Indicators and EAs in MT4

Trading With The Multiple Moving Average

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THE GMMA – TRADING THE BREAKOUT

The Guppy Multiple Moving Average (GMMA) indicator was first mentioned in Trading Tactics in 1997. Since then the use and application of the indicator has been refined. In response to requests from readers, this series of notes brings together these modifications and improvements.

Aggressive traders attempt to identify a change in the downtrend – an up trend breakout – as soon as it happens, or even before it happens. This is aggressive trading because it carries a higher level of failure. Unless the trader has excellent trading discipline there is the danger of holding onto a stock as it continues to go down in the hope that it will eventually rebound.

A more common, and in some ways, safer approach, is to trade the trend breakout in the days or weeks after it has happened. This does reduce profits when compared with an earlier entry, but this reduction is counterbalanced by the increased probability that the trend break will develop into a sustainable new trend. Few traders are content with joining these trends at any price point. Most try to get the best entry possible, based on a pullback in price. If we understand the nature of the trend and the breakout using the techniques discussed last week, then we can take advantage of these points of price weakness because we are confident in our analysis of the developing trend.

The GMMA is applied in real time to assess the best entry opportunities after the breakout is confirmed. It
gives us an answer to the question: Is this price collapse part of a general new trend collapse, or an entry opportunity? This is a significant question because young trends are weak. There is a higher probability of trend collapse.

Breakouts come in two important formats. The most common is the “V” shaped breakout where a clear downtrend develops into a clear up trend. This is clear retrospectively, although at the time the process can be frightening and many traders delay the entry because they are worried about a trend collapse.
The less common is a breakout from a trading range, or a prolonged sideways movement. This is an important characteristic of bear market recoveries and it presented a common pattern in the first months of 2003. It also applied to stocks that have been locked in a downtrend for extended periods. These rarely bounce in a “V” recovery. Instead they drift sideways for months. When they do break out they can deliver very attractive profits. We start with this pattern.

In assessing the GMMA relationships in breakout trades we consider four relationships. The first two apply to the longer term group of averages, and the second group to the short term group of averages. We look for:

• Compression. Early in the breakout the long term group compresses as investors reach agreement on the value of the stock.
• Direction. Compression indicates agreement. The direction of the compression provides clues to the future development of the trend. We look for compression and an upwards bias.
• Collapse. It takes a lot of effort to break out of a downtrend. These rallies are short lived, and we expect them to collapse. The nature of the collapse in the short term group provides clues to the strength of trader activity.
• Rapid bounce. A fast bounce and recovery in the short term group confirms increased trading activity and this forces interested investors to bid higher to get stock.

The APE bar chart highlights the problems we face in many breakout trades. First, we probably missed the initial breakout. By the time it shows up on a once a week search of the database, the initial opportunity has passed. We leave it on our watch list to see how it behaves when prices collapse after the initial rally. At the decision point shown we need to decide on the probability of a bounce occurring. Get this correct and we can trade from around $5.40 to $6.10 or even higher if a full trend develops.

The GMMA indicator help us to make a better decision at the decision point shown by the vertical line. We start with the analysis of the long term group. No trend can survive without buying support from long term investors. We may intend to take a trading approach to this opportunity, but unless investors are there to lend a helping hand, we do not get the opportunity to join a prolonged trend.

Compression is an easy question to answer. Already the long term group is well separated. It shows no sign of compression in response to the drop in prices seen on the bar chart and shown here by the collapse of the short term group of averages.

The direction of the long term group is still upwards, even though the speed of the rise has slowed slightly. The compression and direction suggest this trend has strength so we can trade with increased confidence and take advantage of this temporary low in prices.

This analysis is confirmed when we turn our attention to the short term group. Trader activity always leads investor activity as traders probe for weakness in down trends, and test the strength of up trends. This has been a orderly collapse in prices. Traders are not panicked. It does not take long before new traders come into the market and start buying. They see the fall in prices as an opportunity rather than an alert signal to abandon a weak trend. The period of compression and agreement is short, and the expansion starts quickly.
If we choose to wait a few days, the rapid compression that precedes a rapid bounce is revealed. At this decision point many traders will buy APE in anticipation of this type of rebound because the first three factors – compression, direction and collapse – are consistent with a breakout developing into a longer term trend.



This conclusion does beg the question of how we decide that this is a real breakout from the sideways pattern. The answer comes from the comparison of area A and area B. We start with the pullback in the short term group. In area A this pullback never develops into a rebound. In area B, the degree of pullback is smaller, and the pullback quickly develops into a rebound that carries the short term group to new highs.
This is further confirmed by the long term group. In area A this group does not get a chance to separate. They do not expand. At the time of the pullback in the short term group, the long term group is just a thick red line. Compare this with the pullback relationship in area B. The long term group is well separated and clearly moving upwards.

This analysis confirms the breakout spike to $6.10 shown on the bar chart has a higher probability of becoming part of a broad up trend development rather than just a temporary rally or spike.





It is easier to apply GMMA analysis to the classic “V” shaped trend breakout where a downtrend quickly develops into a new up trend. The danger in these young trends is that the breakout may turn out to be just a short lived rally. Our fears are confirmed when the breakout falters and prices dip back from the initial highs. Is this a buy point, or an exit signal?

