This week’s question comes from Thambirajah, who asks:
In your article about settlement period, you said: “you need accurate support and resistance levels.” I understand that the support and resistance are areas rather than specific levels. But if this is true and the session close is within the area, how do you identify if the candle has closed above or below the key level?
What Thambirajah is asking here is a pretty common dilemma among traders. It stems from the idea that support and resistance are often areas rather than specific prices.
So if the area in question is between 1.0710 and 1.0720 yet the market closes at 1.0715, how do you determine if it broke the level or not?
It’s in these moments that price action really shines. The very existence of a bullish or bearish candlestick pattern near that key area is your answer.
In this post, I’ll explain how to use confirming price action to tell if an area has been broken. We’ll also discuss the importance of doing nothing when faced with uncertainty.
Last but not least we’ll wrap things up with my preferred time frame for using confirming price action.
Confirming Price Action Is the Best Indicator
One reason I favor raw price action over any other method is that I get to see where buyers and sellers are hiding.
How do I do this?
I do it with confirming price action. Simply put, this is a candlestick pattern that confirms key support or resistance. It rejects the area in a way that shows me where bids (buyers) and offers (sellers) are positioned.
It’s almost like having X-ray vision. I get a behind the scenes look at the orders that move the market.
The same price action we use to find key levels can be used to confirm them.
Here’s an excellent example from the USDJPY daily chart:
Notice how the session before the bearish pin bar closed right near the resistance area. If that had happened in real time, you might wonder whether the USDJPY had just broken resistance.
But by staying patient, we got our answer within the next 24 hours. The pin bar signaled that the pair did not break resistance and that a move lower over the coming sessions was likely.
By using confirming price action, you’re no longer left wondering if a pair broke support or resistance. Instead of guessing, you simply let the market do the hard work for you.
This is why I always say to let the market make the first move. As price action traders, we want to react to what happens on the chart.
We don’t just guess, and we certainly never hope for a particular outcome.
Another useful signal is the engulfing pattern. This occurs when one session completely overlaps the previous one.
Here’s an example of a bearish engulfing day that formed on the AUDUSD at an area that spanned nearly 20 pips.
Note that we had an area of resistance formed by two trend lines. There were a couple of ways to draw this particular level as you can see from the highlighted area in the chart below.
Once again, by staying patient and waiting for a signal, the price action told us what was likely to happen next.
Notice a consistent theme here?
We just wait and watch for the market to show its hand.
In essence, the engulfing pattern above represents the same thing as the pin bar before it. Both suggest that sellers control that particular area and that a move lower is likely over the coming sessions.
And just like the pin bar, we can use engulfing patterns to confirm whether a support or resistance area is intact or not.
In fact, one of my rules for trading an engulfing candlestick is that it must break a key level.
For more on this including a video on how to trade engulfing patterns, see this post.
Good Trading Should Be Effortless
It’s somewhat ironic that the best advice I can offer someone is to do nothing when faced with uncertainty.
You don’t have to trade. No mandate says you must stay active and you surely don’t have a boss standing over you demanding that you put money at risk.
If you’re ever unsure about something, the best thing you can do is nothing.
I get hundreds of emails every week. A common theme seems to be uncertainty around a particular trade setup.
Perhaps the level is more of an area like the ones on the USDJPY and AUDUSD charts above. Whatever the case, the person emailing me is uncertain about whether to buy or sell a particular currency pair.
My response to this is always the same…
If you’re unsure about what to do, do nothing.
That uncertainty is your brain’s way of telling you to stay out of the market. Your ego, on the other hand, is probably trying to convince you to take the trade.
Always remember that good trading should be effortless. If you find yourself unable to decide whether a setup is worth the risk, it’s probably best to stay on the sideline.
The hard work in trading comes in the preparation. The actual process of trading, however, should be effortless.
Jack Schwager – Author of Market Wizards
The part that should be effortless is the decision of whether a setup is valid and favorable. If it is, you should know right away.
However, if you find yourself debating whether it is or isn’t favorable, chances are it isn’t.
My best trades have been the easiest ones to put on. Sure, I had to put in a ton of work to learn what I know now, but the trade itself was easy. I didn’t have to think about it too much, and I certainly didn’t waste time debating whether it was worth the risk.
The Daily Time Frame Is Key
All of the above only works if you’re trading from the daily time frame. There are cases where the 4-hour chart will work, but the daily is preferable.
This is especially true if you’re just starting out and are not yet profitable. If this is the case, my best advice is to stick with the daily time frame until you can turn a consistent profit.
Only once you can do that should you consider venturing into the intraday time frames.
Why is the daily chart so good, you ask?
It comes down to the settlement period. When you use New York close charts, the last hour of each session – between 4 pm and 5 pm EST – can be extremely helpful in determining a market’s likely path forward.
It’s helpful because it shows whether buyers or sellers won the battle for that day.
And when it comes to confirming breakouts, seeing the results from a particular session is key. It allows you to have greater confidence in the break and can also give you a place to hide your stop loss.
This is why pin bars and engulfing patterns are such effective price action signals. They’re the best indicator out there in my opinion.
Just remember that the daily time frame will usually give you the best signals, especially when you’re just starting out with price action.
If you find yourself questioning a break of support or resistance, wait for confirming price action. By doing this, you’ll have greater confidence in the break and also have a valid setup to trade.
My favorite way to confirm a breakout is to wait for a bullish or bearish pin bar to form. It shows me where the buy or sell orders are and also provides an area to hide my stop loss should I choose to take the trade.
The engulfing candlestick is another excellent way to determine if support or resistance is intact. These patterns indicate strength or weakness at swing lows or swing highs respectively.
Always remember that you don’t need to act. If you’re unsure about a particular trade setup, it’s usually best to do nothing and thereby protect your capital.
Your Turn: Ask Justin Anything
I’d love for this new weekly Q&A to be successful and provide an invaluable repository of answers to common Forex questions.
To do that, I need your help.
Here’s what you can do to get involved and have your question answered in next week’s post:
- Ask questions. Post them in the comments below or Tweet them to me @JustinBennettFX
- Help me answer questions. If I missed something or if you have something to add, don’t hesitate to leave a comment below.