pressure, there is arguably no better ally to
get double pressure going than a 00 or 50-level about 20 pip out.
This too is a variant of the earlier mentioned magnet effect. By the same
token, however, the pull of a major round number could work the other
way around, to the detriment of a trade; we can refer to this as the ad-
verse magnet effect.
Taking both mechanisms into account, one of our primary goals is to
set up our trades in line with a favorable magnet, while trying to avoid the
adverse pull of a 00 or 50-level as much as we can. (There will be no
shortage of examples in the chapters ahead.)

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In a normally active environment, the eurjusd pair shows an aver-age daily range of
over a 100 pip, meaning hardly a session will go by without at least one decent round
number fight printed. To keep good track of these potential skirmishes, the 00 and 50-levels
are best plot-ted thinly in the chart by default.

Note: In a low-volatility environment, which can be quite persistent, prices will have a
much harder time swinging back and forth between 00 and 50; as a typical consequence,
the market tends to shift its at-tention away from the 00-50 stretches in favor of the 20-
levels. While none of this affects the nature of price action itself, or the way the round
number battles are fought, it may indeed pay to adapt our own game to the tighter climate
as well. In Chapter 11 we will examine this adapta-tion process from the perspective of a
faster intraday chart on several popular markets.

This concludes our theoretical discussions on the most essential of

price action principles. In our next chapter will expand on all these con-cepts further, but
this time from the practical viewpoint of the 5-minute chart.

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Chapter 3

Price Action Principles-Practice

Armed with the theory part of price action principles, let us now explore
how all this translates to real price action on the eurjusd 5-minute. In no
hierarchical order of appearance, each of the following charts will show
at least several examples of the core principles at work. We will get to
see the typical round number fights, false breaks, tease breaks, proper
breaks, pullbacks, technical tests, ceiling tests, false highs and lows, and
a whole array of practical hints and clues yet to be discussed.
It is important to realize, though, that historical studies can only offer a
representation of past market behavior. On the good side, time and time
again this behavior has proved itself extremely persistent and a diligent
price action student should have little trouble incorporating the past
messages of the market into a viable strategy for the future.
No studying effort, however, could ever bring across the true essence of
what it means to trade live, but that is never a valid excuse to ignore the
virtues of preparation.
One of the biggest mistakes the aspiring trader can make-and prob-
ably the most common folly at that-is to adopt a certain method that
seems doable and then immediately go out and trade it without properly
backtesting it first or fully making it his own. Another common mistake is
to utilize charts that come free with a trading platform, rather than renting
a superior standalone package for a small monthly fee. Bar the occasional
exception, free charts usually make for terrible backtesting if only for the
fact that not much historical data is provided. A good

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standalone package will allow you to backtest at least a full year on the 5-minute. That's an
incredible amount of useful information, all at the push of a button. Furthermore, professional
charts are fully customiz-able, do not irritatingly reshape the price or time axis when you
scroll through them and you can draw in them without ever accidently firing off trades. It is all
up to the individual, but the importance of proper charts, the very tools of the trade, is best
taken to heart.

In all of our studies, the 5-minute chart of the eur/usd pair will be the instrument of
reference (with the exception of Chapter 1 1). The set-ting is classic candlestick, with the
bullish bodies printed white and the bearish bodies printed black. As price action traders we
have no need for bells and whistles in our charts, but allow me to suggest the luxury of one
technical tool that takes up no space at all, yet can be a very useful asset: the 25 exponential
moving average (25ema) . Surely we can do our trading without this "indicator" plotted, but I
have come to appreciate this average as an excellent guide and filter in both analysis and
trading operations.

As the name suggests, the 25ema represents the average closing price of the last 25
bars, but with a small tweak in computation that favors the weight of the most recent bars. It
is slightly slower than its more popular cousin, the 20ema, which is often plotted for similar
guid-ing purposes. The exponential tweak itself adds very little, though, and when used as
a mere gauge of market pressure, any average between, say, 18 and 30 would serve this
purpose just fine. Sloping up, with most bars closing above it, the bulls are momentarily on
top; sloping down, the bears have the best of the action. All this in relative terms.

In order not to compress the bars too tight horizontally, it is chosen to show about 6 to 7
hours of price action per chart, which should give an adequate view on the nature of the
session at hand. When trading live, a trader could set up his charts with some extra hours in
it. On the 5-minute, however, there is usually little benefit to be gained by plotting more than
a day's worth of price action on the screen. Too much infor-mation may even start to conflict.

When setting up the horizontal stretch, keeping a tiny bit of space between one bar and
the next will make for pleasant charting. As to

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the price scale on the right, I prefer to squeeze down my charts on this axis, thereby
decreasing the height of all bars; this creates a calm, non-awessive feel, quite opposite to
a chart that has been stretched out vertically. And lastly, to keep the charts clutter free,
there are no grid lines in them, just the thinly plotted round number levels of 00 and 50. lt is
chosen to let these charts reflect the three session nature of the

Forex markets in Central European Time (CET), starting with the Asian session at 00:00,
followed by the European and London Open at 08:00 and 09:00 respectively, and the US
Open at 15:30 (US stock markets Open).

