Let me now show you how to use Action Reaction to trade the DAX. There was a perfect opportunity of that yesterday (April 29, 2019) which I shared with members in the signal channel. Congratulations to those of you that followed that trading signal and also made some money. It was a nice trade.
But before we look at the specific trade, let’s go back to basics. (The article below covers the specifics of how to identidy the components parts of Action Reaction linesets. The video below combines a bit of daily technical analysis with the explanation of the content in this article)
Action reaction line-sets are a trio of parallel lines, equidistant from each other. The trio of lines consist of the Action line, the Centre line and the Reaction line. I will refer to these Action Reaction line-sets as ACR (Action Centre Reaction) line-sets for the majority of this article. Our job as a trader using this type of trading geometry is gaining the ability to identify each of the individual component part of the ACR line set. Let’s start the Centre Line.
In this first example below I have drawn an example of a basic trend line. The trend line is an upsloping, bullish trend line connecting two points and extending beyond. In fact this example actually sees a third touch, but we can ignore that for now. A centre line typically starts its life as a basic trend line like this. You will likely already be familiar with identifying a trend line.
The situation that we must look for is one where a trend line received multiple touches without being significantly broken. This is because the line needs to be respected as a valid level of support. The more touches the line gets, the better. Once you have a trend line that receives multiple touches, this would be classed as stage one. Stage one is identifying where a trend line can be ‘promoted’ to a centre line.
The next stage in this ACR line-set is the ‘action’ stage. In order to identify ‘action’ I look for price to accelerate away from its trend line. Or more specifically accelerates away from its centre line. So in the example below, price was trading in a confined range, respecting its centre line. But then all of a sudden there was an acceleration out of that range to a new high. This would be classed as action.
In our example above, the action point is the highest point. An aggressive trader using a similar (newly formed) ACR line set may want to short (or fade) from here as they expect for price to turn around. Perhaps it works, perhaps not. From my experience, it’s difficult to predict the turning point on the DAX because it can often catch heavy momentum and you can be left ‘holding the bag’. This kind of counter-trend trading is attempting to ‘call tops’. I try to avoid calling tops where possible. What I prefer to do is to watch the price to turn around and retreat back to the centre line. When price retreats back to the centre line, it takes us into the next stage of this setup. The next step would be the Reaction stage.
When learning more about using action and reaction techniques in financial markets: Roger Babson, George Marechal and Alan Andrews are just a few names to study. With some time spent on Google you could find a lot of interesting articles about the work that these guys have done. But if course if you want to learn more about these here, then check out membership following this link.
What I often find with these line sets is that once price peels away from its action point it will return back to the centreline. Once it reaches the centreline it often either bounces and continues to trend as it was, or it collapses through the centre line. In the case of bouncing and continuing to trend, this means we don’t have an opportunity to trade it. But in the case of collapsing through the centre line, this offers an opportunity to get short.
Once price breaks through the centre line, it has a high probability of reaching the reaction line. The reaction line is opposite and equal to the first action line.
This geometry-based trading ‘setup’ carries a high probability of success assuming the following conditions:
Nothing is ever guaranteed in trading, there are only probabilities. If those conditions listed above are true then the probability of this setup being successful is much higher.
The best way to extract the maximum value from this type of setup is to use correct bankroll management. And use the correct reward to risk ratio. These setups may fail, don’t fall into the trap of expecting a winner all the time, but if you understand the probability of your reward vs risk and you can do no wrong.
The second part of trading using action reaction is to convert this ACR line set into a pitch fork. In order to draw a pitchfork we need three alternating pivots. Our first pivot will be the first point we used for our centreline. Our second pivot will be the high point of ‘action’. Finally the third pivot it will be our ‘reaction’ point. These are our three alternating pits.
They are alternating because the first is a low the second is a high and the third is a low. They all tonight.
Notice how our main fork line is exactly the same as the ACR centre line? Whilst the ACR line set has now evolved into a pitchfork, the lines are very similar. But how do you trade from here?
I am specifically looking for price to respect the lower median line parallel. Think of the lower median line parallel (LMLH) as the reaction line. They are the same. So I am looking for price to respect that line and not break below it. If price continues to respect that line, then there is a high probability it will bounce from here and reach the median line. With that in mind there is an opportunity to take a long. In this example that is exactly what we did. We took a long after price respected and bounced from the LMLH. And this is the set up.
The trade signal that I sent out yesterday was:
This was a trade that I took on CFD and it went on to hit target and added +4% to the account. Congratulations to everybody who also followed that signal. Particular trade was a great example of how to use action reaction to trade the DAX.
Open price: 12299.89
Closed at price: 12346.44