In a classic, text book example of the “V” shaped trend reversal this question does not arise. Price simply clearly change direction, and do not look back. There is no point in waiting for a price pullback, or a rally collapse so it is important to recognize these breakout characteristics early. We can reach some initial conclusions at the decision point shown. Wait a week or so, and the conclusions are clearly confirmed.
The key is the behavior of the long term group. They have gone from separated and down to compressed and up. The direction of the long term group has changed rapidly. Remember that the longest average in this group is a 60 day calculation. Yet by the time of the decision point all the long term group of averages have turned up. This is an early confirmation of the trend break and of the strength of the trend. You cannot get this type of information from any other indicator, and certainly not from just two moving averages using a crossover signal.

The long term group has also compressed and this tells us that the investors are in agreement about the value of the stock. They are not waiting for a pullback before taking action. They are worried they are going to miss out, so they are aggressively starting to outbid each other to establish a position.

Traders see this and they choose not to sell. Look at the character of the short term group of averages. They compress a few days before the decision point line, and then move upwards and spread out quickly. There is a lot of steady buying activity here. Compare this relationship with area C on the APE GMMA display. We are being aggressive at this decision point, but the nature of this expansion suggests strong trader and investor support. When traders come to sell, there are other traders who are prepared to buy at these prices. They are not waiting for a price pullback to get an entry. As a result there is no compression in the short term group. They quickly move into a parallel relationship. The circled area A is further confirmation of this. See this pattern and you know you have no choice but to take the current price if you want to join this robust trend.




Most time a trend breakout follows a series of attempted breakouts – the rally and retreat behavior discussed last week. When the breakout develops we see a pattern of rallies and retreats and rebounds. The FFL chart illustrates how these occur and shows how we apply GMMA analysis to make a better judgment about the advisability of an entry at decision point 1 and 2. Although we are cautious in applying the GMMA as a means of anticipating a trend break, the FFL display shows how this can be achieved.
The bar chart shows a downtrend defined by the straight edge trend line. Prices have consistently moved up to the line, and then dropped down. This pattern of rise and retreat has defined the downtrend so there is no obvious reason why we would be interested in decision point 1. There has been no break above the trend line. Decision point 2 which follows the collapse of the initial breakout rally is the more traditional application of the GMMA to breakout trading. Our concern is that if we buy in this area that prices may drop to the trend line, rebound, then retreat to the trend line again as shown by the thick red line. We use the GMMA to decide whether this is a likely outcome, or if prices are likely to rebound in a new up trend as shown by the thicker blue line.





The GMMA provides answers to both decision points. The key analysis that favors an entry at decision point one starts with the long term group of averages. Traders need investors, so we need to understand their behavior. We start with the compression and directional behavior shown in the area circled. The long term group is beginning to compress. Some investors are beginning to think that FFL has a brighter future. Compression tells us that investors are not taking advantage of temporarily higher prices to sell. It tells us they are beginning to buy as prices rise. Some of them are beginning to worry that they might miss out on an opportunity.

Their action is most likely driven by fundamental analysis. We do not need to read their analysis to know that it is bullish because the direction of the compression is upwards. This is a bullish signal in a downtrend from the most conservative market participants.

Shift our attention to the trader activity and it is the rally collapse and rebound behavior that attracts our interest. This is not a sharp rally. The collapse does not resemble that shown in area A. This is a slower decline. Traders are not in a rush to take profits.

The short term group does slip below the long term group, and then it rebounds as shown by the rapid compression. There is a lot of excitement here as traders jostle each other to buy stock. They believe FFL is going to lift.

And the investors also believe this. The long term group continues to compress and the direction is up, even after the minor stumble in late May. This is a very bullish environment. Aggressive traders have no hesitation in buying at decision point 1 because of the developing investor activity. Traders lead the way, but we only follow when investors are showing increased willingness to become buyers. This GMMA analysis signal leads the price break above the trend line by several days.

The FFL bar chart presents a different set of problems at decision point 2. We have the opportunity to join a developing trend at a point of price weakness. We have to know that this is not a point of trend weakness. The important relationship is shown by the long term group. The group is not compressed. The wide spread that developed at the top of this initial rise is largely maintained as the long term group begins to turn down slightly. This degree of spread is also maintained as we move beyond decision point 2.
The underlying feature of the GMMA is the compression and expansion relationship. Compression shows agreement. Expansion shows disagreement. If the long term group turned down, and began to compress we would infer that investors are selling. When the long term group slows, move sideways, or takes a slight dip and remains well separated then we infer that investors are still buying stock. They are not fools. They will not pay more than they have to, so as prices dip, driven by trader selling, the investors do not have to pay as much to buy. In unison, they lower their bid prices and we see a dip in the long term group but the averages remain parallel with each other.

It is the move towards compression which shows some investors are selling into the price rise, and selling into the price dip, that is a cause for concern. This does not happen at decision point 2.
The direction of the long term group is not down. This is certainly a pause, and a broad move sideways, but it is not a reversal. We can be confident this trend is intact, and strong.

