AB = CD Price Action Strategy

This strategy is a bit different from all the other strategies that I use. The reason is that it is based more on market psychology rather than on the institutional activity. I personally use it as a confirmation of my main (institutional and volume-based) strategies. 

Still, it is very good strategy even if you use it as a standalone strategy. The main idea behind it is that the markets move in a sort of waves. The highs/lows of those waves or swings have names (A, B, C, and D). It goes like this: 

1. The distance from A to B is the distance from the first to the second swing point.
2. The C is made if there is a retrace at least to 50 % to distance from AB. However, the price must not go past A. 
3. The D is placed the same distance from C as A is from B. Because of this the pattern is called AB = CD. The leg AB has the same pip distance as the leg CD. 
4. If it is a bullish AB = CD, then you enter a long trade at the D. If it is a bearish AB = CD, then you enter a short position at the D.

To make this more clear, here are bullish and bearish AB = CD schemes:

You can trade this setup basically on all timeframes. I look for this pattern on 30-minute or 1- hour charts, 4-hour charts, Daily charts and weekly charts. I usually don't look for this pattern on lower timeframes than 30-minute timeframes.

Best thing to measure the distances between the swing points is with the Fibonacci tool. First, you place the Fibonacci so that 0 % is at A and 100 % is at B. Then you make sure the C is more than 50 % of this distance. After that, you move the fib tool (without changing the measured distance) so the 0 % is at C. The 100 % of the Fibonacci will show you where D is (this is the place where you enter your trade).

This is how you find the D in two steps:

Step 1: Use the Fibonacci to significant swing points making A and B and finding C below 50 % (in case of a Bearish AB=CD):

Step 2: Place the 0 % to C. Don’t change the measured AB distance. This way you will find the D which is at 100 %. From this place (D) you will enter a short trade:

Here are some real trade examples of the AB = CD pattern: 

Bullish AB = CD (EUR/USD, 60-minute timeframe)

Bearish AB = CD (EUR/USD, 240-minute timeframe)

Advanced Reversal Strategy

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STEP 1 - IDENTIFY A LEVEL OF DYNAMIC SUPPORT OR RESISTANCE ON THE WEEKLY TIME FRAME:.

We start on the weekly time frame so that we know what is going on, on the big picture. Without looking at the weekly time frame you can get caught on the wrong side of the dominant trend.

 Why do we need to identify key levels of dynamic support or resistance? Because if price reacted to these level s in the past , there i s a possibility that price can react to these levels again in the future so we need to have them drawn in as a reminder once price get s to these levels again.

 After we identify and draw in our dynamic level of support or resistance, then we move to. step-2

STEP 2 - LOOK FOR PRICE ACTION PATTERNS:

Once price get s to a dynamic level of support or resistance we need to look for key price action patterns to tell us that piece is “actually reacting” to the level.

 Without price act ion patterns occurring at a dynamic level of support or resistance, this means price is disregarding the level and buyers and sellers are not taking action at the level and we do not move onto the next step without price action.

 Price action patterns we like to see: long wick candles , multiple candle rejections , momentum loss candles , patterns & shapes .

 Once we have identified a key price action pat tern at a dynamic level of support or resistance then we move onto step 3. 

STEP 3 - TIME FRAME CONFLUENCE: 

We want our directional bias on the weekly to be the same as the daily (bullish bias or bearish bias ).

 The reason for this is because if you have a short bias on the weekly, but the daily is showing bullish momentum, you have conflicting data and can get caught on the wrong side of a trade.

 We first establish our bias through looking for price action on the weekly that is either bullish or bearish, and once we have that , then we jump to the daily to see if we have a matching directional bias . 

Once we have confluent and matching directional biases on the weekly and daily, then we need to further confirm the direct ion through the 4h time frame as the daily time frame i s 24 hours worth of data per candle and we want to look deeper into the immediate trend to see a more detailed representation.

