Rules of Price Action Trading [PDF]

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A Price Action Trader’s 14 Rules for Survival By Steve W.

Price action is the #1 tool in any trader's toolkit for a very simple reason: everything else is based upon it. If everything else is the derivative, then price action is the underlayer. Below is our brief summary that discusses price itself and the mental model required to follow. 1. Know your price patterns, and know them all. All it takes is a couple weeks of regular study to familiarize yourself with every single one of them. Price structure is extremely helpful in identifying new opportunities. The more opportunities you have, the better able you are to hone in on what simply works

best for you over the long haul. Getting married to one or two strategies that produce mediocre or poor results can leave you in limbo for a very long time. By dissecting price into various workable structures, you can wean your way forward by having more than enough options to chew at. If you need some help in this department, you can start with our own unique price patterns and this post leads to a great resource for the more conventional. 2. Draw your trend lines using the most historical hits (inner trendlines), as well as conventionally. We've discussed inner trendlines on this site several times now, such as this post and this post. Conventional trend lines (thorough explaination here) follow the perimeter of price, and they are always the last to break. Oftentimes, because they are so obvious, price turns into a consolidated mess when it actually runs into the level. This makes entry extremely difficult with price behaving in a convoluted manner. Inner trend lines are drawn using historical hits, and in our experience, register much cleaner retests on the back end once broken. Additionally, these breaks happen ahead of the main, outer trend line, positioning yourself well ahead of the whipsaw price action regularly occurring around conventional trend lines. 3. Know the cardinal rule of price patterns: Every single one of them “fails”. Have a plan of attack for both potential scenarios. If there is one thing that bothers me the most about the way in which books and other literature discuss price patterns, it is that the author (usually copying the word of past authors) associates a future direction of price based on a pattern itself. I spoke a bit about this topic in this video. In addition to trading them in the “conventional” sense, you should be able to identify “failures” (or as we call them, successes) on them as well. For instance, a bullish flag is violated when 38% of the initial thrust is broken to the downside. Prices then uses the back end of that level as resistance, etc. 4. Be curious. Whenever something happens that you don't understand, find a way to “figure it out” to take advantage the next time it happens.

Nothing is more powerful or useful to your understanding of the way price “works” than that of raw observation, and your ability to find a way to recognize behaviors on a reoccurring basis. “Screen time” is only valuable if you are diligently finding ways to better grasp the way price moves during various circumstances. I am a huge proponent of using Fibonacci guides in order to do this. Forget the conventional wisdom and draw lines haphazardly in order to better make sense of regular price reversal points. 5. The little things can lead to massive gains. If you see price reacting off of a surpassed level, take the hint. When a level is being used, used, and used some more, take the hint. Many times, traders will attempt to fade a level, only to have it quickly surpassed and witness a bullish or bearish thrust off of the level against his or her trade. These “signals” oftentimes offer better entry than the fade itself. Be prepared, and recognize the reaction when you see it. Alternatively, just sweat the small stuff. 6. Fibonacci numbers are a guide, though an extremely useful one. Use them to make sense of common occurrences, and adopt techniques that make complete sense to you. Fibonacci levels can be used in a massive range of contexts, much more than just simply their traditional sense, over longer periods. For instance, we measure retracements on short term pullbacks in order to fade bottoms and tops. Sometimes, these retracements are as little at 12 or 15 pips, but when 68 or 74% gets hit, price makes it's final turn in the opposite direction. 7. Trade the professional move, not the “scaredy cat” one. When price leaps out of an obvious range, go with the flow. As the trend gets larger, so does your risk of it fading. There is an old saying that there are really two types of movements in this or any other market: the “professional” move, where price just keeps leaping higher or lower, and the “amateur” one, where the major move is done, but amateurs start to get on board just as price gets consolidated again. Drawing blocks around price ranges is an excellent way to tell you when a “professional” move is on, and it's time to take out your trend following techniques.

8. Momentum is hard to kill. Stopping the freight train is something a lot of newer traders attempt to do, but momentum is extremely hard to kill. When the professional move is finished, the amateurs take over, and the professionals resume thereafter. These movements always happen within a short window of time, and attempting to fade them is the equivalent of donating money to your broker. Follow the macro trend, and be conscientious of the fact that it takes a greater amount of momentum than what existed to flip a trend. When people latch onto something, they want a part of it, and stopping this mentality is a task that takes a tremendous amount of force. 9. No matter what you know in terms of price action, it can only help you should you ever decide to use anything else. Regardless of your ultimate expertise, price action is component number one when it comes to charting of any form. 10. Failing to plan is planning to fail, as the cliche goes. Traders that sit down at their desks and immediately execute aren't traders…..they're cash donators. The process prior to hitting the buy or sell button should include nothing short of a very long and careful assessment of a wide range of factors. Itchy trigger fingers always lose at the end of the day. Gaining a professional mindset means just being smart, and not careless or reckless. Do your homework. 11. If price is in an area that was just seen, it is going to wane. If price is making new highs or lows, it is going to go nuts. When price retraces ex any stimulus, expect it to wane. Price has just seen these levels and so you can't expect the same volatility that you had leading into them. Back off, and cool down. Take a methodical approach in terms of what you're going to do next. 12. Keep asking yourself: “What am I missing?”. A lack of thorough analysis is all it takes to get a bad trade, and a bad trade is all it takes to set back hours of very hard work and thought. Constantly dig for more,

and ensure that you truly are looking at the proper, most effective means of entry and exit. 13. Trading for fun is an easy way to plow forward. Trading out of desperation leads to more desperation. Think: “this is easy!” Traders usually have the most fun in the very beginning of their careers. They are hungry, exploring a wide range of options, and many times successful right out of the gate. Over time, that fades. Things are taken for granted and the trader loses the spark he or she had in the early days. Trading should be a challenge to the extent that it is not a stress-ridden activity. Stress kills a lot of things: relationships, flat stomachs, and trading accounts. 14. If you don't understand it, don't trade it. You're better off going to a casino. You probably won't lose as much money because none of it is “digitized”. Back off until certainty presents itself. If your certainty comes around once every other day, then so be it until you master techniques that present more opportunity.