How to Trade With the Trend When There’s Something Standing in the Way

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Welcome to our monthly blog article for October, 2016, sponsored by the Trend line Mastery Trader’s Club membership service, and related foundation course.

For this month’s installment, we’re going to address the following topic:

How to trade with the trend when there’s something standing in the way.

And that “something”, of course, always comes down to either a clear and specific Resistance level against an uptrend, or Support against a downtrend.

The General Principles

I know very well from experience, having conversed by email with literally thousands of traders around the world since becoming affiliated with Forexmentor in fall of 2007, that one of the most frequently recurring technical issues which explains why a certain trend-trade attempt did not succeed, was a failure to properly identify – and take prudent precautions around – a significant Support or Resistance barrier standing against a pre-existing trend bias.

It’s almost as if the identification of a strong trending market causes enough giddy anticipation that many traders simply want to jump in – right now – without looking to see whether potential danger lies ahead. And so many of the queries I get from trading students asking for help in figuring out why such-and-such trade attempt didn’t work out satisfactorily comes down to the issue of not having done one’s homework when it comes to Support/Resistance.  If only they had paid attention to this issue, and done the right thing in response, the failed trade they asked for help figuring out might not have happened.

So we’re going to spend this month’s article looking at a couple of simple and practical things you can do to reduce the chances of a trade going sideways on you due to Support/Resistance barriers standing against the trend, including the following:

  1. Taking the time and effort to do proper Top-Down Analysis identifying and annotating any and all nearby Support/Resistance barriers on each timeframe.(Please note that when we use the term “barrier” here, we can refer to either a singular price level denoted with a horizontal line annotation, or a zone extending from one horizontal level, up or down to another that lies parallel to it. And when we say “nearby”, we typically mean a price level that lies within an interval less than the current 5-day ADR figure, i.e. which could be reached inside the same trading day).And then…
  2. Waiting patiently for either:

i)  A Continuation Pattern setup from ahead of the identified Support or Resistance barrier that may provide enough “room” to get risk out of the trade before price possibly makes a reversal against the open position on a subsequent test or retest of that level, or:

ii)  A clean breakout on the other side of the identified Support or Resistance barrier to confirm that its trend-inhibiting influence is no longer in effect, and then drilling down to a lower-level timeframe for a subsequent Continuation Pattern setup into the prevailing trend direction.

Though you can not infrequently find chart examples where price approached a “barrier” level and then just proceeded to blast right on through it leaving you possibly wishing you had thrown caution to the wind and simply ignored it, our attitude here is that a safe and prudent, consistently applied trade entry filter that sidesteps these levels makes the most sense. Not just because doing so will cut down on stop triggers, but because we have to keep in mind that a truly trending market won’t come and go in just a few hours; over time, there should be plenty of good re-entry opportunities along the way to jump on board that trend at a later juncture.  In short, if you can’t trade a good trend reading right now, as price is hovering just ahead of a S/R level, you should be able to do so later when the danger has passed.

A Mini Case Study Example Proves The Point

As is always the case in trading, any point or principle can usually be most convincingly proved with recourse to real-world chart examples, and so that’s what we’re going to turn our attention to now: A mini “cast study” example that conveys the above-noted two-part process of identifying and then navigating around, a S/R barrier that stands in the way of a pre-existing trend reading.

Our chart example here pertains to a long bias on the AUD/PY pair during the transition timeframe of the 4am GMT bar (spanning the Asian session into the European and London session opens) for Friday, October 14th, 2016.

The easiest cue to a trending market profile for the above pair at the above-noted timeframe was a RSI (Relative Strength Index) bullish “Quad Screen” reading, whereby the indicator was generating a numerical reading of 50 or higher on all of the Daily, 4hr, 60m and 15m timeframes.  With that metric in hand, we can then set about the task of validating the screener reading with our usual Trendline Analysis techniques (as discussed and explained in the Trendline Mastery foundation course, and demonstrated regularly in the Trendline Mastery Trader’s Club content streams). At the same time, we want to look carefully to see if there are any specifically horizontal levels – typically Old Highs and/or Lows – that might impede the progress of price action in the trending direction.

