*How and why to trade when markets are squeezing price using a recent EURJPY long trade as an example*
I am starting this week with a short educational post that I feel might help a lot of you when you are feeling like price isn’t moving and you are itching to get in to trade positions.
A lot of the success of your trading relies on your ability to stay patient and wait for the set ups that tick all the rules of your strategy but this can and is hard. It is not uncommon to feel like you need to be in trading positions at all times or else you are “missing out” on profits but if the markets aren’t moving like you want them to then you just sit it out and wait for the trades to come to you vs going to them.
Top Tip: Dont change your strategy to the markets to enter a trade. Wait for the markets to change to align with your strategy.
So what if the markets aren’t trending or bouncing along in a nice range? There may still be a good opportunity just over the horizon if you are patient and know what to look for in the price squeeze!
Markets move in phases, this is a very important part of my analysis and although don’t always show it on my analysis, I am always looking at how market price is moving to see what phase it is currently in.
Price can trend. It moves in one direction (up or down) with a fair degree of momentum. This is when you want to look at trading with the trend and buy low/sell high and capitalise on the momentum.
Price can be range bound. This is when price moves up and down within a range. There is no clear trend and this is when you want to look at trading support and resistance zones to buy low and sell high.
Price can consolidate. It pauses/becomes range bound for a period of time usually after a period of trending. The market is waiting for its next direction to be decided by buyers and sellers. This is when you want to wait, watch and get ready for the next move because it is normally a good one.
In this blog post I will be focusing on the period of time traders hate most, the consolidation. Why? Because it’s boring.
The main types of consolidation are wedges, flags and triangle patterns that are quite easy to spot. I have already covered the flag continuation pattern in previous blog posts which can be found by clicking on the link. As the name suggests, this pattern is a continuation pattern and you would be looking to trade with the previous momentum. The triangle pattern is similar and normally proceeds in the direction of overall momentum and is therefore also a continuation pattern.
However, if price isn’t just pausing but is squeezing then there might be an even greater trade opportunity that is about to occur. A larger “wedge pattern” is what can be seen when price is squeezing which is a form of consolidation but because of the nature of the pattern it can produce even greater trades with larger reward:risk ratios. This is because price gets squeezes, the lower highs/higher lows of the trend get smaller and therefore a smaller stop loss is needed.
The best part about wedges and price getting squeezed like it does is that the longer it goes on, the tighter the consolidation and the bigger the eventual breakout move is. Therefore it pays to be patient! It is sometimes not possible to know what direction the breakout might occur if it isn’t a continuation pattern like the basic flag or triangle because there may not be a strong directional momentum move prior to the consolidation forming. Therefore it is best to wait for the breakout direction to appear first before entering any positions.
Advance Tip: You can use other analysis points like established support/resistance zones and fibonacci retracement levels to predict which direction the breakout might occur. You can then improve your R:R and get into positions before the move but this is advance trading and not entirely necessary.
I will show you a perfect example of this squeezing wedge pattern by using my recent EURJPY long trade.
- Direction – Long
- Entry Date – 8th October 2019
- Stop Loss – 20 pips
- Final Target – 268 pips
- Description – Wedge pattern breakout
Let’s look at the 1hr timeframe chart before I entered the position so you can see why I was looking for a strong momentum breakout on the EURJPY fx currency pair.
I hope you can all clearly see on the chart that price was slowly getting squeezed together whilst descending. I was actually short EURJPY from the previous highs and you can see my analysis on this trade on a previous blog post by clicking on the link below.
At the point I was shorting the EURJPY I was willing to hold the trade for along as it remained in a bearish trend on the 1hr/4hr timeframe and continued to reject the 50EMA and make new lows. However, it always pays dividend to keep an eye on what is happening in the “bigger picture” and after shorting the fx currency pair for around 8 days I decided to lock in profits when I saw what looked like a wedge pattern beginning to form.
I have drawn on 2 basic trendlines using the lower highs and lower lows of the bearish move and this created the outline of the squeezing wedge pattern. It is really that simple when you know what you are looking for. At the point I was looking at the chart above, I was also noticing a few other points of analysis to decide when and how I was going to place my next trade position.
- Price was stalling and rejecting the 117.200 price level and therefore an intraday support level was beginning to form there.
- Price was flattening out and the bearish momentum appeared to be dying out.
