The 80% rule is a powerful concept in day trading that revolves around value area—an area where the majority (typically 70%) of the previous day’s trading activity occurred.
This rule provides a strategy for predicting and capitalizing on potential market movements based on the initial behavior of the price relative to the value area. It’s a favored technique among day traders for its simplicity and effectiveness in identifying high-probability trading opportunities.
Understanding the 80% Rule
Here’s a breakdown of how the 80% rule works in the context of value area trading:
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Identification of the Value Area: The first step involves identifying the value area from the previous trading session. This is the range where 70% of the previous day’s trades were executed, indicating a zone of significant trading activity and interest.
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Initial Market Movement: The rule comes into play when, in the current session, the price initially moves outside of the previous session’s value area but then re-enters it. This re-entry is a critical trigger that suggests the market may lack the momentum to sustain its movement outside the value area, hinting at a potential reversal or significant move within it.
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The 80% Probability: Once the price re-enters the value area, the 80% rule posits that there is approximately an 80% chance that the price will continue to move through the value area and reach the opposite side. This is based on historical observations that show a strong tendency for the market to explore the full extent of the value area once it re-enters after initially breaking out.
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Application in Trading: Traders use this rule to set up trades that capitalize on this predicted movement. For example, if the price moves back into the value area from above, a trader might take a short position, anticipating the price to traverse the value area towards the lower end. Conversely, if the price enters from below, the trader might go long, expecting the price to move towards the higher end of the value area.
How to Use the 80% Rule for Day Trading
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Entry Point: The entry point for a trade based on the 80% rule is triggered when the price re-enters the value area after initially moving outside of it. This is seen as a signal that the price is likely to traverse the value area.
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Stop Loss: To manage risk, a stop loss is often placed just outside the value area from which the price re-entered. This limits potential losses if the price reverses direction again and moves out of the value area, invalidating the 80% rule prediction.
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Profit Targets: The primary profit target is typically set near the opposite end of the value area, capitalizing on the expected movement across it. Traders might also look for secondary signals or use partial profit taking as the price moves in their favor.
Importance of Context
While the 80% rule offers a high probability setup, it’s crucial for traders to consider the broader market context before executing trades. Factors such as market sentiment, news events, and overall market trends can influence the effectiveness of the rule. Successful application often involves combining this rule with other technical analysis tools and indicators to confirm signals and manage risk effectively.
Conclusion
The 80% rule in value area trading is a testament to the importance of understanding market psychology and price action. By leveraging the predictable behaviors of traders within the value area, day traders can find high-probability trading opportunities that align with market dynamics. Like all trading strategies, success with the 80% rule requires practice, discipline, and a well-rounded approach to risk management.
Risk Disclosure:
Futures and Forex trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing one’s financial security or lifestyle. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results.
Hypothetical Performance Disclosure:
Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points, which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program, which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect trading results.
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