From the November 01, 2011 issue of Futures Magazine • Subscribe!

Clearing up price level trading

Price level trading

Experienced traders know the importance of using key price levels as support and resistance against which to trade. Traders, regardless of time frame, look for relevant price levels as a guide. Price level trading, in addition to specific price patterns to guide trade entry decisions, often makes up the core of a well-developed technical trading strategy.

To that end, let’s exchange the often overly busy price chart of technical indicators with a simplified view of the market that consists of just a small number of key price levels. "Level headed" (below) shows an example where only three price levels are the focus: The previous day’s high and low, and the current day’s open. The price chart is a favorite among day-traders, as the previous day’s price extremes define levels that may be respected in the next day’s trading, offering levels against which to fade, or define levels of new price discovery, offering levels where breakouts may occur. The day session open serves as an important intraday price level, similar to the way interday swing traders concentrate on the day session closing price.

When just a few key price levels are the focus, the price chart is cleared of the noise from traditional technical indicators. With just a small number of price levels to focus on, the trader can begin to consider price action theories that may form the basis of a comprehensive trading approach.

Here’s one example where the open can serve as the basis for a simple trade strategy. In this model, if price moves below the open on a bearish day, then reversion to the open can make for a well-defined short entry. Similarly, if price moves above the open on a bullish day, then reversion to the open can make for a well-defined long entry.

To determine what constitutes a bearish or bullish day, we use the NYSE Breadth indicator, which measures the number of advancing issues minus the number of declining issues. If Breadth>N, then bullish; if Breadth

This simple model has a rational basis to it as well. Namely, on a bearish day, retracement to the open offers an opportunity for those who missed an initial move down to make a well-placed sale. Similarly, on a bullish day, retracement to the open offers an opportunity for those who missed the initial rally to get on a well-placed purchase. Although exceptionally simple, this kind of analysis may be more thoughtful than that which relies on a combination of technical indicators to blindly generate buy and sell orders, where many times the indicator calculations are not well understood by the user.

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