STEP 4 - INTRADAY CONFIRMATION & ENTRY:

The 4h time frame i s the key to understanding the immediate trend as it shows you exactly how price i s moving at that particular moment .

We then look for a breakout in the direct ion of our daily and weekly bias and enter with a stoploss behind some form of protect ion, such as an intraday level of support or resistance or behind a t rend line, because price can swing before i t moves in our desired direct ion and you don’t want to choke the trade and have your stoploss hit before it moves in your favour.
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ENTRY CHECKLIST:
STEP 1 - IDENTIFY A LEVEL OF DYNAMIC SUPPORT OR RESISTANCE ON THE WEEKLY TIME FRAME:.

• Are we at a key level of support or resistance
• Is the level obvious ?
• How many reject ions of this level ? ( the more the better)
• Was it recently respected?
• Has it acted as both support and resistance?
• Is i t an extreme swing high or swing low? Meaning is it at the highest or lowest point price has reach in recent  time?
• Evidently you don’t need all of the above but the more criteria you check off the better and higher quality the dynamic level is . 

STEP 2 - LOOK FOR PRICE ACTION PATTERNS:

Price action patterns to look for :

•  Long wick candles
•  Multiple candle
•  rejections
•  Momentum loss candles
•  Patterns & shapes : triangle, wedge, double bottom, head & shoulders , etc.

STEP 3 - TIME FRAME CONFLUENCE:

To do: 

• Check the weekly again for your directional bias (bullish or bearish)
• Check the daily for your directional bias (bullish or bearish)
• Is the weekly and daily directional bias the same? 
• Only if both time frames are the same do we go to the 4h time frame

STEP 4 - INTRADAY CONFIRMATION & ENTRY:

Ask your self:

• Ask your self:
• What i s the directional bias we have on the 4h time frame? 
• What price act ion pat terns do we have?
• Does the 4h directional bias match the daily and weekly directional bias ? 
• If all time frames are confluent look for a momentum breakout and enter 

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Typical Price Action Strategy

To be clear, these are guidelines.
They help to identify specific characteristics of price patterns like the two-bar reversal. But they are by no means the only way to define two-bar reversal patterns.

Before we start, I’ll like to introduce the concept of the typical price.

Typical price = ( H + L + C ) / 3

To find the typical price of a bar or candlestick, you take the average of its highest, lowest, and closing prices.

In the guidelines below, we’ll be relying on the typical price to find the best two-bar reversals.

Diagram notes:

• The blue line across each bar is the typical price of that bar.
• The background shading indicates if the bar is a trend bar.

The diagram below shows the technical considerations of a bullish two-bar reversal pattern.

(Apply the same principles to derive the guidelines for the bearish pattern.)

TECHNICAL GUIDELINES FOR THE TWO-BAR REVERSAL PATTERN

The basic form is simply two consecutive price bars that close in opposing direction.

• Bearish two-bar reversal – One bullish bar followed by a bearish bar
• Bullish two-bar reversal – One bearish bar followed by a bullish bar

A bullish bar closes higher than it opened. A bearish bar closes lower than it opened.

In the chart above, Bar B and Bar C form the bullish two-bar reversal pattern.

To identify the two-bar reversals that stick out:

• The typical price of Bar B must be below the low of Bar A.

To find strength in both directions:

• Bar B and Bar C must be trend bars. 

To ensure sufficient bar overlap:

• The typical price of Bar B must be within the range of Bar C.
• The typical price of Bar C must be within the range of Bar B.

Make sure you understand these guidelines before reviewing the examples below.

In the examples that follow, we will be pointing out the patterns that conform to these guidelines. We will also discuss why those that do not fit might also offer reasonable trades.

HOW TO ENTER THE MARKET WITH THE TWO-BAR REVERSAL

There are two common ways to enter the market with a two-bar reversal:

• Enter once the pattern completes (i.e., at the close of Bar C)
• Enter when the market breaks out of the setup bar (Bar C)

In the examples below, we will use the more conservative option – the breakout method.