Knowing the ground is firm underfoot. We can then turn to understanding how traders are reacting. The price collapse is sudden, but so is the rebound. There is a significant gap between the 3 and 5 day averages and the rest of the averages in the short term average group. Short term traders have sold down the stock aggressively, but those with a slightly longer time frame are not so eager to sell. The most aggressive sellers dip into the long term group of averages, but the least aggressive see the price dip as a buying opportunity. The rebound starts quickly as the shorter averages turn up in a scramble to buy back into the stock.

A successful breakout quickly drags the long term investors with it. This group separates rapidly and does not react significantly to the inevitable breakout rally collapse. It is this relationship that confirms that decision point 2 is a safe entry point and that there is a strong probability that this new up trend will continue.

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Moving Average Strategy

Here is a strategy using the 100 SMA and 200 SMA.

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A trader can choose a moving average based on the time frame that he is trading; the trader might choose the moving average to measure minute chart, hourly charts, day charts or even weekly.

The trader can also choose to average the closing price, opening price or median price.

Moving average is commonly used devices to measure strength of trends. The data is precise and its output as a line can be customized to ones preferences.

Using the moving average is one of the basic ways to generate buy and sell signals which are used to trade in the direction of the trend, since the moving average is a lagging and a trend following indicator. The Moving average indicator as a lagging indicator means that it will tend to give late signals as opposed to leading indicators. However, the Moving average as a lagging indicator gives more accurate signals and is less prone to whipsaws compared to leading indicators.

Traders choose the moving average period to use depending on the type of trading they do; short-term, medium-term and long-term.

• Short-term: 10 -50 Period Moving Average
• Medium-term: 50 - 100 Period Moving Average
• Long-term: 100 - 200 Period Moving Average

The period in this case can be measured in minute chart, hourly charts, day charts or even weekly. For our example we will use 1 hour period.

Short term moving averages are sensitive to price action and can spot trends signals faster than the long term moving averages. line more closely than a long term (200 period) average. Shorter term moving averages are also more prone to whipsaws compared to long term ones.

Long term averages help avoid whipsaws, but are slower in spotting new trends and reversals.

Because long term moving averages calculate the average using more price data, it does not reverse as fast as a short term moving average and it is slow to catch the changes in the trend. However the longer term moving average is better when the trend stays in force for a longer time.

The work of a trader is to find a moving average that will identify trends as early as possible while at the same time avoiding fake-out signals (whipsaws).

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20 Pips Price Range Moving Average Forex Strategy

The 20 pips price range moving average strategy is used with the 1 Hour and 15 minute Trading charts. On this chart time-frames we use the 100 and 200 simple moving average indicator.

Both the 1 Hour and 15 minute chart time-frames will use the 100 and 200 SMA (SMA Indicator) to determine the direction of the Forex trend.

The 1 Hour chart time-frame checks the long term direction of the Forex trend, upward or downward trend, depending on the direction of the moving averages. All trades taken should be in this direction.

We then use the 15 minute price chart to find the optimal point to enter trades. Trades are opened only when the price is within 20 pips range of the 200 simple MA, if price is not within this pip range trades are not opened.

Buy Signal - Forex Uptrend/Bullish Market

To generate Forex buy (bullish signals) using the 20 pips moving average Forex trading strategy, we shall use the 1hour and 15 minute chart time-frame.

On the 1 hour Forex chart time-frame the price of the currency pair should be above both the 100 and 200 simple moving average. We then move to a lower chart time-frame, the 15 minute chart time-frame to generate a trade signal.

On 15 minute chart time-frame, when price reaches the 20 pips range above the 200 SMA, we open a buy trade and place a stop loss 30 pips below the 200 SMA. Stop loss can be adjusted to the amount of Pips that are suitable for your risk but to avoid being stopped out by normal Forex volatility its best to use 30 pips stop loss.

A buy trade can also be opened when price touches the 100 Simple moving average, provided it’s not very far from the 200 SMA. Normally the 100 SMA will be within the 20 pips range of the 200 SMA.


Sell Signal – Forex Downtrend/Bearish Market

To generate Forex sell (short signals) using the 20 pips moving average Forex trading strategy, we shall also use the 1hour and 15 minute chart time-frame.

On the 1 hour chart time-frame, the price should be below both the 100 and 200 simple moving average. We then move to the 15 minute chart time-frame to generate a Trading Signal.

On 15 minute chart, when price reaches the 20 pips range below the 200 SMA, we open a sell trade and place a stop loss 30 pips above the 200 simple moving average.


With this method price will generally bounce of these levels because many traders watch these levels, and open similar trades at around the same point.

These levels act as short term resistance or support levels within the currency price charts.

Profit Taking level For This Trading Strategy

With this trading strategy the price will bounce and make a move in the direction of the original Forex trend. This move will range from 70 - 100 pips.

The best profit taking level would therefore be considered to be 80 pips from the 200 simple moving average.

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Moving Averages - How to Use Them and Which Ones to Use by Toni Hansen

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There are 4 types of moving averages:

1. Simple moving average
2. Exponential moving average
3. Smoothed moving average
4. Linear weighted moving average

The difference between these 4 moving averages is the weight assigned in to the most recent price data.

