Trade Setup Guide

Fig. 1: AUDUSD Daily Chart

Trend

The first step we take when looking for trade setups is to identify in what market we are. Is the market trending, or going sideways or are we in a choppy market?

Basically, there are three ways we use to identify the market type we are in:

Obvious Patterns
Price Swings
Moving Averages

Obvious Patterns

The first way to identify the long-term market trend is to simply zoom out the chart and see how prices are moving. Are they clearly going up, or down, or sideways? Do not try to be fancy here. The most obvious direction will give a good first indication of the long-term trend (see fig. 2).

Fig. 2: USDCAD Daily Chart

If we analyze the chart a bit more we can see that the following story developed in the past year for the Forex pair USDCAD (see fig. 3): Overall the market stepped higher with a period of consolidation in November and December of last year. Although the long-term trend is clearly up, the pair has been moving lower in the past three months, so the mid-term trend is down or bearish.

Fig. 3: USDCAD Daily Chart

Price Swings

The second way to identify the market trend is to look at the highs and lows of the price swings.

Trending markets will make higher highs and higher lows in up-trending markets and lower lows en lower highs in down-trending markets See fig. 4. If we zoom in on the previous chart and analyze the mid-term downtrend, then we see almost consistent lower highs and lower lows were formed.

Fig. 4: USDCAD Daily Chart down-trend

In sideways markets, the highs and the lows tend to form at the same levels. The levels are confirmed after the second bounce. We can trade of the third bounce. The more bounces we have had the more like it is that the next approach to the level will be a break of that level. See fig. 5.

Fig. 5: USDCAD Daily Chart, Sideways range-bound market

Choppy markets are markets that have very compressed price swings. It is best to stay out of choppy markets.

Fig. 6: USDCAD Daily Chart, Choppy market

Moving Averages

The third way to identify the trend is by using moving averages. For this, we will use the 8 and 21 periods Exponential Moving Averages (EMAs).

If the 8 EMA is above the 21 EMA and the 21 EMA is sloping up, then the trend is up.
If the 8 EMA is below the 21 EMA and the 21 EMA is sloping down, then the trend is down.
If the EMAs are diverging then the trend is getting stronger
If the price is moving away from the EMAs then the trend is getting stronger.
If the price is far away from the EMAs this can indicate the trend is overextended.
If the EMAs are more or less flat and continuously crossing each other and if the price is close to both EMAs, then we are in a sideways or possibly choppy market.

How to Trade The Trend

Once we have identified the trend type we can trade it in the following ways:

We can trade with the up and down trend using breakout or reversal setups.
We can trade counter to the up and down trend using reversal setups.
We can trade outside the tops and bottoms of a sideways trend using breakout setups.
We can trade inside the tops and bottoms of a sideways trend using reversal setups.
We stay out of the market if it is choppy.

Level

We always want to trade of-of significant levels in the market. We will use two kinds of levels:

Horizontal support and resistance
Dynamic support and resistance levels 8 and 21 EMA (50 EMA and 200 SMA)

Horizontal support and resistance

Horizontal S&R are areas on the chart where historically prices have bounced off of-of. We can call them historical swing points. Quite often they are seen at round numbers as that is where many traders tend to place their orders. When drawing in the levels we will follow BCW to prioritize the importance of certain levels:

Body
Bounces of the candle bodies (open and close prices) are the most significant.
Congestion
Many time levels line up with previous areas of price congestion.
Wick
Bounces of the wick are important but less significant than body bounces or congestions areas.

Dynamic Support and Resistance

Dynamic S&R is formed by the moving averages. More often than not the price will respect the 8, 21, 50, and 200 EMA.

Signal

We will be looking for price action signals in the form of candlestick patterns on identified price levels and in the context of the overall market (trend).

These are the candlestick patterns we consider trading:

Inside bar / Harami
An inside bar is a pattern formed by two candles. The second candle has an open and a close that falls within the range of the open and close of the first candle. Also the high and the low of the second candle fall within the range of the high and low of the first candle.
Pin bar
A pin bar shows a rejection of a certain level. The story is that price moved in one direction, but then moved in the opposite direction on the same day closing around the same level as the day started.
Engulfing pattern
This is a two-candle pattern where the second candle engulfs the first candle. Means: the second candle has small wicks and the range of the second candle covers the range of the first candle. This pattern shows that there is momentum and conviction in the direction of the second candle.
Fakey pattern
This pattern is formed when an inside bar breakout fails. Price will move in the opposite direction of the breakout after this pattern.
Tailed bars
This pattern looks like a pin bar, but with a larger body. Like the pin bar, it shows rejection of a certain level, but in a less obvious and powerful way. More often than not we can see several tailed bars form on a level before the price reverses of that level.
Anchor bars
These are also called momentum bars. These are bars with wide ranges and small wicks. These bars are signaling if a move is just a retracement or a reversal. See figure 7.

Setup examples

Below are some examples of possible trade setups that are in line with the methods described above. Of course, these are ideal examples. Always understand and accept that these setups can and will fail.