Does size matter?
This is a very important question. I see a lot of traders focus their attentions too much on the structure of reversal price action setups and forget the most important part of a reversal price action setup – the size of the price action setup.
What does the size indicate?
It’s very simple, when we see a large candle stick being printed it indicates a strong momentum. This informs me where the market wants to go. Using the logic that price is unable to continuously move in just one direction we have to expect price to reverse at some point, to get back to value.
The reason why price does reverse after a strong move is because of the traders who entered the market in that direction will look to take profit. The only way to do this is close out their trades and thus explaining why price reverses.
When price does reverse and traders take profits, we can expect to see price action reversal setups such as pin bars and engulfing bars to form. Now, these price action setups can be a bit misleading and is where traders can get a bit unstuck because they confuse profit taking signals with signals that indicate changes in market momentum.
The difference between profit taking candles and changes in momentum candles.
The main difference between the two types of price action setups is again down to the size of the setups. If the price action is larger in size than the surrounding candles then to me it indicates a change in momentum could be on the cards. Small sized price action candles are just that, small price action. Take a look for yourself at say a 4hr chart and see how many small pin bars get printed. Being selective and choosing only the large sized candles is what makes us stands out from the crowd.
Using the size of the price action setups to guide us is a great rule to have because it makes us only take the price action setups that have a high probability of coming off. This also reduces the number of trades we take, which is no bad thing because our win rate will increase.
Taking small price action setups like small pin bars is something I see traders do all the time and yes it’s great when they come off because the small price action setups result in smaller stop losses and in turn greater risk reward potentials. This though in my experience will be short lived and taking these types of trades over a long period of time will be produce weak results and a poor win rate.
The only way you can make this type of trading work is if you can make your winners big because the number of losing trades will be high. Feeling like you have to maximise those winning trades and catch big runners to make up for the losses is a hard call and exerts a lot of pressure on traders. We all know what happens when we get into pressurised situations, we tend to make mistakes and because the Forex markets allow for very little mistakes. The punishment will be seen in our accounts.
Before entering a trade.
So the main question I ask myself before entering any trade is –“does this price action candle stand out from all the other surrounding candles”. Better still consider if we moved forward a year and we looked back at the chart, would the price action you are considering to trade pop out at you and say “TRADE ME”.
If the answer is no, then it’s a simple pass and move onto the next potential trade setup.
The number of trades we take does not directly correlate to the growth of our trading account.
Traders can feel pressured into taking high volumes of trades each month to validate themselves as traders and this is where problems can arise.
If we focus on only taking the very best high probability trades we will increase our win rate, the number of high probability trades that do form can be low in volume each month and traders can find this hard to understand.
I myself used to think that the more trades I could take each month the more money I would make.
The problem is to get into more trades each month means we have to reduce our standards of what a valid price action setup is.
Let’s look at an example of two traders who have different win rates and take completely different quantities of trades each month.
Trader 1, takes on average 20 trades a month but has a win rate of only 30%, so 70% of the time the trades taken will be losing trades. Trader 1 risk 2% on each trade, 14 trades will be losers and so each month will be down by 28% each month.
To break even each month the 6 trades that will be winners have to return over 4.6% each (requiring at least a 1/2.3 risk/reward). This is a lot to ask and to make say 10% profits each month those winners will need to return around 6.5% each (1/3.25 risk/reward).
I fancy this trader will have to learn very quickly not to let losing trades effect their strategy, being used to having more losers than winners is hard to take.
Now trader 2, on the other hand is a lot more conservative looking to take only the very best trade setups and so on average only takes 4 trades a month. Trader 2’s win rate however is much higher at 80%. So on average this trader will have 3 winners and 1 loser each month, again the risk per trade is 2%.
The results speak for themselves, due to the lower number of losing trades the losses per month will only be 2% and so putting a lot less pressure on the winning trades. Therefore, even if the winning trades only produced say 2% returns each (1/1 risk/reward), the trader would still be up 4% per month.
To make 10% profits each month, the winning trades would need to return on average 4% per trade or a 1/2 risk/reward. Therefore, asking far less from the markets to still make a healthy return each month.
Trader 2 is therefore in a much better state of mind, their accounts will have much lower drawdowns and will be experiencing the feeling of taking winners much more frequently.
This isn’t the end of the story though because trader 2 who takes less trades per month is in a much better state of mind and is able to consider increasing the % risked per trade. Trader 2 decides to up the % risk per trade to 5%.
Using the same figures as before, trader 2 will have a 5% deficit to recover each month but the 3 winning trades now will return 15% even if the winners only return a 1/1 risk/reward. Totalling 10% per month profits.
Therefore, taking less trades per month and having a better win rate means that:
1. We don’t need to take huge numbers of trades per month
2. We are in a better state of mind and so increasing the % risk per trade is a viable option, this means we can increase our gains per month but having no impact on the quality of the price action setups we take.
3. Account drawdowns are low and so we are not under pressure to make our winning trades massive runners.
4. Plus our profits per month will be more consistent.
Trading doesn’t have to be full of stress and complicated decision making processes. Having strict rules, planning trades out before entering them and taking only the best setups, will produce consistent results and a healthy mind set. Getting into the habit of winning consistently and taking the right trades is not easy but a process that will grow as you grow.
I hope this article has maybe made you ask yourself the question “do I trade the right sized candles or do I trade too much?” I know I myself fell foul to this in the beginning of my trading journey. My initial eagerness to be in the markets all the time clouded my judgement and got in the way of making consistent profits.