Understand the Forex Market

In Module 3, Understanding the Forex Market’, we will explore how to place good trades with what was learned in the first module. In order to place good trades, you must know now where to enter and where to exit a trade. In this lesson and the next we will be focusing on entries and exits. Failing to know this will mostly likely lead to unsuccessful trades. 

How to Spot the Agents of the Market

Learning price action and the market source code is the most direct source of what is happening in the markets, and in my opinion the best way to pick up clues as to the whereabouts of the agents and where they are buying and selling. The agents often have billions of dollars in equity with which to trade.

Particular source code “letters” provide clues in price action where banks and institutional players might be. The most basic (and also the most accurate) price action bar is the PIN BAR (T, t).

Pin Bar ‘t’ Characteristics

  1. The wick of the candle must be at least 2 times the size of the body;
  2. The close and open must be close together (the closer the better);
  3. The body of the candle must be at the top 1/3 of a bull candle or bottom 1/3 of a bear candle;
  4. The wick must protrude through other candles in the set (the longer the wick the better).

  • Pin bars are often seen at the top or bottom of a trend.
  • This candle has immense price rejection and is often created by agents.
  • If you see this candle on a high time-frame, you may have spotted a heavy buyer or seller. (Other signals later in this course will help you confirm this).
  • The higher the time frame, the more accurate the pin bar signal.

A Highly Probable Trade Set-up (No. 1)

We will now look at a highly probable trade set up which you will encounter in your day to day forex trading and explain what you should do in a bearish and bullish situation. The action trigger to performs and target to achieve are explained below.

 

Bearish Set-up (4 Hour or Day Chart)

  • Must see at least 5 previous “up” bars;
  • The close of the nose candle bar must be inside the previous candle;
  • Nose bar must protrude through recent price action and touch a value area.

Trigger: Once the “nose” candle has been printed, wait for slight pullback on the right eye candle (more on this in the advanced price action lesson). Then place order, with a SL of 3 pips above nose candle.

Target: 20ema or previous support areas (or a good target would be twice your risk).

Bullish Set-up (4 Hour or Day Chart)

  • Must see at least 5 previous “down” bars;
  • The close of the nose candle bar must be inside the previous candle;
  • Nose bar must protrude through recent price action.

Trigger: Once the “nose” candle has been printed, wait for slight pullback on the right eye candle (more on this in the advanced price action lesson). Then place order, with a SL of 3 pips below the nose candle.

Target: 20ema or previous resistance areas (or a good target would be twice your risk).

Pin Bar Traps

Not every pin bar will work in your favour; this is where your judgment and experience will come into practice. Nevertheless, here are some potential pin bar traps:

  • Pin bars that do not form at a significant area of support or resistance;
  • Relatively small 4hr and day pin bars against a strong trend;
  • Pin bars that do not break through recent price action.

CHART: AGENT REVERSAL SETUP

 

The above chart shows how to trade a typical pin bar setup with a greater than 2:1 risk-to-reward ratio. The right pin bars provides accurate reversal patterns from which traders can profit while agents are making noise in the markets.

 

Reversals or Continuations?

In this section we will be discussing the inside bar “u” price action formations as it has great importance on what the market is trying to communicate to us.

An inside bar is a bar that has completely been overtaken by the previous bar (including the wicks of the candles); they are fairly common patterns seen on the charts.

Candle “q” is sometimes known as the mother candle and “u” is the baby or inside candle. Although inside bars can happen for many reasons, they can mean either one of two things: a continuation pattern in the direction of the trend or an exhaustive period where the market will reverse course.

Here are several scenarios where inside bars could form:

(1) right before a major news announcement where liquidity dries up;

(2) after a prolonged move in the markets where investors are booking profits; or

(3) at a major support or resistance level in the markets.

As we will see later, not every inside bar is ideal to place a trade. Major news announcements can go either way and thus lead to poor trades; one also runs the risk of false breakouts at major supports and resistance with inside bars. Therefore, it is critical to know your environment and to place favourable trades when conditions are prime.

CHART: INSIDE BAR CHART

 

Nevertheless, inside bars, when formed with a trend as shown in the chart above, present high probability trades (if executed correctly). All eight inside bars that formed on this daily chart would have resulted in a successful trade. (Execution of inside bars will be discussed in a later section in this lesson.)

CHART: INSIDE BAR EXHAUSTION

 

In the case of the Inside Bar Exhaustion chart, an inside bar was created out of exhaustion and so continuation of the trend was not able to be carried out, due largely to a lack of commitment by the buyers. This inside bar formation was also at an important long-term resistance level where price was not able to cross.

In the end, inside bars are good clues as to what the market is communicating and can lead to strong price moves. Inside bars that form with the trend are usually good opportunities to enter. However, as mentioned above, watch out for certain criteria. Inside bars that form at a major value area or after an over-extended move may be worth staying on the sidelines.

