Finding Confluence at Key Levels of Supply and Demand
Hello traders! Welcome to the Price Action Course and the third module, ‘Nailing Entries and Exits, Sniping for Levels.’ In this lesson, we’re going to talk about finding confluence on overextended moves with key levels of supply and demand.
Now, what we’re going to do here is we’re going to use what we’ve learned so far and we are going to calculate overextended areas or overextended ratios. And we are also going to look for key levels that confluence with these ratios and, of course, we are going to read rejection of the candles to have confirmation of our trade idea.
Now, the good thing about this is that this is the first step on learning how to countertrend trade. For the moment, we are just focusing on shorting overextended moves to the upside and going long on overextended moves to the downside.
So let’s start by talking about this. Now that we know how to spot and calculate overextended moves, we are going to learn how to trade them. Trading overextended moves can be tricky and quite frustrating if you don’t follow the steps that we have taught you. You measure the moves and corrections, you measure the extension levels, and you look for strong key levels in the past.
Now, why do we say that this can be tricky and quite frustrating? Because traders are always trying to pick tops and bottoms. And when your system is based on picking tops and bottoms and trying to get into very long trends, you are going to be stopped out a lot. And this is not what we are trying to do. What we are trying to do is we are trying to determine key levels where market is going or is supposed to turn around because the move is overextended and because we have found confluence between key levels on our ratios and, of course, these levels can also be profit taking from the entire move. So, we are not picking tops and bottoms. We are trading overextended moves, which will help us later on to understand how to countertrend trade.
Now, these are the first steps into countertrend trading. But for now, we are just going to focus on overextended moves in the medium and long term, and this means that we are going to be taking profit at the next key level and our stops are going to be tight. And the classic rejection ratings must be used to determine if we are going to enter the market or not. What we have learned so far in price action reading or reading the charts is going to be very helpful when we decide if we are going to take the trade or not because if we don’t find confirmation in the candles, it might mean that the price is going to continue with the trend. And this is why you have to be very careful when you are trading overextended moves and this is why you also need to lower your risk exposure when you are doing this. Because it is not the same as just following the trend and jumping in on a dip or on a rally.
Now, stop-loss levels must go above the swing high or low, which means that we are trading with tight stops and we are going to take profit at the next key level. We are not countertrend trading. We are just profiting from overextended moves and very strong corrections. And right now, we are going to go to an Aussie-US dollar chart and I’m going to show you how this is done.
Okay, so this is a Euro-GBP chart, sorry about that, I thought we were going to analyze an Aussie-US dollar, but we are going to analyze a Euro-GBP four-hour chart. The first thing we are going to do is we are going to measure from this swing low to this swing high, the number of pips that we have moved on this cycle up. Right now, we are looking at price action as if this is where we are trading at. We don’t know what’s going to happen, even though this is historical price action.
So, the first thing we are going to do is we are going to measure from this swing low to this swing high. And we have actually gone up 141 pips. And the real swing high is this one right here, so it’s 174 pips. And the corrective zone which we are looking at is from this high to this low. And the reason is that we were making higher lows and higher highs, but right here we failed to make a higher high and we broke with this higher low, making a lower low. And this is just a correction, so from this high to this low is the corrective phase. And if we measure from this high to this low how many pips we have corrected, you can see that we have corrected around 83 pips, so this is basically around a 50% retracement from the move up.
And the third step is to measure from the low of the corrective move to the high of the second wave of the cycle. And we have 158 pips, which accounts for a symmetrical move. So, we have now measured the first wave up, the corrective move, and the second wave up, and you can see that we have a one-to-two overextension ratio from the corrective area or the corrective zone to the second extension.
Now, what we’re going to do right now is I’m going to plot a vertical line so I don’t get lost on my charts and I don’t go forward to the right and you can see what happens next. So what we’re going to do is we’re going to first of all calculate the Fibonacci extension that we might be trading at. We go from this low to the high of the move to the low again. And, as you can see, we are right here and we are going to choose the ratios that we want this extension to show us. And, I think that, if we plot the 161.8, it’s going to be just fine. So, the 161.8 is all the way up here. But, because this was around a 50% retracement on the first move up, we are going to plot another Fibonacci extension ratio, and the ratio is 138.2% and you can see that we are right there, trading at the 138.2 extension ratio.
Now, let me just thicken this blue line and make it green. And now we are going to go back and we are going to look for levels. And you can see that we have a first and very strong level when we see the price tested it once, twice, three, four times before it broke to the down side, and I think it tested it again on its way up. So, let’s use a horizontal line right here and we’re going to thicken this one.
So, this is the first level that we have got. Price tested it once and you can see the price also tested it as resistance. Once, twice, and then when we broke to the upside, it was tested once, twice, three, four times, as support and then again as support. So, we have basically found a very strong level and we are going to be using this area as a resistance level. So we go back to where we are right now and you can see that we are basically trading around this area of previously tested support and now being tested as resistance. We are not quite there yet, but we want to get feel, so we are going to go short around the 138.2. And we are going to use a stop above this high, which means that we are going to use a stop above this area of resistance, which means that we are going to use a 22 pip stop area and we are going to take profit at the next key level, which is this level of support. And this means that we are going to be taking profit for around 62 pips, which means that we have a 1:3 risk-to-reward ratio on our hands. And as you can see here, price moves all the way down here and bursts through our profit-taking zone, making us a 62 pip win.
And this is basically how you are going to trade overextended moves and in this case, we just measured the corrective phase, with the extension phase, and we saw that we have hit a very nice round Fibonacci extension level, which confluenced with previously strongly tested levels of support that were going to be tested as resistance. We went short and we risked 22 pips for a 62 pip win. And, actually, we could have used these highs as a profit-taking area for a new profit of 80 pips. But I think that using the previously tested area of support as a profit-taking target was big enough to give us a big enough risk-to-reward ratio that was logical for us take this trade.
Now this is just how you are going to trade overextended moves. On our next lesson, we’re going to take it all together and teach you how to countertrend trade and how to pick key levels to do so and how to snipe for those entries.