Price action analysis of boom and crash indices

Boom and Crash indices simulate real world market movements however their behaviour is created from the use of randomly generated numbers. In order to trade these indices, a trader must have good knowledge of market psychology, pricing and risk management. These indices are offered by Deriv. If you do not have an account with the broker, I recommend following these steps to create a synthetic indices account.

Table of Contents

1. Introduction to price action
2. Support and resistance
3. Identifying the key support and resistance levels
4. Trading psychology
5. Risk management

Introduction to price action

With this method, we will be looking for opportunities to buy the market at the support zone and enter sell positions at resistance levels. We will also be using trendlines to determine entry points. It is important to patiently wait for confirmation that the market is still respecting that level of support or resistance. When looking for trades near a support or resistance level, consider waiting for price to consolidate at that level until it breaks above the high of the small consolidation (when looking for buy entries) or to wait until price breaks below the low of the small consolidation when looking for sell entries). 

Support and resistance

A price point below the current market price is a level of support and it indicates the area where asset price tends to stop falling. Resistance is the opposite of support. It is the area where asset price tends to stop rising.

There are major and minor support and resistance levels. Major support and resistance levels are levels that have recently caused a trend reversal. For example, when price has been moving in an uptrend then it reverses into a downtrend then the area where it bounced back becomes a resistance level. When price fails to break a major support or resistance level, it will struggle to break through that level, hence you will see it bouncing back at that level until it breaks through it.

Minor support and resistance levels are levels where price tends to bounce back for a short period of time. For example, if price is moving in an uptrend, these are levels where price bounces back to form lower highs but eventually price will break that level without ranging at that level for a long period of time. 

Recommended for further reading:  Trend Analysis

We will be using the one hour timeframe to identify the key levels where price tends to retrace, then we use the five minutes timeframe to identify possible entry points. 

Identifying the key support and resistance levels

In order to be able to identify setups, we need to first identify key levels on a higher timeframe. We will be using horizontal lines to draw key levels on the 1 hour timeframe.  The easiest way to do this is to use the line chart to look for major swings points and draw a line connecting at least two points. The line chart depicts only the changes in the closing price of an asset over time. Alternatively, you can zoom out your candlestick chart and connect at least two swing points. 

To be able to identify setups, we look for continuation and reversal patterns near the support and resistance levels. When reversal patterns appear near a resistance zone it means that the market is changing from bullish to bearish. Similarly, if a reversal pattern appears near a support zone it means that the market is changing to a bullish market. For example, the image below shows the formation of a double top on the 5 minute timeframe near a resistance level and after the setup we can see price moving in a downtrend.

Recommended: Analysis of Trend Continuation and Trend Reversal Chart Patterns

To find proper entries, we need to be able to draw trendlines. A trendline should touch two peaks, and on the third we can look for entry. The market can either bounce back at that level or it can break that trendline into a trend reversal. 

So we can see from the image above that the market first formed a double top near the resistance level and then there was a breakout and the market started selling.

Trading psychology

This refers to the ability to manage the emotions and mental state that may arise when trading. Emotions such as fear or greed often cause traders to act impulsively. Some traders tend to hold onto losing positions for a long period. On the other hand, fear may cause some traders to close a position prematurely and end up losing money in the market. When using price action, it is important to clearly identify and setup the maximum loss that you can afford to lose in a trade. Develop a trading plan and stick to it. Set realistic expectations and keep track of your progress towards the success of your trading plan. The best way to do this is by keeping a trading journal. Remember to use proper risk management and trade reasonable lot sizes.

Risk management

When entering a position, first determine where to set your target profit level and stop loss level. In a bullish market, stop loss is set several ticks below the support level and target profit level should be several ticks below resistance level. Similarly, in a bearish market, stop loss is set several ticks above resistance level and target profit is placed several ticks above support level. Also consider how much you will be risking with that set target profit and stop loss level. Do not risk more than what you can gain from the trade. 

Recommended: Moving average strategies for trading boom and crash indices