The below tips for filtering trades can be applied to any trading signal or entry trigger, but we mainly use pin bar strategies on the daily chart in the following examples, as well as an example on a 4-hour chart. It should be noted before continuing that these are not "hard" rules but rather general filters that you should apply with care:
When we see a reversal/rejection signal like a pin bar with the wick or the “rejected part” of the signal clearly exceeding a key support or resistance level, it is often a very high probability signal.
When a pin bar signal has a wick that breaks through a support or resistance line, it also means that it has created a false breakout trading strategy, and a false breakout of a support line adds a lot more weight to any signal. A false breakout of a key level is a very important event, it shows that the market has not been able to maintain price above or below a significant level and that a move in the opposite direction is highly likely.
We can see an example of a pin bar signal that broke key support on the EUR/GBP daily chart, creating a false breakout of that level:
In the following daily EUR/CHF chart, we can see two more examples of pin bar signals with clear and obvious breakouts through a level and which also created false breakouts of these levels. These two signals led to substantial downward price shifts:
The wick of a pin bar is very important, it shows the rejection of a price. Furthermore, the longer the wick of a pin bar, the "stronger" the price rejection. This doesn't mean that every pin bar with a long wick works perfectly, but certainly a lot of them do and it's a high probability setup that should be a staple of any trader's price action trading plan. Also note that in the previous EUR/CHF example, the wick created a false breakout of a key resistance level, as we saw in the previous tip.
In the next example, we can see a bar pin with a long wick that occurred during a downtrend of the GBP/USD. When you see a move against a trend and then a bar pin forms with a long wick, it is a good sign that the retracement is ending and that the trend will resume from the pin bar. The key here is movement; when price is moving, pin bars or other signals will be much more effective than they will be in a consolidating scenario. Note the entry with 50% retracement of the pin bar, this is an entry technique that works well on a pin bar with a long wick, giving you a much better risk/reward ratio due to the closer distance of the stop loss level.
Traders often get caught up in seemingly tempting breakout trades. As we've seen, many breakouts result in false trading signals. While there is no sure way of knowing whether a given breakout will be genuine or fake, it is very risky to trade directly on key support or resistance levels; the closer a market is to a key level, the less likely it is to continue.
Don't bet on a breakout before it happens, instead wait for a close above or below the level, as you can always enter later, after the breakout and on a retracement. Inside bars are the cause of many false breakout, especially when a market is in a range and not trending, or when the inside bar setup involves a breakout as in the following example:
A pin bar with a long wick can be used as a type of filter, as it tends to perform very well after a sustained move in one direction, often marking a major market reversal or a change in the long term trend.
For example, in the following EUR/CHF chart, we can see that a bullish pin bar with a long wick occurred after a sustained downtrend, then the pin bar kicked off a big rise.
One trading filter that works well is to simply look for retracements or "pullbacks" to the support or resistance levels of a trending market. For example, in the next chart, we can see both an uptrend and a downtrend in the EUR/CHF pair. Note that in the uptrend the retracement is quite modest... but the trend is clearly upward and the pin bar has a 'confluence' with a key market support level... so this is a high probability configuration. In the downtrend part, the retracement to resistance is a more significant pullback, and we see a key resistance level rejected in the broader downtrend... it also ended up being a very lucrative signal.
Trading signals that form in the middle of thick consolidation, is not a good idea. For example, if you see consecutive consolidation bars for a while, and then a pin bar signal within that choppy zone... the signal becomes less valid. Always wait for momentum and a confirmed breakout of the choppy congestion zone to validate your signal. A "confirmed" breakout would be a close outside of the choppy area. Here we see an example of a few recent pin bars that failed on the GBP/JPY.
A "confluence level" is a level that has at least 2 supporting factors behind it. These factors can be an obvious support or resistance level with an exponential moving average level, or a 50% pullback along with a key support and resistance level; the more, the merrier. In other words, confluence adds weight to ANY trading signal. Looking for a signal that forms at a confluence point in the market is one of the best filters for separating a "good" signal from a "bad" signal. Note: While you can sometimes trade a signal on the daily chart that has not occurred at an obvious confluence level, you should avoid trading 4-hour or 1-hour signals that do not have confluence with other supporting factors (see the next section for more on this).
