Candlestick Confessions: The Doji
Article Summary: The Doji is probably the most simplistic formation to learn, but it can tell us quite a bit about price action. In this article, we introduce the Doji, we examine how it can be traded, and we then look at how traders can spot and trade reversals using the Doji.
The first candlestick formation that most traders learn is probably also one of the most important. The Doji is notable for its small body found in the middle of the candle, with wicks on either side. The picture below illustrates the Doji formation:
The Doji has a skinny candle body, with wicks on either side
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What Messages Does the Doji Tell the Trader?
The skinny body of the doji candle illustrates indecision. During the formation of this candle, prices moved higher, and prices moved lower – but they ended up closing very close to where they had opened. The fact that traders couldn’t decide to bid prices higher or lower shows us indecision in the market, and this indecision can be an important turning point that, as traders, we might be able to take advantage of.
The Importance of Context with the Doji
Perhaps more important than the Doji itself is what else might be happening with price action leading into, or around the Doji formation. Because after all, the indecision of a Doji candle can only tell us so much, right?
If the currency pair is or has been trending into the Doji formation, this can be an excellent sign of a retracement, as the picture below illustrates.
The Doji can be a signal of a retracement
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While it would be optimal for each Doji printed to mean that we have a brief pause in the trend, so that we can re-enter before the trend continues, this will unfortunately not always be the case. And the reason for this is that indecision, and further, retracements – can last for much longer than one simple candle.
The picture below will illustrate this premise:
The Retracement may extend past the Doji, as indecision may continue
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Multiple Dojis
To take the above concept a step further, when a doji may be simply the beginning of a retracement or period of indecision in the market; price action can show multiple dojis over a period of time. The picture
below will illustrate:
Multiple Dojis may appear in a short period of time
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The multiple dojis are simply highlighting more-extended indecision. Think of price action leading up to a really big fundamental news event. Traders around the world know this event is going to happen, so there will often be reticence to bid prices significantly higher or lower. This indecision in the market place can be shown in the form of multiple dojis in a short period of time.
When the Doji Works Best
One of the prevailing themes in The Forex Trader’s Guide to Price Action is the fact that no formation, no indicator, and no trading setups offer 100% accuracy. So, traders are best served by assuming that future price action is unpredictable, and setting their trades up so that wins may benefit them more than losses may hurt them. This falls in line with avoiding The Number One Mistake that Forex Traders Make.
This is where the doji formation can be most advantageous; in situations in which traders may be able to gleam favorable risk-reward ratios. This can be done with the addition of support and resistance to highlight where traders these situations might present themselves.
Take, for example, the situation on EUR/USD in November of last year. After running from 1.3140 to 1.2700 in a little under a month, price intersected with a strong area of support (1.2678 is the 76.4% Fibonacci retracement of the major EUR/USD move from 1.1640 (11/15/2005) to the 1.6039 high (7/15/2008)).
After running so far, so fast, and upon intersecting into a strong area of support, indecision entered the marketplace in the form of the doji.
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Trading Reversals
Trading price reversals can be extremely attractive; even though it’s probably one of the more dangerous market conditions that traders can speculate in. Because if we’re trading a reversal, we’re looking for a trend to reverse; and that trend was taking place for some reason previously, so if left unchecked – the trader looking for a reversal may end up holding a losing trade that depletes their equity. So, first things first – if trading reversals, use strong risk management.
The above setup on EUR/USD was a textbook reversal that played out beautifully, but unfortunately, most reversals will not be so clean. Traders want to look to incorporate additional analysis into their repertoire to avoid the effects of reversals gone awry; a simple doji formation is not enough alone to trade a reversal.
In the example below, we move down to the 4-hour chart to investigate an entry in the same EUR/USD setup we examined a moment ago. This is called Multiple Time Frame Analysis, and we investigated this in the article The Time Frames of Trading.
