Thursday, February 20, 2014

Wicks – How to Cut Loss and Take Profit

Wicks are an interesting phenomenon in price candles formations and are a part of every candle, and an important variable in determining the Cut Loss and Take Profit points. Wicks can be formed on the top, bottom or both sides of a candle, and they represent the highs and lows of that candle during that period of time.
What is important to remember after reading this article is that the wicks are basically ‘rejection’ areas where the market simply rejected the prices of the wick. It is important to note that we are talking about the “Close” of the candle and the wicks it forms after candle closes. it is the final and permanent shape of the candle.
When we see a long wick, it clearly confirms that the market (or participants) rejected the price move compression during that period of time, therefore, prices weren’t accepted. On the other hand, if prices were accepted, then the price would remain there for a decent amount of time and most probable close somewhere around there. And since the relationship between “when” and “what is considered a must in business, but its importance rises in this context, which is the market’s rejection to the price value during that specific period of time.

FXLORDS | Hammer Hanging Man

If we are talking about 5min charts, then the wick formed is for only relevant to 5 minutes charts, which are non-essential or of real impact. However, when we start to look at 4 hour or daily charts, then they are of great significance.
If you think about it, day traders are only witnessing two or three 4 hour candles during a day. So in order to have a long wick on a 4 hour chart, then forces behind the price move must be very strong and important. And since day traders will rarely take notice of this move because it take a long period of time to form – hence they will usually end up trading against the price action trend. This basically supports the conflict of interest theory between the retail investors and commercial brokers.
FXLORDS recommends using the 4 hour chart when working with strategy, or when a long wick forms on the daily chart.
Take a look at the example below, notice how every time this pair reversed, it did so with a very long wick and on the same price level. This was telling us that the market simply did not accept prices at these levels, simply because the move didn’t coincide with the time frame (No participants), Therefore, sellers aggressively entered the market quickly causing the pair to drop fast which the confirmation of the drop.

FXLORDS | Wicks, take profit and cut loss points 1

If a long wick is formed on a daily chart, day traders across all time zones should take note of it and really be confident about their trade going against the wick, especially given enough conviction via technical or fundamental analysis. The main reason is that the market has rejected that price level that entire day. With that being said, there’s also ways to incorporate this approach to target range trading or breakouts, in both cases, these guidelines serve as “Risk Management” principles if applied properly.
Since the wick represent the high and low price of a candle, and is an area of “rejection”, then the probability of trading inside the wick is pretty low, which means that trading within daily candles’ region is going to be less likely, and so your Stop Loss order.
It should be noted when analyzing price action that the market will usually make a second attempt on the previous rejection level (wick’s tail). Notice in the example below how these levels served as support levels. For that reason, when trading wicks, we should account for another test to the previous wick’s tail; thus, using the tail will offer a better risk/reward opportunity.

No comments: