Trend Confirmation with Price Action Benchmarks

In this post, we use the premium Ichimoku indicator to align a trend and momentum bias across multiple time-frames. However, just as with legal or medical advice, it’s always good with a second and maybe even third opinion, before making an important decision. In this post, we’ll look at how the regular open may be used for trend confirmation. To improve probability, we also show how to align setups with institutional value as strong moves generally depend on the participation of big players. Check out the video, or continue reading below to learn more.

Ichimoku Signals

The Ichimoku Kinko Hyo indicator was developed by Goichi Hosoda who published a book about it back in 1969. The indicator applies five (5) time-frames to determine a trend and momentum bias, as explained in our Spotlight Post here.

An alternative display, available with our premium Ichimoku, is simply to access the trend information via paint bars. This improves overall visibility and focus on the price action. Case in point, our Ichimoku indicator only dispatches setups once a thrust bar has been identified. They are required to be:

  • Minimum half the size of the average range
  • Up-close (close > open)
  • Close above the mid-range
  • Close above the high of the prior bar

In the above example, the key signal is marked with a double triangle, whereas the consecutive signals are marked with single triangles. Accordingly, the double triangle marks the beginning of a new trend, whereas single triangles are continuation setups.

Trend Confirmation and the Regular Open

It’s generally a good idea to have a second or third opinion approach to confirm the market trend. A classic directional bias is to look at where the market is trading relative to the regular open. And although many markets now trade “around the clock”, the regular session generally has significantly higher volume than during the overnight session. Therefore, many traders and algorithms use the regular open for trend confirmation.

The chart above displays the regular open for both the EU and US sessions. We’re displaying a 1 min. Opening Range as a lot of activity takes place during the first minute of trading. It will therefore be a more stable reference point than using the first tick of the regular trading session. A short bias is present when prices trade below the regular open and there’s a long scenario when prices are moving above.

The VWAP Value Area

A second price action benchmark which is very useful is the VWAP value area. This is an important benchmark for large institutional traders, as their main challenge is to keep execution costs in check and avoid moving the market when taking positions. Briefly, they can only execute large positions where there’s plenty of supply / demand. The VWAP records the prices of all transactions and then calculates the weighted average price for the current session. Statistically, data-points within one standard deviation of the VWAP will then represent about 2/3 of the dataset. In other words, this is where we expect the majority of the days’ transactions take place. In a normal distribution scenario, 68% of all trades will occur within 1 StDev of the VWAP.

By looking for setups in this area, you may align yourself with scenarios that may be attractive for institutional investors. Once prices move towards the outer standard deviation bands however, institutional traders may take the other side of the trade and exit their positions, halting a directional move. The idea is therefore to look for setups within the VWAP value area, taking directional trades from within, towards the outer standard deviation bands.

Anchored vs. Rolling VWAPs

A challenge with anchored VWAPs, is that they need to put on some weight, in order to get useful information from the standard deviation bands. For example, during the European session the bands are often fairly narrow and even minor price moves will break the 2nd and 3rd standard deviations. Making reliable VWAP value readings, may therefore at times be challenging. Furthermore, VWAP trend readings will be less stable and often jump back and forth. In the below chart, the VWAP trend contradicts the EU open bias, effectively blocking an early Ichimoku short setup.

If we instead apply a 1 day rolling VWAP, taking data from last week‘s session, moving it forwards, a wider and more stable value area becomes available. As can be seen below, this would have allowed us to consider the early bearish setup during the EU session.

As for the Key signals, they’re also important in terms of probability, seeing they’re the first setup in a new trend. Below is an example for the long scenario with a Key signal early on in the US regular session. Prices are trading above the regular open and the VWAP trend / value area is consistent with that bias. Finally, we see how the mid-band between the VWAP and the 1st StDev can work as dynamic support / resistance levels. Generally the idea is to take directional entries only when there’s sufficient room for the trade to develop. Setups that go straight up against a known support / resistance level (headwind), should be avoided.

Summary

We first showed how the premium Ichimoku indicator aligns a multi-timeframe trend bias with short term momentum and thrust bars. Trend confirmation is made by applying two well established price action benchmarks, namely the regular open and the VWAP trend. To improve the probability of the setups, we then align ourselves with institutional value. Specifically, we want setups to occur within the 1st standard deviation bands of a 1 day rolling VWAP.

A follow-up posts on this presentation, showing how to implement the concept with Bloodhound from Shark Indicators, will follow.