What do you get if you put two traders side by side for four weeks with the exact same training and trading plan? Most likely, you will get dramatically different results. Trading is a highly individualistic profession, and no two traders think exactly alike or possess the same level of natural trading skill, intelligence, talent or intuition. When you’re a student of the markets trying to develop your ability to find top-quality trading signals on the charts, even after years of study, it can still be mentally challenging and stressful.
There is obviously a plethora of variables and influences that affect a trader’s decision making process when analyzing a chart, finding a trading signal and then executing a trade. Today I am going to talk about the main challenge in this process; filtering bad signals from good signals.
It’s probably safe to say that you struggle with your trading decisions sometimes, you struggle to pull the trigger due to a lack of confidence, or you struggle because you aren’t sure if this is a ‘good signal’ or a ‘bad signal’. Knowing what to look for and what the best signals look like is one of the main steps to increasing your chart-reading skills and confidence in your trading ability.
In this lesson, we will discuss a simple trading signal combined with various ‘filters’ that a trader may look for to enter trades. Keep in mind, the signal itself could be substituted with other strategies or signals of your choosing. The purpose of this article is to provide you with a guide to ‘filter’ your trading signals and build your confidence.
Tips for filtering trade signals
The following tips for filtering trades can be applied to any trade signal or entry trigger, but we are mainly using daily chart pin bar strategies in the examples below, as well as one 4 hour chart example. It should be noted before proceeding that these are not “rigid” rules but more like general filters that you should apply with discretion:
1. Look for a signal with a protruding tail that creates a false-break of a level
When we see a reversal / rejection signal like a pin bar with the tail or “rejection part” of the signal clearly protruding from a key level in the market, it’s a typically a very high-probability signal. When a pin bar signal has a tail that protrudes through a level, it also means that it created a false break trading strategy, and a false-break of a level adds a lot more weight to any signal. A false-break of a key level is a very important event, it shows that the market could not sustain itself below or above an important level and that a move in the opposite direction is highly probable. We can see an example of a pin bar signal that protruded through a key support in the NZDUSD, creating a false-break of that level:
In the GBPUSD chart below, we can see two more examples of pin bar signals that had clear and obvious protrusions through a level and that also created false-breaks of the levels. Both of these signals lead to substantial moves lower, in fact, price is still moving lower as of this writing from the long-tailed pin bar that created a false-break through 1.6300 resistance on January 2nd:
2. A long-tailed pin bar is a high-probability pin bar
The tail on a pin bar is very important, it shows rejection of price. It’s safe to say, generally speaking, the longer the tail on a pin bar the more “forceful” the rejection of price. This essentially means that a longer-tailed pin bar is more significant than a shorter-tailed pin, and that longer tail helps to “spring” prices in the opposite direction. It doesn’t mean that ‘every’ long-tailed pin bar works out perfectly, but certainly many of them do and it’s a high-probability setup that should be a staple of any price action trader’s trading plan. Note also that in the GBPUSD example below, the long-tailed pin bars tail was clearly protruding and created a false-break of a key resistance, as we discussed in the previous tip:
In the example below, we can see a long-tailed pin bar that occurred within the context of a downtrend in the EURJPY. When you see a move against a trend and then a long-tailed pin bar forms, it’s a good clue that the retracement is terminating and the trend will resume from the long-tailed pin bar. The key here is movement; when price is moving then the pin bars or other signals are going to be much more effective than they will be in stagnate or consolidating market. Note the 50% retrace entry of the pin bar, this is an entry technique we teach on our courses and it works good on long-tailed pins, giving you a much better risk reward potential due to the tighter stop loss distance.
