Simple Trading Using Price Action
The would-be-trader or investor has to keep in mind that much of this confusion is created for a reason. The purpose of this disorder is to urge you to seek professional help. Books, trading courses, stock gurus, TV, brokers and advisors all stand ready to pluck your wallet in exchange for giving you the secrets of making money. As with most everything else, some of this advice is useful and much of it is not. Perhaps there is something a little bit different and simpler. One key to successful trading is to keep things simple.
How can a trader make his trading life easier? By having to make fewer decisions in regards to every trade. Contrary to what most experts say, it is very possible to trade with fewer inputs. Inputs would be areas like financial news, world news, and economy related news. It might also include the number of indicators and charting tools that are used for discovering and managing trades. Another input that could be avoided is listening to other’s opinions about what or when to make a trade.
Whenever you listen to the news and the opinions of others, you then have to filter that data through your thinking process. You actually have to make some kind of decision concerning all those tidbits of information you come across. And attempting to understand how all those various inputs will affect the markets is usually difficult to manage. Predicting how other traders and investors will react to the multitude of news items is often futile. It is really a guessing game that most so-called experts are unable to consistently figure out.
If a trader is aware of his thinking, often he will find himself second-guessing a possible trade set-up. That piece of information he came across yesterday is affecting his thinking. Or, he heard some news today that has him contemplating future events. It is extremely rare that all the inputs will point in one direction at the same time. In effect, the more data points that you try to use in your methodology, the more chance for conflicting and confusing findings. This opens the door for more mistakes and losses from trading.
Instead of setting up a number of specifications and then trying to find a trade to fit those parameters, why not switch your focus in the opposite direction. Set your sights on trading only one market. But you will trade this market in relation to its own price movements. Basically, you will trade pure price-action only, and with very few outside distractions. The idea is to eliminate as much conflicting information as possible. This is somewhat of a radical idea because it goes against much of what the trading world teaches.
Let’s expand this concept with an actual example. By market we mean one trading vehicle. The perfect market to trade is an ETF or exchange traded fund. These are like mini mutual funds except they are composed of stocks from a single sector. They can be bought and sold just like any regular stock. Like the SMH which is made up of semiconductor related stocks. Or the BBH which is comprised of bio-tech stocks. Other more popular ETF’s are the DIA, SPY and QQQQ. These represent the the broader market averages: the Dow Jones, S&P 500, and the NASDAQ. There are now about 300 ETF’s covering everything from gold to bonds and emerging markets.
A great ETF to look at is the OIH. This is made up of 18 oil service stocks. Since oil has been in the news for years, this has been an excellent trading vehicle. By concentrating on the price movements of this one ETF, you will get to know how it moves. Once you get familiar with the price changes and trends, you can then devise a strategy to trade it. Prices will always go up and down as well as create similar patterns that always repeat themselves. You can trade it while ignoring most of the daily news and opinions that drift into your thinking and cause hesitation and conflict. About the only items of interest you need to touch base with are major earthshaking events and the price trend of oil.
Specifically, I track the OIH using a 60 minute price chart going back about 15 days. This gives a good picture of longer day to day trends as well as action during each hour of the day. I use a 20 and 47 period moving average and some trend lines also. Add in some horizontal price lines at major price peaks and price bottoms going back 3 to 6 months and you have some great support/resistance points. The only indicator I use is the Wilder RSI set to 5 periods. This works well as a divergence indicator and as a position sell signal. That is it. I check the price trend for oil but do not rely on the OIH always trading exactly in the same direction.
This chart set-up is extremely easy to follow and concentrate on. In fact, once you get totally familiar with how a particular market trades, you can trade it using nothing but a simple, plain price chart. In this case, the OIH is very liquid and easily traded because of the high share volume. The current price is about $133 a share. So a 100 share trade will cost you about $13,300 without commissions. However, there is another way to trade the OIH. Using about a third of that $13,000, you can trade 5 to 10 option contracts. This is the same as trading 500 to 1000 shares. The options are very liquid and can be traded in both directions. You can profit in both up and down price movements using calls and puts.
All I am doing is making a buy or sell decision based on the price movement and how it relates to previous trends and price points. I do not need any other outside news or commentary to distract me. For example, today, Friday September 8, there was a nice trade set up. The OIH has been in a downtrend over the last few months since hitting a high of $170 in May. Over the last three weeks, it has made several attempts to break above the $141/142 price range. Every time, it has failed to break through that resistance area. This is a possible sign of lower prices to come. However there are no 100% certainties in trading.
In the first hour of today’s trading, the OIH moved up in price from about $135 to the $136/137 area. This was a resistance area on my chart based on a horizontal price line and the downward sloping moving averages. And from there the price began to fall, signaling a trade using put options. Yesterday’s price action, which saw prices retreat from that same range, were also a factor. The trade was to buy the September $135 put options. The buy price at the end of the first hour of trading was $220 per contract. Now, in the last hour of trading, these options can be sold for $430 per contract. This is because the price of the OIH index has fallen below $132.
Had the price reversed earlier in the day and moved above $137, I might have closed my position and taken a small loss of about $40 per contract. But I would take my profits in this case since the OIH is about to hit another strong support point. This is about $131, where it is likely to try to reverse and move back up in price. By trading put options, I was able to profit from a downswing in prices. This just happened to work out as a day trade, but that was not my original intention. Should the OIH continue to fall in price, I can still make profitable trades. This is in opposition to most traders who only trade when prices are rising.
Not every trade works out for a profit. But using a simple system and knowing how the OIH has been trading, I put the odds in my favor for a profitable trade. I didn’t pay any attention to the rest of the market or any of the day’s news. I traded only the actual price action of my chosen market. I watched my chart and traded according to what I was seeing. I had a plan to exit if the trade reversed and take a relatively small loss. No big deal, since I would still have capital to make the next trade. That is known as surviving to trade once again.
The object of this example was to provide a different perspective on trading. If you can learn how to trade one thing very well, you can increase your chances for consistent profits. It doesn’t have to be using the OIH, it can be in any other market. This is stress-free trading without all the hype and extra decision making. Without having to worry about all the external factors, you can focus on trading the price action. Thinking for yourself is one way to accomplish this. Despite all the nonsense that you will come across in your trading/investing travels, there are paths to follow that differ from the mainstream. Don’t be afraid to explore some. Over time, with an open mind and determination, you can formulate a simple trading system that works for you.
