LESSON 6

ACCURATELY PREDICTING MARKET DIRECTION

LEARN TO TRADE

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This Learn to Trade mini-series is provided by The Duomo Initiative to

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Learn to Trade

Lesson 6 : Accurately Predicting Market Direction

Introduction

Welcome back traders. This is lesson 6 in our mini-series on learning to trade The

Duomo Method.

We are getting close now to having the basis of a fully working system for your

trading. We know how to manage ourselves and work like a professional. We know

about how to manage our risk and assess the trade potential. Now it is time to learn

how to assess the trade direction, as we start to introduce some tools for predicting

the next market movements.

In this lesson we will be answering the following questions:

1. How can we predict the market direction?

2. What are the most prolific tools to use?

3. How can we increase our success rate?

4. How do we include this in our system?

Sound good to you? Ok, then lets go.

In the past few videos we have spoken a lot about significant levels. Just to recap,

these are levels where the price has an increased level of activity and we

mentioned in the last lesson that these can be created through support and

resistance, trend lines, Fibonacci lines and a few other different tools.

So far we have used these significant levels to predict where the market is going to

be moving towards. In other words, how much we can expect from a trade - our

TMP. But now, we want to look at the other side of the setup, which means we will

use these levels to actually find the opening setups for the trades.

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When the market is constantly moving, how can we predict when it is the right time

to enter a trade? Is it just a guess? Are we just blindly having a stab in the dark? Is

there anything we can do to get a higher certainty? Of course there is.

The first thing to note is that it is not essential to get absolutely perfect entries.

Some of the greatest traders have had a very poor success rate on their trades. For

example, Mark Douglas who wrote the book Trading in the Zone often talks about

Richard Dennis, who used to lose 95% of his trades. However, the 5% of winning

trades were such killers that he reportedly made $200 million profit in about 10

years.

The reason we tell you this now is because a lot of new traders put all their focus on

the entries and if the trade does not go their way instantly, they start to panic. We

do not want you feeling like you are doing something wrong constantly, if the trade

goes against you the second you click to open it. We should have a lot more focus

on risk management and trade management so we can make sure we cut our

losses before they get too big and let our winning trades run.

But with that being said, we can definitely give ourselves a helping hand. We will

not be teaching you every tool out there, but we are going to show you the quickest

ones to grasp, which are extremely prolific. Once we get onto the advanced tools in

our intermediate and advanced lessons, we will be able to show you a more

complex method that will get you entries so precise that the market will not even

move a single point against you. That is by using combinations of things like

Fibonacci tools, and swing high and lows.

But for this lesson, we are going to focus on just two tools which are an absolute

must for any trader: reversal zones and trend lines.

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Reversal Zones

So let us start off with the easiest one - reversal zones. This is something you can

grasp in a matter of minutes, but do not let the simplicity of it fool you. It is actually

extremely powerful and, in fact, we know traders that only rely on these to make

their regular income. Like we always say, trading does not need to be difficult, you

just need to know what you are doing and when to do it.

In order to explain reversal zones, we will first quickly touch on support and

resistance lines to help make it all easy to understand. Support and resistance lines

are a tool that are taught to most traders early on in their career and will usually

become a staple tool for any trader.

Although we do rate this higher than many of the other useless tools that are

available, it is still not quite the finished product and should not be the trading tool

cult icon that it has become!

A support and resistance line is a horizontal price level on the chart that will put up

a bit of a fight when the price tries to move through it.

Chart 1 : Resistance Line

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Chart 2 : Support Line

Support lines are levels underneath the price, in other words, a level that supports

the price, like the foundations of a building; and a resistance line is above the price,

therefore resisting against the price moving higher.

But here is the issue: markets are not static, they are dynamic and always moving.

So we cannot just base market activity on one parameter, like we would be there,

with the one parameter being price. It is not a good idea to base trades on one

particular price level, we need to have something that moves and adapts with the

markets.

This is how the tools we teach you at The Duomo Initiative are so different to what

everyone else focuses on and also why they are so successful - and we say that

very seriously. We focus on tools that look at the market as a dynamic, live animal.

Not a bunch of static levels that have some sort of unexplainable, magical force

field.

This is where reversal zones come into the picture.

As a by-product of both the psychological effect around significant price points; like

round numbers or new highs and lows, and the herd behaviour of placing limit

orders and stop losses around particular levels, there are ranges of prices where

activity in the market is anticipated more than at other areas.

When there is a particular level which the market has struggled to break, it is then

given more importance in the future; whether it was broken or reversed the price.

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That makes this particular area on the chart become an activity zone; volume will

also usually pick up in this area of the chart.

This then means that this zone has become a hotbed for stop losses, profit taking,

market order placing and trade openings. Also, we have to bear in mind that a large

percentage of the market will flip trades; meaning a long trade beyond a certain

point will be flipped to become a short trade and vice versa. This then means a

number of actions are being taken in the activity range:

Traders expecting a breakout that did not happen will cover their trades or take

the opposite direction.

Traders may close a trade for profit or loss, realising the trade may have reached

its last leg as it enters the activity zone.

Traders expecting a reversal and actually seeing a breakout may need to cover

their trade.

Traders who expected a reversal at this level and placed their stop losses just

outside the zone to cover themselves may have their stops filled.

Traders who expect a breakout or reversal in this area may have orders in the

market ready to execute a trade when one or the other activity occurs.

So although these are only some of the reasons for the increase in activity, these

points cover a large number of traders and it is because of the importance of the

price point that these actions come together as a herd here, rather than at other

points on the chart.

These areas on a chart can usually be identified by finding points where the price

consistently reverses, or consolidates, like we mentioned before. It may also be an

area which the market struggled to break, but once it did, the price enjoyed a break

out where it picked up volatility in one direction. The reason this is a zone rather

than a single level is obvious when you analyse a chart.

