Back to Basics, Part 3: Entry Techniques by Sam Evans

 

This week I would like to wrap up my series of "Back To Basics" articles by bringing you the third and final installment. So far in previous weeks, we have looked at ways to measure and identify trends in the Forex Markets and also explored the fundamental definitions of Stop Loss orders. This week I will highlight the next piece of the puzzle: Trade Entries. Now while this may seem a little obvious to some, in my experience of teaching in the classroom and within the ongoing Online Trading Academy Extended Learning Track environment, I discovered very quickly that the vast majority of novice traders struggle with reasons and clear methodic rules on entering a position. It is of great importance to know each and every time, before getting into any trade, exactly where we will get into a position and the criteria required for pulling the trigger. It is trading suicide to just jump into the market because it looks like it is going up or down! Rather, we need to adhere to strict entry rules and recognize that our entry point itself is really the only stage of any trade where we have complete control. After that, fate is left purely in the hands of the market, so it would be wise to take control whenever we are given an opportunity to do so.

Stripping things right back down, there are really only two distinct entry methods available to traders across any markets, namely the Pullback entry and Breakout entry. First, let's look at the Pullback method. In the case of being a willing buyer, the trader would be looking to buy the market when it revisits a previous area of Support or Demand, in an attempt to buy the asset at a cheap price; or in the case of being a seller, the trader would be looking to sell the market upon a retest of previous Resistance or Supply, when the asset could be defined as expensive. This is an ideal technique for use in both trending and range-bound market scenarios. In simple terms, the Pullback involves Buying Low and looking to Sell Higher, or Selling High and looking to Buy Lower.

The Breakout method, however, is slightly different in its dynamic. This time, a willing buyer of the market would be looking to buy the asset as it makes new highs, seeing this as a good indication of strength. We could reasonably expect the market to, therefore, move on to make new highs in the near future. A willing seller would surely be doing the opposite. They would be interested in selling the asset as it makes new lows, taking this as a sign of increasing weakness in the market, with the expectation that we could see a further decline in value shortly. This method could prove to be an ideal way to engage the market in strong momentum trend environments, but we also need to be aware of the fact that there are many false signals during periods of consolidation and ranging activity, thus making this a higher risk entry for low volatility market conditions. Therefore, we can define the Breakout as a style of Buying High and looking to Sell Higher, or Selling Low and looking to Buy Lower.

So let us now look at how these entries would present themselves on a chart example:

 


Figure 1

 

This is a 60-minute chart of some previous price activity on EURUSD. The time frame and currency pair used, however, is of no great importance. We should trade each and every asset the same way as this promotes consistency in our trading, and the added bonus is that any particular Technical Analysis style or entry trigger can be used to the same degree of effectiveness on any type of chart. The Day trader would use say 5-minute charts for their entries and targets, while the Swing trader would possibly use a 60-minute chart for the very same thing, right up to Position traders who focus on Weekly and Monthly charts. The key itself is to understand the criteria for entry on the chart that matches your style of trading.

As we can see from the chart example, the price on EURUSD was resting at 1.3600 where it had found a barrier of resistance. With this in mind, the astute trader is faced with the choice of:

  1. Shorting now at the resistance point and looking for a retest of the lows at support of 1.3540 for a target
  2. Buying the market when it reaches the lower demand area around 1.3540 with targets at 1.3600, 1.3700 and beyond
  3. Buying the market as it breaks the supply area at 1.3620 with a target of 1.3700 and beyond

The question is which is the right option to take? Well, in reality, all three are sound plans as long as they follow the rules and use protective stops to control losses. The reality is that nobody really knows what will happen next so all we have to go by is our analysis of the opportunities available and then to choose the right one which suits us best. It should be noted that if we decide to buy a retest of the lows at 1.3540, we can place a clear stop loss order below the pivot low around 1.3520; yet if we take the breakout of 1.3620, then to truly place a stop order in a position where the market will prove us wrong would require a stop below the higher pivot low of 1.3560.

 


Figure 2

 

As we can see, all three trades would have worked out, but we also need to acknowledge the differences in the outcomes as risk to reward parameters, too. Sure the breakout buy was good and as price cleanly broke above 1.3600, it easily moved higher to nearly 1.3800, but when we look at the risk to reward taken on this position, we can see that while it was good, it was not as impressive as that achieved on the pullback buy at 1.3550. Remember to always analyze and understand the risks you are taking on all trades and ideally, we should be looking for trades which offer at least a 1:3 ratio possibility. The breakout is the riskier of the two as it will always require a greater risk and lesser reward, but as long as the individual trader understands this and only takes objective trades which offer solid risk to reward potential, there are opportunities for breakouts and in ferociously trending markets, sometimes a breakout entry is the only way in. The pullback entry, however, will always offer us the lowest possible risk and largest potential reward, but it does require patience to wait for and can be used effectively in all market conditions.

With this in mind, all we need to do is decide which entry is right for us with respect to current market conditions. Personally, I am not a fan of breakout trades and will always sit on my hands until the best pullback opportunity arises, but remember this is what works for my style of trading. Equally, I know many professional accomplished traders who have worked the breakout trade into a fine art and if it gets the results, who am I to question them? This, my friends, is the beauty of trading. We all have to mark our stamp of individuality on our trading activities and take ownership of that model consistently. Only then can we hope to acquire a realization of ongoing trading profitability in the long run.

Have a great week,

Sam Evans sevans@tradingacademy.com

 

If you would like to read more articles by Sam Evans click here

If you would like to read more articles about General Trading click here