So here is a briefly summarized chart rundown of all timeframes, from Monthly down to 5m, which reflects this top-down approach.  Again, all of the following commentary pertains to the Asian session for Friday, October 14th, 2016:

  1. Monthly Chart: A mixed trend reading (both bullish and bearish elements present), but at least there is a Demand Trend Line intact, which is compatible with the RSI screener reading mentioned above. From the rejection wick low for June 2016, it was possible to draw a bullish Rising Support trend line connecting to the higher rejection low for September, 2016. Because RSI on the Monthly chart was bearish at the time, we had to assume that the updraft we were seeing on this timeframe was likely indicative of a very large-scale upside retracement, as opposed to a true uptrend; at least until such time as RSI were to cross above 50 and/or price were to break the pre-existing Supply trend line that was drawn earlier in 2016.
    Chart Extract #1: Monthly

  2. Weekly Chart: This timeframe yields pretty much all the exact same analytics as cited above in regards to the Monthly chart: A pre-existing Supply trend line (connecting the descending highs from the week of June 1st, 2015 to that for the week of April 25th, 2016) which had previously conveyed a downtrend but, at the same time, a more recently formed Demand trend line (connecting the low for the week of June 29th, 2016 to the higher low for September 26th, 2016). The only difference between this timeframe and the Monthly is that RSI appeared to be just in the process of crossing above the midline threshold (i.e. numerical value of 50) for the weekly bar for October 10th, which provided a lagging confirmation of a trend reversal of significance on this timeframe. So, at the very least, the shorter term bias conveyed on this timeframe appeared to be at least compatible with the RSI Quad Screen reading for this pair.
    Chart Extract #2: Weekly

  3. Daily Chart: After price had spent several days testing a prior Support Zone extending to just around the 76.00 round-number handle (as conveyed by the green rectangle annotated on this chart extract) to as recently as September 27th, a rally ensued, taking the market all the way back to an overhanging Resistance Zone to just around another round-number handle, at about the 79.00 handle (here denoted by the red rectangle annotation). This is our first glimmer of potential trouble in the upwards direction during the trading day in question: As is always the case, we cannot predict with perfect accuracy how price will interact with a prior reaction level, as the options could include a sharp reversal back in the opposite direction, consolidation near that level, or a sharp breakout. (In this case, it was the latter scenario, at least for the day in question).  So, once we’ve seen the level in question where price has repeatedly been knocking against a singular level or possibly a zone of two or different levels, we need to annotate it – and that means not just here on the Daily chart but on all lower timeframes as we drill down in succession.  That horizontal level barrier at the 79.00 round-number handle will be a level to watch closely in relation to any Uptrend Continuation patterns that might form in real-time.
    Chart Extract #3: Daily

  4. 4hr Chart: As is the case with all of the chart extracts we’re referencing for this mini-case study example, the dashed vertical line drawn on this chart shows us where we were at the same point in question across all timeframes, on this one, it is the 4am GMT bar for October 14th. Though price ended up making a bullish breakout above the clearly established Resistance level on the 79.00 handle, we could only possibly guess that this might be the outcome; there was no way to know with certainty ahead of time that would happen. As a result, there were two potential options we had to look for to trade safely around this level: Either find a lower-level corrective pullback allowing for a possible later trade entry from within no less than 30 pips of the barrier level (in this case, going long from 78.70 or lower, if the opportunity presented itself), or waiting for a 4hr close on the other side of Resistance  and then drilling down for a subsequent Continuation Pattern setup. On this timeframe, there was no such setup ahead of time, so we had to either find it drilling down to the lower timeframes, or wait for the 4am GMT bar to close measurably above the 79.00 handle.
    Chart Extract #4: 4 hour

  5. 60m Chart: Ahead of the dashed vertical line drawn on the 7am GMT bar (which ended up corresponding with a bullish breakout above the 79.00 handle already identified through Top-Down Analysis) it was possible to anticipate an Uptrend Continuation Pattern setup, as denoted by our usual three-point labeling scheme, with the latest Impulse Wave complete from Swing Points A to B, and the expected partial retracement against it ending in the sequence from Swing Points B to C.  So, if we were looking for an opportunity to buy a corrective dip ahead of an expected breakout above Resistance, here is a possible chance. The only problem, though, on closer inspection, is that by the time the dip in question was finished and price had a chance of popping up and through SP-B, the market was at a level of about 78.89 (on the open for the 7am GMT bar), and that is substantially less than the 30-pip “breathing room” we ideally want to have in cases like this.  So, even though price went on to prove our concerns about Resistance overstated, it was nevertheless good form in this case to wait for the bullish breakout, and thereafter look for a lower level setup and entry point.(Again, it will absolutely drive you crazy if you try to rewrite your trading rules to better fit the particularities of the latest chart example, as opposed to applying the same approach consistently every single time, as the possible alternate scenario that could have just as easily happened here was that price hit the identified level, turned the corner sharply, and yielded in a stop trigger on the buy. It’s when the market fails at a level where we thought it might that feelings of voluntarily committing to an avoidable mistake become prevalent, and that’s not good for your positive trading mindset).
    Chart Extract #5: 60 minute

