Each time price moves down a level they can be referred to as achieving or making either a Level I, Level II or a Level III move.
Level I and Level II have relatively similar patterns of behaviour (1-2-3 stop hunt). However Level III tends to be choppy with a wide range and represents an area of profit-taking for the institutions and signifies the beginning of an accumulation period for another cycle.
The reasons for this behaviour can be understood if you consider what happens during the rundown:
1. On day one, you (the retail trader) are selling and the institution buys from you.
2. On day two, you are selling and again the institution buys from you.
3. However, on day three the retail trader is again interested in selling and the institution buys up heavily.
4. Now they move price up aggressively triggering stops and taking a profit. (In effect, they are using a scaling-in method to book their profit).
5. Following a Level III pullback price becomes choppy and continues because of what happens with the trader’s psychological adaptation to loss. After the market has run down for three days and traders have taken losses, these individuals react by pulling away from the market quite literally and having a few days off before coming back to trade. During this period the market is choppy and relatively stagnant until the traders have returned to play in the game again.
To remember the patterns use the following:
1. "After a big drop the market must chop"
2. "After three days of drop the market must chop"
3. "After a big rise the market needs more guys"
4. "After three days of rise the market needs more guys"
Also, it is again worth remembering that the patterns are similar in different time frames. Additionally, the areas of reversal in both are often synchronised so that they occur at the same time in different timeframes. Using this knowledge it is possible to convert a spot trade into a swing trade when you enter it from a peak formation high peak formation low. If you are prepared to continue adding to your position as the trade progresses in your direction, it is possible to make very large profits as the whole move might be as much as 300-400 pip with numerous possibilities for supplementary
To be continued...