Simple Moving Average - SMA

Simple moving averages apply equal weight to the prices used to calculate the average

Simple moving average is calculated by summing up the price periods of a financial instrument and this value is then divided by the number of such periods. For example simple moving average 10, adds price for the last 10 periods and divides them by 10.

Exponential Moving Average - EMA

Exponential moving averages apply more weight to the most recent price data.

Exponential moving averages are calculated by assigning the latest price values more weight based on a percent P, multiplier that is used to multiply and assign more weight to the latest price data.

Linear Weighted Moving Average - LWMA

Linear weighted moving averages apply more weight to the most recent price data.

Linear weighted moving average - the latest data is of more value than earlier data. Weighted moving average is calculated by multiplying each of the closing prices within the price series, by a certain weight coefficient.

Smoothed moving average - SMMA

The smoothed moving average is calculated by applying a smoothing factor of N, the smoothing factor is composed of N smoothing periods.

The example below shows SMA, EMA and LWMA. The smoothed moving average is not commonly used so it is not shown below.

The Linear weighted moving average reacts fastest to price data, followed by the exponential moving average and then the SMA.




Day Trading with Exponential moving averages and simple moving averages

The moving averages most commonly used are simple moving average (SMA) and more and exponential moving average (EMA). Whereas the EMA has a more sophisticated method of calculation, its more popular than the SMA moving average.

SMA is the arithmetic mean of the closing prices in the period based on the set time period where each time period the price is added and then it is divided by the number of time periods chosen. If 10 is the period used the price for the last ten periods added up then it is divided by 10.

SMA is the result of a simple arithmetic average. Very simple and some forex traders tend to associate with the forex trend since it closely follows price action.

EMA on the other hand uses an acceleration factor and it is more responsive to the trend.

The SMA is used in price charts to analyze price action relative to the SMA. If the price action in more than 3 or 4 time periods show below the SMA then its an indication that long trades should be closed immediately and the bullish momentum is waning.

The shorter the SMA Price action period the faster the SMA is to respond to price change. SMA can be used to show direct information regarding the trend of the market and the strength by looking at the slope of the SMA, the steeper or more pronounced slope display is, the stronger the forex trend.

The EMA is also used by many traders in the same way as the SMA but it reacts faster to price action and therefore preferred by some traders.

The SMA and EMA can also be used to generate entry and exit points. These Moving averages can also be combined with Fibonacci and ADX indicator to generate confirmation signals. Most day traders use 5- 10 period moving average.

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Lesson 1 -- Fibonacci Number Sequence

The Fibonacci Sequence is most likely the most influential series of numbers in the world. It is also likely that you encounter the numerical pattern everyday. This mathematical series was discovered by Leonardo Fibonacci of Pisa in the early thirteenth century and was outlined in his book, Book of Calculations. 1, 1, 2, 5, 8, 13, 21, 34, 55, etc. are the "golden" numbers that are found in geometry, art, anatomy, music, biology, botany, conchology, and even trading. After the two starting values, each following number is the sum of the two proceeding numbers. Fn=Fn-1 + Fn-2

How does this relate to trading? The ratio of any number to the next larger number of the sequence is 62% (or specifically 61.8%), the "Golden" ratio. The inverse of that Fibonacci ratio is 38% (or specifically 38.2%). Mathematical psychologist, Vladimir Lefebvre suggested that traders exhibit positive and negative evaluations of the opinions they hold about the market. These negative and positive evaluations have direct correlation with the retracement percentage seen in market analysis.

If you are interested the Fibonacci Sequence you may also want to obtain more information on Elliot Wave and W. D. Gann.

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Introduction

Fibonacci Retracements are ratios used to identify potential reversal levels. These ratios are found in the Fibonacci sequence. The most popular Fibonacci Retracements are 61.8% and 38.2%. Note that 38.2% is often rounded to 38% and 61.8 is rounded to 62%. After an advance, chartists apply Fibonacci ratios to define retracement levels and forecast the extent of a correction or pullback. Fibonacci Retracements can also be applied after a decline to forecast the length of a counter trend bounce. These retracements can be combined with other indicators and price patterns to create an overall strategy.

The Sequence and Ratios

This article is not designed to delve too deep into the mathematical properties behind the Fibonacci sequence and Golden Ratio. There are plenty of other sources for this detail. A few basics, however, will provide the necessary background for the most popular numbers. Leonardo Pisano Bogollo (1170-1250), an Italian mathematician from Pisa, is credited with introducing the Fibonacci sequence to the West. It is as follows:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610……

The sequence extends to infinity and contains many unique mathematical properties.

• After 0 and 1, each number is the sum of the two prior numbers (1+2=3, 2+3=5, 5+8=13 8+13=21 etc…).
• A number divided by the previous number approximates 1.618 (21/13=1.6153, 34/21=1.6190, 55/34=1.6176, 89/55=1.6181). The approximation nears 1.6180 as the numbers increase.
• A number divided by the next highest number approximates .6180 (13/21=.6190, 21/34=.6176, 34/55=.6181, 55/89=.6179 etc….). The approximation nears .6180 as the numbers increase. This is the basis for the 61.8% retracement.
• A number divided by another two places higher approximates .3820 (13/34=.382, 21/55=.3818, 34/89=.3820, 55/=144=3819 etc….). The approximation nears .3820 as the numbers increase. This is the basis for the 38.2% retracement. Also, note that 1 - .618 = .382
• A number divided by another three places higher approximates .2360 (13/55=.2363, 21/89=.2359, 34/144=.2361, 55/233=.2361 etc….). The approximation nears .2360 as the numbers increase. This is the basis for the 23.6% retracement.

