The principle behind successful trading is simple :
- Buy low, sell high
- Sell high, buy low
Unfortunately in the free market system, what the future price will be is unknown, which opens up almost infinite possibilities as to what can be defined as a current ‘high’ or ‘low’ price.
The market trades sideways (within a range) at least 60% of the time, based on researched statistics. So the only way to be consistently profitable in both trending and ranging markets, is to understand what is a relatively high or low price.
Most traders buy on impulse as a market breaks out upwards or downwards, but in the majority of cases this will not be a breakout but merely a test of the extremities of a sideways range.
Although trading is much more complicated that these simple statements, they are useful rules that can improve your risk/reward ratio. It’s the context in which the rules are applied, that matters, for example :
- If a market is trending upwards. Then buy low, when the market pulls back. Then sell high, when the market resumes the trend.
- If a market is ranging. Buy low, when it approaches the bottom of the range, and sell high when it approaches the top. Vice versa, at the top of the range.
- Swing trading involves buying at the swing low, and selling at the swing high.
These rules seem simple. However, it is surprising how often a trader will see a market rally in one direction, impulsively jump in and trade in that direction, only to see the market then pull back immediately and hit their stop-loss.
There is always a relatively low and high price. If a trader is patient and waits for the relatively good value price, then they will improve their overall chances of success, and reduce risk.
Trading is an auction process. A successful trader wants to find good investment opportunities. They need to invest at such a price that allows them to later sell on for a profit.
The two charts above show crude oil in an uptrend for the day. Both the Volume Weighted Averapge Prive (VWAP) and the regular moving averages can be used to show trend direction, and trade entry opportunities.
In the cases above the pink VWAP line is a good entry point for trends, along with the 100 Moving Average (black line). The concept is to trade with the trend, but only at point where the market pulls back.
If the market breaks, and remains, well below the MA and the VWAP’s, then the trend has broken. So it is important to have a stop loss in that eventuality.
On a swing day, it will be clear that the market is not moving in one direction, it will likely move within a range. Strong levels of support and resistance are usually good points for entry, as this is where the market is most likely to change direction.
As show in the chart above, VWAP standard deviation lines can also mark the top and bottom of a swing. The most outer bands at the top and the bottom can be an area for directional change, on a swing or range bound day.
The opportunities here are relatively low risk, high reward, as stops can be placed tight, behind the support/resistance.