The following article aims to provide:
- Information on Enhancer #4: The first return of price to the level
- The reasons why trading the first return is a higher probability trade
When trading, it is good to keep in mind the reasoning and logic behind our trades. As Supply and Demand traders, whether we trade Forex or any other market, we are always looking for the areas and levels that show great potential in generating large institutional interest and significant Supply/Demand imbalances. So for us there is no other reason to initiate a trade unless we can anticipate a predictable reaction with a statistically meaningful accuracy in order to achieve a long term consistency in our performance.
There is no other reason to initiate a trade unless we can anticipate a predictable reaction with a statistically meaningful accuracy
This is the only way to make a consistent profit in the long run, regardless of which particular trades worked and which failed. Stacking the probabilities on our side allows us to maintain a satisfactory win ratio and make a living out of trading without worrying about the temporary ups and downs. The first three enhancers help us evaluate the probabilities a level has to produce the predictable reaction we are looking for. This fourth one sounds more like a simple rule, but still has the same purpose: to help us stack the probabilities even more on our side.
In order to understand the deeper meaning and significance of this enhancer, one has to have a good basic understanding of how markets work. But there is no need to over-complicate stuff, the supplementary educational articles as well as the enhancer articles themselves can provide a good start. The main concept here is that when we identify a level with promising potential, we should always choose to trade only the first return of price to that level. Since the reason for trading any valid level is its potential to create a large Supply/Demand imbalance which we can use to improve the probabilities of our trade, we want to enter the market when these probabilities are at their highest point. Remember that each time price hits a level it chops away some of the strength of the level due to filling a part or all of the previously (or newly created) unsatisfied Supply or Demand. So why not enter during the first return of price to the level when the imbalance is at its highest and either excess Demand or excess Supply (depending on the level) is waiting to be filled?
But don't assume that the same exact orders are patiently waiting in any specific level since its creation. A level can sometimes be many months old but no one keeps orders in the market for so long. The reason why any valid level that meets the requirements can produce a similar Supply/Demand imbalance many days/weeks/months later as it did during its creation, is because other professionals, including large institutions, banks and brokers, can all recognize these levels and choose to trade them due to the advantages they offer. So in some cases it could be argued that this works as a kind of self-fulfilling prophecy, but it is important to understand that usually there are additional valid, real reasons why a specific level was created in the first place. In either case, if you can identify the levels that will attract attention and create an imbalance, the reasons why the original level was created become secondary.
The way price moved from one area to the next can provide the signs we need in order to determine that a large part of the Supply or Demand was left unsatisfied at that level
So why does the first return of price, i.e. the first time price hits a level after its creation, carry the highest probabilities? If we start from the beginning, the reason we are examining and evaluating any particular level is because of the signs it provides (like the strength of the initial move) showing that there was a Supply/Demand imbalance and traders were competing for specific prices, thus driving price to a specific direction. If the Supply and Demand was relatively balanced, all orders would have been filled and no significant unsatisfied trading potential (Supply/Demand) would have remained behind. But the way price moved from one area to the next can provide the signs we need in order to determine that a large part of the Supply or Demand was left unsatisfied at that level during its creation, which is capable of renewing trading interest near the level.
After verifying the level by examining its placement in the bigger picture and after confirming that the related profit margin (and reward ratio) are acceptable, we are looking for the opportunity to enter a low risk and high reward trade near that level. So when price returns to the level (and if our evaluation remains valid, i.e. no opposing levels or other factors are blocking the trade potential), we can enter the trade. By entering such a trade, we will be buying or selling to the most novice of traders, e.g. someone who would (for any reason) be willing to buy right below a Supply level (where Supply exceeds Demand) or to sell right above a Demand level (where Demand exceeds Supply). The chances the novice trader has to make any money on such a trade are very low, and any professional trader would be happy to be on the other side of such a novice trade.
But each time price hits our level it fills some of that Supply or Demand, thus bringing the imbalance closer to balance, and the probabilities much lower and closer to those of a random trade. So the first return of price is the one which will fall into the highest imbalance, at least under normal market conditions, and is the one we can reasonably expect to produce a predictable reaction. This means that statistically speaking, it is a much better choice for someone to trade the first return than any subsequent one. It doesn't mean that levels cannot take 2, 3 or more hits and still work, it only means that as Supply and Demand traders we are looking for the highest probabilities possible, and these are offered by the first return of price to a valid level.
In the above (somewhat complicated but informative nonetheless) example, we can see the identified Supply level on the left. The strong initial move is also visible here, and the placement on the big picture (larger timeframes) was ok although not ideal (not visible above). The margin was good and the overall reward ratio acceptable. So what happened in this case was price returned for the first time to the level (point "1"), hit the level, and created the anticipated reaction (point "R1"). It is important to understand that this is as far as any reaction can be anticipated in a statistically meaningful way. But lets examine what happened later on as it can provide some useful information. Price returned later on for a second time and hit the level again (point "2"). Notice how much deeper within the level price reached and almost broke the level. Despite the fact that price did not break the level and even turned around once again to produce a second even larger reaction (marked by points R2(a) and R2(b) as sub-parts of the same second reaction), the probabilities of this happening were much lower than those of the first reaction. This could not have been easily predicted in any statistically meaningful way, so there was no reason for a second trade there as anything could have happened.
