The 3 Worst Mistakes All Price Action Traders Make

Making mistakes is all part of the learning process of becoming a successful forex trader provided you always learn something from making a mistake and don’t make the same mistake again. Unfortunately due to the miseducation that’s out there on price action trading, I think there are some really costly mistakes a large number of traders are unaware they’re making. Today I thought I’d give you a little rundown of what I think these mistakes are and give you some tips on the things you can do to correct them so you can become more profitable in your trading.

 

Mistake #1. Assuming All Pin Bars Form For The Same Reason

A big mistake I think a large number of price action traders make is assuming all pin bars form in the market for the same reason. Pin bars are one of the most common price action patterns you see form on the charts, but traders that look out for pin bars believe every pin has the potential to cause the market to reverse, based simply on the fact they have been told that all pin bars that form in the market have formed for the same reason, and that is as a result of traders wanting the market to reverse. They don’t actually get told this in trading books and courses, but it’s assumed, because of the fact the tail of the pin bar is always said to be showing you the traders in the market have rejected higher or lower prices, therefore they want the market to move in the opposite direction to which the rejection has taken place.

Now because the majority of price action traders just assume all pin bars have formed due to traders wanting the market to reverse, it means as far as they’re concerned every pin bar they see form in the market has the potential to cause a reversal to take place. What they do to filter out which pins have a high probability of causing the market to reverse, is analyze things like the characteristics of the pin bar itself, such as the size of the wick, and what technical levels the pin bar has confluence with. If a pin bar happens to be found at a technical level or has a wick size which the trader deems to be above average, then that pin is said to have a good chance of causing a reversal to occur.

The problem with filtering pin bars in this manner, is that although the characteristics of the pin and the levels it has confluence with are important, they are not the things which actually determine whether or not a pin bar has a high probability of causing a reversal to take place. What really dictates whether a pin bar is going to cause a successful reversal to occur, is the action which caused the pin bar to form in the first place. Contrary to what the price action books and course assume, not all pin bars are created as a result of traders wanting the market to reverse. Some are, but the vast majority have really formed because the bank traders are taking profits off their trades.

image of bearish pin bar on 1 hour chart of aud/usd Here’s an image of a bearish pin bar which formed during an up-swing on the 1hour chart of AUD/USD.

To a typical price action trader, the bearish pin bar above is seen to be exactly the same as all the other bearish pin bars that form in the market, in that it’s formed because traders want the market to reverse, as evidenced by fact the wick of the pin is showing that higher prices have been rejected. Because the pin is considered to be the same as all other bearish pin bars, it means the trader thinks the pin has a chance of causing the market to reverse, and will analyze the pin using the common techniques I explained previously to see if it actually has a high probability of causing a reversal to take place.

The issue for the trader is that analyzing the pin using the common techniques is not going to reveal whether or not the pin bar has a high probability of causing the market to reverse, because the bearish pin bar itself has not formed as a result of traders wanting the market to reverse. The real reason it formed was because the bank traders were taking some profits off the buy trades they had got placed earlier on in the upswing. The way you can tell is by looking at what happened after the pin bar had formed.

You can see that a few hours after the bearish pin formed the market moves up again and breaks well above the high of the pin. The fact it’s broken such a large distance above the high, tells us the pin had to have been created by the bank traders taking profits, because it doesn’t make sense the banks would place sell trades to make the market reverse and thus cause the bearish pin bar to form, to then go and close these same sell trades after a small down-move has taken place two hours later.

Now when the bearish pin first forms you wouldn’t know for sure it has been created by the bank traders taking profits, but you would suspected it by looking at the market structure which preceded the formation of the pin. If you look at the image again you can see that the hour before the bearish pin bar formed, a bullish large range candle had appeared and pushed the market up by 25 pips. A big movement like that would’ve caused the buy trades placed by the bank traders to go into a large amount of profit.

With their trades now being at a much bigger profit than what they were at previously, what do you think the bank traders are going to want to do with their trades ?

Take some 0f their new found profits off so they can get more buy trades placed. Taking profits off a buy trade means you’ll be putting sell orders into the market. If these sell orders become bigger than the buy orders, the price will drop and the resulting candlestick will be seen as a bearish pin bar. The bearish pin bar created by the profit taking has a low chance of causing the market to reverse for an amount of time long enough for you to make a substantial amount of money, due to the fact the banks still want the market to continue moving higher, so they can continue to make money off the buy trades they’ve still got placed.’

My tip to you if you use pin bars in your trading strategy, is to always hold off trading the pins you see form after large movements have taken place. Large movements being moves which consists of one or more large range candles forming in a quick succession. When you see movements like this occur, the pin bar which you’ll sometimes see form during the move or right after the move is over, is more often than not a profit taking pin bar which has a really low chance of causing a decent reversal to take place, no matter which technical levels the pin has confluence with or how big the size of the wick may be.

 

Mistake 2. Assuming A New Higher High Or Lower Low Automatically Signals A Continuation Or Reversal Of Trend

Assuming a new higher high or lower low automatically signals a continuation or reversal of trend is a mistake caused by the Dow Theory being flawed with the way the forex market works. The Dow Theory is a method of analysis which traders use to identify which direction the market is currently trending in and when it has reversed and changed direction. It states that if a market is moving down and makes a swing low which is lower than the previous swing low, then that is a signal the move down is likely to continue. Conversely if a market was moving higher and made a swing high which was higher than the previous swing high, it would be a signal more upside is to be expected in the market.