TRADING EXAMPLES

For better learning visuals, I’ve included the typical price of each bar in the examples below. (blue lines)

In the charts below, all references to two-bar reversals point at the second (final) bar of the pattern.

EXAMPLE #1: 

The chart below shows the market rising in a new bull trend.

1. This two-bar reversal pattern bounced off the new bull trend line. It was also the second test of the bottom of the circled gap area. With the confluence of two support devices, it was a reliable setup.
2. Look at this earlier two-bar reversal price pattern.
3. Its form is inferior to the pattern in Point #1 above. This is because it does not stick out as much. (Notice how the typical price here was not below the low of the preceding bar.)

Nonetheless, it was a reasonable trade as it found support from a congestion zone.

EXAMPLE #2: 

You can find the two-bar reversal pattern in almost all time frames.

1. Look at this two-bar reversal. Given that the market action has been drifting sideways at that point, it was not an ideal setup. However, its success in pushing the market down confirmed the start of a fresh bear trend.
2. We connected the highest pivot in this chart with this new swing pivot to form a bear trend line.
3. This two-bar reversal pattern was exceptional. It found resistance at the bear trend line. And it ended with a downwards outside bar, which affirmed the bearish strength.

(Note to course students: It was also a bearish congestion breakout setup.)

EXAMPLE #3: 

Our technical definition for two-bar reversals gives us a good starting point. But we should not be too hung up on the exact form of the pattern.

This example shows two patterns. The first one fits our definition, and the second one is a borderline case.

At the end of this example, you’ll find that choosing the superior setup is not so straightforward.

1. This two-bar reversal pattern fitted our definition nicely.
2. This instance was a borderline case.
3. According to our rules, the typical price of the first bar of the two-bar reversal must be higher than the high of the previous bar. Here, the typical price was merely at the previous bar high.

Hence, you might conclude that the first pattern was superior.

But let us recall the rationale for this rule. It is to ensure that the pattern is not within a congestion area and that it juts out of earlier price action.

The first pattern in the example pushed above the preceding two bars.

The second pattern above pushed above the preceding five bars.

From this perspective, the second pattern did an excellent job of “sticking out” from surrounding price action.

Also, traders new to price action trading tend to assume that definitions are rigid and distinct. With some experience, you’ll soon learn that price patterns are always in shades of gray. Overlaps are commonplace.

For instance, the second two-bar reversal here is also an outside bar breakout failure.

CONCLUSION – Typical Price Action TRADING GUIDE

The two-bar reversal is a classic trading pattern. Combine it with support and resistance, and you have a sound basis for a price action strategy.

Using the typical price measure, we proposed a definition for the best two-bar reversals.

(You can design such guidelines for other price patterns too. Use the typical price as a way to define otherwise vague price action concepts.)

But in the examples, we pointed out patterns that do not fit our description. Some were valid and profitable too.

TYPICAL PRICE

The Typical Price indicator takes the simple average between the close, high, and low prices.

Selecting the Typical Price indicator allows you to set the Period (as number of minutes), whether the indicator displays as an Overlay on the chart, and the color of the result.

Configuration Options

• Period: Number of bars to use in the calculations.
• Overlay: Whether to display the curve on top of the graph instead of below the graph.
• Color Selectors: Colors to use for graph elements.
• Display Axis Label: Whether to display the most recent value on the Y axis.

Formula

The Typical Price indicator adds the high, low, and close prices. The total is then averaged (i.e., divided by a factor of 3).

TP=Close+High+Low3

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Risk Disclaimer

All information is for educational purposes only. Nothing should be considered as a buy or sell recommendation. The risk of loss in trading stocks, commodity futures and options is substantial. Before trading, you should carefully consider your financial position to determine if trading is appropriate. When trading stock, futures or options, it is possible to lose more than the full value of your account. All funds committed should be risk capital. Past performance is not necessarily indicative of future results. This email may is a paid advertisement. It could be for a product or service that is not offered, recommended or endorsed by Stock Alphabets and neither the company nor its affiliates bear responsibility or control over the content of the advertisement and the product or service offered. Proceed at your own risk.