Confirming a Reversal by moving down to lower time frame for entry
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In the above 4-hour chart, we get a much more granular look at the doji that was investigated in the previous example. Notice that no doji is showing on the 4-hour chart, and the reason for that is because the doji was on the daily chart; but that doesn’t mean the 4-hour chart can’t help us, because it can.
We can then incorporate other principals of price action, such as up-trends form continuous higher-highs and higher-lows.
On the 4-hour chart, we wait for the higher-low to be printed, and then we can look to enter shortly thereafter; placing a stop just below the low of the doji, and looking for a minimum 1-2 risk-reward ratio.
This way, if the reversal does pan out – the trader can profit handsomely. But if the reversal doesn’t take place, and the previous trend continues, the damage can be mitigated and the trader can use price action logic to get out of the position.
-- Written by James Stanley
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Strong & Weak: British Pound Strength Holds Up
Article Summary: Applying Forex trend analysis to a currency rather than a currency pair, we find the British Pound has been one of the strongest for three weeks in a row. One Forex trading tip is to buy strength and let the trend do the work for you. Therefore, buy the British Pound via a basket of currencies
Last week’s piece highlighted the potential for a trend change taking place in several currencies. Specifically, we focused on the Japanese Yen changing from relatively strong to relatively weak within 5 trading days. The analysis from last week was used as an opportunity to continue selling weakness of the Japanese Yen (JPY). Fortunately, this trade on selling the JPY as a basket worked out well. Last week’s additional weakness pushed the JPY to lower to occupy the lowest spot in the analysis meaning it is the weakest.
When looking at this week’s analysis of strong and weak currencies, we will highlight the British Pound (GBP).
Forex Strategy: Matching Strong versus Weak
| Currency |
Up Arrows |
Down Arrows |
Change From Last Week |
| AUD |
7 |
|
Higher 2 rankings |
| GBP |
5 |
1 |
Lower 1 ranking |
| NZD |
5 |
1 |
Higher 6 rankings |
| CAD |
4 |
3 |
Higher 2 rankings |
| USD |
2 |
4 |
Lower 3 rankings |
| EUR |
2 |
4 |
Lower 1 ranking |
| CHF |
1 |
6 |
Lower 3 rankings |
| JPY |
|
7 |
Lower 1 ranking |
The British Pound has been in the top three slots for three weeks in a row. This suggests the single currency has been relatively strong for the past month. Even while several other pairs underwent trend changes, the GBP has held steady towards the top of the charts.
Additionally, FXCM’s proprietary indicator, the Speculative Sentiment Index (SSI), shows a lofty percentage of traders already in short positions against the Pound. For example, at the time of this writing, the GBPUSD had a -3.0 reading which means there are three times as many short traders as long in the GBP.
Additionally, the GBPJPY had a -4.8 reading with nearly 5 times as many traders short the Pound than who are long.
The SSI indicator is a contrarian signal and suggests additional gains may be in store for the British Pound…even if those gains are solely against the US Dollar and Japanese Yen. However, I will abandon the bullish bias on the Pound if the GBPUSD exchange rate trades up to 1.6000 or if the GBPJPY pair trades up to 161.00. I’m not suggesting those pairs will reach those levels, but if they do, there is strong resistance those price levels will likely create a reaction towards GBP weakness.
Forex Analysis: Equal Wave Patterns on GBPCHF and EURGBP
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(Note: In the EURGBP pair, the GBP weakens if the exchange rate rises. In the GBPCHF pair, the GBP weakens if the exchange rate drops.)
There is a risk to buying the GBP as a basket for the week. When scrolling through the charts, I have noticed there are two other British Pound patterns that concern me about broad based GBP strength. Both the EURGBP and GBPCHF appear to be carving out equal wave patterns on the daily chart. If those patterns hold, then the GBP would be weaker against the Euro and Swiss Franc.
These patterns are early in development, and may not pan out. For the time being, we will continue to follow the strong SSI reading and see if it can carry the British Pound higher as a basket.
Good luck with your trading!
Gauging relative strength of currencies is a common method employed by traders of all skill levels.