1.618 refers to the Golden Ratio or Golden Mean, also called Phi. The inverse of 1.618 is .618. These ratios can be found throughout nature, architecture, art and biology. In his book, Elliott Wave Principle, Robert Prechter quotes William Hoffer from the December 1975 issue of Smithsonian Magazine:

….the proportion of .618034 to 1 is the mathematical basis for the shape of playing cards and the Parthenon, sunflowers and snail shells, Greek vases and the spiral galaxies of outer space. The Greeks based much of their art and architecture upon this proportion. They called it the golden mean.

Alert Zones

Retracement levels alert traders or investors of a potential trend reversal, resistance area or support area. Retracements are based on the prior move. A bounce is expected to retrace a portion of the prior decline, while a correction is expected to retrace a portion of the prior advance. Once a pullback starts, chartists can identify specific Fibonacci retracement levels for monitoring. As the correction approaches these retracements, chartists should become more alert for a potential bullish reversal. Chart 1 shows Home Depot retracing around 50% of its prior advance.

The inverse applies to a bounce or corrective advance after a decline. Once a bounce begins, chartists can identify specific Fibonacci retracement levels for monitoring. As the correction approaches these retracements, chartists should become more alert for a potential bearish reversal. Chart 2 shows 3M (MMM) retracing around 50% of its prior decline.

Keep in mind that these retracement levels are not hard reversal points. Instead, they serve as alert zones for a potential reversal. It is at this point that traders should employ other aspects of technical analysis to identify or confirm a reversal. These may include candlesticks, price patterns, momentum oscillators or moving averages.

Common Retracements

The Fibonacci Retracements Tool at StockCharts shows four common retracements: 23.6%, 38.2%, 50% and 61.8%. From the Fibonacci section above, it is clear that 23.6%, 38.2% and 61.8% stem from ratios found within the Fibonacci sequence. The 50% retracement is not based on a Fibonacci number. Instead, this number stems from Dow Theory's assertion that the Averages often retrace half their prior move.

Based on depth, we can consider a 23.6% retracement to be relatively shallow. Such retracements would be appropriate for flags or short pullbacks. Retracements in the 38.2%-50% range would be considered moderate. Even though deeper, the 61.8% retracement can be referred to as the golden retracement. It is, after all, based on the Golden Ratio.
Shallow retracements occur, but catching these requires a closer watch and quicker trigger finger. The examples below use daily charts covering 3-9 months. Focus will be on moderate retracements (38.2-50%) and golden retracements (61.8%). In addition, these examples will show how to combine retracements with other indicators to confirm a reversal.

Moderate Retracements

Chart 3 shows Target (TGT) with a correction that retraced 38% of the prior advance. This decline also formed a falling wedge, which is typical for corrective moves. The combination raised the reversal alert. Chaikin Money Flow turned positive as the stock surged in late June, but this first reversal attempt failed. Yes, there will be failures. The second reversal in mid July was successful. Notice that TGT gapped up, broke the wedge trend line and Chaikin Money Flow turned positive (green line).

Chart 4 shows Petsmart (PETM) with a moderate 38% retracement and other signals coming together. After declining in September-October, the stock bounced back to around 28 in November. In addition to the 38% retracement, notice that broken support turned into resistance in this area. The combination served as an alert for a potential reversal. William %R was trading above -20% and overbought as well. Subsequent signals affirmed the reversal. First, Williams %R moved back below -20%. Second, PETM formed a rising flag and broke flag support with a sharp decline the second week of December.

Golden Retracements

Chart 4 shows Pfizer (PFE) bottoming near the 62% retracement level. Prior to this successful bounce, there was a failed bounce near the 50% retracement. The successful reversal occurred with a hammer on high volume and follow through with a breakout a few days later.

Chart 5 shows JP Morgan (JPM) topping near the 62% retracement level. The surge to the 62% retracement was quite strong, but resistance suddenly appeared with a reversal confirmation coming from MACD (5,35,5). The red candlestick and gap down affirmed resistance near the 62% retracement. There was a two day bounce back above 44.5, but this bounce quickly failed as MACD moved below its signal line (red dotted line).

Conclusions

Fibonacci retracements are often used to identify the end of a correction or a counter-trend bounce. Corrections and counter-trend bounces often retrace a portion of the prior move. While short 23.6% retracements do occur, the 38.2-61.8% covers the more possibilities (with 50% in the middle). This zone may seem big, but it is just a reversal alert zone. Other technical signals are needed to confirm a reversal. Reversals can be confirmed with candlesticks, momentum indicators, volume or chart patterns. In fact, the more confirming factors the more robust the signal.

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Lesson 2 - Moving Averages

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Moving averages are one of the most basic tools in technical analysis. The moving averages are a lagging indicator and do not predict trend, but confirm trend once it has been established. The calculations smooth out day-to-day price fluctuations and reduce noise.

