How To Find The Best Buy?
Price Action Lesson #2
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I am really afraid of this one. Not because it is some scary or risky thing. In trading everything is risky.
I am afraid because I don’t know if I would be able to explain it to you the right way. And the lesson here is really important
A chart was posted on the Talking Chart Facebook page. A chart with a question to find the best buy points.
There were many comments. Some picked correctly the right move, but most of them focused on the entry only. While exit is where we should pay attention.
So, which one is the best buy? Look at the chart and think for a moment.
If you show this chart to somebody on the street and then ask “where should I buy to make the most money” he or she will tell you point D. The obvious answer. Because this is the lowest point on the chart and if we assume we hold our positions open till the highest point (upper, right corner) then we make the most money.
Now, be honest and tell me, can you do it? Can you hold a position open for that long, through a one-month range (from D through G) or after such severe declines (before I and J)?
You can’t, right? Neither can I!
If we are long-term investors in Gold (or hedging a stock portfolio), then it is possible. But in that case, we won’t bother with timing and finding point D!
If we are searching for the best entry, we are most likely a short-term or a swing trader. And that means at some moment we will:
– close the trade, because our target is reached
– exit, because our trailing stop got hit
– hit the close button, because price action signals it
– exit the position, because WE GOT SCARED
I’ll repeat this one more time “because we got scared”.
We got scared because we don’t know will it break the resistance or not. We got scared because we’re sitting on a big profit and the market just made a few ticks (pips) against us. We got scared because it took the last day’s low and now it’s going to crash.
And that is the answer:
The best buy is the one preceding a move which doesn’t do anything to scare us out of the trade!
If it doesn’t scare us we’ll ride it for longer! And riding a move longer is crucial for our survival in trading. This is how you make the best Risk-Reward trades.
That means that D can’t make the most money because we won’t be able to hold the position open. That is, of course, if we completely ignore the fact how impossible is to catch the ultimate bottom 🙂 But more on this later in this mini course.
So what is the right answer? Look at the next image.
You can pick between G, K and J. If you ask me I’ll choose K.
J looks fantastic but it is also the trade nobody wants to take. I mean, who can buy after such a decline? It might be the right thing to do, but trading is an emotional game and such big down candlestick will play with our emotions during the entry and the exit. Even if we open a position based on the EQ candlestick, that monstrous, down LB candlestick will psychologically make the exit harder. Because we’ll compare everything to it!
G is a good one, except for that small tight range after the entry. The entry is the Long Body Candlestick highlighted with yellow. Will that range scare us? Maybe not, because we’ve entered on the high of the Long Body candlestick and placed the stop-loss below its lowest point. The market didn’t even reach the middle of that candlestick.
After that, there was not a single break below a daily low until the exit, which is the break below the highlighted 1xN candlestick.
I have chosen K because it made the same money as G but it made it faster and without consolidations. After the entry (the 1xT Long Tail) the first point, where we can get scared and close, is the break below the highlighted 2xN Long Nose candlestick.
Again why K:
- It appears in a market range, after a sharp decline (before I)
- There is a distinctive price action entry, after the 1xT candlestick
- The most important – this is the longest ride because it doesn’t do anything to scare us out of the trade.
- This is a move we can honestly say that it was possible to find, enter and hold longer. A move with a great risk-reward ratio.
It is like in the game of chess where there are some fundamental rules one must follow like castle early, create pins and forks and so on. Following those rules doesn’t guarantee you victory but sure is getting you closer.
There is no certainty in the game of trading either, but such moves are often preceded by something easily identifiable. That is the topic of our next lesson.
A good exercise would be to check charts of other instruments. Try to find such NOT SCARY moves. Study them.
Thank you for taking the time to read this… Lesson #3 is next!
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