The following article aims to provide:
- Information about when to cut the candle wicks of a level while defining it
- When and why to drill into a thick level to improve your profit margin and reward ratio, and how to do it
As always, we define our candidate level for evaluation by first wrapping it between two horizontal lines. These horizontal lines usually aim to contain the whole level with all its candles, including their wicks. Reasons for this include the fact that wicks too represent trading activity and they also define the extreme prices reached. Additionally, wicks will frequently appear as part of the main candle body (or main candle bodies will appear as wicks) depending on the timeframe used, and since different professionals might trade on different timeframes, ideally we would like to adapt our setup to as much of that trading activity as possible. On top of that, due to time-shifting applied on some broker's charts the same effect as above can be observed between different trading platforms, especially in Forex. So when you define your level you want to define it in a way that will contain most scenarios. The drawback is that the thicker your level is, the smaller your traded position should be, and the harder for your profit margin requirements to be met. On the positive side, you will miss fewer proper entries. It can be really frustrating when you miss the proper entry for a few pips and price turns and starts running away without you. Our rules forbid us to run behind price if we miss the proper entry, and also forbid us from entering if price returns for a second time after the primary market reaction has already happened because the level is weaker and probably invalid by that time.
This means that under normal circumstances we prefer not to cut the wicks and to accept a slightly early entry (usually just few pips earlier), while improving our chances against missing a good entry. But there are exceptions to this and they are not necessarily rare. One reason to decide to cut the wicks is when our candidate level is thicker than what would be optimal. You will find that many professionals will have the same feeling and so they will choose to do the same thing. If that is the case the price is more likely to reach the inner part of the level, i.e. with the wicks cut, before producing the primary reaction. But if you cut the wicks when there is no reason to do so (i.e. when the reward ratio is already good enough, or when the level is very well placed on the larger timeframes and competition for an entry will be above average), then you risk missing your proper entry.
In the above example we have two valid Supply levels that produced sizable reactions. Looking at the first level at point "A" defined between the upper and lower line, we can see that the level already produced an acceptable reaction, and our entry would have been activated with a high degree of precision. But what happened later is this: price returned for a second time at point "B" and produced the "main" reaction after touching the limits of the level as they would have been defined with the wicks cut (see middle line at point "A"). This makes it instantly clear that the majority of professional orders and the Supply/Demand imbalance got concentrated at the "core" part of the level.
From one perspective this is great, the level worked, it even produced two reactions, and its second reaction left behind a new level to trade. But it is also not ideal because the second reaction was the largest and many of us would have missed it due to the rules regarding trading only the first return of price. But have in mind that in most cases there will not be two reactions, i.e. if price ignores the wicks it will simply reach the core part of the level and produce its reaction at that point, so it will still be the first return when it reaches the core part of the level (unlike above). Finally, one other clue that price was going to reach deeper into the level was the gradual way it approached the outer part of the level (as defined with the wicks included). See how much more decisively it hit the level during the second return (if you have no idea why this is important please read the article about the way price approaches a level).
You have to choose whether you want to improve your entry price by worsening your chances of obtaining a proper entry. The way to judge this is by checking how much of the level thickness is due to the wicks
So you have to choose whether you want to attempt to improve your entry price by consciously accepting to worsen your chances of obtaining a proper entry. The way to judge this is by checking how much of the level thickness is due to the wicks. The thickness of the level at point "A" was mostly due to the long wicks, and this is an important clue. The level at point "B" also worked nicely and produced a large reaction, but cutting the wicks wouldn't greatly improve our entry (as shown by the two lower lines close together) because the level thickness was mostly due to its candles. Additionally, the upper wick slightly extended the level (above the top of the candle on its left), although not too much. With the benefit of hindsight we can now see that this level would have worked best by having the wicks cut on both sides of the level, although this is not easy to determine in advance. The less experienced traders should accept the wicks and reduce their trade size instead. And if that makes the level not meet the criteria for Enhancer #3 (profit margin), then it is always better to abandon the level than to trade it incorrectly.
The other topic of this article is about drilling into levels, and that simply means finding a level within another level. This is applicable to levels on two different timeframes, not on the same timeframe. For example you might have a level on the 4H chart which is quite thick for your preferences, or although being otherwise valid it is still failing your profit margin evaluation. In cases like these you might want to check the next smaller timeframes in case you can identify a same-direction level within the boundaries of the larger level, e.g. a 1H Demand level within the boundaries of a 4H level. This can be a very effective way of improving your profit margin / reward ratio, if this opportunity is present. Also, if the inner level and the outer level agree, i.e. their defined limits (towards the side of current price) coincide or fall closely together, it can be great confirmation that your level will be strong. It will basically make the professional orders from both timeframes coincide, and the level will have its strength concentrated near your entry.
The above screenshot was taken on the 4H timeframe but this is equally applicable to all other timeframes. If you have a level that looks thick like this one it can sometimes be hard to trade. Initially the level would be defined by the two outer black lines (i.e. including the wicks on both sides). This would instantly make the level huge and hard to trade properly. If we went a step further and just cut the wicks (as seen defined by the green lines), it would improve the situation but not always enough. Some times we prefer to aim for a sharper entry, if the circumstances permit it. The screenshot below is the same entire level as it looks on the smaller 1H timeframe.
As can be seen above, the huge 4H level contains within its boarders a nice 1H level. This is an example of a level within a larger level, and a way to drill into very large levels that might otherwise have to be discarded due to their thickness. But also note that in this case the upper limit of the 1H level was a bit far from the upper limit of the 4H level (even with its wicks cut), and this difference in calculated entries can cause a missed entry if the tighter level is chosen. As seen above, price managed to reach almost half way through the 4H level but still it did not manage to reach the tighter 1H entry. Levels within levels can be quite strong, so if all the interest of such a level is concentrated on its inner part then price might not even be able to reach the tighter entry. Still though, it was comfortably within the limits of the 4H level, although it is probably inconvenient for most traders to trade such a level on the 4H timeframe.
The above example was meant to show you both the potential of drilling within very large levels, and the drawbacks that might arise from it. Each case is different but when the inner level's limits coincide with the limits of the larger level (usually with the wicks cut), then you can trade the tighter inner level without risking missing your entry. The level will be much stronger though so you might want to allow a few extra pips for your entry because price might turn around a bit earlier due to the increased Supply/Demand imbalance near the coinciding levels.