You can use moving averages in simple, exponential or weighted form.

1.Simple -- computes the averages (mean) of the closing price over the chosen amount of periods (tick/bars) and displays in a joined smooth curving line. Short term: 10-30 days, Intermediate term: 30-100 days, Long term: 100-200+. Sum of all closing prices divided by number of closing prices in specific period.
2.Exponential -- applies more weight to recent prices in comparison older prices. Found by applying a percentage of today's closing price to yesterday's closing moving averages.
3.Weighted -- gives current data more weight than older data. Older data is considered of less value/significance. Each price in a series is multiplied by the number of periods preceding it: the old the price the smaller its multiplier.

What can I use this for? The moving averages can be used for various task, but it is suggested that they are used with other technical indicators. The great thing about moving averages is that they simplify data for the eyes.

1.Support -- look for price reversing when it moves close to a longer term moving average line.
2.Resistance- when the price comes close to the line of moving average, traders will sell in hopes of taking profits at the top of a natural resistance level.
3.Crossover -- Moving averages can be used as basic buy/sell points by detecting crossovers when the moving averages line crosses above and below the price bars
4.Crossover on Moving Average Ribbons -- When two different moving averages crossover one another, this can signal a possible reversal.

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A trader can choose a moving average based on the time frame that he is trading; the trader might choose the moving average to measure minute chart, hourly charts, day charts or even weekly.

The trader can also choose to average the closing price, opening price or median price.

Moving average is commonly used devices to measure strength of trends. The data is precise and its output as a line can be customized to ones preferences.

Using the moving average is one of the basic ways to generate buy and sell signals which are used to trade in the direction of the trend, since the moving average is a lagging and a trend following indicator. The Moving average indicator as a lagging indicator means that it will tend to give late signals as opposed to leading indicators. However, the Moving average as a lagging indicator gives more accurate signals and is less prone to whipsaws compared to leading indicators.

Traders choose the moving average period to use depending on the type of trading they do; short-term, medium-term and long-term.

• Short-term: 10 -50 Period Moving Average
• Medium-term: 50 - 100 Period Moving Average
• Long-term: 100 - 200 Period Moving Average

The period in this case can be measured in minute chart, hourly charts, day charts or even weekly. For our example we will use 1 hour period.

Short term moving averages are sensitive to price action and can spot trends signals faster than the long term moving averages. line more closely than a long term (200 period) average. Shorter term moving averages are also more prone to whipsaws compared to long term ones.

Long term averages help avoid whipsaws, but are slower in spotting new trends and reversals.

Because long term moving averages calculate the average using more price data, it does not reverse as fast as a short term moving average and it is slow to catch the changes in the trend. However the longer term moving average is better when the trend stays in force for a longer time.

The work of a trader is to find a moving average that will identify trends as early as possible while at the same time avoiding fake-out signals (whipsaws).

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Lesson 3- Bollinger Bands

The Bollinger Bands were created by John Bollinger in the late 1980s. Bollinger studied moving averages and experimented with a new envelope (channel) indicator. This study was one of the first to measure volatility as a dynamic movement. This tool provides a relative definition of price highs/lows in terms of upper and lower bands.

The Bollinger Bands are comprised of three smooth lines. The middle line is the simple moving average, normally set as a period of 20 (number of bar/ticks in a given time period), and is used as a base to create upper/lower bands. The upper band is the middle band added to the given deviation multiplied by a given period moving average. The lower band is the middle band subtracted by the given deviation multiplied by a given period moving averages.

What can we use this for?

1.Trend -- When price moves outside of the bands, it is believed that the current trend will continue.
2.Volatility- The band will expand/contract as the price movement becomes more volatile/or becomes bound into tight trading patterns, respectively.
3.Determine Oversold/Overbought Conditions -- When price continues to hit upper band, the price is deemed overbought (may suggest sell). When price continues to hit lower band, the price is deemed oversold (may suggest buy).

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Bollinger Bands Forex Trading Indicator

Developed by John Bollinger.

The Bollinger Bands indicator acts as a measure of volatility. This indicator is a price overlay indicator. The indicator consists of three lines; the middle line (moving average), an upper line and a lower line. These three bands will enclose the price and the price will move within these three bands.

This indicator forms upper and lower bands around a moving average. The default moving average is the 20-SMA. This indicator use the concept of standard deviations to form their upper and lower Bands.

The example is shown below.


Bollinger Bands Indicator

Because standard deviation is a measure of volatility and volatility of the market is dynamic, the bands keep adjust their width. higher volatility means higher standard deviation and the bands widen. Low volatility means the standard deviation is lower and the bands contract.

Bollinger Bands use price action to give a large amount of information. The information given by the this indicator includes:

• Periods of low volatility- consolidation phase of the forex market.
• Periods of high volatility- extended trends, trending forex markets.
• Support and resistance levels.
• Buy and Sell points.

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How Bollinger Bands Indicator Works

Bollinger Bands calculations uses standard deviation to plot the bands, the default value used is 2.

Calculation

• The middle line is a simple moving average
• The upper line is: Middle line + Standard Deviation
• The lower line is: Middle line - Standard Deviation

Bollinger considered the best default for his indicator to be 20 periods moving average and the the bands are then overlaid on the price action.

