Trade Context Is Key
Have you ever entered a trade based upon what you considered to be a picture perfect setup to only then see it explode in the wrong direction? This probably will leave you quite aggravated and perplexed, and in some cases, desperate to return to the market looking for revenge with emotionally fueled activity which is the absolute worst solution. There is one very significant factor in deciphering price action that if missed can result in this feeling perpetually even if you find yourself waiting patiently for the ideal setup.
This important piece is Context. Context is the price action that forms within a broader range of price action dictating direction. What does this actually mean? The market is fractal, meaning that it is a copy of itself, within itself, and within itself again. This tells you that what you are seeing on one time frame should align with multiple others. If multiple time frame alignment is not present, you should not be entering a trade and anything outside of the former is simply just noise.
It can be easy to become excited and enthralled with a specific trade setup while completely disregarding the broader market context, or as us traders say, not looking to the left side of the chart. For instance, you may have an exceptional looking 5 minute chart but in contrast, your 30 and 60 minute charts may be in direct conflict, signaling something much different than what you were anticipating to take place on your 5 minute signal. Learning how to differentiate between the good and bad price action will make a world of difference in your progression as a trader.
Differentiating Between the Good & the Bad Trading Setups
A very helpful approach is to create a process before initiating a position on a trade. This process is comprised of a series of brief questions to quickly but effectively evaluate a potential trade. I will explain the process I utilize to quantify market context to confirm the bias I may have prior to entering a trade.
- Do you have multiple time frame alignment?
Does the signal you are looking at on a faster time frame, such as a 5 minute chart, align with longer, higher confirmation time frames such as the 30 and 60 minute charts? You want to be seeing the same story on multiple time frames. If they are in conflict, chances are the trade will not work out in your favor, or at the very least, will be much riskier than if alignment was present.
2. Does the signal align with the broader market context?
Is the market range bound? Is the market strongly trending in a clear direction? Asking these questions will help you determine the overall context of the market and whether your trade bias is validated. For example, if you are debating on taking a short sided trade into a strong trending market, you will want to exercise extreme caution or possible rethink the trade altogether. Taking a counter trend trade requires much more skill than trend trading and until you have mastered trend trading, steer clear of the counter trend moves.
3. Do you have a defined trade?
Are you entering the trade near significant levels of support/resistance? Do you have enough clear space for your trade to make a move to justify the risk/reward? These questions are perhaps the most important to ask as they are what will determine your profit/loss on the trade. You want to be absolutely sure that you are not taking a long trade into resistance or taking a short trade into support. Avoiding these traps will surely keep your trade probability on the higher end with fewer stop outs while realizing larger, more consistent gains.
As you practice your market analysis skills, you will quickly realize how much of an effect factoring in the overall market will have on your trading. As time progresses, you will soon find yourself checking the market state prior to even considering a trade. New traders tend to place too much emphasis on the specific trade signal itself which undoubtedly will lead to over trading and the loss of money.
Maintaining a very selective, patient frame of mind about a trade is the product of being able to properly read market context and deciphering price action while also being the initial line of defense in protecting your hard earned capital that you are putting to work. Stick to your strategy and respect your rules!