Last updated on February 10th, 2020
Naked trading is simply trading virtually “indicator-less” so you can see in real time what is going on with current price without it hiding behind a mess of indicators.
It is better known as price action trading where you may trade candlestick chart patterns or even singular patterns such as a pin bar. There is one particular naked trading pattern I like to use and that is what is called a failure test which looks to take advantage of traders trapped in an adverse position.
Without the use of indicators some may say that naked chart trading is highly discretionary.
While there is some discretion is involved, you can set up a trading strategy that is rules based so you are not trading “patterns in clouds”. You will have actual variables you are looking for that should be contained in your trading plan.
Naked Trading Vs Indicators
If your first instinct is to check out an indicator on your chart for a trading decision, you are already a little late to the party since most indicators are a derivative of price.
This is not to say that indicators are worthless but should not be the main driver of your trading decisions. Trading indicators can add value in certain instances such as finding consolidations during a quick scan.
This chart shows two moving averages and during a scan, either programmed or visual, it can highlight us to a potential trading opportunity.
You could see the same thing with a naked chart but this is a fast and simple way to scan many instruments at once using a technical indicator. As a side note, notice the breakout from the consolidations which made for great trading opportunities.
Naked Chart Trade Example
Markets alternate between trending moves and price compression and there are opportunities to be had in both states of your market of choice.
- When markets are trending, you have the opportunity for continuation moves or trend termination trading plays
- Once the markets find a consolidation area, you now have the opportunity to play a support (resistance) holding or failing play.
Four types of trades and there are literally hundreds of ways you can take advantage of these trading opportunities.
In the chart below, there is a move we see time and time again because it is the nature of the markets.
What occurs here is during the markup phase, that big green candle attracts the eyes of traders who jump into the move. These traders are actually late to the party because more astute players are in the move prior to the break.
You will notice in the accumulation area, immediately prior to the break we have price sitting up against resistance in a two candle range. This is an opportunity for a trade where you think one of two things can happen:
- Resistance will hold and you play a short back into the consolidation
- Resistance will fail and price will rally to the upside.
While some traders will use a rate of change indicator or something else to show momentum, you can drop to lower time frames and see what the actual price on the chart is telling you.
These moves happen on every time frame and whether you day trade, swing trade, or look for position trades, these are viable “trading truths” that you can profit from.
Lower Time Frame Chart Structure
You can drop to lower time frames and see what type of structure is playing out in that time frame.
- Is it more bullish indicating a higher probability of a resistance fail?
- Is price starting to put in upper shadows and lower lows indicating that the bears have control?
We can also look at the current chart and gain a rough idea of how the lower time frame played out in the move just before the break out.
On the left side, we have a trading channel and at the bottom, we have what could be considered a failure test of the lows of the channel.
We would consider that a bullish sign in this context.
On the right side, I have drawn what I think the lower time frame would look like. Price has put in an bullish structure as well as an unconfirmed higher low and a double bottom.
Given the bias is to the long side, it is a worthwhile play to get a trade on prior to the potential break of resistance and mitigate risk with a protective stop. I did write about this type of entry in the the blog post about range trading.
While it is always possible to use multiple time frames in your trading approach, you can infer a lot from even a daily candlestick.
This example is a daily uptrend and we are in a strong momentum market condition. These can be difficult to enter at times because there is no pullback?
Or is there?
Understanding naked chart trading will require you to be able to infer lower time frame price action by the higher time frame candlestick. This is the sign of an accomplished price action trader where they can see the intra-day price movement inside the daily candlesticks.
In this example, price does pullback on lower time frames as indicated by the lower shadow of the candlestick. Of course we don’t know the exact route price took to close above the open but we do know price pulled back.
Placing an order near the market close or a buy stop slightly above the high is a high probability play:
- Market is moving with momentum
- Price did work off some of the strong move with a pullback
- The close of the candlestick indicates lower time frame breakout success
While you won’t buy the bottom if there was an obvious lower time frame reversal bar, your trading plan here was end of day trading to free up your days for other ventures.
Do Charts Show A Trading Exit
After price breaks out, break out traders and those waiting to see bull interest pile into the trade.
Is it overbought?
At this point it does not really matter.
Using just the naked chart, we have a level of resistance sitting above the current run in price.
This does not mean that price will fail to continue but it does mean we should be alert to what price does at this level. This applies to both support and resistance. These are areas you look for price action to show signs of what it is about to do.
Being on alert and having the ability to read the forming structure can give you a profit exit long before everyone else rushes to the exits.
Traders will pop on OS/OB indicators, momentum indicators or some other derivative of price but will fail to watch the price action unfold and what it will leave behind.
Key point: When I say price action, I am referring to the action of price but more importantly the structures it will leave behind.
After the big candle, we start to see some reversal candles setting up in the area of resistance. Notice the long shadows on those two candles with one being longer than the other.
Traders were still buying even though it was a resistance area and long top shadows were being printed on the candles.
Price fails and there is another push up towards resistance but you can see the structure that is printing does not point to bull strength.
After a period of sideways action, we see a final spike (the white box) into the resistance level and the bottom falls out. If those longs didn’t bail, they are in serious trouble.
Failed Expectations Can Show You The Way
There was no reason to hold on when it was obvious that the move was in trouble long before price broke to the downside.
“The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. If you can follow these three rules, you may have a chance.” – Ed Seykota
Once price broke into the top range, what would you expect to happen for an up move to continue?
What did we get?
Price ranged with higher bear interest than bull interest.
Is that conducive to a sustained up move? It isn’t.
That is not to say the second range could not resolve to the upside but we can only work with what we have at the present moment. We do not need a trading indicator to tell us what has and has not occurred at this level…..we can see it.
What does this give you?
It gives you a reason to exit your trade and depending on your trading personality, a chance for a trade in the opposite direction.
We know exactly where we would be wrong on a short so our stop is easy to place. You are selling pretty near the top of the up move and catching the move down from an advantageous place.
Naked Price And Structure
You can tell a lot more about the state of the market by simply looking at price and the structures that it plots by using a naked chart.
The Japanese candlesticks give you an “inside view” of who is doing what at each point in the chart. Understanding how the candles on your time frame plot on the lower time frame can give you insight into who is gaining the upper hand at most times.
Take a look through your charts and see where what you expect to happen, as shown in the above image, doesn’t and how you can capitalize on a higher probability trades and entries to pick up some profits.
Is trading naked the holy grail?
Some marketers will attempt to sell you their secret sauce but in reality, there isn’t one.
It’s also not the only way to trade.
In The End, Use What Works
There is nothing inherently wrong with trading indicators but it’s the use of indicators that is the problem. It’s the failure to understand what the indicator is telling you.
For example, I often use a variation of trading bands to help scan for overextended markets that may be ripe for support/resistance failing type of trades. It is also a precursor to a reversal trade.
I will use a momentum indicator to also make it easier to spot momentum that is decreasing or increasing. A trading setup will depend on the context we find ourselves in.
In the end, it will be the structure of price that you can see on a naked chart that will determine if a trade is going to be place and the indicator information is supporting the decision.