---Written by Jeremy Wagner, Head Trading Instructor, DailyFX Education
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Forex Strategy: The US Dollar Hedge
Talking Points:
- Trading is much more than just picking a position and ‘hoping’ that the trade works out.
- Trading is about risk management, and looking to focus on the factors that we know.
- This strategy focuses on capitalizing on US Dollar volatility, and using risk management to offer potentially advantageous setups in the market.
If there is one pervasive lesson that gets taught time and time again to traders, it’s that future price movements are unpredictable.
While this may sound foreign to ears hearing it for the first time, logic and common sense dictate as such. Human beings can’t tell the future; and our job as a trader is to try to forecast future price movements. This is where analysis comes in, hopefully offering traders an advantage. And further, this is where risk management plays an even more important role, just as we saw in our Traits of Successful Traders research in which The Number One Mistake Forex Traders Make was found to be sloppy risk management.
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In this article, we are going to look at a strategy to do exactly that.
What is the USD Hedge?
The USD hedge is a strategy that can be utilized in situations in which we know the US Dollar will probably see some volatility. A good example of such an environment is Non-Farm Payrolls. With The United States reporting the number of new non-farm jobs added, quick and violent moves can transpire in the US Dollar, and as traders this is something we might be able to take advantage of.
Another of these conditions is the US Advance Retail Sales Report. This is a vitally important data print that gives considerable insight into the strongest engine of the US economy; the consumer, which accounts for roughly 65% of US economic production. This number is issued on the 13th of the month (approximately 17.5 hours from the time this article is published for the August 2013 print), and fast moves may transpire shortly thereafter.
High impact USD events can be a great way to look for USD volatility
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The Economic Calendar filtered for ‘High Importance’ USD Announcements
Another example is Federal Reserve meetings; with a very important meeting set to come out next week as much of the world waits to hear whether or not Fed is going to begin tapering the massive easing outlays that they’ve embarked on since the financial collapse to try to keep the global economy afloat.
In all of these situations – it is absolutely impossible to predict what is going to happen.
But once again, as a trader – it is not our job to predict. It’s our job to take the one strain of information that we know will probably happen and to build an approach around that.
In the USD hedge, we look to find opposing currency pairs to take off-setting stances in the US Dollar. So, we find one pair to buy the US Dollar; and a different pair to sell the US Dollar. This way, we offset a portion of the risk of both trades by ‘trading around the dollar.’
A note on hedging
Hedging has a dirty connotation in the Forex market. In the Forex market, hedging is often thought of as going long and short on the same pair at the same time.
This is disastrous, and an atrocity to the term ‘hedging.’ If you buy and sell the same pair at the same time, the only way you can truly profit is from the spread compressing (getting smaller), which means that your top-end profit potential is limited.
In actuality, it’s much more likely that spreads may spike during news announcements which could entail a loss on BOTH sides in this scenario.
Some traders say ‘well, I’ll close out the long at a top and wait for a bottom and then close out the short.’
This just doesn’t make sense. Because if you could time your long exit that well, then why wouldn’t you just initiate the short position there after closing the long position?
You still have to time the market in one of these ‘hedges.’ But extra risk is exposed from the fact that spreads can widen, and potentially trigger stops, margin calls, or any other number of bad events that simply aren’t worth it because there is so little upside of doing so.
The textbook definition of hedging, and this is what is taught in business schools around the world, is that a hedge is an investment that’s intended to offset potential losses or gains that may be incurred by a companion investment.
In the USD hedge strategy, that’s exactly what we’re looking to do.
What Allows the USD Hedge to Work?
Quite simply, risk management; if we’re fairly certain that we’re going to see some US Dollar movement, we can use that in our approach to hypothesize that this movement may continue.
By looking for a 1-to-2 risk-to-reward ratio or greater ($1 risked for every $2 sought), the trader can use this information to their advantage. Advantageous risk-reward ratios are an absolute necessity in the strategy and without them – the USD hedge will not work properly. We looked at this topic in depth in the article How to Identify Positive Risk-Reward Ratios with Price Action.