One of the best "filters" is actually the absence of supporting or confluence factors. If you see a trading setup that is just "floating" in the middle of nowhere with nothing to lend it "weight", this is probably a good setup to avoid. This is even more true for intraday signals. A 4-hour or 1-hour signal with no type of confluence behind it is generally not a high probability setup. See the next illustration of this:
The benefit of using filters like the ones we just covered is that you shouldn't have to invent a trading setup or have to convince yourself of the validity of a setup. The best signals will jump out at you and be so obvious that you won't even get into that mindset of guessing and trying to convince yourself that a signal is valid. Remember, the market isn't going anywhere, so set aside any sense of urgency... if you're not "sure" your signal is there, waiting for you to trade it then leave, there will probably be another signal tomorrow.
If you miss a trade that would have been a winner, learn from your experience, but don't beat yourself up. Keep in mind that even some of the worst signals can be winners. Also, as Dave Mustaine once said in his Sweating Bullets song, "hindsight is always 20/20" so don't let missed opportunities influence your trading system. It's good to learn from missed trades but don't worry about "losing money" because you missed out on an ideal opportunity.
Learning how to miss trades is part of life, and as you start defining your own filters, like the ones we talked about, you'll begin to develop a more refined sense of signals that worth trading and those that are not. The most important thing is to learn how to be patient on the sidelines. It's ok to let a few trades slip by; don't get emotionally attached to post-trade setups that "might" have worked for you.
If you think the pros are making 50 trades a day, you're incorrect. Many of those with a lot of money wait patiently on the sidelines and only pull the trigger when the best signals, levels and trends are present on their charts. You have to learn to think like the pros; be smart and stop using the market as entertainment and start treating it like a real business.
The best reason why you should trade less is that there are inherently fewer good signals for any strategy or system; think about it... the reason a signal has a high probability is because it doesn't happen extremely often, if it did it wouldn't be a high probability event, right? If you force yourself to trade all the time, you are going to use a large amount of unnecessary and second-rate signals, which simply wastes time and money.
A good exercise for any trader is to create a checklist of the different filters they use to analyse the markets for potential signals.
Here is a filter checklist example I created from the examples we discussed earlier (in yours you can even add a sample image next to each filter you use:
1. Look for a signal with a protruding wick that creates a false (support or resistance level) breakout. Watch for obvious protrusions and false breakouts of key market levels. This filter can be applied to trending markets or counter-trend trades. Wherever you have a key support or resistance level, keep an eye out for false breakouts/protrusions from that level.
2. A pin bar with a long wick offers a high probability. Pin bars with long wicks work very well in trending markets and as counter-trend signals, as we have seen in the today's examples. Always keep your eyes out for a pin bar with a long wick when analysing the markets.
3. Don't "bet" on a breakout, wait for a confirmation instead. A good filter to use for breakout trades that look tempting is to wait for the breakout and a closed candle above or below the level. The breakout is then "confirmed" and you can start looking for a signal in the direction of the breakout. This will allow you to avoid many false breakouts, especially in fluctuating markets.
4. Look for continuation signals after a pullback to the trend's support or resistance. Trend continuation signals are a basic strategy that you should adopt: watch trends and then watch the retracements within those trends - keep an eye out for signals from areas that indicate the trend may resume.
5. Don't trade signals in choppy ranges. Be careful when trading pin bars or other signals that form within thick, choppy consolidation. If you see two or three pin bars in a row, as in an earlier illustration, and the market is not moving in the direction suggested by the pin bars, this is an indication that it is probably not going to move in the expected direction. We need to see momentum and a clear break out of the range before entering from a signal formed during consolidation.
6. Look for "confluence". Look out for obvious market "hot spots", or areas where two or three or more levels intersect as these are high-probability trading levels.
7. Avoid signals that form in the middle of nowhere. This is basically the opposite of the previous point. If you see a signal that appears to have formed without any type of confluence and it seems misplaced, you should probably avoid it. It is especially important to use this filter on 1-hour and 4-hour charts.
While things like checklists and an overall trading plan are very important, they are only part of finding the best trading signals. The person trading is just as important as his or her strategy or trading plan.
As a trader, you need to develop your subconscious intuition on an ongoing basis, learning from charts, taking notes and by immersing yourself in regular analyses of the market. This will help you to develop good intuition and instincts which go hand in hand with a good trading strategy.
The leading problem traders have is identifying bad trades from good ones. So, many of them miss out on good trades while others act on what they think are "signals" of a good trade (which end up being bad). It's like when a hunter shoots at anything that moves, regardless of whether it's the game he's after.
Trading and money are weapons, and as with a shotgun, you need to be careful. You have to be patient and filter your trades, and then "pick your targets" and execute your trades with both precision and confidence.