Trading reversals based on price action, candlestick analysis and support and resistance is a profitable trading strategy. It’s been working for me for many years. But it only works if your entries, stops and targets are correct.
In this post I will show you where you have to get in (entry), where you have to cut your losses (stop loss) and where you have to get out and take profits (take profit target).
With every trade you have to plan this in advance. This way you can simply place your orders and walk away from your trade.
If price turns against you, your trade is automatically closed by your stop loss order. And if price moves in the right direction, your trade will automatically close in profit by your take profit order.
So here is the list:
- Stop loss
- Take profit
The path of least (and most) resistance
When it comes to placing smart stop losses and take profit orders, there is an important rule that you must keep in mind:
The path of least resistance.
Your stop loss must be difficult to hit and your take profit target must be easy to hit. Always place your stops BEHIND a barrier and your take profit orders IN FRONT of a barrier.
If you’ve read my other posts you should now know what a barrier is… they’re called support and resistance zones. So when you open a trade, put your stop loss just above resistance for a short trade and just below the support for a long trade.
The smart stop loss
For a short trade I would put my stop loss here for example:
The blue line at the top is the resistance zone and the red line is my stop loss. This way I’m placing my stop loss behind a barrier, because that is what resistance is.
But if you look closely, I have also used another barrier, namely the high of the indecision candle. I explained to you how important higher highs and lower lows are. These recent swing highs and lows also act as barriers.
To hit my stop loss, price now has to break through 2 barriers. It has to break through the resistance zone and then it has to make a new high. So it will be difficult for buyers to take out my stop loss here.
That’s how easy it is to place a smart stop loss.
Set smart targets where you want to take profit
When you’ve set a stop loss, picking a target is fairly easy. Your target must meet these 2 criteria:
1. Go for a minimum of 1:1.5 risk vs reward
This means that with a stop loss of for example $100 you want to make a minimum of $150 profit. So you risk $100 to win $150.
That’s a risk to reward ratio of 1:1.5.
With a $200 stop loss you want to win at least $300 and with a $50 stop loss you want to win at least $75.
2. Place your take profit orders in front of support and resistance zones
So your minimum target is 1.5x your stop loss and your target must be in an open area without barriers. Because again; you want your target to be easy to hit and your stop loss difficult to reach.
In this example I place my take profit order just above the next support zone, because it’s a short trade which means we are selling.
The top blue line is resistance an the bottom one is support. This appears to be a super good risk to reward ration from the current price. I estimate about 1:7. That is nicely above the minimum of 1:1.5.
But this is measured from the current price level, because we don’t have an entry yet. But at the moment this setup looks great.
The stop loss is not far from the current price and because the take profit target is much further away than the stop loss, we can win way more on this trade than we can lose. Price also has a nice open area without any other support in between.
Entry. Where do you get in?
Once you have a healthy stop and target, you need to figure out where you will get into the trade. This is your entry. You can’t just hit buy or sell. There must be a reason and confirmation based on price action before we get in.
You know how important higher highs and lower lows are. So if you want to open a short trade in this example, where you bet on price to change direction and go down, where would you get in?
Let’s have look again:
You only want to get in when price action shows you that the sellers have taken control of price. If we go short, we want the sellers to show us they won the battle right?
So you want your entry to:
1: Be located below the resistance zone (above support for a long trade)
And you also want:
2: Price to make a lower low (higher high for a long)
If you link these two criteria to the indecision candle that forms on top of a resistance zone, then you have a good entry. In this case it looks like this:
As you can see, this is still a great risk to reward ratio from our entry point. Probably still 1:6 which is well above our minimum 1:1.5. And this is a trade that I would take instantly. If we look at how this trade played out, we would have made a nice profit.
By the way, do you see how after the entry price (on the fifth candle) came all the way back to the resistance zone and how it helped as a barrier? I actually created another beautiful indecision candle, with that big upper wick. That is exactly what I mean.
And in the end price was free to go move down and hit the target.
Place your stop loss behind 2 walls: support / resistance zones and the last high or low. Place your take profit order where the price cannot be impeded along the way. So just above support (for a short) or just below resistance (for a long).
Enter your trades just below the low (short trade) or just above the high (long trade) of the indecision candle when the next candle breaks that level.
If your risk / reward is at least 1: 1.5, you have a tasty trade. The best way to master this is to practice a lot.
Do you have questions about entries, stops and take profit targets? Let me know in the comments below!