Micro-strategy: Level Failures as a Trigger for Reversals
January 20, 2015
4 Min Read
Regardless of the time frame and overall objective of your trading strategy, it’s essential that you create a micro-strategy to enhance the precision of your trade entries and exits. It’s an incredibly incorrect, yet common belief that micro precision on trade execution is only a priority for scalping-style trading systems (riding small price movements) and that gaining decimal points here and there on a trade reaching double figures is not necessary. This couldn’t be more wrong and can be the cause of a strategy failing as a result of a number of reasons, including:
- The lack of micro precision means a trade is executed when a more refined approach would see it is actually not an opportunity; or worse, it is actually an opportunity to trade the opposite direction.
- The lack of discipline with precision means the risk:reward ratio is reduced. Therefore, a trade unnecessarily increases risk for a lower reward.
For this article I want us to take a look at significant levels; a significant level is a price or area on a chart where activity is expected to be heightened, such as Fibonacci levels, trend lines, reversal zones (support & resistance) and so on. Our focus is not to determine which levels deserve the status as ‘significant’ or how to identify these levels, but simply how we operate around these levels with the most reliable micro-strategy available to us, in order to gain precision.There are a few ways we can use significant levels:
- Deflection (instant reversal);
- Breakout (moving through the level);
- Consolidation (price staying at the level);
- Failure (price attempts to breakout without success).
To save you from taking up all your time reading, so that we can get straight to the charts, I won’t go into detail about the pros and cons of each of those points. Instead, I will reveal that ‘failure’ at significant levels is, by far, the most reliable method – on one condition… you actually understand how to determine it properly!Failure can happen in three different ways, Type 1, 2 and 3. The most consistent of these are Type 1 and 2, so these are the ones we will focus on in this article and ignore Type 3 for now.
Type 1 Level Failure
Significant levels can attract or repel the price. Therefore one method of failure at a line will be an instant rejection (repelling) of the price. The price won’t move past the line at all, but it will touch it before a reversal. The end of the candle will show the very top (or bottom) of the wick touching the line, but nothing else.
You will always want to wait for the candle to close, because until that happens it’s impossible to tell whether the price is really rebounding from the level or if it will continue through the level before the close of the candle and cause a breakout. This also means that you need to use chart candles that correspond with the timeframe of the significant level. For example, if you are looking at a trend-line which you have mapped out from a 15 minute chart, you will need to refer to 15 minute candles for finding the closing candle position.
Type 2 Level Failure
The Type 2 failure is a little bit more complicated in rationale, but equally as easy to identify as a Type 1. I’ll come onto the explanation for why it works in just a moment, but first of all let’s have a look at how we’re going to identify these failure set-ups.A Type 2 occurs when the price breaks the significant level but then closes precisely on the level itself (I would normally allow a very small level of tolerance; small enough that you can’t visually notice it). This means that price passed through the level, attempting to break-out, but then returned to the level i.e. not breaking it, for the close of the candle.
Once again, the candle closing needs to correspond with the timeframe of the level.[embed]https://www.youtube.com/watch?v=WxtLx5KmoAE[/embed]Once you are able to spot these opportunities easily in the market by yourself, you’ll be ready to add more layers and more elements to your micro-strategy.