Closing prices of bars
This lesson will cover the following
- Why do closing prices matter?
- Some issues regarding trading on smaller time frames
If one looks at a daily price chart, he/she will probably notice that some bars opened close to their low prices, but closed near the middle. Each of those bars probably was a strong bull trend bar with a last price matching their high price at some time during the trading day. In case one goes long assuming that the bar will close on its high price and actually purchases near the high, but instead the candle closes in its middle, the mistake he/she made will be obvious.
Smaller time frames have some issues
There are some common issues, which occur on smaller time frames. One of them is when a trader looks to pick a bottom in a strong trend. He/she will usually see a lower low after a trend line has been breached and will be willing to see a strong reversal bar forming on the chart, especially if the bear trend channel line has been overshot. Let us imagine that the bar begins to appear as a strong bull reversal bar, say by the fourth minute. Prices tend to remain in proximity to the high of that bar for a number of seconds, which lures more traders, willing to go in a countertrend direction and to enter early in order to minimize their risk exposure. That is so, because they will probably place their stop-loss below the low of the bar. However, within a few seconds remaining before the bar closes, the price declines and the bar closes on its low. Now it comes to that all early buyers, who were willing to risk a few pips less, are losing considerably more. They are being trapped into a trade they should not have entered.
Such situations may occur many times during a day, when a trader assumes that a possible signal bar is forming before the bar itself closes. The trader intends to go short below a bear reversal bar, which has a few more seconds left before it closes. The price at the moment is close to the low of the bar. A moment before the bar closes, the price distances a few pips from the low and the bar closes off its low. This suggests that the reversal signal is weakening and the trader should not enter the market based only on expectation and hope.
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Another issue is a situation, when a trader is trapped out of a good trade. Let us imagine a trader that just went long, while his/her position had an open profit of 3-5 pips, but the price did not allow him/her 6 pips. On a larger time frame, moments before the bar closes, the trader determines that this is a strong bear reversal bar. He/she immediately moves his/her stop-loss to 1-2 pips below this bar, but just before the close of the bar itself, the price falls and triggers the stop, after which it rises a few pips in the final three seconds before the close. During the first minute of the next bar the price continues to climb, some cunning traders recorded partial gains, but our trader abstained from action. Bad discipline caused the trader to get trapped out of a good position. In case he/she has stuck to his/her trading plan and left the original stop-loss as it was until the entry bar closed, he/she would have obtained a profit.
There is something else worth noting. Closing prices of bars are relevant, because many institutional traders make their decisions to place an order on value, not on price action. The type of charts they use are line charts, based on closing prices. These traders would not examine charts at all if the charts did not affect their decisions. If they take into consideration the charts, the only element they will be looking is the closing price, thus, the importance of this price becomes greater.
Trading on smaller time frames enables you to place smaller stops, but also creates a greater chance of stopping you out of a good trade. Smaller time frames reduce the risk of trading, but also reduce the probability of success. On a 1-minute chart the number of trades is usually larger (in comparison with a 5-minute chart, for instance), which adds to risk of missing the best trades. This causes a lower overall profitability of 1-minute trades for many participants in the market.
Stop runs on a 1-minute chart are more often than on the 5-minute chart at essential reversals and cunning traders look to take advantage of them. They usually look to trap weak bulls (bulls with limited capacity) out of the market.
All in all, it is better to examine and trade off one price chart, as at times price movement develops too rapidly for a trader to think fast where to position himself/herself, if he/she is looking at two different time frames, trying to detect and harmonize contradiction.