 

A Highly Probable Trade Set-Up No. 2

In this section I will show you the method I use to trade inside bars. As in the previous example the trigger point and expected outcome are detailed below.

 

Bullish Inside Bar Set-Up (4-Hr or Day Charts with Trend)

 

Trigger: Place limit order 7 pips above candle “q”

Stop Loss: At the low of Candle “q”

Target: 4hr charts (30 pips) Day charts (50 pips) Some discretion should be used here

 

Bearish Inside Bar Set-Up (4-Hr or Day Charts with Trend)

 

Trigger: Place limit order 7 pips below candle “q”

Stop Loss: At the high of Candle “q”

Target: 4hr charts (30 pips) Day charts (50 pips) Some discretion should be used here.

 

Inside Bar Traps

Not every inside bar will work in your favour. This is where your judgment and experience will come into practice. Nevertheless, here are some potential inside bar traps:

  • Inside bars that form at a significant area of support or resistance;
  • Sunday or Holiday inside bars;
  • Inside bars right before an important news announcement;
  • Inside bars that form after an extended move in the market.

Here is an example of how to place a proper inside bar trade. Once a “u” bar is printed, place a limit order 7 pips above the “q”. A SL order is placed below the low of “q” bar and a target of 50 pips which was reached on the same day.

CHART: INSIDE BAR TRADE EXAMPLE

 

Out of the eight inside bars that formed on the chart above, five would have been profitable trades, two would have never been tagged, and one would have been a loss (1/8 = 12.5%).

This is a low probability for a losing trade. To help accuracy even further, place trades after inside bars with the general direction of the major trend.

What you need to Know about Momentum

 

As we have seen with inside bars, momentum helps us determine who is in control of the market. For instance, once the market has broken out of a trading range, it is not uncommon for the market to explode out of its range.

When price is trading in a range it could be building tension and anxiety—which, if it is a winner, will continue with the trend. However, the range could also be demonstrating a period of fear and/or a lack of confidence, in which case the trend would reverse course.

Yet, certain candles do provide momentum clues as to what the market is communicating to us. For instance, if the candle closes at the highs or lows and leaves very little or no wick in its current direction of trend, it is like pressing ‘stop’ on a video showing a ball in freefall. Once you press ‘play’ again, the trend is likely to resume and the ball will continue its freefall in the same direction. However, this is not a holy grail; it is meant to provide you with an analogy of this strong, probable continuation pattern.

It is always important to know who is in control of the markets and to trade alongside this invaluable piece of information. Bars with no wicks are what I like to call “victory bars” or, as we learnt in Lesson 2, “V, v”.

Depending on your Forex broker, you may have erroneous victory bars due to different server times.

If, for example, the close of the broker’s server were not aligned with the New York close, you would not see the same charts as the Agents of Fed are seeing. Again here is where you can get these New York close charts.

Victory Bar (V,v) Characteristics

  1. You should consider only 4hr and day candles; 
  2. The close of the bar must be within less than 5% of the total candle length;
  3. The body of the candles must be at least twice the size of the wick.

A Highly Probable Trade Setup No.3

In this section we will take a look at a Victory Bar trade example and expected action and results.

 

Bullish Victory Bar Setup: (4hr or day charts with trend)

 

Trigger: Place limit order 7 pips above victory bar

Stop Loss: At the low of the v bar

Target: 4hr charts (30 pips) Day charts (50 pips)

 

Bearish Victory Bar Setup: (4hr or day charts with trend)

 

Trigger: Place limit order 7 pips below victory bar

Stop Loss: At the high of the v bar

Target: 4hr charts (30 pips) Day charts (50 pips)

 

Bald Bar Setup Traps

Not every v bar set up will work in your favour; this is where your judgment and experience will come into practise. Nevertheless, here are some potential v bar traps:

  • Victory bars that form at a significant area of support or resistance;
  • Sunday or Holiday victory bars;
  • Victory bars right before an important news announcement;
  • Victory bars that form after an extended move in the market.

Victory “V” bars typically represent a continuation pattern as there is little rejection (which is indicated by their small or non-existent wicks on the direction of the trend).

The bulls or bears (depending on the direction) would be in control throughout the entire time frame right to the very end of the close of the candle. Here is a typical V bar execution.

Notice how the v bar was formed right after a pin bar. This provides an even greater probability that the trend will continue.

CHART: BALD BAR SET-UP

You might be wondering: “The market moved higher. Why didn’t you place a higher target order?”

That is a good question.

We do not know for sure where the market is heading. Therefore, this strategy is meant to grab money out of the market, just as in the case with inside bars. Placing smaller and more attainable targets as such will lead to higher probable trades that will hit your targets effortlessly.

We will provide you with more great examples of how to trade these setups in a future lesson.