Understanding Price Action

This post jumps around to different time periods and different charts because it’s actually a compilation of various observations and twitter threads from over the past year. Each section doesn’t really connect to any other section except in the most important way; they all deal with price action and chart analysis which I have successfully used over many years of trading. It is worth your time to read (and re-read) each section to understand the various points that I’m trying to make! Before you even get to section 1, I’ve posted a chart below that demonstrates how I use an analysis technique of ‘what should happen’ and how I compare that to ‘what is happening’. That allows me to identify specific areas of opportunity to get long or short. I hope you find this post useful! Finally, in some earlier sections I referred to the 50%-61.8% retracement zone as the HB (Half-Back) zone but then changed to calling it the Fib zone because there was so much confusion as to what HB zone meant. So HB zone and Fib zone both refer to the 50%-61.8% retracement zone. Understanding price action is an important part of my trading and there are multiple posts on the blog that deal with that subject. When you get done reading this post I’d suggest you scroll back here and check out this post as well: Fib Levels or Patience is a Virtue?

Section 1

One week ago I wrote a post examining the prior week’s SPX price action and how I would trade it based on the chart. Today I re-tweeted it and quoted from the post that “HB zone support from Friday’s daily candle is in the 4525 area so I could add long Deltas there (with a stop below 4507) and then be looking to DH (Delta Hedge) the long position in the 4572-88 resistance zone from the weekly chart. If price did reach the 4575 area I’d then be looking for a bearish reversal on either the hourly or the daily chart to potentially add short Deltas to my portfolio.” I didn’t get the opportunity to get long since Monday’s low was 4539 but how would the short have worked out? A short at 4575 would have experienced an 18 point drawdown and a 143 point gain at Thursday’s low. The point of the post is weekends are the time to prepare for the next week’s trade. Start the week with a plan! Here’s a link to that post: Preparing For Next Week

In doing the prior week’s analysis I had relied on the SPX Mar28-Apr1 weekly chart below to have a bearish bias prior to the open on Monday Apr4. That was quite clearly a bearish reversal candle and, as long as the HB zone resistance held, it would be a good opportunity and location for a short SPX trade. The area in which to initiate a short was near 4575 and the stop would have been .01 above the weekly candle’s 4637.30 high.

Below is the SPX daily chart with the prior week’s 50%-61.8% retracement resistance shown. Notice how price spiked above that resistance zone and then was quickly rejected and continued much lower!

The SPX daily chart below from today (Saturday, 4/9/22) shows the prior 2 week’s resistance levels plus the 8-day SMA bands. A declining upper band often provides good location for a bearish price reversal so that should be viewed as a strong area of resistance. This chart added to my bearish bias as there is considerable resistance from 4520-90. Of course *IF* price is able to overcome that resistance area I’d have little doubt that the buyers were highly motivated and I’d be looking for pullback areas to get long!!!

Below is the current 30-minute SPX chart. I’ve brought the weekly resistance levels over and I’ve added the HB zone resistance from the prior day’s daily candle. That 4498-4503 resistance area is much smaller and would offer a better potential short entry for Monday’s trading. The hard stop would be $.01 above Friday’s 4521.75 high but if price finds acceptance above the 4510 area I’d likely exit a short and see how price resolves that area. I’d reinitiate a short on a breakdown back below 4497. Before moving on, look at the candle near the top of the chart labeled #1. That was the 30-minute candle reaction to price hitting the 61.8% retracement from the weekly chart. The sellers affirmed that was significant resistance and that they were likely taking prices aggressively lower!

Finally, I want you to step back a bit and look at a bigger picture view of the SPX 30-minute chart below. Compare the momentum of the move down to the move up in price. See how the angle of descent is much greater than the angle of ascent? Both moves lasted about 11 hours of trading time but the drop in price was more than twice the rally. Clearly over this period of time the sellers were more motivated! That adds to a bearish bias for the near term future.

Section 2

Every night I go over the $SPX chart to prepare for the next day. I map out the HB zone support/resistance areas on the 30 and 60 minute charts. The HB *line* is very useful to have on the charts because when price is *trending* it’ll typically find support/resistance there. When I’m intraday trading I watch the HB line on the 30 minute chart and when swing trading I focus on the hourly HB line.

Below is SPX hourly chart with the white HB line and with HB support (green) and resistance (red) zones. The 4174-79 support zone of #1 is a downside target where there ‘should’ be buyer’s. If price drops Monday, how it reacts there will be a clue for the rest of the trading day. Upside resistance is at the 4250 and 4280 areas.

