Have you ever wondered whats the best way to determine the trend of the market?
There are plenty of tools, indicators, etc including:
- Technical indicators such as RSI, MACD, Momentum, etc
- Fibonacci retracements and extensions
- Elliot Waves
- Gann cycles
- Other tools
You name it… Some of them are pretty subjective, and some other techniques are good.
But the question remains, among them all, which one is the best?
I don’t know about you, but I think trading is not a game, and I rather use something objective…
So to determine the best tool, I’d recommend you to take the following considerations. Make your strategy:
- As objective as possible (there will always be a certain degree of subjectivity)
- As simple as possible (KISS principle)
Once your strategy (or system) these two characteristics, you’ll have a system with a very good profit potential :)
Ok, so now, want to know what my take on this? What is as objective and simple as possible?
You guessed it.
Support and resistance levels plus price action.
In todays article, I’m going to show you how you can use support and resistance levels plus price action to make a chart talk to you, to show you how to convert a chart like this one:
Into actionable and reliable trading advice.
Like gold for traders
From my point of view, using support and resistance levels plus price action is the best strategy to determine the direction of the market, its simple, objective and reliable.
And guess what? That is exactly what our job is as traders: knowing what the market is likely to do its like gold to us. With this information we are able to:
- Determine what currency pairs to trade
- What direction to trade them
- Where to set your SL and TP levels
- When you are going to stop looking for trades
- and more
Quite important isn’t it?
Now, have you noticed I haven’t talked about the entry system or entry signal?
The reason for it its because it doesn’t matter what strategy you use to find your entries. Seriously.
As long as you have a good strategy to determine the trend of the market, you can use what ever you like the most as your entry system: now you can use technical indicators, Fibonacci, Elliot Waves, etc.
See my point?
It is more important to know what the market is likely to do, than the entry system.
Ok, as every post, I try to show you what I mean with actionable advice, so I’m going to build a case to trade the AUDUSD…
Support and resistance levels
Support and resistance levels are objective because there is no guesswork to do.
It’s not like: “I think there is a resistance level right here.” it’s more like, there is an important level or it isn’t and important level, as simple as that.
Here are the rules to draw perfect support and resistance levels:
1 – The market needs to get rejected at least twice from the level
2 – The more rejections the level has, the more important it becomes
3 – Most recent rejections are more important than less recent rejections.
As clear as water?
Since we are trying to determine the direction of the market, we need to focus on the long term charts.
You can use the 4 hour charts, the daily chart or even the weekly charts. (If I was trying to find my entry level I’d focus on the short term charts, right?).
Here is the AUDUSD daily chart
Clear support and resistance levels huh?
So, what can you say about the above chart?
Support and resistance levels are showing us exactly at what levels the market might change direction.
It doesn’t matter what happened before though… The real question we need to answer is this one:
What can I do right now with this information?
Ok, since the market has been rejected from this level before, the market might get rejected again. Could be because of the same reason or not. I don’t really care, what really matters is that the market is likely to get rejected again from the support level around 1.0173
This is the type of actionable advice you need to get from this analysis.
But it doesn’t stop there, support and resistance levels can tell you more valuable information.
For instance… lets say the market gets rejected from the support level (1.0173) and it continues its way up.
For how long would I hold my trades or for how long would I keep looking for long opportunities?
Until the market reaches the next LT resistance level which is at 1.0573.
Ok, so you now have a lot of actionable information about the AUDUSD:
- You know it is likely to get rejected from the support level
- You’ll look for long opportunities until it reaches the next resistance level
And, what if the support and resistance levels aren’t as clear as the chart above?
Of course you’ll find that sometimes aren’t as clear as this one, but that’s the point. We are doing this whole thing to determine: what currency pairs to trade right?
So if it is not as clear as this one, just forget about trading it, and try to trade some other chart (currency pair) with clearer support and resistance levels.
Our job as traders is not to trade the same pair every day, but to trade the pairs where you have a clear idea of what they are likely to do.
If it doesn’t, feel free to leave a comment below.
Now, lets isolate price action and see what the market is actually telling us:
See those green square?
Well, on each one of them, the is some kind of pressure, upward pressure around the bottom of the range, and downward pressure around the top of the range.
Lets see what the green blue square is telling us so you know exactly what I mean by pressure:
It looks like the market didn’t like the level it was trading before, and reacted with a strong upward move.
So the market first goes down [candlestick 1] (sellers take control over the market) but then at some level, it starts to move up [candlestick 2] (buyers take control over the market) with even more strength then the downward movement.
This means a lot to the market. It means that the market is not yet ready to trade at lower levels, once the market gets at those levels it attracts plenty of buyers (or just a few with deep pockets) making the market turn around.
Now again… What can I do right now with this information?
Well, if the market it’s not ready to go down, it only has two possibilities left: either it stalls around there, or it goes up.
So you know that “if” you are going to do anything with the AUDUSD, it is going long. I say “if” because we need to confirm this with the short term chart to start your trade.
And this takes us to…
Using both S&R plus price action
This chart is worth a thousand words:
So you now have clear support and resistance levels plus well identified levels with upward and downward pressure.
Support and resistance levels tell me when the market is likely to change direction
Price action tells me when the market might be ready to change direction.
If we combine both analysis, we get to a very interesting conclusion:
The market is likely to change direction right now.
Now, you need to remember something, we are not talking about market entries right now, that is out of the scope of this article. But I’ll address it in the coming weeks.
So what this analysis tells me is that the AUDUSD is ready to go up, now I only need to confirm this with the short term charts, and find my entry.
What do you think about using price action and support and resistance levels to determine the direction of the market?
What other methodologies you use to determine the trend of the market?
What do you think about the AUDUSD? Are you bullish already?