Of all the facets of trading, the first a novice trader must learn before he can engage the markets with any degree of confidence is identifying low risk entry points on a price chart. Notice that not just any entry will do, only those offering the biggest reward for the least amount of capital exposed are acceptable.
If you’ve ever read about or had the chance to chat with any successful trader, you’ll find a common thread: They all (without exception) have an edge based on low risk entries and consistently execute those entries.
What defines a low risk entry? The price level where a trader can expose the least amount of capital to prove whether his edge will work. I tell students to look for these areas by identifying “the line in the sand” or “drop-dead level” where price has to hold. These are generally found at prior inflection points on the chart.
Specifically, inflection points can be spotted by looking for those price levels where there was a clear change of direction. In other words, where was the dominance of either the buyers or sellers relinquished? Moreover, the more powerful the reversal, the more important that point becomes on the retest.
Also noteworthy is the fact that the first time these levels were “tested,” not only did they provide low risk trade setups, but they also held, and reversed a high percentage of the time.
I’ve used the chart of the British Pound futures below to illustrate this premise.
Depending on how much risk one is comfortable in assuming, a limit order can be placed at the line where prices formed a zone before turning and a stop slightly below the “drop dead ” line . In this chart, we can see how fast the British Pound was falling before it reversed. This is where the lowest risk entry point was found in this trade.
In the second example, AD (Australian Dollar Futures) in the chart below was falling sharply, this is signaling an extended market in which the odds of a reversal are heightened. If we look to the right, we can see previous inflection points (highlighted in yellow). These would be deemed areas that would attract buyers. Given that we know (based on our scoring system) that there is very high probability of price holding at that zone, and our risk will is modest, we have to execute a trade against that zone.
As we can see in the chart, the zone held, and the trade worked nicely.
Suffice it to say, not all trades will work as well as these did, but the key here is when they don’t pan out, the losses will be minimal compared to the profit potential.
Once a trader learns the skill of identifying these levels, the biggest challenge is putting on the trades. Why do I say this? Well, all of these trades are being placed when price is either retracing or the market is moving strongly into one of these areas.
If you look closely at the two chart examples, in both trades you were buying into a series of red candles and the trend was lower; psychologically, this doesn’t sit well with most non-professional traders. Only by knowing probabilities and accepting risk can a trader place these trades with a high degree of self-assurance.
The other issue is patience. These setups don’t come about every minute, or five minutes for that matter – more like two or three times on some days.
Indeed, this style of trading perhaps is not for everyone, but regardless of your method, identifying and executing low risk entries are the hallmark of a consistently profitable trader.
Until next time, I hope everyone has a great trading week.