Today we’re going to look at confirmation signals and how to weed the chaff from the good using price action analysis. Confirmation signals are the alerts of price action analysis. They gives you the thumbs up when your trading edge is present.
You know, searching for confirmation signals can be an almighty struggle, especially when you’re trading for the first time. You’re so scared of going for the bull’s eye because you’re not sure whether the signal is a good one or a bad one. Well, newsflash!If you want to perfect the art of catching confirmation signals, you need to be clear in your mind what you’re looking for and what the signals look like. If you can get these two figured out, it’s 80% of the job done.
So here is what we’re going to do.We ‘re going to define what price confirmation signals and then decide how to filter them.
What are Price Confirmation Signals?
Well,like I said earlier, price confirmation signals reflect the presence of a price action setup on the forex chart. They’re also known as price action signals, so when you hear of price confirmation signals, think of price action signals. To put it mildly price confirmation signals are simply obvious price setups that form in the forex market.
You can find these signals along the level of support or resistance or in the trends. In other words, price confirmation signals can also be described as a perfect alignment of factors on the charts. In other words, there must be a confluence of events on the charts for your trading edge,or strategy to unfold. If you want to understand the workings of confluence, Go to Something Called Confluence
Let’s get on thing perfectly clear here. You are not going to get two trading situations looking the same on the market. Why is that so? Because each trade and each chart representation is different. They have their own weirdness points.
So what you have to do is to approach your trades based on your own discretion and your perception of the chart. Just make sure your perception matches with the market’s perception or else your forex account will shedding a lot of tears.
Let’s take a look at some confirmation signals on an EUR/USD chart
See the first hammer confirmation at the bottom of the uptrend. That’s a good sign. The bullish candlestick triggers the beginning of the up trend. Once you get confirmation of a second bullish candle with a bigger and fuller body,then you make you trade.
Don’t make the mistake of jumping in the moment you spot a bullish candlestick. Get confirmation from the candlestick with a bigger fuller body and then make your entry. You use the same strategy when trading support/resistance. Just hang on for the confirmation candle to announce itself after the breakout and then make your entry.
Let’s take another look at confirmation signals at work at support/resistance levels.
Right in front of us are confirmation signals along the lines of support and resistance. We have two confirmation opportunities along the lines of support. Those are engulfed candles with the bearish candle eclipsing the bullish candles.
The bigger bearish candles act as confirmation candles by way of their fuller bodies that I talked about earlier. Up top at the line of resistance is another engulfed situation kicking of the bearish trend.That setup also signals the possibility of a decent trade.but it took the appearance of a third candle that is bigger and fuller to confirm the existence of a trading opportunity.
So the moral of the story is this. Get confirmation from a second, and in some cases third candle before you make trade entry. Jumping into the fray at the sight of just one candle may cause you a lot of grief later..
Now that we’ve gotten the introduction out of the way the next question we should be concerning ourselves with is:
How Do We Weed The Chaff From The Good?
Before we get started , I just want you to know that the tips I’m about to dish out can be utilized on any trade set up. But for purposes of illustration, we’re going to use the Inside Bar Pattern. So off we go.
Look For A Signal Whose Protruding Tail Creates A False Break.
Assuming you’re looking for an inside bar, make sure the tail juts out from a key level in the market. And when we say key level,you should know that we’re referring to support and resistance levels. When an Inside Bar puts on its protruding disposition it can only mean one thing –FALSE BREAK. A false break adds more credibility to a confirmation signal in that it illustrates the market’s inability to maintain its momentum. consequentially the possibility of a sharp reversal becomes ever so real.
Right in front of us is the inside bar false breakout at the support level. Labelled in pink and turquoise with the protruding tails are the small bullish and bearish inside bars.Their little prank in misdirecting anxious traders expecting a bearish trend seems to have worked. Now what we have here is a bearish dive for the hills.So in case you get the urge to get in on the prank, make sure your inside bar’s tailis jutting out of the level of support
Now let’s take another look at another inside bar false break at the level of resistance.