The arrows in the chart call attention to the so-called entry bars (entry taken on the
break of the forgoing bar) , but since we have yet to address our entry techniques in Chapter
5, at this point they are just put in for future reference and to already give an impression of
how a confluence of price action affairs can lead to powerful breakouts.

To minimize the disturbance of having to flip back and forth between chart and text,
effort has been made to present the charts at the top of the left page (a few exceptions here
and there) . What will certainly aid the absorption of discussions below them as well is to
spend a few moments to examine each chart example first, so as to already obtain a general
idea on the technical topics ahead; this will surely get easier with every new chart that is
introduced. Later on in our recap series in Chapter 8, with all the concepts and principles
already well ingrained, the discussions will be shortened to fit a two-page format, which will
keep the charts in view throughout. In Part 2, in the long series of con-secutive intraday
charts, the commentaries are minimized even further and will appear within the charts
themselves.

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Understanding Price Aaion

I Fig 3.11 WW>N.ProReaITime.com eur/usd 5-minute

8 9
' 355

4 olÿOI,ot61

'IOÿ --1ÿÿÿÿ1
12
1.35

ProReatTime.com
07:00 08:00 09:00 10:00 11:00 12:00

Figure 3.1 This chart seIVes well to illustrate the concept of the double-pressure pop
stemming from a buildup situation (bull swings 3-4, 7-8 and 13-14). Without delving into
details of entry and exit technique, let's find out if there were price action principles at work
that may have hinted at the coming of these powerful breakouts.

A little before the European Open at 08:00, bulls had slowly taken the initiative (prices
above the 25ema) , but their dominance was far from outspoken. To their credit, they had
managed to successfully fend off a bear attack in bar 1, which had put a mini higher low in
the chart.
A little bullish cue.

With prices back on the 25ema, a small pattern line may already have been plotted as
depicted, but it wasn't a telling boundary by any means. The line did earn merit, though,
when bar 2 briefly broke out on the upside, only to retreat and close below it. A point won
by the bears.
Note: When plotting lines for visual assistance, there is no need to look for anything
grand. Small boundaries (spanning about an hour of price action) can be very effective
also. For bullish purposes, draw your lines either flat, or let them slope down across some
descending highs, never up; vice versa for breaks on the bear side. But do keep in mind
that any pattern line, big or small, is always a function of personal in-terpretation. If only for
this reason, the mere perforation of a line may not make for the best of trading signals.
The break of a 5-minute bar, on the other hand, is incontestable and the more crucial the
position of this bar in relation to the neighboring price action, the bigger the impact of its
break. This principle lies at the base of our operating tactics and

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Chapter 3 Price Action Principles-Practice

the general idea will be to trade the break of such a bar more or less in conjunction with a
pattern line perforation. On occasion, we may al-ready enter before our pattern line itself is
taken out, but more common is to hop along shortly after the event.

The first breakout situation is a good example of the latter. Note how bar 3 opened more
or less on the pattern line (low of the white body), then went down a bit, only to close bullishly
outside the pattern (high of the white body) . This was a token of bullish resilience, but no
crucial bar was broken yet. The very moment the high of bar 3 was taken out, however, bulls
didn't waste time buying themselves in, leaving plenty of bears little choice but to quickly buy
out. A classic double-pressure situation. (From what is shown on the left of this chart, it's hard
to say whether this truly called for action.)

While there are countless ways to snap up prices in a pullback (4-6), the conservative
route is to wait for the correction to hit upon a techni-cal element in the chart (a test of support
or resistance), and then see if prices can find some footing in it (buildup) .
If you take position merely on
account of an attractive retracement level, say, a 50 percent correc-tion of the foregoing
swing, you are basically resorting to tactics of the hope-and-pray variety. Buying or selling
straight into a technical test is not without danger either, for prices may very well march
through it, if only to shake out the partles who came in with a tight stop. Hence the
recommended approach of waiting for some bars to settle in the area first.

The 1 -3 cluster from where the first bull swing had taken off is a good example of an area
of technical support. On balance, the thicker such a block on the left, the harder it will be for
prices to fully cut through it on their way down.

Quite like an angular line can help to mark a boundary of interest, wrapping a box around
a cluster of neighboring bars can be very useful also, particularly when dealing with a potential
reversal in the high or low of a pullback. A single horizontal line at the side of the anticipated
break may suffice, but a box can really help to visualize the tension in the turn (5-6-7) .

Underneath the dotted pullback line, bar 7 was a false low with its

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direct neighbor and a higher low inside the box. When this bar was taken out topside, so too
was the resistance of the box pattern, the pullback line, the 25ema and the round number.
Such a confluence of broken sweetspots present in a single breakout stands to work to the
benefit of follow-through simply because it will have many traders focus their attention on the
very same break; and contrarians are less likely to counter such event.