- On the higher, daily, timeframe chart price had broken a long standing bearish trendline and had made a higher high at 120.00 the previous month. This was a sign of a higher timeframe trend reversal.
Using the points above, I built up a bullish breakout bias and was waiting for price to break that upper descending trendline. Let’s look at where I ended up entering my first long position.
As planned, price broke out to the upside with a strong bullish momentum break of the upper descending trendline and 1hr 50 EMA. It then produced a higher high on this timeframe (another sign of a reverse in direction) before it began to drop back down in to my desired entry zone.
Now, there are 2 methods I use to entering on this style of breakout. The first is to use the 1hr 50 EMA and daily pivot levels to look for a bounce from these as an intraday support and go long. My other option is what I used in this example which was to wait for the price to retest the broken trendline and 117.200 support zone. This occurred just after the FX market daily close (and Asia session opening) on the 8th October.
My stop loss is placed 20 pips below my entry price which left it below the large bullish wick test candle of the trendline that was broken and the 117.200 support zone. This may seem like a tight and aggressive stop loss to some of you but on EURJPY I have found this is more than enough for my accuracy levels of position entries.
Let’s look at what happened next.
Price made one last test of the support zone and then began to climb throughout the asian trading session and through the following day. A new 1hr higher high was made and price was residing above the 1hr 50 EMA.
At this point I moved my original stop loss to breakeven because the position was floating at around +3.8R. I then actually broke my normal trading plan and decided to lock in the profit early. This caused me to miss out on a lot of potential profit and I will explain why in more detail later.
Top Tip: Locking in profit is never a bad idea but closing trades early when your strategy/plan is saying to do the opposite is not great. I learnt my lesson on this one.
I am a big fan of capitalising on a trend and buying the consecutive dips in price to increase my exposure and therefore potential reward from the same overall trend. On this EURJPY I was looking to buy in on any significant pullbacks on the 1hr timeframe.
My next long entry on EURJPY was on the pullback and retest of the 1hr 50ema and fibonacci 0.50 retracement level. Price has made a higher high previously and therefore the trend was now definitely bullish with 2 consecutive higher highs and higher lows.
I bought in at 117.650 with a 20 pip stop loss like before. I kept the same profit target of 120.00 like with my original entry.
Why did I target 120.00?
My target profit target of 120.00 was criticised by a few people on TradingView as being “greedy” and I can understand why they thought that. With a stop loss of 20 pips, the reward:risk ratio of any long positions at these levels would be over 11:1 RR and most retail traders on the platform never see trades like this.
120.00 was a previous daily and 4hr resistance zone and the only significant price level above where price was currently at. Therefore it was likely price would climb pretty easily before it reached that level.
The chart above shows the final move on the FX currency pair. Price gained significant momentum over the net 3 trading days with a climb of nearly 300 pips in a single week.
As I said previously, you can track both trade positions live via the TradingView platform by clicking on the link below. I shared both entries online and I believe a few others followed my analysis which is always nice to see.
My analysis, entry and scaling in on this EURJPY trade was all excellent. I followed my normal strategy and got 2 excellent position entries with great potential returns. I ruined it with poor management and a lapse in trading psychology.
- I should have left my original long psoiton running or only locked in 50% of the returns at the first higher high.
- I should have held both positions until the final 120.00 profit target.
I actually calculated that I missed out on nearly 10R of potential returns by closing the positions early which is never nice to see but I am over it.
I made the grand mistake of closing a current profit in the hope of a future one. I was of the belief that price would make multiple other pullbacks to the 1hr 50 EMA before it finally reached the 120.00 level and that I could enter multiple times to profit for the overall move.
In reality, as you can see on the chart above, price just gathered huge momentum and made its way upwards in a near straight line. This is great for those in long positions but not great for someone wanting to get in on the action. I was already in the action but closed out before it got good.
Lesson well and truly learnt.
Below is the 4hr timeframe chart showing the clear wedge that formed, the breakout and the 2 long positions I had entered.
Thanks for reading and I hope you have learnt a little more about how I like to trade based on HOW the market is moving and not WHY. Technical analysis and “pattern trading” at its finest. Please don’t forget to LIKE, SHARE and FOLLOW my blog to get the latest blog posts and analysis.
DISCLAIMER: None of the information posted on this site is to be considered investment/financial advice. Trading is high risk and you should only trade with money you can afford to lose.