Up top is the inside bar false break. Just like the false break at the Just like the false break at the support level, anxious traders have been tricked into believing the uptrend was going to sustain itself only to be sucked into a sharp bearish inside bar false break.
Notice the tail of the bullish and the bearish inside bars jut out. When you see this set up,it means the false break for the valley is on. If you don’t understand how the false break works, read up on Trade The False Break
Wait For Confirmation
Instead of hedging your bets on a breakout wait for confirmation instead. The last thing you want is to put all your eggs in a breakout basket only for the market to do a 360 U-Turn and go on the dreaded false break.
Sure, it hard to tell a genuine breakout from a fakeout. However, you’ll be committing suicide if you trade straight into a support or resistance level. You risk losing a ton of money that way. Imagine driving straight into a huge hurricane. That’s exactly how it will feel like when you trade into the path of a key level. So how do you avoid such a calamity? Wait for the price to close above or below the key level(support or resistance). Then once the price breaks out of either of the key levels, you then make your trade entry. Let’s take a look at an illustration of this scenario
As you can see,the resistance line has been breached by the bulls, triggering a false break for the hills. Like I said,earlier, don’t trade on a whim before the breakout happens. Wait for the breakout to take shape. Just wait for the price to get close or above the key level before you make your move.
Look For Continuation Signals After Pull Backs
One effective filter you could use is to look for continuation signals after pull backs in support or resistance levels in trending markets. There are times when the pull back is pretty small,but the trend is on the up with the inside bar in confluence with a key level at the market.
In the downtrend, the pull backs are more elaborate with the key resistance facing strong opposition. This can also present great trading opportunities. Let’s take a look at both scenarios
Here is the inside bar pull back at the resistance level. Notice the slight pullback just before the resistance level. And the inside bar signal along the resistance level has buy written all over it.
Now let’s look at the downtrend continuation setup.
As you can see up top, there are major pull backs around the line of resistance. Notice the huge rejections along the line of resistance just before the continuation. Of course, the major players are taking a breather through the period of consolidation before they continue with their journey.
Don’t Trade in Choppy Waters
Don’t ever trade in choppy waters or you’ll drown. Put it simply,you are not going to find any trades. In case some of you have forgotten, choppy waters is my apt description of range-bound markets. Just because you see long periods of consolidation, then all of a sudden, you spot a trading signal in the midst of the confusion does not make the signal valid.
You need to have at least three confirmations in order to make the signal valid. Besides, confirmation signals rarely reveal themselves in choppy waters due to the heavy contraction in range bound markets. Let’s see what range-bound markets look like
The choppy waters are within the two dark lines as labelled. As you can see there is so much confusion in these waters such that you’d be crazy to risk your money in this situation. Wait for an upward trend to breakout of this confusion, and then you make your trade. If you want to understand the personality of choppy waters, check out Forex Market Goes Sideways.
Look For Signals with Confluence Levels
If you’re counting for areas with great trading possibilities ,look for signals with confluence levels. In case, some of you have forgotten, confluence levels are levels with supporting factors behind them. These factors could be a simple support or resistance level with a dynamic EMA level(Exponential Moving Average) or a 50% retrace(pull back).
This confluence in action along the support/resistance zone which is labelled green.. At the far left corner the 200 EMA (Exponential Moving Strategy) manages to catch bulls breaking through the resistance level. This,on my opinion, is a hot trading opportunity. And in case you’ve forgotten, the EMA averages prices of the recent trading period.
In fact the EMA carries more weight since it measures the most recent prices. If you’re not sure about your moving averages knowledge visit my posts, We’re Moving Averages Part I and We’re Moving Averages Part II. Even better, to understand how confluence works, read up on Something Called Confluence
That’s a wrap for “Price Confirmation Signals: How To Weed the Chaff From The Good.” Hopefully you would have deciphered how to tell a a great price confirmation signal from a lousy one. I know it can be scary sometimes trying to tell the difference.But once you get the hang of it, it’s a breeze.
Til next time take care.
Open Live Forex Trading Account
If you’re looking to open a live trading account sign up with EasyMarkets.