The Dow Theory also states that if a market was trending down ( i.e making lower lows and lower highs ), a move up which manages to break above the most recent swing high is a sign the down-move has come to an end and more upside should be expected. Also, if the market was trending higher by making higher highs and higher lows, a break below the most recent swing low is said to mean the up-move is now likely to be over and you’re probably going to see a move down take place.

Now although the market usually does what I’ve explained above after a swing high or swing low has been broken, there are lots of times when it ends up doing the complete opposite, and when it does the opposite it can mess up your analysis of the market and potentially cause you to have losing trades. The problem is traders don’t know when the market is actually going to do as the Dow Theory predicted once a high or low has been broken, which means they have to assume that every higher high or lower low they see form in the market is going to cause the market to do as the Dow Theory suggests it should do.

image of lower low taking place on usd/jpyHere’s an image of USD/JPY making a swing low which was lower than the previous swing low that had formed in the market.

According to the Dow Theory the market would’ve continued moving lower soon after the lower low had been made, but as you can see, instead of moving lower the market actually started to move higher and eventually ended up making a higher high, which was a signal further upside was going to take place. Had a trader using the Dow Theory automatically assumed that seeing this lower swing low form meant that more down movement was on it’s way, they could have entered a sell trade which may have potentially caused them to lose money.

The reason why the market doesn’t always do as the Dow Theory predicts is because of the way bank traders operate in the forex market. When the bank traders take an action in the market, like get trades placed or take profits off existing trades, they tend to do so around the same price as one another. If you go onto the 1 hour chart and look at some of the big reversals that have taken place on the daily chart, you’ll see there’s always multiple swing lows ( or swing highs in the case of an up-move to down-move reversal ), found around the same price as one another before the reversal begins. These swings have all formed as a result of the bank traders placing trades to make the market reverse.

Because the banks place their trades and take profits at similar prices, it means there are often times when they’ll place trades or take profits above or below a point where they’ve already taken some profits or placed some of their trades. When this happens it causes a lower low or higher high to form, and because of the Dow Theory traders mistake this lower low or higher high for signalling a continuation or reversal of the current trend, when really it’s a signal the market is about to do the opposite.

If you use the Dow Theory to determine the direction of the trend, my advice to you is to always wait until the market has completely broken through the most recent low or high before considering it to be a trend reversal or trend continuation. Completely broken means that you’ve seen multiple candlesticks close at least 20 pips past the swing low or high in question. If you just see a slight spike below the low or high occur, do not think that it means a continuation or reversal is going to take place, because usually if a new low or high is going to cause the market to do the opposite to what the Dow Theory predicts, it will only break the previous low or high by a few pips, as the banks always want to get their trades placed as close together as possible.

 

Mistake 3. Always Trading In The Direction Of The Long Term Trend

The final mistake we’re going to look at is always making sure you trade in the direction of the long term trend. This is a mistake I know a huge number of price action traders make, and it’s something which can really cause you to have a large number of losing trades if you make it consistently. Trading in the direction of the long term trend is basically where you will place your trades in-line with what the trend is on a time-frame much higher than the one you use to conduct all of your analysis off and place all of your trades off.

If I used the 1 hour chart to place trades and analyze the market, the long term trend for me would be something like the daily chart, so trading in the direction of the long term trend would mean me trading in accordance with whatever the trend is on the daily chart. For someone who trades on the lower time-frames like the 5 or 15 minute charts, the long term trend for them means making sure to trade in the direction of the trend on the 1hour chart.

I’m not sure who originally came up with the idea that you should always trade in the direction of the long term trend, but it’s a piece of trading advice your hear repeated again and again in various books and courses.

It sounds like a good piece of advice because the long term trend is the trend that has the highest chance of continuing, but the problem is that although it has a high chance of continuing there are lots of times when the market will move against the long term trend, and during these times the traders who always make it a priority  to trade in the direction of the long term trend will place trades against the counter trend movement to try to anticipate when the long term trend is likely to resume again.

image of eur/usd downtrend Here’s an image of the long term downtrend we are seeing take place on the daily chart of EUR/USD.

Even though the long term trend is down you can see there have been times when the market has retraced for a few days (marked with black lines). During these retracements the market is actually trending higher on the time-frame the trader uses to place his trades and conduct his analysis. The fact that it’s trending higher means that he shouldn’t be placing short trades, because that’s essentially counter trend trading which everyone knows usually results in losing trades, but this doesn’t matter to the trader because he’s been told that you should always be trading in the direction of the long term trend.

The thing is trading in the direction of the long term trend when the market is in a completely different trend on the time-frame you use for your analysis and trade placing, more often than not results in you having lot’s of losing trades, because you’re trading against the current momentum in the market.

The key to solving this problem is to make sure you always trade in the direction of the trend on the time-frame you use to place all of your trades and conduct your analysis. Do not start trading in the direction of the long term trend until you see the momentum change on the time-frame you use for trade placing. A change of momentum is signaled by the market making a new lower low or higher high, so wait for one of those to take place before trading back in the direction of the long term trend.

 

Summary

Well there you have it, the top three costliest mistakes I think all price action traders make in the market. Hopefully this article has now made you aware of these mistakes and given you some decent ideas on how to stop making them. If you have any question about these mistakes or the advice given in this article, let me know in the comment section below.

 

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