Time & Price Algorithmic Trading: Invalidation Levels

Summary

This lecture explains how to set effective invalidation levels within the 2025 trading protocol by distinguishing between high-probability Type 1 and lower-probability Type 2 stop-loss placements. The instructor walks through how smart-money concepts, such as accumulation/distribution stages, SMT, CSD, and displacement above arrays, define where stops should be positioned. Through multiple chart-based examples, the video demonstrates how to anchor stops to previous or current stages of accumulation or distribution, how to manage trades as new arrays form, and why Type 1 invalidations should generally be prioritized for higher win rates, using Type 2 only when necessary due to oversized stop distances.

Takeaways

• 😀 Understanding invalidation levels is crucial for determining stop loss placements when entering trades.
• 😀 Type 1 invalidation involves placing the stop loss below the previous stage of accumulation or distribution, providing a higher probability of success.
• 😀 Type 2 invalidation places the stop loss below the current stage of accumulation or distribution, offering a lower probability and higher risk/reward.
• 😀 A Type 1 invalidation is confirmed by a swing low or high with SMT (Smart Money Tools) at the previous stage of accumulation or distribution.
• 😀 To execute a Type 1 invalidation, identify the entry point by displacing above an array that formed on the left side of the curve, then place the stop loss below the previous accumulation phase.
• 😀 Type 2 invalidation should be used as a last resort when the stop loss for a Type 1 invalidation is too large, but it comes with increased risk due to lower probability.
• 😀 In a bullish scenario, the stop loss for a Type 1 invalidation is placed below the lowest buy (smart money reversal) at the start of the first stage of accumulation.
• 😀 The key difference between Type 1 and Type 2 invalidations is that Type 1 is based on previous phases of accumulation/distribution, while Type 2 relies on the current phase, resulting in wider stop losses and higher risk.
• 😀 Always prioritize Type 1 invalidation for higher win rates and use Type 2 only when necessary, knowing that Type 2 can lead to more frequent stop-outs.
• 😀 Risk management is vital when trading with Type 2 invalidations, as they have lower probabilities and are more vulnerable to market consolidations and high resistance liquidity environments.

Q & A

What is the purpose of defining invalidation levels in trading?

Invalidation levels are used to determine where to place stop losses when entering trades. They help identify the point at which the trade would be considered invalid if price moves against the trader, ensuring proper risk management.

What is the difference between Type 1 and Type 2 invalidation levels?

Type 1 invalidation levels are placed below the previous stage of accumulation or distribution, making them higher probability entries with tighter stop losses. Type 2 invalidation levels are placed below the current stage of accumulation or distribution, offering higher risk/reward but lower probability due to wider stop losses.

Why is a Type 1 invalidation level considered to have a higher probability?

Type 1 is higher probability because the stop loss is set below the previous stage of accumulation or distribution, which offers a tighter stop and more precision in predicting price movements. Additionally, it is confirmed through methods like SMT and CSD, which increase its accuracy.

What is the role of SMT (Smart Money Technique) in determining Type 1 invalidation levels?

SMT is used to confirm the involvement of smart money at a specific price level. It provides validation for the previous stage of accumulation or distribution, ensuring that the price movement is supported by institutional activity, which helps in placing a more reliable stop loss.

How does the concept of ‘arrays’ relate to invalidation levels?

Arrays refer to price levels where significant market movements or reversals have occurred in the past. When price displaces above or below these arrays, it indicates the formation of a new phase of accumulation or distribution. These arrays help define where to place stop losses for both Type 1 and Type 2 invalidations.

When is it appropriate to use a Type 2 invalidation level?

Type 2 invalidation levels are used when the stop loss from a Type 1 is too large to be practical. Traders use Type 2 to set stop losses below the current stage of accumulation or distribution, but it carries a higher risk due to wider stop losses and lower probability.

What is the significance of placing a stop loss below the 'previous' or 'current' stage of accumulation or distribution?

Placing a stop below the previous stage (Type 1) ensures that the trade remains valid if the smart money's involvement holds. The current stage (Type 2) is used when the stop loss needs to be adjusted for larger trades but sacrifices probability for higher risk/reward potential.

How does using lower timeframes, like 5-second or 15-second, enhance the execution of Type 2 invalidations?

Using lower timeframes allows traders to confirm the current stage of accumulation or distribution with greater detail and precision. By zooming into these smaller intervals, traders can identify smaller price moves and confirm SMT, helping them set a more accurate stop loss for Type 2 invalidations.

Why is it crucial to prioritize Type 1 invalidations over Type 2?

Type 1 invalidations are higher probability setups with tighter stop losses, making them more reliable and less risky. Prioritizing Type 1 ensures better risk management, while Type 2 should only be used as a last resort when the Type 1 stop loss is too large or impractical.

What are the potential risks of using Type 2 invalidations in highly volatile or consolidating markets?

In volatile or consolidating markets, Type 2 invalidations are more prone to failure. Even small consolidations around an array can trigger the stop loss before price finally expands, leading to higher frequency of false signals and potential losses. Traders must be more selective when using Type 2 in such environments.