I know some may be skeptical that any technical analysis works on the $VIX. I really hope that you all are very skeptical about anything that I (or anybody else) tweet or post on blogs! Everything I present is for you to learn from my experience and adjust it to fit your style.

I tweeted this mid-day Friday. The $VIX is especially important to watch right now. $SPX will not be able to sustain a move down unless the $VIX is rising. If traders/investors have bot all the Puts that they want/need then dealers will no longer be selling $ES futures.

The last 3 hourly $VIX candles happened while $SPX was dropping by 60 points. This can be a ‘which came first, the chicken or the egg?’ scenario. Did the rising $VIX cause the $SPX to drop or vice versa? I believe the $VIX is driving the bus but does it even matter?

If you see the $VIX and $SPX diverging then you should be prepared for a potentially large move that surprises many. For instance, if $SPX drops sharply Monday but the $VIX doesn’t move higher or even starts to drop I’ll be adding long Deltas. The opposite case applies also.

This daily chart below has everything I need to know about SPX levels going into tomorrow’s trading. I then can use this as a guide and drop down to the 30 or 60 minute charts to look for bullish or bearish reversals at any of the key levels to get a good long or short setup. The current daily bias is lower!

Is a Doji bearish or bullish? Neither but if it appears after a decline in price it’s a potential bullish reversal. Put a Fib (from bottom to top) and watch how next day’s price reacts to the HB zone. If it finds support there that Doji is probably a bullish reversal. If price doesn’t find support in the HB zone then at least a retest of the low is likely and, if price doesn’t find support there, then even lower prices are likely. Flip all of that description around if a Doji appears after a rally.

Section 3

On Friday, 3/18/22 I tweeted this:

That was a good setup for a short (bearish) trade. What makes a ‘good’ setup? First, it was a clear potential bearish reversal candle with a long upper wick. Those types of candles often mark a pivot high and a reversal in price. Second, the stop level where I would exit the short trade was less than 4.5 points above the entry. This is critically important in trading! If I don’t have the ability to limit my losses to a very small amount then the drawdowns in my account will often exceed the gains. I can’t begin to count the number of unsuccessful traders that I have seen over the years who continue to hold a losing trade until the loss becomes unbearable and then turn around and close out a winning trade too quickly to avoid it turning into another loser. You cannot be a profitable trader following that behavior! Cut your losses quickly. It’s simply a cost of doing business as a trader!

Here’s a couple examples from the /ETH crypto daily chart.

More price action from the current rally as of 3/21/22. See the /ES (S&P 500 futures) daily chart. Below the chart I’ll explain the 6 labeled candles.

#1 was a large green engulfing candle where price made a lower low than the previous candle, failed to remain below the previous day’s low (failed breakdown) and then rallied strongly to close above the previous day’s high. Price also closed above the HB line (Half-Back or mid-point of the prior day’s price range). Finally, price also closed above last year’s HB. Impressive day by the bulls! Any short positions should have been exited. I would be looking to add a new long position on the following day (#2) at HB of candle #1.

#2 was a very large green candle and the low never even came close to offering good trade location at HB of candle #1. This is typical of a very high demand day. Whether that demand was due to new buyers or short covering isn’t knowable nor does it matter! This is now a 🚀 headed higher!

#3 wasn’t quite as impressive as day #2 but still didn’t offer good trade location for a long because it never touched the prior day’s HB so this candle also qualifies as a strong demand day.

#4 finally offered good location for a long (bullish) trade when it touched the prior day’s HB. Well, technically it didn’t touch it as price reversed within exactly 1 point of the prior day’s HB. That’s why when I place an order to buy (or sell in a downtrend) at prior day’s HB I place the order about 5 points closer than HB to have a greater chance of getting filled on the order.

#5 found support exactly at the 50% retracement (HB) of candle #4 just as it should in an uptrend!

#6 found support just below the 61.8% retracement support. That’s a bit of a warning that price is struggling to stay in an uptrend. Price only dropped about 4 points below that support level which is hardly catastrophic but if buyers were very motivated that likely wouldn’t have happened. So, again, for now it’s just a warning that this uptrend may be weakening or pausing. It doesn’t mean that price will reverse sharply, price could simply move sideways for a period of time before resuming it’s uptrend. It’s worth watching for additional clues for now.

Section 4

The white line on the chart below is the HB (Half-Back) line. Each dot on the line is the midpoint of the prior period’s range. Since this is a daily chart of INTC then each dot represents the midpoint of the prior day’s price range. There are various ways to classify the trend of an instrument. One simple way that I use to determine trend is the slope of an important moving average such as the 8 SMA. Another way is by comparing the close of each candle in relation to the HB line. If the candles are closing each period above the HB line then that instrument is in an uptrend and if the candles are closing each period below the HB line then it is in an downtrend. In this example I am focusing on the current 5-day uptrend. Read the strategy on the chart and see it’s results.

