This week I would like to return to my Back to Basics series with a final and final installment.
In the past weeks, we have looked at ways to measure and identify trends in the Forex market, and have also explored the fundamental concept of stop loss. This week I will focus on the next piece of the puzzle: Trade entries. While this may seem obvious to some, my experience teaching at a trading academy says that most aspiring traders struggle with prudence and clear structured rules when entering a position. It is very important every time to know, before starting any trade, the exact place where we will enter and the necessary criteria for pulling the trigger (i.e. for direct entry into the market).
Trading is suicidal if you only enter the market because you see a move up or down! On the contrary, we must adhere to strict rules for entry and recognize that the moment of entry is the only stage in any transaction when we have complete control. After that, our fate passes into the hands of the market, so it would be wise to take control whenever we are given the opportunity.
Removing all the husk, we will see that in reality there are two different ways for traders to enter any market, namely, an entry on a pullback and an entry on a breakout. First, let’s take a look at the pullback entry. In the case of a buy, a trader would look to buy when the market revisits a past demand or support area and tries to buy an asset at a low price; or, as in the case of a sell, the trader would hope to sell when the market retests a past supply or resistance area where he would try to do so at a high price. It is an ideal technique to use when trading both in a trend and in a price range. In simple terms, a pullback encourages buying at the low and hoping to sell at the high, or sell at the high with the hope of buying at the low.
However, the breakout method is slightly different in its dynamics. In the event of a buy, the trader would hope to buy the asset when it makes new highs, taking this as a good sign of strength. It would be reasonable to expect the market to move further in the near future, making new highs. In the case of a sale, sellers would of course do the opposite. They would be interested in selling the asset when it made new lows, taking this as a sign of strengthening market weakness, and would expect it to decline further. This method could be an ideal way to enter a market with a strong impulse trend, but we also need to know that in fact, during the consolidation period, there are many false signals, which makes it risky to enter in markets with low volatility. Therefore, we can determine the breakdown like buying at the high with the hope of selling even higher, or selling at the low with the hope of selling even lower. So let’s take a look at how these inputs look on the chart:
This is a 60 minute EURUSD chart. The time frame and currency pair used are irrelevant. We must trade any asset in the same way, as this gives consistency to our trading and gives a bonus to a technical analysis style or trigger to enter that can be used in the same way on any type of chart. The day trader could use 5 minute charts for his entries and targets, while the swing trader could use the 60 minute chart for the same, and the position trader could focus on weekly or monthly charts. It is important to understand the entry criteria that match your trading style.
As we can see in the example chart, the EURUSD price was at 1.3600, where it found a barrier in the form of resistance. With this in mind, the nimble trader would be faced with the following choice:
1. Sell now at the resistance area and seek retesting at the support at 1.3540 as a target.
2. Buy when the market reaches the lower demand area around 1.3540 with targets at 1.3600, 1.3700 and above.
3. Buy when the market breaks the supply area at 1.3620 with the target at 1.3700 and above.
The question is, which of the options is correct? In reality, all of the plans announced, as long as you follow the rules and use stop loss to control losses, are correct. Nobody really knows what will happen next, so we have to analyze all the available options and then choose the one that suits us best. It should be noted that if we decide to buy, when retesting the lows, at 1.3540, then we have a clear place to place a stop loss, below the pivot low in the 1.3520 area, and if we take a breakdown of 1.3620, then there is a place to place a stop loss where the market says we are wrong will be below the pivot low at 1.3560.
As we can see, all three trades would succeed, but we must recognize the difference in reward and risk. I am sure the breakout buying was good, as the price easily broke above 1.3600 and moved further, almost to 1.3800. But when we look at the risk / reward ratio in this position, we can see that although it was a good trade, it was not as impressive as the trade with a pullback to the 1.3550 level. During any trade, do not forget to analyze and understand the risk, ideally we should look for trades that give at least a 1: 3 ratio. Breakout will always be more risky because requires more risk and gives less reward, but as long as the trader understands this and takes only objective transactions with a normal ratio of risk and reward, then a breakout entry in a strong trending market may be the only alternative. However, a pullback entry provides the least risk and the greatest reward, but it takes patience to wait for all the market conditions to be met.
With this in mind, we must decide which market entry is right for us. Personally, I am not a fan of breakout trading and will always sit and wait for the best opportunity a pullback presents, but remember that this is just my trading style. However, I know that many professional and experienced traders have achieved excellent results when trading breakouts. Our personality must be reflected in our trading activities. Only in this way, in the long run, can we hope to make consistent profits.
