How To Identify and Trade Premium & Discount Zones
Premium & Discount Zones are a trading concept used by price action traders (also known as SMC or ICT traders). These zones allow traders to know if they are buying or selling an asset at a discounted price, paying a premium, or purchasing at a fair value. In this guide, we will cover the theory behind these zones and how to identify and trade with them.
The Basics of Premium & Discount
In everyday life, the concepts of premium and discount are easy to spot. A premium occurs when something is priced higher than its perceived value. For example, concert tickets for a popular artist might sell for much more than their original price. Conversely, a discount happens when an item is priced lower than its perceived value. For example, coats are on sale at the end of the winter season.
What is a Premium & Discount in Trading?
In trading, the concepts of premium and discount are similar to their everyday meanings. Just as concert tickets or winter coats might be priced above or below their perceived value, financial assets can also trade at a premium or discount.
A premium in trading occurs when an asset is priced higher than its intrinsic value. For instance, if a stock is trading at a significantly higher price than its historical average due to market speculation or strong demand, it’s considered to be at a premium.
A discount in trading happens when an asset is priced lower than its intrinsic value. This might be seen when an asset is undervalued compared to its historical performance or intrinsic worth.
How to Identify Premium & Discount Zones?
Identifying whether an asset is trading at a premium or discount can be approached through various methods, with fundamental analysis being a common one. However, for this article, we will focus on identifying these premium and discount areas through a technical analysis approach.
In order to do this, we will be using the Fibonacci Retracement tool. Before we anchor our points on our chart, we need to configure our Fibonacci tool to use it properly. Disable all the Fibonacci lines except for the 0, 0.5, and 1. Now, you can anchor your first point at the swing low and your second point at the swing high. The area between 0-0.5 will be your discount zone, while the area between 0.5-1 will be your premium zone.
How to Trade With Premium & Discount Zones
Now that you understand the basic concept of Premium & Discount zones, we need to learn how to effectively use it when trading. Pairing premium and discount zones with Liquidity Grabs and Fair Value Gaps (FVG) is an extremely common strategy among price action traders. If we are looking for a long setup or buys, we want to take trades inside of a discount zone. If we are looking for a short setup or sells, we want to take trades inside of a premium zone.
Long Trade Example
In this trade example, we combined all three of these concepts to take a winning long trade. There was a recent low in the market, forming an area of liquidity. Price came down to this area, grabbed the liquidity, and jumped back up. This gives us our bullish Liquidity Grab, signaling we should look for long trade opportunities. When price jumped up, it took out the most recent high, giving us a bullish Break of Structure (BOS). This jump in price also formed a bullish Fair Value Gap (FVG), which we will use as our entry point. However, before we trade this FVG, we want to confirm that it is in a discount zone since we are looking for a long trade. Take the Fibonacci tool, using the settings discussed above, and anchor it from our swing low to our swing high. We can see that the FVG is in our discount zone. Once price comes down to retest the FVG, we can set our stop loss at the swing low and take profit at the swing high.
Indicators used in this example:
Fair Value Gaps (Volumetric) | Flux Charts
Short Trade Example
In this trade example, we combined all three of these concepts to take a winning short trade. There was a recent high in the market, forming an area of liquidity. Price came up to this area, grabbed the liquidity, and jumped back down. This gives us our bearish Liquidity Grab, signaling we should look for short trade opportunities. This jump in price formed a bearish Fair Value Gap (FVG), which we will use as our entry point. However, before we trade this FVG, we want to confirm that it is in a premium zone since we are looking for a short trade. Take the Fibonacci tool, using the settings discussed above, and anchor it from our swing low to our swing high. We can see that the FVG is in our premium zone. Once price comes up to retest the FVG, we can set our stop loss at the swing high and take profit at the swing low.
Indicators used in this example:
Fair Value Gaps (Volumetric) | Flux Charts
Why Should You Use Premium & Discount Zones?
Using Premium & Discount Zones helps traders take favorable risk/reward trades. It's advantageous to enter long positions at a discount and short positions at a premium.
What's The Best Timeframe To Trade Premium & Discount Zones On?
You can use Premium & Discount Zones on any timeframe. However, it's recommended to use a higher timeframe when analyzing if price is in a premium or discounted area. This ensures that you have a bigger-picture look at the market and don't take unfavorable trades.
Can You Trade Premium & Discount Zones Only?
No, you should not trade Premium & Discount Zones by themselves. It's important to pair these zones with other forms of technical analysis. In our examples above, we used liquidity grabs and fair value gaps to give more confluence for our trade entries.