3. Don’t “bet” on a breakout…wait for confirmation instead
Traders often get sucked into tempting looking breakout trades. Many breakouts result in false-breaks as we saw earlier. While there’s no “sure way” to know whether any given breakout will be a genuine one or a fake-out, it’s high-risk trading right into a key resistance or support; the closer a market is to a key level, the less chance it has of continuing. Don’t bet on a breakout before it happens, instead wait for a close above or below the level, because you can always enter later after the breakout on a retrace. Inside bars cause a lot of false-break scenarios like these, especially when a market is range-bound and not trending or if the inside bar setup is implying a counter-trend breakout like we see below:
4. Long-tailed pin bars work very good as reversals after a sustained move
One aspect of long-tailed pin bars that can be used as a type of filter is that they tend to work very well after a sustained move in one direction; often marking important market turning points or even long-term trend changes. For example, in the USDJPY chart below, we can see that a long-tailed bullish pin bar occurred after a sustained downtrend, then the pin kicked off a large move higher…
5. Look for continuation signals after a pullback to support or resistance in the trend
One of the “bread and butter” trading filters that I apply on a regular basis is to simply look for retracements or “pullbacks” to support or resistance within a trending market. For example, in the chart below we can see both an uptrend and a downtrend in the GBPUSD. Note how in the uptrend the retrace was pretty small…but the trend was clearly up and the pin bar had “confluence” with a key support level in the market…so it was a high-probability setup. In the downtrend portion, the retracement to resistance was a more significant pullback, and we had a key resistance level being rejected within the broader downtrend…this ended up being a very lucrative signal as well.
6. Don’t trade signals in tight “chop”
Trading signals that form in the middle of thick consolidation, also known as “chop”, is usually a bad idea. For example, if you see consecutive bars of consolidation for a period of time, and then a pin bar signal forms inside that chop…the signal become less valid. ALWAYS wait for momentum and a confirmed break of the choppy congestion area to validate your signal…a “confirmed” break would be a close outside of the chop. Below, we see an example of some recent pin bars that failed on the AUDUSD, note how there was no protrusion from the surrounding price action and that they formed in the middle of “chop”:
7. Look for “confluence”
A “confluent level” is simply a level that has at least two supporting factors behind it. Those factors might be an obvious support or resistance level with a dynamic EMA level, or a 50% retrace and a key support and resistance level; the more the merrier. Simply put…confluence adds weight to ANY trade signal. Looking for a signal that forms at a confluent point in the market is one of the best filters for separating a ‘good’ signal from a ‘bad’ signal. Note: whilst sometimes you can trade a daily chart signal that didn’t occur at an obviously confluent level, you want to avoid trading 4 hour signals or 1 hour signals that don’t have any confluence with other supporting factors (see point 8 for an example of this)
8. Avoid signals that form in “no man’s land”
One of the best “filters” is actually the lack of any supporting factors or confluence. If you see a trade setup that is essentially just “floating” in “no man’s land” without anything to give “weight” to it, it’s probably a good setup to pass on. This is even more accurate for intra-day signals. A 4 hour or 1 hour signal without any type of confluence behind it is usually not a high-probability setup worth trading. See the example below:
You shouldn’t have to “think” too hard about whether or not a setup is valid
The point of using filters like the ones we discussed above is that you should never “guess” about a trade setup or try to convince yourself a setup is valid. The best signals will “jump” out at you and are so obvious that you don’t even enter into that mindset of guessing and trying to convince yourself a signal is worth taking. Remember, the market will always be there, so leave any sense of urgency at the door…if you’re not “sure” that your signal is there waiting for you to trade it, then walk away, there will be another signal tomorrow or the next day.
Don’t get caught up in fretting over what “could have been”
If you pass on a trade and it goes on to work out in your favor, learn from it, and increase your knowledge form it, but don’t beat yourself up or fall into the trap of believing your missing all these ‘great signals’… remember even some of the worst signals can end up working out, and if you start teaching yourself with ‘hindsight’ and telling yourself “oh i should have traded that and next time I will”… you’re really going to confuse the hell out of your subconscious and it will end up destroying your trading career. So whilst you should learn from each potential missed trade, you should not become emotional or “worried” that you are “losing money” because you’re passing up some good setups.
Learning to pass on trades is part of being a trader, and as you get your own filters down like the ones we discussed above, you will start to develop a more refined sense of which signals are worth trading and which aren’t, over time you’ll get better at this. The most important thing is to remain sickeningly patient on the sidelines…let a lot of trades pass and don’t get attached to hindsight trade setups that
“might” have worked out for you.