Standard Deviation is a statistics concept. It originates from the notion of normal distribution. One standard deviation away from the mean either plus or minus, will enclose 67.5 % of all price action movement. Two standard deviations away from the mean either plus or minus, will enclose 95 % of all price action movement.

This is why the Bollinger Bands indicator uses the standard deviation of 2 which will enclose 95 % of all price action. Only 5 % of price action will be outside the bands, this is why traders open or close trades when price hits one of the outer Bands.

The Bollinger Bands indicator main function is to measure volatility. What the Bollinger Bands upper and lower limits try to do is to confine price action of up to 95 percent of the possible closing prices
This indicator compares the current closing price with the moving average of the closing price. The difference between them is the volatility of the current price compared to the moving average. The volatility will increase or decrease the standard deviation.

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Bollinger Bands and Volatility

When volatility is high; prices close far away from the moving average, the Bands width increases to accommodate more possible price action movement that can fall within 95% of the mean.

Bollinger bands will widen as volatility widens. This will show as bulges around the price. When bollinger bands widen like this it is a continuation pattern and price will continue moving in this direction. This is normally a continuation signal.

The example below illustrates the Bollinger bulge.



High Volatility and Low Volatility

When volatility is low; prices close closer towards the moving average, the width decreases to reduce the possible price action movement that can fall within 95% of the mean.

When volatility is low price will start to consolidate waiting for price to breakout. When the bollinger bands is moving sideways it is best to stay on the sidelines and not to place any trades.

The example is shown below when the bands narrowed.

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Bollinger Bands Indicator Bulge and Squeeze Technical Analysis

The Bollinger Bands are self adjusting which means the bands widen and narrow depending on volatility.

Standard Deviation is the statistical measure of the volatility used to calculate the widening or narrowing of the bands. Standard deviation will be higher when prices are changing significantly and lower when markets are calmer.

• When volatility is high the Bands widen.
• When volatility is low the Bands narrows.

The Bollinger Squeeze

Narrowing of Bands is a sign of consolidation and is known as the Bollinger band squeeze.

When the Bollinger Bands display narrow standard deviation it is usually a time of consolidation, and it is a signal that there will be a price breakout and it shows people are adjusting their positions for a new move. Also, the longer the prices stay within the narrow bands the greater the chance of a breakou



The Bollinger Bulge

The widening of Bands is a sign of a breakout and is known as the Bulge.
Bollinger Bands that are far apart can serve as a signal that a trend reversal is approaching. In the example below, the bands get very wide as a result of high volatility on the down swing. The trend reverses as prices reach an extreme level according to statistics and the theory of normal distribution. The "bulge" predicts the change to downtrend.

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Google's Stock Analyzed (Symbol GOOG)

Watch over Adam Hewison's shoulder as he analyzes Google's stock (symbol: goog). Where are the support and resistant levels as GOOG moves into a trading range opposed to a trending range? How long will we move sideways before goog starts to test the lows again.

This video is good practical example about how to analyse support/resistance for stocks

How I Became A Successful Trader

We interview Adam Hewison, president and CEO of INO.com

Every trader needs one. Do you know what it is?

Every trader needs one.
Do you know what it is.
Many times it's the difference between success and failure in the market.
Watch the fifth episode of the "Traders Whiteboard" series and learn from master trader Adam Hewison on how to incorporate this key element into your own trading.

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Talking Points:

• Failing to plan is planning to fail; every trader needs a trading plan.
• This article covers the what, how, when, and why that needs to be answered in the plan.
• Sample strategies are referred for multiple trader types in the section for the ‘how.’

Trading plans are a lot like insurance: People don’t usually want it until they’ve already faced a catastrophe. But after that catastrophe; maybe it was a big loss on a single position, or perhaps even worse, a margin call from one bad trade, the trader will often recognize that something needs to be done.

But regardless how one gets there, just the fact that they arrive at the destination of realizing that a trading plan isn’t just a preference, but often a necessity is generally a positive development in the career of the trader.

The next quandary that follows is usually along the lines of, ‘well how do I go about creating a trading plan?’
What follows are suggestions for that trading plan. This is a way where traders can define their approach and strategies for approaching the market: Think of this like the personal ‘constitution’ of the trader; the document that outlines the strategies, operations and procedures with which that trader is looking to implement in the marketplace.

The ‘What’

The most important aspect of a trading plan is the definition of the type of trader that you are. And if you’re a new trader and aren’t quite sure of what type of trader you want to be, it’s ok to modify this as you see more results and get a better idea of which direction you want to move towards.

The benefit behind this is that it helps to keep you grounded. Let’s say that you’re a technical swing trader, but with an upcoming NFP report you see an especially attractive setup that you decide is worth of a quick scalp position.

Well, if that scalp doesn’t work out and a loss is taken – the ‘what’ of a trading plan serves as a reminder that you were trading outside of your comfort zone. Below is a table with various types of trader ‘styles’ that one may look to use as a portion of this section of the trading plan.