Below is the /ES hourly chart showing the daily Fib retracements from the last few days. As price approaches support based on the daily candle I’ll be watching for a bullish reversal on the hourly chart to potentially take a long trade. At a minimum I’d need to see a hourly candle close above the HB line to hold onto any long that I might take.

Below is the 30-minute chart with the daily candle support shown. A trend change from the current down to an uptrend will show up on the 30-minute chart faster then the hourly chart. If I see a bullish reversal on the 30-minute chart and price can get above the declining 8 SMA bands and the HB line while price is within the daily support zone I’ll be trading with 2 uptrends; the 30-minute and the daily!

Below is a 60-minute chart of SPX. On 3/23/22 price sold off sharply and closed on the lows of the day. The hourly trend was down based on several metrics that I use; price was closing candles below the HB line, the 8 SMA bands were sloping down and the kicker was that price closed below the prior week’s high after spending the better part of two days trading above it. That looked like a failed breakout above a prior week’s high which is often bearish…unless price fails to follow through lower and gets back above prior week’s high again! Read the comments on the chart and see my summary comments below.

I frequently say that ‘when what should happen doesn’t, often the opposite reaction occurs’. When price failed to follow thru lower in the opening range (first 30 minutes of trading) on the 3/24 it was the first clue that something unexpected might be occurring. This is also the reason I tend to be reasonably flat Deltas at the close of each session. Even in a strong trend the best long or short opportunities often occur near the midpoint of the prior candle. It would’ve been very tempting to add short Deltas just before the close on 3/23 since it looked liked SPX was really breaking down and yet, in hindsight, that was a bear trap, probably triggered by sell stops being triggered below the prior week’s high. Clearly it wasn’t due to strong selling pressure because there wasn’t any downside follow through.

Section 5

While I most often trade using the 8 SMA bands, when price moves beyond those bands I’ll use the 20 SMA bands for good trade location. As shown on the chart below, the weekly 20 SMA is typically very reliable for capturing the longer trend. A close above middle band often confirms the bull reversal. Using the slope of the bands to identify the underlying longer-term trend it’s clear that QQQ has flipped from bull to bear. In fact, price ‘should’ have rallied up to the now declining upper band (#5) before reversing lower but the bull wasn’t strong enough to even do that. That doesn’t mean however that QQQ is in a good location for a longer-term short here since current price is 10% below the declining upper band. The daily chart will always provide more precise long/short locations and that trend is often different than weekly. It’s very important to use multiple time frame chart analysis to refine support/resistance areas and to determine trend! An instrument can and will often be in different trends on the different time frames. The strongest and most reliable price moves occur when multiple time frame trends are aligned!

Adding Fib retracements to significant candles adds context to a chart. Long upper or lower wicks like bull and bear reversals and candles that represent a change in the character of the price action are potentially significant. What about a pivot high or low? Of course those are also significant especially if that pivot high or low is a bull or bear reversal candle. And there’s one more significant candle that I watch closely. It’s the candle on a chart that’s just prior to the current candle. What happened just prior to the present candle defines the current trend and sentiment in the market. Unless the prior candle turns out to be a reversal or represents a change in character in retrospect it won’t appear significant at all so in most cases the significance of the prior candle is gone once it’s replaced by a new candle. In the case of any significant candle, watch for the reaction at the HB zone to gauge bull or bear strength. On the SMH chart below price found resistance within $.03 of the 61.8% retracement of the significant candle.

Section 6

This is a top-down analysis of the price action. I’m starting with the longest-term chart that I utilize in my trading, the monthly chart, and then placing the resistance lines from that chart on the weekly chart.

The chart below is the weekly chart but it has the monthly resistance zone levels shown. What I’m looking for is a potential weekly bearish reversal candle at or near the monthly resistance zone. In this instance the 20-week SMA upper band is nearby so that adds a third important price action indicator to the analysis.

After the weekly candle formed a bearish reversal I added that candle’s 50%-61.8% retracement resistance zone to the monthly resistance zone and found that the 61.8% retracement of both were within 3 points of each other. When there is a confluence of support or resistance from different time frames that price level becomes more important and more reliable for trading!

Finally, below is the 60-minute chart of /ES. I’m adding it to the post here because it’s another great example of how the 50%-61.8% retracement zone (which I often refer to as the HB or Half-Back zone) is so important in price action analysis. Read the comments on the chart.