The “big boys” know how to filter their trades
If you’ve fallen prey to thinking that the “big boys” are trading a hundred times a day and day trading until their eyes bleed, you’re mistaken. Many of the guys with big money wait on the sidelines patiently and “pounce” only when the best signals, levels and trends are present on their charts. You need to learn to think like the big boys, act “as if” you’re a “player”; be intelligent and stop using the market for entertainment and start treating this as a real business.
The best and most logical explanation for why you should trade less is because there are inherently less good signals for any strategy or system; think about it…the reason a signal is high-probability is because it doesn’t happen extremely often, if it did then it wouldn’t be a high-probability event would it? If you force yourself to trade all the time you’re going to be taking a large quantity of useless and second-rate signals, this is simply a waste of your time and money.
Creating a filter checklist for you trades
A good exercise for any trader is to create their own checklist of different filters that they use to scan the markets for potential signals. You can just create a quick checklist with one to three sentences describing what the filter is and then an example image of the filter under it.
Here’s an example filter checklist that I’ve created from the examples above (in yours you would place an example image below or next to each sentence like the ones above but maybe a little smaller):
1. Look for a signal with a protruding tail that creates a false-break of a level. Watch for obvious protrusions and false-breaks of key levels in the market. This filter can be applied to trending markets or to counter-trend trades. Wherever you have a key support or resistance level, keep an eye out for false-breaks / protrusions of that level.
2. A long-tailed pin bar is a high-probability pin bar. Long-tailed pin bars work very well in trending markets and as counter-trend signals, as we saw in the examples above. A long-tailed pin bar is always something to keep an eye out for when analyzing the markets.
3. Don’t “bet” on a breakout…wait for confirmation instead. A good filter to use for tempting looking breakout trades is to wait for the breakout and close above or below the level. Then, the breakout is “confirmed” and you can start looking for a signal in the direction of the break. This will help you avoid many false-breaks, especially in range-bound markets.
4. Look for continuation signals after a pullback to support or resistance in the trend. Trend continuation signals are a ‘bread and butter’ strategy that you need to watch for.Watch for trends and then retracements within those trends, then keep an eye out for signals forming from “value” areas that indicate the trend might resume.
5. Don’t trade signals in tight “chop”. Be cautious trading pin bars or other signals that form in thick and choppy consolidation. If you see two or three pin bars in a row as in our example above and the market is not coming off in the direction implied by the pins, it’s an indication that it’s probably not going to come off. We need to see momentum and a clear breakout from consolidation before entering from a signal formed in “chop”.
6. Look for “confluence”. Watch for obvious “hot points” in the market, or areas where two or three or more levels are intersecting…these are very high-probability levels to trade from.
7. Avoid signals that form in “no man’s land”. This one is sort of the opposite of the confluence point. If you see a signal that just looks like it formed without any type of confluence and looks like it’s just placed wrong, you should probably avoid it. This filter is especially important to use on the 4 hour and 1 hour charts.
Whilst having things like checklists and an overall trading plan are very important, they are only one part of finding the best trading signals. The man or woman doing the analysis and pulling the trigger is JUST as important as the strategy or trading plan they are using.
As traders, we need to develop our subconscious “gut” trading feel on an ongoing basis, learning from the charts and keeping notes and simply immersing ourselves in day-to-day market analysis and observation (note I didn’t say immerse ourselves in ‘trading’). This helps us develop a good intuition and gut feel which go hand in hand with a good trading strategy.
After twelve years in the markets and five years of teaching traders, it’s obvious to me that the number one problem for most traders is knowing how to filter a good trade from a bad trade. So many traders miss great trades and so many traders tend to get stung by trading everything that they “think” might be a signal. This is like a madman with a gun walking around shooting anything that moves. Trading and money is a weapon, and just like a gun, you do need to be careful with it. You need to be patient and filter your trades…then “pick your targets” and execute the trade with absolute precision and confidence.
If you are interested in developing your ability to filter good trade signals from bad trade signals and increase your overall confidence level in pulling the trigger on quality trades…you should check out my trader’s education courses and daily trade setups newsletter where I expand on these concepts in greater detail.