Various Trader Types and Characteristics of Each

Trader Type	Characteristics of this style
Scalper	Holds trades for a few minutes to a few hours
Day-Trader	Holds trades for less than one day; slightly longer-term focus than scalpers
Swing-Trader	Holds trades from a few hours to a few days
Intermediate-Term	Holds trades for a few days to a few weeks
Long-Term Trader	Holds trades for at least a day and, if possible, multiple years
Position Trader	Holds trades as long as need-be to build and work a position

Table of potential trader types; Created by James Stanley

The ‘How’

A trading plan is worthless without a definition of ‘how’ a trader wants to enter and manage positions. This can be as simple as ‘I’m going to scalp trends,’ to as complex as ‘I’m going to take scalps with 8 period EMA crossovers on the 5 minute chart when price is below the 34 period hourly EMA.’

It really just depends on how in-depth you want to be. The benefit of having a more well-defined strategy in this portion of the plan allows you to come back later to troubleshoot if results aren’t meeting your expectations. A more loosely-defined strategy in this section of the plan may lead to a lack of discipline when you’re actually placing trades as the trader hasn’t made the commitment to the strategy by integrating it as part of their trading plan.

An important note here – the strategy should be yours, customized for your unique risk tolerance and personality. This should also mesh with the ‘what’ of the trading plan, as this is an extension of the type of trader you are.

In the table below, we include links (under the column for ‘sample strategy’) for strategies that have been published by DailyFX for each of the types of traders that we defined above. Once again, you want to make sure that any strategy that is part of your plan is custom-fit specifically for yourself. So please feel free to take the framework of any of the below strategies and modify it as you see fit to more comfortably agree with your trading style.

The ‘When’

This part of the plan is often missed by traders; as many markets somewhat define when you’re actually able to trade. If you’re a stock trader, well you have to adhere to open market hours. Even then, many traders choose to focus on the first or last hour of the day, as this is where the majority of volatility will often take place.

But in the Forex market, there is quite a bit more flexibility available to the trader – and this isn’t always a positive thing. The FX Market moves 24 hours a day, and will often display differing characteristics based on the time-of-the-day and the area of the world that is providing liquidity. Below is a chart taken from our article Trading the World that helps to define some of these major characteristics.

The session being traded can have a massive impact on results




The importance of defining the ‘when’ of a trading plan is that it allows traders to learn and improve upon their strategies and approach with as few moving variables as possible. If a trader normally implements their strategy during the Asian session, but for some reason couldn’t get to sleep and finds themselves trading during the London open with the same strategy; they are introducing an entirely new and unfamiliar risk into their approach.

Namely, the trader is using a strategy built for a markedly different time-of-day. While the Asian session will often be slower with smaller moves, more amenable for range-trading; the London open is often highlighted by quick, violent, and sharp moves that can make a range-trading strategy look pretty bad. If you don’t believe the deviation that can be seen in a strategy based on the time-of-day or session being traded, take a look at The Best Time of the Day to Trade Forex by David Rodriguez. In the article, David took a simple RSI strategy and showed that it gave some pretty undesirable results when allowed to run all-day, every day (depicted by the red line in the chart below).

But when focused on the Asian trading session (the gold line in the below chart), the same simple RSI strategy looked significantly better.

The same strategy performed better when focused in the Asian-trading session (gold line)




Time-of-day is important in the FX market; so define when you’re going to be trading so that you can focus on improving your approach on the type of market condition that you’re speculating in.

The ‘Why’

The last part of the plan is, in my opinion, the most important. This is where you write down your goals and reasons for becoming a trader. This can be as ambitious as ‘I want to be a billionaire,’ to as reasonable as ‘I want to replace my income so that I can spend more time with my family.’ I strongly encourage you to set realistic, honest goals otherwise they’re nearly impossible to adhere to. I speak from experience.

Trading isn’t easy. It can be difficult, and tough, and costly, and frustrating all at the same time. Especially when we have fundamental environments that, as we say in Texas, ‘is about as clear as mud.’

But the fact-of-the-matter is that just having the opportunity to make money in markets is a privilege. If we look around the world right now, there are multiple areas of the world that seem to be on the brink of some type of conflict. People fight in these conflicts, and if those conflicts get bad enough people lose their lives. In the 21st century with the massive amount of technology that has made the world exponentially smaller, more opportunity is open to more people than ever before. Markets are one of the few ways that someone with little formal education, and not much start-up money can actually improve their lot in life. The FX market doesn’t care if you come from a farming family in rural China or whether you have an Ivy League MBA from The Wharton School of Business. Anyone can potentially make money, and everyone can lose money.

The ‘why’ of a trading plan serves as the reminder for why you’re willing to go through the pain; and when times get difficult or a major drawdown is seen on the account, this can help to provide perspective of ‘the bigger picture.’ This allows the trader to take a step back in order to realize that the reasons they want to become a successful trader are worth any trials or tribulations that they may go through.
If the goal doesn’t seem worth the frustration any longer, then at the least you know its time to take a step back and either re-evaluate your options, or quit.

To quote Harvey Dent in The Dark Knight, ‘The night is always darkest just before dawn.’ The ‘why’ of a trading plan serves as a reminder that the sun will still come up, regardless of how dark it may ever really seem.

-- Written by James Stanley

More...

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The 50% Rule

Follow former professional floor trader, Adam Hewison as he walks you through the 50% rule.