Overextended Moves and Counter-Trend Trading
Hello, traders. Welcome to the Price Action Course and the third module “Nailing Entries and Exits: Sniping for Levels.” In this lesson, I’m going to talk about overextended moves. And, the reason we’re going to talk about overextended move is because we’re going to start to understand how we are going to counter trend trade.
The only way to counter trend trade is to measure the moves and look for profit taking areas. So, let’s start by defining what an overextended move is. An overextended move is by definition a strong move in the market that is not backed up by fundamentals in the short term.
In the long term, this move might be fundamentally driven, but they will exceed previous calculated moves. Okay. For example, if you’re looking at the daily Euro/US dollar chart, and notice that the last string high took 25 candles, or 25 days, for merely 375 PIPs, but after a correction price rose 1,125 PIPs in three days, or three candles, we might be in an overextended move.
So, just by looking at a chart, and just by eyeballing the previous string highs and string lows, or the previous cycles, inside the structure, you can know that the recent move might be overextended or not. And if we are in an overextended move, it might be very possible that smart money is in it. And, you want to know when they are going to be taking profit. Okay. This is why it is important to understand what an overextended move is.
Now, to calculate them, we’re going to use the basic ruler and Fibonacci ratios. And, in this lesson, I’m going to teach you how to calculate it and how to spot them. And, in the next lesson, we are going to talk about how to profit from them.
Now, to calculate them we’re going to use the basic ruler and Fibonacci ratios. Okay. We are going to calculate extensions to the terminate exhaustion areas and take profit levels. The extension levels we are going to use are 161.8, 200, 224 and 261.8. These are Fibonacci extension levels.
And, we are going to look for overextension ratios of at least 123. This means we will look for moves that have yielded three times more PIPs than the corrective phase. Now, we’re going to go through the US dollar/Japanese yen chart. And on this chart I’m going to show you an overextended level. And, I’m going to show you how we calculated the profit taking area and suddenly price dipped or went down by 500 PIPs.
But, first of all, we need to look at the first string high of the corrective phase and calculate the PIPs of each of one of them. So let’s go to the charts and let’s look at this US dollar/Japanese yen overextended move.
So, here’s the US dollar/Japanese yen forward chart. And, as you can see, this is the point or the exact point that…well, smart money took profit from this insane rally. And price dipped around 500 PIPs.
So, let’s start by measuring the first wave of the up structure. And the first wave of the up structure yield around 400 PIPs. And after price made it this high, we made a new higher low, but we failed to make a new higher high. And this is why we know that from this low to this high, is the first wave of the up structure.
Now, what we’re going to do now, is we’re going to use the rectangle tool so you can see what the corrective phase is. And the corrective phase is, in fact, everything that goes below this high right here, and up until this low over here.
So, what we’re going to do is, we’re going to measure from this high to this low how much PIPs price has corrected to the downside. From this high to this low, price has corrected 173 PIPs. This means that if price has corrected 173 PIPs, it has corrected about 38.2% of the entire move up.
Now, let me just rearrange these corrective phase calculations so I can actually see the bottom of the corrective move. And we are going to calculate from this bottom to this high to see how many PIPs we have run up. And from this low to this high, we have run up 459 PIPs. Which means that we have actually moved up 50 PIPs more than the first wave up and we have moved 2.65 times more to the upside than we did to the downside of the corrective move. This means that we are achieving an overextended area that we have to calculate with the Fibonacci extension tool.
Now, this is the high that we’re talking about. And what we’re going to do is we’re going to grab our Fibonacci extension tool and we’re going to go from low to high, to the low again, of the move. And, we are going to choose the Fibonacci ratios that we want to use right now. And the Fibonacci ratios that we want to use are the 161.8 and, in this case, the 224.
Now, let’s see where we’re at. As you can see, price has extended to this Fibonacci level. We faked out of it and then it retraced back to the previous lows. So, as I told you, in this lesson we are only going to teach you how to spot these overextended moves and how to calculate them. But, in the next lesson, I’m going to teach you how to trade these overextended moves using what we already learned so far.
Now, this method of calculating and spotting overextended moves using only price action. And we are only using price action because we are calculating the PIPs of one wave, and the PIPs of the correction, and the PIPs of the second wave. If you see a symmetrical pattern in the market, you have to use it.
And, here after the corrective move, we moved almost the same exact amount of PIPs that we did from this low to this high. And, we hit a significant overextension level, or a Fibonacci extension level, which means that we are trying to find confluence to counter trend trade. And you have to be careful when countering trend trading, because it actually can be very hard to do it if you don’t know what you are doing correctly. And, you are not going to use this method on every single chart. You are going to try to spot these overextensions and try to use less risk than your average trade to try to profit from them.
The good reason to try to spot these overextended moves is that they can yield nice profits to the opposite side. If you see from this low to this high, it took 10 days or 40 bars to achieve this high. And it took price merely 18 bars to erase all the gains. So, this is basically what we’re looking with this method. Trying to spot overextended moves, profit taking levels of smart money, and then ride the flush down.