Sitting in a coffee shop somewhere in Montreal, I was discussing with a trader. We came to a point where we discussed types of trades.
In the end, it's really simple. Whatever indicator you are looking for, whatever the time frame, there are only 3 types of trades.
Now stay with me a second…
A lot of people think they've mastered trading but do not understand the differences between the trades they take. However, when you know the type of trade you just took, it will be easier for you to know what to expect from it. You will almost automatically know where to place your stop loss and your take profit.
So let's dive in!
The 3 Types Of Trades
As soon as a professional trader enters a trade, he knows exactly what he's trading. It is one of those:
- Breakout trade
- Pullback trade
- Reversal trade
Some traders specialize in one of those trades. Others are tempted to trade all of them for a limited number of currency pairs. However, when a professional trader enters a trade, he knows what he's trading (hope you get it by now).
Each of those trades has some characteristics which are described below. Depending on the market you're trading, the effectiveness of each type of trades may vary. In Forex trading, the 3 types of trades work quite well.
The Breakout Trade
A lot of traders are looking to trade breakouts. Those trades are usually characterized by a strong continuous movement in a direction. Some traders call it an acceleration because the movement is fast.
Here's an example of breakout trade:
On the chart, a major resistance zone is identified by the green line.
Simply put, the bulls were confident and kept pushing the price higher and higher to point 1. At that price, the sellers became more aggressive and took control of the market until the buyers showed even more strength. The level noted with a 2 shows a price at which bears are known to get more aggressive in the market. However, they weren't very aggressive when the price arrived at that level.
As a result of not seeing traders wanting to sell the currency pair aggressively, more and more traders went long, thus pushing the price higher and breaking through the resistance level.
This is a typical example of Breakout trade.
The stop loss on that trade would usually go slightly below the resistance zone that was broken and the take profit somewhere above the zone (depending on your desired reward). It is acceptable to expect a risk-to-reward of 1:2.
Read: My Favorite Forex Day Trading Strategy (it's taking place at night!)
The Pullback Trade
In my experience, Pullback trades are usually more reliable because the retracement back to a previous price level represents a certain confirmation.
As I said, a pullback trade is characterized by a retracement, usually to the previous support or resistance zone.
Here's an example of pullback trade:
On the chart above, the price kept ranging between a support and resistance zone. At point 2, no one was aggressive enough to move the price significantly higher or lower.
Once the price broke above the resistance zone at point 3, several traders began to feel excited about their profit thus far. Most of them felt like this high price might be a good opportunity to take profit. As more and more people took profit on long trades, the price slowly decreased.
However, once the price got back to the previous resistance zone, some traders started to think that this price was too low. Those traders then bought the currency pair once again (at point 4) to push the price up.
The stop loss on that trade would usually go slightly below the resistance zone that was broken and the take profit somewhere above the zone (depending on your desired reward). It is acceptable to expect a risk-to-reward of 1:2.
Read: How To Trade Pullbacks With Confluence (Forex Trading Strategy)
The Reversal Trade
A lot of traders feel like executing Reversal trades consist of “calling a top” or “calling a bottom”. This isn't necessarily the case. In fact, the entry price of a reversal trade is often in a previous zone of support or resistance. From all the types of trades, I like the reversals since they usually are easy to spot. They take place in a ranging market.
Here's an example of reversal trade:
The buyers were very aggressive on the chart above. They pushed the price up all the way to point 1 from an original support zone.
However, once the price hit a resistance zone (marked by a 1), those buyers started to take profit. As that happened, several traders began to short the currency pair and got more aggressive. They took control of the market. This had for result to create a strong rapid decrease in price.
At point 2, the same result occurred, which was a good opportunity to enter a Reversal trade. The sellers placed their orders at that level and the buyers began to take profit since they knew the price had reversed in the past at the same level.
The stop loss would usually be placed above the highest point (A) and the take profit somewhere below the resistance zone (depending on your desired reward). It is acceptable to expect a risk-to-reward of 1:2.
Read: Forex Trading Strategies To Trade Round Numbers
Action steps – How To Use The Types Of Trades
As I said in the beginning, when a professional trader enters a trade, he knows what he's trading. Do you know what you're trading?
Look at your previous trades and identify the types of trades you were entering. Then ask yourself the following question:
“Did I take that trade well?”
I can tell that if you do that, you'll have made progress.
