Reading The Price Action Candle By Candle

Today’s article is going to be a little different from the usual articles I release, instead of giving you a guide on how to do something I’m going to walk your through how you could have read the market to see a reversal was taking place. I’m not going to use any technical analysis levels in determining this I’m just going watch the price action unfold and use my understanding of how the banks and retail traders trade to figure out what might be taking place in the market.

image of bullish pin bar in downtrend

In the blue box we had retail traders selling short on the bullish pin bar with the arrow pointing to it due to them believing during the creation of the pin that the market was going to fall.

Now although the other candle I’ve marked is bearish, at some point it would have been bullish and is likely to have trapped a number of retail traders in long trades whilst also causing a lot of retail traders who sold on the bearish pin close their trades at a loss.

If the resulting drop wasn’t as big as it was then the bearish candle would have been significant as it represents a point where retail traders would have been trapped in losing buy trades. The problem was the price dropped so much that the majority of the trapped traders are likely to have closed their losing trades, therefore if the market returned to this point after declining there is probably not going to be a large reaction as no traders are left to close their losing trades.

Since both the retail traders have closed their losing sell trades on the bearish pin and the losing buy trades on the bearish candle it means they must find a new place to enter the market.

The area I’ve marked in the green box shows where these retail traders are likely to place new sell trades.

We know retail traders will place trades once they believe the trend is going to continue, the move down from the blue box will make retail traders on lower time-frames place short trades as on the lower time-frames the down-move looks like a  large trend. These traders close their sell trades when the banks take profits off the sell trades they placed back when the market was in the blue box, this is the small retracement you see at the far left of the green box.

After the retracement ends another move down takes place, now even more retail traders begin selling as the retracement reinforces their belief that the move down is a solid trend.

image of the beginning of a retracement

Most of the traders who are trading the down-move will go short on the bullish pin I’ve shaded for the same reasons traders went short on the other bullish pins i.e because during the time the pin bar was forming the candle would have looked incredibly bearish, leading the traders to believe the market is about to drop a large distance.

Now since we know there are masses of retail traders trapped in short trades on the length of bullish pin bar wick, we know if the market was to move up a large enough distance, these traders would be forced to close their trades as the loss on their trades will be very big.

With so many traders going short it means the banks have the ability to make a big profit if they place buy trades and make the market move up, this is what they do as evidenced by the wick on the bullish pin bar. At the point we see the pin we wouldn’t know if the banks are placing buy trades or taking more profits off sell trades, the first clue we get that they may be placing buy trades is the bearish pin you can see two candles after the bullish pin.

This pin is caused by banks taking profits off the buy trades they have just placed, we know this because the market continues to move up after the pin appears.

As the price moves up some retail traders begin entering long positions and a lot of the traders who sold on the bullish pin close their trades at a loss which puts buy orders into the market. The banks eventually have enough buy orders available in the market to take profits off the buy trades they had placed on the bullish pin.

This profit taking pushes the market lower, causing all the retail traders who went long to close their trades at a loss which make the price decline even faster due to all the sell orders now coming into the market.

As the price falls more retail traders begin to believe the entire move up was just a retracement in the downtrend and since the market is now dropping once again its likely for the downtrend to continue. The point still remains that we ourselves would not know for sure if the down-move is a continuation of the downtrend or the beginning of a new uptrend, but we have got a couple of clues which suggest to us it might be the start of a new up-trend.

Our evidence is based on the fact the market has made a move higher which can only be caused by bank traders placing buy trades to make retail traders lose or by profit taking off existing sell positions.

The second piece of evidence we have is the amount of retail traders who will be going short in the market due to how long this overall down-move has been taking place. If you look on your charts you’ll see the price had been falling in a near vertical fashion since the 29th of March, the size of this decline coupled with the length of time it has been dropping means there will be a huge number of retail traders selling on all time-frames below the daily chart.

The more traders there are placing trades in the same direction the bigger the profit the banks able to make if they take the market in the other direction.

image of swing low being broken

The most important point we would need to focus on if we were analyzing this situation is the bullish pin bar where we knew a significant number of retail traders went short. If the banks did indeed place buy trades in order to make retail traders lose money then this bullish pin bar is the point where they placed their first buy trades.

Whether or not the market breaks below the low of the bullish pin is something we need to keep a close eye on. A break below would mean the retracement was caused by profit taking rather than banks placing buy trades, whereas a failure to break the low could suggest the retracement was caused by banks placing buy trades.

When the market comes back to the area of the bullish pin bar the price action needs to be watched for signs of more buying, the first candle into the area manages to penetrate the low of the pin bar, its likely this was a run into the stop losses of the retail traders who were buying when the retracement was taking place.

image of banks buying after new higher high

When the banks have placed more of their buy trades the market moves up, at this point all of the sell orders which were coming into the market from the retail traders selling on the down-move into the area have been consumed, if the banks still have more buy trades left they need to place they need to make the price drop again in order to generate enough sell orders to match the rest of their buy trades with.

One important change in market structure this move up provides is the higher high. The new high is the first technical signal we have had that a trend change may be taking place, all the other clues we have seen were based on our understanding of what the price action meant to other traders whereas the new high is the first piece of standard technical analysis which tells us the move downmove may be over.

With the new high in place the banks take a small amount of profit off the buy trades they have been placing in order to make the market fall so their able to generate additional sell orders which they need to place the remainder of their buy trades.

The price stops falling when it enters the demand zone created by the second bout of buying from the bank traders.

Now the banks place the rest of their buy trades into the market and the price begins to rise, it continues rising over the next 2 days before dropping back into the area where we can see the banks have been placing their buy trades. They buy again and the price moves higher over the next 4 days before coming to a stop and moving back in the direction of the overall downtrend.

People say you cannot locate where the banks are buying but as we can see it is very possible to do just that if you understand how they trade and how they need to manipulate retail traders into doing the wrong thing to get their positions placed into the market.

Summary

 

From this small example you can see how having knowledge of how traders trade coupled with an understanding of what the price action in the market means for these traders can provide you with a great edge in the market. Most traders will have looked at this reversal and said it was caused by a support level or an old demand zone but its obvious that this wasn’t the case because we used no technical levels in our analysis.

We simply read the market as new developments occurred and formulated a hypothesis for what we thought was taking place, it was the understanding we had of the market which allowed to figure out what was going on, not a trading strategy or tool which told us when to enter, had we used any of them the information we would have gathered about what was happening in the market would likely not be enough for us to have the confidence to take a trade.

This is just another example of how its your understanding of the market and not the trading method which is the most important factor in whether you’ll eventually become consistently profitable or not.

 

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4 comments

  1. Phil

    Nice walk through. I used this approach today as a 1st attempt.
    Was great to experience it. Didn’t draw any lines or zones up front, but when any pinbaror engulfing pattern formed then I checked for confluence with any line/zone.

    Thanks for your site, I’m noticing improvement in my trading. Not yet there, but I now am more confident I can do this.

    • ForexMentorOnline
      Author

      I’m happy your making progress Phil. It’ll take a while to for things to ‘click’ but when they inevitably do you’ll see a much bigger improvement in your trading.

  2. Floyd Lewis

    Just happened to have stumbled on your website a couple of days back. Since then have been happily hogging through every line and every chart in the articles that you have uploaded here till date. Sheer gems that you have been sharing with us all. Felt it my moral responsibility to thank you for all your good efforts and kindness. God Bless and may all your trades be green.

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