The trader looks to buy the dollar in a pair, using a 1-to-2 risk reward ratio; and then the trader looks to sell the dollar in a pair, also using a 1-to-2 risk to reward ratio. The risk and reward amounts from each setup need to be roughly equal.
Risk-Reward is what allows the strategy to work properly
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Then, when the US dollar begins its movement, the objective is for one trade to hit its stop, and the other to move to its profit target.
But because the trader is making two times the amount on the winner than they lose on the other position, they can net a profit simply by looking to utilize win-one, lose-one logic.
How to Make the Strategy Most Effective
There are numerous ways to buy or sell US dollars, and theoretically traders could look to utilize the strategy on any of them.
But to give ourselves the best chances of success, we can integrate some of the aforementioned analysis to try to make the strategy as optimal as possible.
If I’m looking to buy the US Dollar, I want to do it against the currency that’s shown me the most weakness against the dollar of recent. And further to that point – if I’m going to sell the US Dollar I want to do it in the pairing that has shown me the most strength against the greenback.
There are quite a few ways to decide how to do this. Personally, I prefer price action. We looked at quite a few ways of doing this in The Forex Traders Guide to Price Action. Another popular, common way of doing so is by using ‘strong-weak analysis.’ Since we have the constant of the US Dollar in all observed pairs, we can simply grade currency strength by comparing relative performance to the US Dollar. In the recent article Strong & Weak, Jeremy Wagner looked at exactly that process.
This process of analysis has grown so popular that FXCM recently added an app to the FXCM App Store that automatically does this analysis for traders.
Strong Weak Analyzer from the FXCMApp store
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The StrongWeak program allows traders to analyze currencies based on time frames of their choosing; visually showing which currencies have been individually weakest, and strongest. This can be a fantastic tool to integrate into this strategy.
-- Written by James Stanley
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Forex Trading Tip: Trading a Currency Rather than a Pair
-What is a currency basket?
-What are the benefits of trading a Forex basket?
-What currency baskets are available?
-A big challenge for basket traders
What is a currency basket?
A currency basket is simply a collection of trades with a single currency in common. Those collection of trades are placed in a way to isolate that common currency.
So for example, a US Dollar basket might include the GBPUSD, EURUSD, AUDUSD, and USDJPY. If we buy the US Dollar basket, we would sell GBPUSD, sell EURUSD, sell AUDUSD, and buy USDJPY. In that way, we are effectively long the US Dollar while simultaneously selling it against the GBP, EUR, AUD, and JPY.
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What are the benefits of trading a currency basket rather than a specific currency pair?
A huge advantage of a currency basket is that it provides a simple way to express your opinion in a currency. That opinion is expressed through diversification. By spreading your trades across four different pairs, your profit and loss in the US Dollar, for example, is focused towards movements soley in the US Dollar.
On the other hand, if we place a single trade in a single currency pair, then the exchange rate is subject to the counterpart to the US Dollar. Let me explain further.
Assume we think the US Dollar is going to gain strength. So we sell the EURUSD currency pair rather than trading the USD Buy basket. The Greenback could end up broadly gaining strength, but losing against the Euro. Perhaps a fundamental news release or positive comments came from the Eurozone causing traders to bid up the Euro. As a result, we had an idea of US Dollar strength, but tried to express that idea in the wrong manner and ended up with a losing trade due to the counterpart (namely the Euro).
An additional benefit is that baskets can smartly smooth out market volatility. This is a big benefit during news announcements. If you wish to hold onto a basket position for several days, the volatility resulting from news announcements is likely to be reduced due to the diversification.
Rather than being subject to the movements of a specific pair, a basket trade is spread out over several pairs that mutes the focus a single news announcement may deliver.
