In this guide we will try to consider the construction of a simple trading system based on the methodology of using short-term and medium-term fluctuations outlined in the book by L. Williams “Long-Term Secrets of Short-Term Trading”.
The guide to effectively constructing support/resistance zones based on candlestick patterns will consist of 5 parts, in which:
- we will analyze how to structure a price chart based on short-term fluctuations,
- we will consider constructing medium-term fluctuations based on short-term ones,
- we will learn to determine a trend and correction based on medium-term fluctuations,
- we will study possible entry points based on the market structure,
- we will develop an algorithm for a simple trading system based on medium-term fluctuations and test it.
-
Structuring the chart based on short-term price fluctuations.
Financial markets are a visual world where price charts dominate. However, the analysis of price charts through traditional technical analysis is often ineffective and cannot reliably predict price behavior. However, all the market’s non-systemic nature and its chaos can be structured.
Analysis of typical market structures allows us to identify specific patterns of price behavior.
The first task for understanding the market is to identify its short-term structure. To do this:
analyze the price extremes of the bars, every time we see a bar maximum with lower maximums on either side of it, then this bar is a short-term maximum, and vice versa, if a bar minimum appears with higher minimums on either side of it, then this bar is a short-term minimum.
Short-term extremes.
Inside bars are ignored when determining short-term price fluctuations, as they indicate market saturation.
Outside bars, which occur approximately 3% of the time, should be further analyzed depending on the direction of their further breakout.
External and internal bars.
By understanding these basic price dynamics, one can mechanically and automatically measure and determine short-term market movements.
Short-term fluctuations.
After constructing short-term extremes (oscillations), we see not a chaotic structure of price movement, but some ordered models.
Although it is possible to trade according to short-term oscillation models, they do not reflect the current market structure on your working timeframe, but rather show what is happening on a shorter period.
Short-term fluctuations.
Therefore, we will use short-term fluctuations as a basis for constructing medium-term fluctuations and searching for an entry trigger.
2. Structuring the chart based on medium-term fluctuations.
The next step in constructing the medium-term market structure is based on a similar principle, assuming that medium-term highs/lows are short-term highs/lows with lower/higher short-term highs/lows on either side.
Thus, short-term fluctuations are combined into medium-term fluctuations in the same way that individual bars are combined into short-term fluctuations.
However, the market structure based on medium-term fluctuations already reflects the current picture on the scale of the time frame used.
Medium-term fluctuations.
That is, by analyzing the market structure based on medium-term extremes, we can determine what the current trend is on our working timeframe, whether there is a correction. This information will be fundamental for making a decision to enter a transaction.
Medium-term fluctuations.
- How to determine the trend and correction by medium-term fluctuations?
Obviously, in order to trade in the direction of the trend (and this is the safest way to trade), you need to be able to determine the trend.
An effective and clear way to determine the trend is to analyze it based on medium-term fluctuations. The starting point of an upward trend will be a situation in which the medium-term low is located above the previous medium-term low. In this case, there is an understanding that the sellers did not have enough strength to update the previous low, which shows their weakness. However, to confirm the strength of buyers, it is necessary to see an update of the medium-term high, in this case we can say that the current trend is upward.
Formation of an upward trend.
In turn, the definition of a downward trend will be the mirror opposite. If the price forms a lower medium-term high, this means that buyers did not have enough strength to raise the price above the previous medium-term high, which shows their weakness. To confirm the strength of sellers in this situation, we wait for the medium-term low to be updated, in which case we can say that the trend is becoming downward.
Formation of a downward trend.
In turn, any medium-term fluctuations going against the current trend are corrections. The correction will exist until a new trend appears. Corrections on medium-term fluctuations.
Corrections on medium-term fluctuations.
- Entry point into a position by trend.
According to L. Williams’ method, you can enter a position directly at the moment of a trend reversal, that is, at the moment when the trend changes from ascending to descending or vice versa. However, in our opinion, a safer entry point may be the moment of entry from correction when the medium-term fluctuation reverses in the direction of the main trend.
For example, the current trend is ascending, which means we expect a correction against the trend. That is, we wait for the appearance of a medium-term fluctuation towards sales. Next, we wait for this downward medium-term fluctuation to reverse towards the trend. The moment of the reversal of the medium-term fluctuation is easy to track by the reversal of short-term fluctuations, an “undershoot” will be visible on the low (that is, the short-term low will be higher than the previous one and the short-term high will be updated).
Entry point for purchase from correction
In selling, the entry point will look like a mirror image. For example, the current trend is downward, which means we expect a correction against the trend. That is, we wait for the emergence of a medium-term fluctuation in the direction of growth. Then we wait for this upward medium-term fluctuation to reverse in the direction of the trend. The moment of the reversal of the medium-term fluctuation is easy to track by the reversal of short-term fluctuations, an “undershoot” will be visible on the high (that is, the short-term high will be lower than the previous one and the short-term low will be updated).
Entry point for sale from correction.
Stop loss for such an entry can be located either behind the newly formed medium-term fluctuation or behind the short-term fluctuation that forms the shortfall.
Stop loss and take profit when entering a sell position from a correction.
Stop loss and take profit when entering from correction into purchase.
- Trading system based on short-term and medium-term fluctuations
For successful trading based on short-term and medium-term fluctuations, you should adhere to a certain algorithm:
- we determine the trend based on medium-term fluctuations, taking into account the increase of the low for an upward trend, the decrease of the high for a downward trend,
- we wait for a correction against the current trend,
- e wait for the end of the correction and the reversal of the medium-term fluctuation in the direction of the trend,
- we place pending orders to enter a position according to the trend, we set the stop loss behind the extremum of the medium-term fluctuation, the take profit is a multiple of the stop loss, when the price passes a distance equal to the stop loss, the position is either moved to breakeven or partially fixed, until the take profit is reached equal to 2 or 3 stop losses.
Entry point for purchase from correction.
Activation of buy orders from correction.
After taking 1 take profit, the position is moved to breakeven.
Next we wait for execution either at 2 take profit or when the trend reverses (changes), exit at the market.
Taking 2 take profit
The result of testing this simple trading system for the EUR/USD pair for 6 months of 2024 on the hourly TF is presented in the chart below.
As we can see, in 6 full months we managed to earn +67.68%, which is a very decent result.
Detailed statistics show a maximum drawdown of 11%. The profit factor is decent 4.12. And the average profitable trade exceeds the average unprofitable one by more than 3 times. The overall conclusion from the statistics allows us to state the profitability and reliability of this trading approach.
Conclusion.
Structuring the price chart based on short-term and medium-term fluctuations allows you to eliminate chaos and uncertainty in the analysis of any asset. This method allows you to quickly and accurately determine both the current trend and the correction. Moreover, the use of short-term reversals helps to identify excellent entry points for the trend. At the same time, the method is self-sufficient and does not require the addition of additional tools, which allows you to fully concentrate on the operation of the tool and deeply penetrate the essence of its work.
To avoid mistakes, it is necessary to strictly follow the described algorithm of the trading system. However, despite the high efficiency of the approach, unprofitable transactions are always possible, therefore, to ensure stable trading, it is worth paying special attention to the ratio of stop loss to take profit, the latter should be equal to at least 2 stop losses.
