Bounce Trading in Forex and the Role of Support and Resistance.

Hello Forex traders,

At one time, USDJPY is pushing through the yearly high and the UJ bounce or break spot was mentioned in a previous article. Let’s take some time to use this as an example of bounce trading in forex and the role of support and resistance.

 

 

Role of  Support and Resistance

Support and resistance (S&R) is the key factor in the Forex market.

support and resistance

When the price reaches pre-determined support or resistance levels, the trader can then mark this zone as a “bounce or break spot” (more on that later on).

There are various ways how forex traders identify the support and resistance zone (testing the usefulness of their S&R identification is important).

Many elements could turn out to be support and resistance; here is a list with a couple of examples:

1)      Tops and bottoms

2)      Trend lines

3)      Trend channels

4)      Fibonacci retracements

5)      Fibonacci targets and extensions

6)      Chart patterns

The support and resistance indicators could be used in various ways:

1)      As a target, thereby placing a Take Profit at that level

2)      As a filter, thereby purposely not taking a trade setup due to S&R

3)      As a trigger and/or entry, thereby taking a potential trade upon the break or bounce

Break or  Bounce Spot

This article is geared towards explaining how a Forex trader can trade/approach a bounce or break spot (and is not focused on how the S&R is determined).

break or bounce spot

Once the Forex trader has identified this spot, then the Forex trader has a “line in the sand”. The Forex trader has a clear level which they mark for themselves as crucial.

Why is this important?

–          The Forex trader needs to mark certain levels, areas, zones, price zones as important in advanced so that there is clear moment when a decision is/has to be made and all other price movement is filtered out (ignored).

–          If a Forex trader does not set up some kind of filter, then the process of trading would become very problematic as all new data would be reviewed with the same importance (creating fear and greed).

Once a break or bounce spot has been identified (according to the trader’s tools), then the trader can wait for the price to reach that particular zone and wait for the price to either break or bounce of that particular support or resistance level.

1)      A break is when price pushes through the support and resistance. This is called a breakout trade and price then has enough momentum to break through that zone.

2)      A bounce is when the price does not push through the support and resistance. In this case, price does not have sufficient momentum to break and price then “respects” the zone.

In our trading room, we are on the lookout for breakout trade setups (strikes) and the first pullback after breakout (boomerang) in the Forex market. This means:

1)      Strike = break trade

2)      Boomerang = bounce trade

Trading Bounces

A bounce scenario could mean that price is either making a small retracement, big retracement or reversal. In the case of a small retracement, the price might still break through the support and resistance a little way later. Big tops and bottoms and Fibonacci levels are usually not broken without at least some “respect” for these levels (price will not go through the level without stopping).

13- 12- 2013 uj

A bounce trade can be entered via various methods.

1)      DIRECT:
A trader attempts to trade directly at the expected support or resistance zone.

Example: Let’s say that you are looking at a particular Fibonacci level or top as a resistance. Having an entry order directly at that level is one way of trading an expected bounce at that S&R.
Advantage: earliest entry.
Risk: price continuing without stopping at level.
Problem: stop loss placement as the price can overextend on smaller time frames through S&R area – even if it’s slight.

2)      CONFIRMATION OF BOUNCE:
A trader waits for a confirmation of price to stop at the expected support or resistance zone.

Example: Let’s say that you are looking at a particular Fibonacci level or top as a resistance. Waiting for a candlestick pattern at the expected S&R is a confirmation method.
Advantage: price is stopping at the expected level and clear stop loss level is known.
Risk: price could move away from S&R (substantially) before confirmation takes place.
Problem: could be a late entry, especially if the trade is taken against a prevailing trend.

3)      BREAKOUT AFTER BOUNCE:
more information in the next paragraph. This is very similar to Tim’s article on 123 reversals. One of the differences, I think, is the usage of fractals.

Bounce Using Fractals

Another way to trade the bounce trade is by using fractals. Here is how the process would be:

1)      A Forex trader can anticipate a certain S&R to be important

2)      Wait for price to stop at or close to that level and make a fractal

3)      Wait for price to move away from that S&R

4)      Wait for price to form a fractal at the opposite side

5)      Wait for a break of that opposite fractal

What does this mean?

13- 12- 2013 au

Basically, by letting price stop, reverse, stop, and reverse, the Forex trader now has 2 lines in the sand. One is at the expected S&R. The other is on the opposite side. A break above or below either of these 2 levels then constitutes the likely winner.

For example:
There is an uptrend on the 4-hour chart. Price stops at the S&R (for instance Fibonacci retracement). Price moves down 40 pips away from it and forms a fractal on top of price on the 4-hour chart. Price then bounces back up again with the trend but fails to breakout above the resistance fractal. At this point, there are 2 fractals. A break above the fractal constitutes a break-out. A break below the fractal means a “bounce break-out” (a breakout in opposite direction after a bounce).

Via this method, it is translated a bounce trade into a breakout. The Forex trader can also use the BPC method as well: break, pullback, and continuation. The Fractal Indicator helps identify clear levels, check out the article with more information on the Fractal here. Also, depending on the time frame, it is a good idea to go a few pips above or below a fractal (6-20).

It is important to realize that the odds of success are greatest when trading the bounce either:
a) during a very strong S&R and a trader is attempting to catch a strong reversal
b) during a trend and a trader is attempting to identify the S&R for trend continuation

This is a Forex concept or method, not a Forex system, which means there are no particular statistics. It would be the same as asking how successful are break-outs or trading with the trend? The sample size is huge and depends on too many variables. The idea could be a building block though for a detail trading strategy (read more here about creating Forex strategies). This Forex concept is a discretionary method of trading and must be used along with other tools and analysis, specifically multiple time frame analysis.

Do you like bounce trading in forex? Or do you prefer break-outs? How to you trade bounces? Let us know down below, thanks!

Good Trading!

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