The information and material contained in these pages and the terms, conditions, and descriptions that appear are subject to change without prior notice. Investments in equity shares, debentures etc, are not obligations of or guaranteed by the Stock Alphabets, and are subject to investment risks.

Momentum Divergence Strategy

Many traders look to the RSI traditionally for its overbought and oversold levels. While using these levels can be helpful to traders, they often overlook points of divergence that is also imbedded in RSI. Divergence is a potent tool that can spot potential market reversals by comparing indicator and market direction. Below we have an example of the Stocks

The word divergence itself means to separate and that is exactly what we are looking for today. Typically RSI will follow price as the Stock declines so will the indicator. Divergence occurs when price splits from the indicator and they begin heading in two different directions. In the example below, we can again see our daily Stock chart with RSI doing just that.

To begin our analysis in a downtrend, we need to compare the standing lows on the graph. In a downtrend prices should be making lower lows . It is important to note the dates of these lows as we need to compare the RSI indicator at the same points. Marked on the chart below, we can see RSI making a series of higher lows. This is the divergence we are looking for! Once spotted traders can then employ the strategy of their choosing while looking for price to swing against the previous trend and break to higher highs.

It is important to note that indicators can stay overbought and oversold for long periods of time. As with any strategy traders should be looking to employ a stop to contain their risk. One method to consider in a downtrend is to employ a stop underneath the current swing low in price.

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Option Strangle (Long Strangle)

The long strangle, also known as buy strangle or simply "strangle", is a neutral strategy in options trading that involve the simultaneous buying of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying stock and expiration date.

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The long options strangle is an unlimited profit, limited risk strategy that is taken when the options trader thinks that the underlying stock will experience significant volatility in the near term. Long strangles are debit spreads as a net debit is taken to enter the trade.

Unlimited Profit Potential

Large gains for the long strangle option strategy is attainable when the underlying stock price makes a very strong move either upwards or downwards at expiration.

The formula for calculating profit is given below:

• Maximum Profit = Unlimited
• Profit Achieved When Price of Underlying > Strike Price of Long Call + Net Premium Paid OR Price of Underlying < Strike Price of Long Put - Net Premium Paid
• Profit = Price of Underlying - Strike Price of Long Call - Net Premium Paid OR Strike Price of Long Put - Price of Underlying - Net Premium Paid

Limited Risk

Maximum loss for the long strangle options strategy is hit when the underlying stock price on expiration date is trading between the strike prices of the options bought. At this price, both options expire worthless and the options trader loses the entire initial debit taken to enter the trade.

The formula for calculating maximum loss is given below:

• Max Loss = Net Premium Paid + Commissions Paid
• Max Loss Occurs When Price of Underlying is in between Strike Price of Long Call and Strike Price of Long Put

Breakeven Point(s)

There are 2 break-even points for the long strangle position. The breakeven points can be calculated using the following formulae.

• Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
• Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

Example

Suppose XYZ stock is trading at $40 in June. An options trader executes a long strangle by buying a JUL 35 put for $100 and a JUL 45 call for $100. The net debit taken to enter the trade is $200, which is also his maximum possible loss.

If XYZ stock rallies and is trading at $50 on expiration in July, the JUL 35 put will expire worthless but the JUL 45 call expires in the money and has an intrinsic value of $500. Subtracting the initial debit of $200, the options trader's profit comes to $300.

On expiration in July, if XYZ stock is still trading at $40, both the JUL 35 put and the JUL 45 call expire worthless and the options trader suffers a maximum loss which is equal to the initial debit of $200 taken to enter the trade.

Note: While we have covered the use of this strategy with reference to stock options, the long strangle is equally applicable using ETF options, index options as well as options on futures.