A big challenge for basket traders
One thing I have noticed in talking with many traders over the years is their inability to trade consistently without having the perfect strategy. This means we need to see our accounts as a collection of trades rather than many individual trades. Too often, newer traders get caught up in what the most recent trade has done and neglect the longer term performance of the account.
Therefore, especially for newer traders, using baskets may seem challenging at first because you need to retrain your mind to look at the profit or loss of the basket of trades. See through and ignore how each leg of the basket is performing and focus on the profit or loss of the basket.
---Written by Jeremy Wagner, Head Trading Instructor, DailyFX Education
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GBPUSD Reaches A Sentiment Extreme
SSI (Speculative Sentiment Index) is a proprietary tool offered to FXCM clients that can act like a compass used to navigate the foreign exchange market. Once mastered, traders will have the ability to add SSI as a component to any working strategy. So let’s take a moment to get familiar with this resource.
- What is SSI
- How to Read SSI
- Trading with SSI
SSI is a calculated ratio that gives us a snapshot of trader positioning while giving hints on market direction. SSI reveals trader positioning by determining if they are net long or short a currency pair, and if so by how much. Let’s take a look at this hand
Below we can see the current SSI ratios posted on DailyFX.com. If clients are net short a currency pair SSI will be negative, and if clients are net long the number will be positive. As of this morning, we can see that SSI for the GBPUSD is currently set at -3.16. This ratio means that trader positioning is net short at a rate over 3 to 1 when compared to all open buying interest.
So now that we know how to read SSI, let’s discuss how these numbers can be used in our trading.
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Trading SSI
SSI is an exceptional trading tool based around the psychology of traders. Traditionally most Forex traders adhere to the old “buy low, sell high” adage. However, when most traders look to pinpoint a market top or bottom they end up fading some of the markets biggest trends! Because of this, SSI is often considered a contrarian indicator. Savvy traders that review SSI can then proceed to look for busy signals when SSI is net long or buy when SSI net short for a specific currency pair. Let’s take a look at an example of SSI at work.
Below we can see a prime example of SSI at work again on the GBPUSD. Going back to the start of July, we can see that positioning on the GBPUSD has moved from an extreme net long to most positions being short. However when compared to the price graph, we can see that as traders began selling the pair has advanced over 1000 pips for the same time period! The current reading of SSI stands at -3.18. As more traders continue to sell into this market advance, SSI data suggests that the GBPUSD uptrend may continue to surge towards higher highs!
Learn Forex – Current GBPUSD SSI
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Automated SSI Trading
For those traders looking to use SSI but do not have an existing strategy, FXCM offers a variety of automated trading applications and solutions. Whether you trade trends, breakouts or momentum there is a system available for all market conditions. The easiest way to get started trading a SSI system is through our Mirror Trader Platform (Free with an FXCM Account).
Using the Mirror Traders software, Traders can select from a variety of automated strategies. This includes SSI strategies provided by DailyFX which includes the Momentum 2 and Breakout 2, and Tidal Wave strategies. These strategies can be applied at any time, while allowing traders the ability to customize position size and currency pair selection.
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---Written by Walker England, Trading Instructor
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What Happens When A Range Ends?
Range traders enjoy taking advantage of sideways moving markets as price toggles between key levels of support and resistance. However, what happens when a range comes to an end? Today we will review how to take advantage of range breakouts.
- Identifying Breakouts
- Setting Breakout Orders
- Managing Risk / Profits
Below we can see the current see today’s breakout of the NZDUSD. Before today’s price action, the NZDUSD was trading between resistance at 8162 and support at .7682. As of this week’s trading open, price has moved outside of our noted value of resistance. This move denotes a price breakout, and on these instances previous resistance will become new support. From this point traders can begin looking for new trading opportunities.
So now that we have learned how to identify a breakout, let’s discuss a trading plan to take advantage of the move.
Learn Forex – NZDUSD Range Breakout
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Trading Range Breakouts
Unlike the range trader, breakout traders are looking for key levels of support or resistance to break. If a level of resistance breaks, traders will buy in anticipation of a new uptrend beginning. Conversely, breakout traders will look to sell a break below support. Normally this technique can be used with a series of entry orders even elect to trade a breakout manually through a market order. Regardless of the method of entry, nullified, and fresh positions will look for a new trending market.
