How To Deal With A Counter Trend Signal to Our Trade
Recently I got a question from a newer student asking the following;
“Right now I’m short this pair. It’s in profit, but it just formed a pin bar against my trade before I hit my profit target. What should I do?”
This is a common question I get about what to do when you see a price action signal that is counter to your trade. The question by itself actually tells me a lot about the student and where they are at in their process (beginning, middle or more advanced).
My response was similar to the following;
“It is important to understand we are not pattern traders. We are price action traders. Being a pattern trader, as in trading pin bars, inside bars, engulfing bars, or fakey’s does not make us a price action trader.
Pin bars are not the death of trends. I can come up with about 50,000 examples of trends both intraday, or on the 4hr and daily time frames whereby the trends ran into a pin bar at a key level, then smashed right through it. I can also come up with thousands where they did the same and reversed.
‘Wait, but those were counter-trend pin bars, what about with trend pin bars?’
Same thing, I can come up with 50,000 of those that were with trend, and the market reversed the prevailing trend. I can also find you thousands that were with trend and worked out.
So what was the difference between the ones that did work out and ones that didn’t?
The key was the price action context around the pin bar. How the price action was leading up to the pin bar, and around it (the context of how the pin bar formed) is what will make that signals useful or not.”
This is why it is such a freshman idea and a complete fallacy to think all you need to trade successfully is 3 simple patterns (pin bars, engulfing bars, inside bars). All that + trading with trend at key levels and VOILA! You have your A+ setup and a profitable price action trade.
If it were only that simple (FYI – if it were, a lot more people would be profitable).
So how do you deal with a counter trend signal to your trade?
The answer is in reading the price action context around it. I will share four charts below to demonstrate the point clearly.
Looking at the chart below, we can see towards the left a double touch off the level R1, then a break through it with a large breakout bar. The market falls heavily and you look to get long around A1 on the bottom right of the chart. Your trade is working out great, but you run into a pin bar + false break (A1) at the key resistance level R1.
Minions of the 50% retrace entry on the pin bar are salivating because they think this is a great chance to short as you have a pin bar + false break at a key level, and the 50% retrace is at the level.
Meanwhile, you being long back at A1 see this pin bar and are worried about the market reversing thinking the move is over, so you exit.
Exhibit B (later on in the same chart)
In this next chart below which is only a couple days later on the same pair, price eventually falls back to the same key level where we bought at A1 prior. It forms a consolidation just above it, then a pin bar + false break.
Great! Time to get in on the 50% retrace entry yes as its at a key level. Or, the other option touted is to get long on a break of the pin bar high yes? Either way, this is an A+ setup right since the pair is in a range and formed a pin bar at a key level right?
Turns out both pin bar entries failed, even though it was at a key level while price action was in a range. Now imagine you were long around the top of this chart, and ran into this counter-trend pin bar signal at a key level. You probably would have taken profit.
But by not understanding the price action context around the level, you would have missed out on a ton of profit, almost double your profit leading up to that pin bar.
This is why its important to graduate beyond the freshman concepts of trading pin bars, inside bars, engulfing bars, fakey’s, or whatever price action patterns. If trading were that easy, as in trading with the trend + key levels + price action signal = profitable trading, then a lot more people would be making money.
The difference between knowing when to take those signals is in learning to read the context and order flow behind the price action. Pin bars are not the death of trends. Nor are the other patterns. In isolation, or even with trend analysis + key level analysis does not make it a good trade.
Thus my answer to this students question about what to do when you see a counter trend price action signal to your trade – my response is to understand the order flow and price action context around that signal. When you begin to do this, your trading will start to turn. You will find yourself winning more trades, and holding onto trades longer. And while others are buying this last pin bar – you are selling it, and you’ll understand why.
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