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The zone should be viewed as a sort of cloud that creates turbulence for the price,

creating more cause for a reversal. Since the movement of the price in the market

will usually move via the route of least obstruction, in other words: The path of least

resistance.

Chart 3 : Reversal Zone

As you can see from the above chart, the zone starts and ends at the highest and

lowest price points; the points where the price reverses. The colour scheme

represents a heat map to show where the greater reversal strength happened,

which we estimate by looking at how far the price reversed afterwards and how

quickly.

Simple?

Of course it is. But it is going to take some practise for you to get proficient enough

at it that you can map these up quickly on your charts and trust yourself trading

them.

But that is why we want you to complete the following activity.

Activity #1

Before your trading session every day, we want you to map your reversal zones on-

to the current chart.

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You can choose the timeframes that you want to trade, but you will need to then

draw onto your chart any reversal zones you see, not just the ones closest to the

price, but also any others that may be hit during that session. If you do this every

day, not only will you be good at spotting them, but you can also then observe what

the activity is like in those areas during the trading session. This will help you to see

the importance of them and also what you can adjust to make them even better and

more precise in the future.

Remember, they can move as the market moves, do not think that they have to

remain in one place the whole time - if the reversal zone expands during the

session, that is absolutely fine.

Got it? Great. Let us move onto trend lines.

Trend Lines

Now you may already be feeling like you have had a lot to take in with the reversal

zones, so you may want to break this lesson down into two sections and deal with

this next part once you become more proficient with reversal zones. But before you

do that, we suggest you just read the end of this lesson anyway as you are going to

pick up some great tricks for increasing your success rate on your trades, with any

trading tool and any strategy.

So trend lines, what are they?

A trend line is a diagonal line drawn between two or more price points on a chart,

using either the wick or the candle body or a combination of both - but always using

a point of reference; in other words, we would not use the middle of a candle body

or the middle of the wick of a candle as a price point for the trend line - we would

only use the ends of the wick or the ends of the candle body.

The line will then act as a significant level on the chart and provide reversal

opportunities based on failure at the line. The following chart gives a very easy and

obvious example. We are sure you have seen these before, even if you were

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not sure what it was.

Chart 4 : Baseline Trend Lines

The more touching points a trend line has, with wicks and bodies of candles, the

more you can trust it and the stronger it is - the less the market will want to break it.

Also, this helps you to draw the line, because the precise angle of the trend line is

important and obviously the more points you have to help you draw the line, the

more accurate it will be.

A trend line is dynamic since it takes into account both time and price and interacts

with price as it moves with a trend direction.

Most traders, and trading books which teach you the wrong methods, will use trend

lines in a standard tramline setup, where the lines run parallel to each other. One

at the top of a trend and one along the bottom. In actual fact these are just the

baseline trend lines - in other words, they are the strongest lines of the group

when drawn correctly (which unfortunately does not seem to happen often for

people who have not learned The Duomo Method).

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The rest of the chart, like the following example, is made up of micro trend lines of

different strengths which the price continues to respect across all timeframes,

including 1 minute or even tick data; which shows every single movement the price

makes.

Chart 5 : Micro Trend Lines

So what does this mean? Well this means that the movement of the price to a

certain extent can, at all times, be predicted based on the trend lines around it.

Remember, earlier in the course we learnt that significant levels attract and repel

the price, particularly at the open or close of the relevant timeframe candle. This

means for example, that if there is a 5 minute candle due to close and it is near a 5

minute trend line, it will try its very best to close with an interaction on the line itself.

And a candle opening near a trend line will be repelled from the line, in other words,

it will reverse.

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In the next lesson we will get into the finer details of this, as we start to break down

the subject of micro-strategies. When a trend line is no longer respected through

attracting or repelling, it can be removed from the chart. If it has not been proven

wrong, then a trend line can remain forever as there really is not any particular shelf

life for them. This means there can be many trend lines on the chart, creating a sort

of spider web. But we would only start off with the major ones first, otherwise it will

become too distracting and confusing.

By practicing drawing the trend lines, you will start to see that every movement on

the chart has meaning. When the price touches certain levels, it is not just a

random movement - usually it is reacting to a nearby significant level. So this leads

us onto your second activity for this lesson.

Activity #2

Yes, you guessed it. We want you to practise drawing trend lines. However, we

want to be very specific with this. We want you to only focus on drawing the

baseline trend lines for now. The baseline trend lines are the biggest trend lines you

can see on the chart, it is the overall trend up or down. We want you to observe

how the price reacts to the line.

When we are trading we always want confirmation that what we are doing is

correct. With technical analysis tools like trend lines and reversal zones, this means

you want confirmation that the tool has been drawn correctly and has relevance.

Therefore, if you want a lower risk trade, you do not want to trade the first test of a

level you are keeping your eye on. You will want to see it tested once and fail, which

will give the level its relevance and then trade a second test. Of course, as always

there are more intricacies you can use to make sure you have the correct trades

and the right approach. This is where our next lesson will come into play.

So far, we have built our weapon for the markets. In fact it is more than just a

weapon, it is a great big cannon, full of potential. Now we want to focus on putting

together a crosshair so we can make sure anything we fire is going to be accurate

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and precise. We will do this by creating a micro-strategy that makes sure everything

you do in the market is done with precision.

Until then, keep working on your reversal zones and trend lines. Watch the video a

few times to make sure you are clear on the subject and also take some time to

read our exclusive e-book The Duomo Method that you received exclusive access

to by signing up to the Inner Circle mailing list.

That should keep you busy for quite a while, so until next time remember - your

story starts here. Stay dedicated, this is just the beginning.