Now to take things one step further, price returned for a third time (point "3"), stopped within the limits of the level and created a fast but sizable reaction (point "R3"). At this point we are much safer to consider this a pure coincidence which had absolutely nothing to do with the Supply level on the left. Maybe it did, or maybe it didn't, there is no way to know and thus no reason to care about something like this. After trading the much more predictable reaction that was created after price hit the level at point "1", we would have left others to find out the rest of the story (all the way to point "4" after the level was finally broken), with their own money at stake while we would have been looking for the next valid level to trade.
Yes, in the above example we would have missed the biggest move, but have in mind that this is only "obvious" with the benefit of hindsight, i.e. after the fact, and it could have not been predicted before it happened, not in any way which maintains the probabilities on our side.
Notice also the area marked with "E", right after the first return of price to the level. This is the "empty space" between two separate "returns of price". If you look closely at point "1" price probably hit the level 2-3 times, especially as it would seem to be the case on a lower timeframe. But there was no empty space between them, not on the same timeframe as the one we used for finding and evaluating the level, so all those small moves are actually part of the same return. Price returned for a true second time only after creating the first reaction at "R1" and left sufficient empty space (marked area "E") before the next return. This matters more for manual entries, e.g. when waiting for a better entry than that of a limit order placed outside the level. If a limit order is used in advance, then the entry will happen just before the level is hit for the first time anyway, at least if your level is indeed "fresh". But still, since you will need to decide when to exit your trade (usually manually depending on the market activity), first you will have to know if you have seen the main part of the reaction or not, whether it is a simple bounce, a swing trade, or even a trend reversal.
When a level has remained untouched by price since its creation, we call it a "fresh" level. This has nothing to do with how old or recent the level is and only depends on whether price has returned and hit the level, which means it should now be considered used and invalid
As explained elsewhere, when a level has remained untouched by price since its creation, we call it a "fresh" level. This has nothing to do with how old or recent the level is and only depends on whether price has returned and hit the level, which means it should now be considered used and invalid. If you noticed, an otherwise "valid" level will be considered invalid after it has been used one or more times. It could still work one more time but that is not what we are looking for, the probabilities will not be stacked on our side so there is no reason to trade this level any more.
If for any reason you have missed the first return of price you should assume that most others did not miss the trade. Especially if the reaction to the level has already happened, then that's extra proof that what was going to happen has already happened, and so you should abandon the level and look for another one. In Forex there is no shortage of opportunities so the next opportunity will present itself sooner than you expect, so don't fall into the trap of persuading yourself that you have not missed the proper entry. If you missed it, accept the fact and simply move on to the next opportunity.
Also, it is equally important to know how to properly count the number of times price has returned to a level. You should always use the same timeframe as the one you used for locating and evaluating the level, which should be the one which shows your level most clearly. If you have found your level on the 1H timeframe, then when price returns you will have to check this timeframe for counting the number of times price has returned. Otherwise, if for example you check this same level on the 5Min timeframe you might see that the level was hit a dozen times, which would be inaccurate and irrelevant at the same time. Also, when checking the above on the same timeframe (i.e. 1H in this example), have in mind that any separate (subsequent) return of price should have some noticeable empty space, as seen on your chart between that and the previous return, otherwise it should be considered to be the same return.
Any separate (subsequent) return of price should have some noticeable empty space between that and the previous return, otherwise it should be considered to be the same return
The reason for this is that any moves with very little or no empty space between them will naturally be part of the same move on a larger timeframe, i.e they might be part of the first return of price, especially if you misjudged the natural timeframe for a specific level and you selected a smaller timeframe than you should have done. In this case you would be observing the "minor" movements that make up the larger timeframe move which should be considered the first return. This might cause you to exit too soon or not enter at all (due to thinking that you missed the proper entry) and miss the actual move as a result. But the opposite can also happen, so be careful not to consider different subsequent returns as part of the same one and enter too late (i.e. during a second or third return) when the probabilities are much lower and the level is not valid anymore. So you should start by figuring out the correct timeframe to use for evaluating a level and for counting the number of returns.
Trading only the first return of price to a valid, properly evaluated level can greatly increase your win ratio. This will allow you to get more out of the market per trade, and to keep more of your profits overall than if you had been trading any subsequent return to the same level. Patience is key as always, so don't forget that a new opportunity is probably just around the corner. Choose the trades that have meaning and purpose, where meaning is the stacked probabilities on your side, and purpose is the long term increase of your wealth. Any other trades will just be noise and will delay you on your quest.