Below we can again see the NZDUSD daily chart. Traders looking to trade today’s breakout can look to buy the NZDUSD as long as price remains over the previous line of resistance near .8162. Traders will want to buy above resistance because traders are looking for this fresh higher high to be the beginning of a new uptrend. Now traders simply need to manage risk, and find profit targets to complete their trading idea.
Learn Forex – NZDUSD Breakout Entry
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Manage Breakout Risk
As with every trading strategy, traders should consider their risk prior to entry. One easy way to manage stop placement, is to set the stop in the middle of the previously defined range. The previous range on the NZDUSD measured 480 pips. Traders can find half this value and subtract it from their entry price to set up a stop order.
Using the range also makes setting a positive Risk/Reward ratio easy. Traders can initially look to take profit after a full extension of the previous range. When combined with a stop of half this distance, a 1:2 Risk/Reward ratio will be created.
---Written by Walker England, Trading Instructor
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Don’t Let This Rare Forex Technical Signal Go Unnoticed
When an unexpected shock comes to a financial market, you may see a gap of price action on the chart. A Gap in and of itself is neutral, however, when you identify what type of gap and where a gap happened you can begin to develop a trade based on the gap.
Here is a breakdown of what will be covered:
- Gap Psychology & Why Gaps Happen
- 3 Types of Price Gaps
- A Way To Trade The Current Gap on US Dollar
Why Gaps Are Rare in FX & Why They Happen
In simple terms, a gap takes place when a price bar opens far away from the previous bar and shows a space between the open or close showing you that no trades took place in between the last bars close and the current bars open.
Learn Forex: Major Gap on Week’s Open upon Major Market News
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In an extremely liquid market like FX, you will likely only see a gap on a weekend open when a significant event takes place that alters the underlying market that is being traded. The psychology behind a gap is what can make the technical occurrence worth considering a trade.
A gap in the US Dollar took place because of two main events over the weekend which had people worried and looking at hoarding money in treasuries i.e. US Dollar. The first was that the Syria deal was inked which many people feared could take US into another foreign conflict. The second and more significant from a financial market point of view is that the front runner for the Federal Reserve Chairman spot, Larry Summers, who was seen a stern hawk meaning he would likely bring about a stronger dollar overtime withdrew his name leaving in the running candidates who were much less aggressive in bringing the dollar back to strength.
Therefore, gaps happen because the underlying sentiment that brought the market to a close the prior week had radically shifted on the markets open. Now that you understand why a gap happens, lets breakdown the 3 major types of gaps that occur in chart analysis and look at a current trade opportunity based on the recent gap in the US Dollar.
3 Types of Price Action Gaps
Breakaway Gaps
The most exciting type of gap is known as a breakaway gap. A Breakaway gap takes place at a key level of price support or ceiling. The significance in a breakaway gap is that everyone holding back price at a certain level has obviously rushed out of the trade in such a way that the current trend may likely resume with little push back. A breakaway gap is similar to a seismic shift that can alter the likely route of price action for a significant amount of time to come.
Continuation Gap
Learn Forex: A Continuation Gap Helps Confirm the Previous Bias
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The next gap should simply confirm the prior trend. This gap is simply known as a continuation gap and is often seen alongside trend lines. If you’re holding a trade in the direction of the trend and find yourself in the favorable position of being in the trade that just gapped in your favor you may want to tighten your stop as the trend is likely confirmed and those who may have been on the other side of your trade are likely less of a force as their mass exodus caused the gap.
Exhaustion Gap
The last type of gap that every one would be weary of is an exhaustion gap. An exhaustion gap often happens when markets are parabolic or trading in a straight line and the last of the trend followers have entered into the trade. Naturally, when you have no more people entering into the trade the price will often fall and fall fast and the trend has likely ended. An exhaustion can often follow the previously mentioned type of gaps and can be used as a great entry confirmation of a trend turn.