It took some pushing and pulling in the current highs of the market (double top 8-9) , but
once bar 9 was broken down, bulls finally let go and a bearish pullback ensued (9-10). Note
that this correction only retraced about 50 percent of the foregoing swing 7-8, an indication
that the bulls were keen on keeping the pressure up.

While conservatism in the markets is highly promoted, it is always a pleasant fact that
many parties have no problem with aggression.
For example, the typical buying of the proverbial falling knife on a 50 percent correction can
be indirectly beneficial to the breakout trader's cause, for this kind of bravery is necessary to
slow down the pullback's momentum, so as to set the stage for a sideways phase from
where a more "conservative" trade may sprout.

A rather effective way to anticipate the break from this buildup is to monitor closely the
current low of the pullback and the first high that follows it. The moment prices edge down
from the latter, we can already wrap a box around both extremes and extend it to the right.
(In this situation, the initial box could have been plotted around the low of bar 10 and the high
of bar 1 1; prior to the actual breakout, however, I ad-justed the top barrier a little to match
the high of bar 13.)

With an empty box in place, the next few bars will usually start to pull and push within it-
the first stage of buildup. There is no way of knowing, of course, how many bars will show up
in the box, but each one will add to the pre-breakout tension. Prices could break out either
way, but chances are good that the market will pick the side of least resistance, in line with
the earlier dominant pressure. This implies also that there is a potential for a breakout trap at
the "less favorable" side of the box.

At some point in a buildup progression, parties will have to step up

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to the plate and force their way out. But a mere break of a box bar-rier,
even at the favorable side, may still not suffice to attract sufficient
participation. Always preferable is to first see some extra tension in the box
prior to the breakout; buildup within the buildup, so to speak. At times, this
final tension can be subtle to detect, but it is never a matter of "feel". The
bars will always guide the way.
Let's take a closer look at how this second box was built up. The lO-II
upswing was the first bull attempt to end the correction, but it didn't take
long for bears to take over again and short prices back to the for-mer low:
a common seesaw motion in the potential turn of a pullback.
Very interesting was to see bar 12 briefly break below bar 10, only to be
bought up instantaneously, and quite aggressively at that. A textbook
contrarian trap.
Not long after this false low incident, with prices pulling and push-ing
back inside the box, bar 13 provided another technical tell of significance.
This bar, too, first surpassed the low of its little neighbor (technically a
bearish feat) and then closed strongly up. This not only printed another false
low in the chart, it put a higher low in the box. If we compare the implications
of bar 13 with those of bar 7 earlier on, we can already see some nice price
technical repetition at work.
The second box took twice as long to break as the first, but in many
instances this only enhances the likelihood of a double-pressure pop.
After all, the more trading done within the buildup, the more parties trapped
on the wrong side of the market when prices finally break out, and their
flights to safety can only add to the breakout pressure.
All this is not to suggest that the break trade above bar 13 was a
guaranteed winner, but with (a) bullish pressure in the overall chart, (b)
prices in a 50 percent retracement zone, (c) a false low at 12, (d) a false
and higher low at 13, (e) an upside break of a box pattern, and (t) the 50-
level magnet hanging above, at least the prospects for bullish follow-through
were excellent. (Entry and exit specifics will be taken up in Chapter 5.)

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IFig 3.21 'WWW.ProRe.ffime.com eur/usd 5-minute

1 375

10:00 11:00 1200 1ÿ00 14:00 15:00

Figure 3.2 There are many ways to analyze price action but there is
never any need to overdo it. Particularly when going the leisurely route
of the conservative style there is seldom reason to strip the chart apart.
This is not to suggest that some bars are not relevant. All of them are.
But there's little point in busying ourselves with every skirmish in the
chart. Always remember, it takes time for the market to set up a trade in
high-odds fashion. Whether prices are currently trending or ranging,
breaking away or pulling back, eventually things will work up to a boil-ing
point in almost any session; that's the time to sharpen up the focus.
In Figure 3.2, the activity caught between the two pattern lines, more
than three hours worth of price action, was essentially the mar-ket's way
to absorb the bull rally that had protruded from the London Open at 09:00
(1-3). A quick scan tells us that prices never pulled back more than 50
percent from the high of this rally: this was a bullish sign throughout and
the core reason also to shun all trades on the short side. Surely it may
have been possible to scalp some pip on the way down within this pattern,
but that is not the premise of the conservative style we're about to discuss.
It's best to concentrate on the nondebat-able high-odds ventures first.
They do not come in abundance; maybe once or twice a session in any
one market. But you need no more than that to prosper in this field.

Even among conservative breakout traders there will always be room

for debate as to what exactly constitutes a proper break. Yet few traders
will have questioned the bullish potential of the pattern line breakout above
bar 1 1. Without bickering over the fact if this was indeed the best

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