We have learnt how to identify high probability setups in the market; this doesn’t mean that all engulfing bar patterns are worth trading.
Price action signals with low risk /reward ratios should be ignored.
Once the criteria for a high probability setup are in place, there is no more analysis to be made, just make sure your trade has a potential of 2:1 risk to reward ratio.
I mean that the amount of money you will win has to be twice the amount of money you will risk or more.
See an example below:
As you can see all the conditions were in place to take a buying order, the market was ranging, as we discussed before, major demand and supply zones are the best price levels in sideways markets.
The formation of an engulfing bar in the demand area is a good trading opportunity, but you have to look at the risk /reward to make sure that the trade respects your money management’s rules.
This trade has 3:1 risk to reward which increases your chances to be winner in the long term, because if you risk 200 dollars in this trade, you are likely to win 600 dollars. It is very important to calculate your
risk to reward ratio before taking any single trade.
Case study
Imagine you take 10 trades with 3:1 risk /reward on each single trade, I mean when you win you get 600 dollars, and when the market goes against you, you lose 200 dollars.
Let’s suppose you lost 7 trades and you won just 3 trades. Let’s do the math to know if you are winner or loser.
Seven losing trades will cost you 1400 dollars, and 3 wining trades will make you 1800 dollars.
As you see you lost seven trades, but you are still making money. This is the magic of money management.
The entry and exit strategy
Don’t try to be smarter than the rest of traders, keep it simple, you know what you are looking for, when you identify an engulfing bar pattern, and you think all conditions are in place to execute your trade. Take an order immediately after the price action signal forms, put your stop loss below the candlestick pattern, and look at simply the chart to find the next support or resistance level, this is going to be your profit target.
See the illustration below:
When you set your protective stop and your target, don’t never look back, let the market tell you if you are wrong or right. This will help you trade successfully out of your emotions.
If the market goes against you, you will not feel good, it’s normal, losing money can be emotionally painful, it is our human nature, nobody wants to lose, especially when it is about money, in the trading environment, you have to think differently, and accept the fact that losing is a part of the game.
Studies have shown that successful traders don’t risk more than 2% of their equity on each single trade.
If you are beginner, don’t risk more than 1%. Don’t risk money you can’t afford on a single trade even if the engulfing bar pattern you identify indicates a high probability signal.
No matter how smart you are, you have to think always in term of probabilities, bear in mind that you can experience series of losing trades, and if you risk too much money, you will not survive longer.