A Way to Trade the Current Gap on US Dollar
As mentioned earlier, the gap that developed on Monday’s open was a breakaway gap. That means that as the US Dollar Index was sitting at support on Friday’s close, the open took out support with conviction as the USDOLLAR looks at further selling so we can look at targets below with a stop at Friday’s close. In Technical Analysis, you’ll often see that a break of support can convert the price floor into a price ceiling so we will use that information to place a stop above the new resistance point while entering into the trend.
Learn Forex: Trade Opportunity on US Dollar Breakaway Gap
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Entry to Buy: Sell On a Break of Today’s Low at 10,580
Stop: 10,660 (Friday’s close is unlikely to be retested due to Breakaway Gap)
Limit: 10,386 (Fibonacci Expansion Target)
Closing Thoughts
The breakaway gap is not a crystal ball but rather shows you a dramatic shift in sentiment. As a trader, we can use the shift in sentiment to develop a trade idea regarding the US Dollar breaking through support. However, the stop is always key when developing a trade idea because we can only identify an edge but never a sure thing when trading.
Happy Trading!
---Written by Tyler Yell, Trading Instructor
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5 Easy Steps to Trade the Forex Falling Wedge Price Pattern
-In well-established uptrends, falling wedges usually mark the halfway point of a major move.
- As continuation patterns, falling wedges have a high probability of breaking out in direction of the trend
- Stops and limits can be easily determined ahead of time.
A popular chart pattern used by many FOREX traders is the falling wedge. The reason this pattern is especially beneficial to traders is its ability to give traders who had missed a previous up move another chance to rejoin the trend. The falling wedge is a continuation pattern that also has the added benefit of providing excellent risk to reward forex trade setups. Though, upon first glance, it resembles a triangle pattern, there are significant differences
Learn Forex: Narrowing Descending Channel
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First of all wedge pattern differs from its cousin, the triangle, in that it is composed of many more candles that can take a lot longer to develop before a breakout. Next, it is made up of converging trendlines that slant in a downward slant, which differs from the downtrend resistance and uptrend support of triangles. As there are three main types of triangles, there are two types of wedges; falling and rising. We will focus our attention on the falling wedge as it is a great way for traders to get into an established uptrend.
When a trader sees a falling wedge near the top of an uptrend, the first instinct may be to short the currency pair. However, after a bit of time, the pair fails to make substantial new lows and then starts to make higher lows in a narrowing range. A sudden surge in price above topside resistance follows and the trend resumes. Based on research by Thomas Bulkowski, author of
TheEncyclopediaofChartPatterns, falling wedges break upward 68% of the time. With this type of predictive ability. How do we trade a falling wedge?
Learn Forex: Trading Falling Wedge
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There are five simple steps to trading a falling wedge. Following an established uptrend, identify price churning in a channel bound by converging and descending trendlines. Usually, three to five overlapping swings happen within a narrowing channel, but the currency pair moves down very slowly.
After prices grinds slowly lower, selling pressure begins to dissipate as sellers lose interest. Bargain hunters who were waiting to get back into the strong uptrend at better prices begin to take control and eventually push prices above the resistance trend line. Once a higher low appears within the pattern, measure the height of the pattern to obtain a profit limit target. When the currency pair breaks out above the resistance trendline, enter a trade long about four pips above the last swing high that was formed within the pattern.
This reduces the chance of getting caught in a false breakout by giving added confirmation that the move may continue. Finally, set a limit equal to the height of the pattern. Place a protective stop four pips below lowest swing in the pattern. In the event that the pattern may fail, a relatively small amount of risk was taken in relation to the larger potential gain.
In sum, falling wedges can help a trader spot strong uptrends that they can join. This pattern is attractive as it has a well-defined risk reward profile and keeps traders on the right side of the trend.
--- Written by Gregory McLeod, Trading Instructor
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