Section 7

I use the 8 SMA bands instead of RSI or MACD to measure price momentum as well as identifying good trade location. The bands work as a trend indicator on all time frames. Current *hourly* price action indicates a strong downtrend followed by a weak rally overnight.

Section 8

Look at the last candle on the chart below. Is it bullish or bearish? Wait a minute…where is the price and the time/date axis? What instrument is this? Neither of those things matter when determining if a candle is bullish or bearish! Let’s stay focused here! 😣 That last candle appears to be a Doji candle which is mostly indecisive. In other words, neither bullish nor bearish. However, if I had to guess, based only on this chart, I’d be more likely to say bullish because it’s a pause after a big downtrend. That might indicate a reversal in momentum. Of course, it could be a bearish continuation also. How about this? Instead of guessing, wouldn’t it be better to wait for more information generated by the price action? Let’s try that instead!

All of my trading is based upon an IF/THEN analysis of price action. Using the chart above as an example, the analysis is: IF that candle is bullish THEN the Fib zone (50%-61.8% retracement drawn from the bottom of the candle to the top) should provide support on future candles. IF that candle is bearish THEN the Fib zone (50%-61.8% retracement drawn from the top of the candle to the bottom) should provide resistance on future candles. The chart below is what the bearish scenario would look like as of the following candle. The resistance zone of the /ES (S&P 500 futures) weekly (10/10-10/14 2022) Doji candle was 3617-3645. The following week opened at 3591 and rallied strongly from the open. It exceeded the high of that Fib resistance zone early in the week and continued higher. So that’s a non-starter for the bearish scenario!

Below is the chart of the bullish scenario. IF the Doji candle was a bullish reversal candle THEN the Fib zone of 3590-3618 should be support. The actual low of the weekly candle was 3590.50 which, if my math is correct, is pretty close to 3590. 😃 That is confirmation that the Doji was indeed a bullish reversal candle. The only problem is that I wouldn’t know, when price opened the following week at 3591, that the bullish Fib support zone would hold and that price would rally. If I initiated a bullish trade there then I would use the 3502 low of the prior Doji candle as the stop. That’s 88 points of risk. 🤔 Isn’t there a way to reduce that amount of risk? This is the point in the analysis when we look at a shorter time frame chart.

In order to trade off that price action I would actually drop down to the 60-minute chart which is the time frame I initiate most of my trades on. I utilize the 8 SMA bands and the HB (Half-Back) line on the 60-minute chart to follow trend and measure momentum but I bring the Fib support/resistance lines from the weekly and daily time frames and place them on the 60-minute chart for reference. The chart below is the 60-minute chart with the Fib support zone from the prior week’s Doji candle.

Candle #1 is the first 60-minute candle of the /ES futures trading week following the Doji week. Price opened almost exactly at the 61.8% support level and then rallied up to the 50% support level where it found resistance for the next 6 hours. A consolidation after a rally is most often a continuation pattern which is expected to break higher. However, no need to guess about that! Wait for the price action to further develop. Candle #2 is the breakout above the top of the 6 hour range. At that point I could take a long (bullish) trade because the Fib support zone from the weekly chart has done it’s job and I could use the low of candle #1 (which is the 61.8% retracement level of the prior week) as the stop level. So that would be a long trade initiated around the 3620 area with a 30 point stop (below 3590). That trade would’ve resulted in a 75 point gain in the next 10 hours and a 150 point gain within the next 2 days! By actually trading off the 60-minute chart I was able to reduce the stop level from 80 points down to a maximum of 30. I could reduce that risk even more by watching the candles develop in relation to the 8 SMA bands on the 60-minute chart. See how bringing multiple time frame price analysis works to make trade setups better?

Regardless of whatever time frame you choose to trade from you can see how using the weekly and daily Fib support/resistance levels on those charts can provide an ‘edge’ in that trading.

Section 9

Section 10

Section 11

I think the weekly chart below is self explanatory. If you’ve been a breakout trader in the past you might want to take the time to compare what the profit would’ve been if a long trade was taken after price broke above the previous week’s high vs. buying a retracement to the previous week’s 61.8% retracement. Quite a difference! And don’t forget to compare what the drawdown would’ve been using a breakout strategy vs. a retracement strategy.

Section 12

It’s hard to avoid the temptation of getting short at the close of a bearish daily candle. What if price plunges again the next day? I don’t want to miss that move, right? Look at the ES futures chart below and see how that temptation would be better off resisted in most cases!

Section 13

The tweet below was from when there was a lot of news about problems in the banking sector. Of course the usual perma bears were talking about a market crash but the price structure just didn’t support that type of analysis. It’s important to ignore the news and the talking heads on TV and focus on the price action itself.