I have a 3-step formula that I’ve backtested thousands of times, and every single month that I tested it, it was profitable in the long term. No indicators, no patterns, just pure price action, baby. By the end of this article, you too will know this strategy and will be able to take calculated trades just like this one and make insane amounts of money.
Step 1: Understanding Market Structure
To jump right into it, the first step involves market structure. This is arguably one of the most important steps because if you even slightly mess this part up, it will ruin the whole strategy. One of the very first things you learn as a trader is uptrends and downtrends. It’s almost the sippy cup of trading. A chart that makes higher highs and higher lows is an uptrend. A chart that makes lower lows and lower highs is a downtrend. Simple enough. Everybody knows this.
Now you may be thinking, why are we even going over this? I already know all of this. Well, what if I told you you’re probably doing all of this completely wrong? Let me explain.
So going back to our example, the chart does this, making higher highs and higher lows. And as we already stated, it’s an uptrend. Okay, but then something interesting happens. The chart starts heading downwards, and in the process, the price makes this low and breaks right through it. This exact point is where I see the majority of traders make the mistake. Since the price broke this low, a lot of traders think we are now in a reversal and the price is in a downtrend. So they start looking for short trades because they now think the price is going to head lower.
But what if I told you this chart is still fundamentally bullish? You see, sure price made this low, but this low is not a low at all, or at least a valid one. Why? Because the price never broke the valid low which is right here. The only way you can get a valid low is by breaking the previous high. If the price did something like this, where the price didn’t break the previous high, this would not be a valid low.
I want to make this clear: for a low to be validated, it needs to break the previous high. If you do not understand this part of the strategy, the strategy will not work. So say if the price does break this high, we now know this is the valid low. Okay, good. So now the price is in an uptrend, which means we should only look for bullish trades. The only time we should start looking for short trades is if the price breaks this low.
It can do anything right here. It can go up, down, sideways—anything as long as it doesn’t break this low. We are in an uptrend. So if Price did this, what are we in? Well, a lot of people would say downtrend because we broke this low right here. But as I said before, a low is only validated if it breaks the previous high, which this low did not break the previous high. So it’s not validated.
So we are still looking at our previous low, which price hasn’t broken, so we are still in an uptrend. Now say if instead of doing this, the price did end up breaking upwards. Since the price did break our previous high, our new low will be transferred from this point to this one. I know it can be slightly confusing, but the main thing you have to remember is the only way a low is validated is if it breaks the previous high. If you remember that one simple rule, you will easily be able to identify if we are in a bullish trend or a bearish one.
So that’s the first step: identifying if we are in an uptrend or a downtrend.
Step 2: Identifying Supply and Demand
So what’s next? That would be step 2 in the formula. Step 2 is identifying supply and demand in the markets. Demand zones take place in uptrends, while supply zones take place in downtrends. A good style of thinking is you want to buy from demand zones and sell from supply zones.
The reason why you want to buy from demand zones is this: if we look closely, the market is going up. Since we saw a large push from the beginning of this move, it simply shows us that a lot of people wanted to buy from this point onwards. So we can assume if the price comes back down to this area, traders will have the same style of thinking and want to buy in this same area again.
A supply zone is the exact opposite. Since we saw a large downward move from this point on, it shows us that a lot of people want to sell in this area. So if the price ever retests this zone, we can assume the price will again move downwards from this point. This supply and demand theory is the core of our strategy. But we still have one more step in our 3-step formula.
Let’s put all that we learned so far to the test on a real-life chart example. Looking at a real chart, we see price moved upwards, came down and then broke this previous high. This means we have higher highs and higher lows, indicating we are in an uptrend. Since we are in an uptrend, we only look for long trades. We do not look for any sell positions, as shorting in an uptrend is just silly.
Since this low broke the previous high, this is our valid low, and the price will only be in a downtrend if it breaks this point. Now that we know we are in an uptrend, we want to look for demand zone opportunities. We can find our demand zones by identifying an area of consolidation or a point where the price moved sideways before having a sharp move upwards.
As you can see from this chart, we had some consolidation right here before the price shot straight upwards. How I like to mark my demand zones is by marking the candle right before the impulse move. So grab your rectangle tool on the side, find the area of consolidation before the big move, and then mark from the low to the high of the previous candle before the big move. This is our area of demand.
Again, we are not even considering areas of supply because we are in an uptrend, so we don’t need to worry about that. We wait for the price to re-enter this zone, and this is where we would enter. Set your stop loss right below the demand zone and set your take profit at the recent highs. Boom! We got an easy trade.
That’s an example of one winning trade. But I want to show you just how accurate this strategy is. Let’s break it down with another real chart example. Here we get an uptrend because the price is making higher highs and higher lows. As we can see, this low is what broke the previous high. So, this is where the price needs to break to be in a downtrend, which is exactly what happens.
Now we are in a downtrend, and we only look for areas of supply or short trades. We mark our areas of supply. Price comes back up to this area of supply, and we enter. Set our stop loss above the area of supply and set our take profit at the recent lows. Boom! Easy winning trade.
But wait! We’re not done. Price created another area of supply up here, and we’re still in a downtrend. So we wait for the price to come up to this supply zone, enter, set our stop loss above the area of supply, and target recent lows. Another winning trade.
But again, we’re still not done. Price created another area of supply. Wait for the price to come up to it, set your stop loss above the area of supply, and set take profit at recent lows. And again, we got another winning trade. But wait, there’s more! We have ANOTHER area of supply. Wait for the price to come up here again, set your stop loss, and take profit. And we got another winning trade.
That’s the power of this strategy. It’s extremely accurate, and you are only trading in the direction of the trend, which raises the probability of you winning a trade significantly.
Step 3: Risk to Reward Ratio
Now that you know just how powerful this strategy is, let’s go to the third and final step on how to improve this strategy even more. Our last step involves risk to reward. Sometimes while using this strategy, you’ll get a trade that checks all of the boxes, but when you set up your stop loss and take profit, it has a low risk to reward, like in this example.
We only want to take trades if the risk to reward is above 2.5:1. This means for every $250 we’re getting back, we’re only risking $100. So even if the chart follows both steps 1 and 2, but the risk to reward is under 2.5, we do not take this trade. This one rule increases the profit rate of the strategy by a ton.
For our final example, we have price-making higher highs and higher lows, meaning we are in an uptrend, so we only mark our areas of demand. Price consolidated right here before shooting upwards, so we mark this area. We wait for it to come to this area again, enter, set our stop loss below the demand zone, and set our take profit at the recent high.
The last step is to check our risk to reward and ensure it’s over 2.5. In this example, it’s 3, so we’re good to go there. If it’s anything under 2.5, we do not take the trade. Wait for the price to play out, and we get a beautiful winning trade. Then we repeat the process forever.
This three-step formula is designed to simplify your trading approach and enhance your profitability. By focusing on market structure, identifying supply and demand zones, and ensuring a favorable risk-to-reward ratio, you can make informed trading decisions that align with the market’s natural movements. Remember, consistency is key, and with practice, you can master this strategy and achieve your trading goals.