  6. 15m Chart: Immediately prior to the dashed vertical line for the 15m bar open for 7am GMT, we can see how price had hit the resistance level in question several times, and failed to achieve a close above it. To the live edge of trading at the London session open, therefore, that pesky 79.00 handle was still a barrier even here on the second-to-lowest timeframe. But 15 minutes later – evident at the same time on the 60m and 4hr bars in progress – it was clear that price was finally blasting up and through, in the direction of the prevailing trend. On this timeframe, however, there is no pending setup on the long side as of the open for 7:15am GMT. That means we either have to wait a while longer for one to materialize, or possibly drill down even lower – to the 5m chart – to see if we can find one of those “fractal” setups that can sometimes come in handy.<
    Chart Extract #6: 15 minute

  7. 5m Chart: On this timeframe, something interesting happens following the close above resistance at the 79.00 handle. Firstly, that level transforms from Resistance into Support (thus we format the line green on this chart example) as several bars pass by with no hint of price retreating to back below it. Secondly, we see what looks to be a textbook corrective pullback unfolding, providing us the opportunity to use a Supply Trend Line annotation to denote it, and then, on a 5m close above it, to find a potential entry trigger on the long side. In this case, we are looking for a fractal long setup in the aftermath of price breaking to the upside past a previously intact Resistance level which could have been problematic if trying to go long while that level was still in force. Yes, there will be fewer pips of profit potential typically ensuing in a scenario like this, but on the other hand, there should also be a heightened probability of success, or put another way, a lesser chance of a hard stop loss.
    Chart Extract #7: 5 minute

So there you have it: By working with a RSI screener reading, we were able to find a trend bias for a specific pair at a specific point in time. We were then able to validate that reading with Top-Down Trendline Analysis, which told us that despite some ambiguities on the two highest timeframes, generally speaking the trendline bias was in agreement across multiple timeframes. But we also noted a potential barrier standing in the way of the uptrend – a previously tested Resistance on a round-number handle – and that was a wild card we had to be careful with in regards to any fresh positions.  Looking for a Continuation Pattern setup yielding an entry point at least 30 pips away proved fruitless, so the next best option was to wait for a possible bullish breakout above the identified barrier, and then drill down to one of the lower intraday timeframes for a Continuation Pattern setup executed from above the prior Resistance level.

The profit potential on this particular setup ended up being fairly short-term in nature: A Day Trade long through Friday’s NY session high; thereafter, a sharper downside retracement took price all the way back down for a retest of broken resistance as support, again at the 79.00 handle. But we can’t pre-judge setups based on after-the-fact results, and by avoiding the temptation of looking at a too easily “cherry picked” example, hopefully this one proves its point more realistically.  All in all, it’s better to avoid going long in an uptrend too close to Resistance, and/or going short in a downtrend too close to Support. Failed trade attempts that reflect a deliberate insistence on throwing caution to the wind in such cases do nothing to bolster your trading confidence.

We hope you’re able to find within this discussion some simple and practical precautionary measures for dealing with barrier levels standing in the way of Top-Down Trend readings.  If you have any questions or comments on this topic, please feel free to direct them to me via email at frank@forexmentor.com.

Good Trading!

Frank Paul

Frank Paul at Forexmentor.com

Frank Paul at Forexmentor.com

I am well known for my ability to deliver clear and concise explanations of complex trading topics.   I am the force behind a series of comprehensive, yet practical, forex courses and training programs at Forexmentor.  (Forexmentor links to www.ForexMentor.com.)

“…purchased at least two of your courses and I must say that I greatly appreciate your methodology and willingness to share with others. One of the things I appreciate most about you is that you are not like some of those money grabbers out there who is so quick to sell you a system for huge bucks. I believe you are a very genuine person who would want to see me or anybody succeed in their Forex Trading career. Thanks again, Omar.”

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