Three Ways to Make Your Strategy Most Effective
Talking Points:
- Traders should look to concentrate their strategy in the optimal market condition.
- The trade management of a strategy should be customized for that condition.
- Trader’s risk management should be customized for the optimal market condition.
The reasons for having a trading strategy are numerous; but key of which is that it allows a trader to take a certain approach in an uncertain endeavor like trading.
Finding that strategy, however, can be a challenge. Many traders like to make their own strategies; and this can be a fundamental-based approach or something built around technical analysis. Other traders prefer to adopt another strategy to make it their own, and these can all be ways of going about finding that ‘right fit’ for each individual trader to traverse the marketplace.
But the strategy is just a part of the approach; and in many cases, it’s one of the less-important factors that can determine a trader’s success.
In this article, we’re going to look at three factors that can be more important than your trading strategy so that you can look to properly address these issues in an effort to make your overall approach most effective.
Focus Your Strategy in the Optimal Condition
The importance of matching your trading strategy to the prevailing market condition cannot be understated. We looked at the three primary conditions that are commonly exhibited in the article The Life Cycle of Markets. In the image below, we show the three primary conditions of trends, ranges, and the breakout:
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But just knowing the three primary market conditions is not enough: Traders need to be able to adjust their strategy so that it’s designed to work within the condition for which it was built.
We showed traders how they can do this in the article How to Direct Your Strategy Based on Market Condition. In the article we showed how a combination of multiple time frame analysis along with a few different indicators can be used to more accurately determine the ‘bigger-picture’ condition.
We looked at each strategy in-depth in individual articles so that traders can get an idea for the types of modifications or adjustments that can be made to cater to each market condition. We first looked at trends, followed by breakouts, and we addressed range-bound market conditions last.
Employ Trade Management Befitting of the Market Condition
The entry into a trade is but a small part of the overall approach. Once the trade is opened and the position is live, that is when the trader is left to their devices.
Many traders go into a trade without any trade management strategy at all. Perhaps they place a stop and limit and just watch prices move expecting to get some magical ‘gut-instinct’ type of feel that will allow them to know exactly what to do at the right time.
This can be pretty disastrous: It’s a straight road to falling the trap of the Number One Mistake that FX Traders Make. Guessing is not a solid trading strategy; nor is guessing a solid trade management strategy.
Traders should design their trade management in the same way they design the entry into the trade. So, when the trade is entered, a protective stop is placed in case the position doesn’t work out; and profit targets are set in the event that it does work.
The first point of emphasis for trade management is often the break-even stop. This is when the trader can move their stop-loss to their initial entry price so that, worst case scenario; the trader can avoid a loss on the position.
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But the optimal time to move the stop to break-even differs amongst market conditions. Trend strategies are, by nature, looking for a bias in the marketplace to continue. So the fear of reversal is high, and traders can look to move their stop to break-even relatively quickly in an attempt to avoid losing precious capital if the profit target isn’t obtained.
Ranges, on the other hand, are generally more congested and can be slower-moving type of markets. This can lead the trader to be slightly more conservative on the break-even stop movement; since a quick break-even stop move might entail more instances of getting ‘wicked’ out of the trade as the range continues with an element of congestion.
Breakouts are marked by their sharp and fast price movements. The upside of this is that if the trader finds themselves on the right side of the move, the benefit can be fantastic. But, if on the wrong side of the move this can be a very costly endeavor. This is where traders will usually look to be most aggressive with their break-even stop move, as a breakout market can reverse very quickly; and that gain in the trade can quickly be wiped away as a loss.
After the break-even stop has been addressed, traders can look to implement scale-out strategies in trending and breakout market conditions in an effort to net as much as possible from the position. This allows traders the potential to get far more on the profit side of the trade than they might have had they just placed a limit order and let the profit target get hit.
The opposite of this, scaling-in, entails traders adding positions as the trade moves in their favor. This is most relevant in trending conditions; and it allows the trader to enter with the trade idea with slightly less risk since a smaller initial position is used to initiate the trade. If the trade shows profitable potential, then another lot can be added. But to get this type of movement, the trader really needs a strong trend to work with; while breakouts are generally too quick and violent to be able to tactically scale-in to a position; and the limited up-side of ranges makes the prospect just less appealing.
Structure Risk Management Appropriately
Risk management is probably one of the biggest determinants of success or failure in markets. We saw this throughout the Traits of Successful Traders research performed by DailyFX.
But just as we saw with the previous two factors, it isn’t as simple as saying ‘this is the best way to always manage our risk, so let’s just do that.’ No: The risk management of a strategy should be customized to the strategy itself, and the condition with which it is looking to trade in.
Trend strategies, by nature, are looking for a bias to continue in the marketplace. But, the fear of a reversal is ever-present, and traders should address this by targeting a minimum 1-to-2 risk-to-reward ratio for each entry in a trend-based system. Does this mean the position has to be closed once two times the initial risk is met? No, absolutely not. Traders can look to scale-out of the position as prices move in their favor in an effort to capture the most up-side.
Scaling-out can be hugely beneficial in strong trends
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Range strategies are generally more modest; and up-side is generally limited. After all, if we’re buying support in a range, we rationally want to close out that trade once resistance is met; in anticipation of th range continuing. The risk-to-reward ratio of a range strategy should be greater than 1-to-1; and the reason a trader doesn’t want to risk more than they might make is because you never know if the range will break against your position; and since up-side is limited, the prospect of a breakout continuing against the trader can eliminate profits from numerous successful trades.
Breakouts are even more difficult to be on the right side of, and this is the condition that often gives new traders the most trouble. False breakouts are abundant, and each false breakout can entail a hefty loss if risk isn’t properly managed. On the other hand, when prices do move in the trader’s favor, the potential up-side can be enormous. This is a necessity to factor into the risk management of a breakout strategy.
Traders should look to be most aggressive in a breakout strategy, since so many false breakouts will happen. Traders should look for a minimum 1-to-2 risk-to-reward ratio as a minimum litmus; with many traders looking at even more aggressive risk-to-reward ratios of 1-to-4 or 1-to-5.
-- Written by James Stanley
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Introduction to Technical Indicators
Talking Points:
- Chart analysis tools are called Technical Indicators
- Technical Indicators are used for trend following, tracking price oscillation, measuring volatility, and finding support and resistance levels.
- Grouping indicators into these “families” accelerates the learning process.
The first time I opened a charting package and viewed all the available indicators, I felt completely overwhelmed. It looked like an endless list of terms written in a different language. Attempting to learn what all of them did seemed like a near impossible task, but over time, I did learn how many indicators can be helpful with my trading.
The most enlightening part of my journey was realizing that many indicators are VERY similar to each other, and understanding major indicator “families” went a long way in figuring out what they all mean. So in today’s lesson, we will break down the different groups of indicators and describe how they work.
Trend Following
Trend following indicators were created to help traders trade currency pairs that are trending up or trending down. We have all heard the phrase “the trend is your friend.” These indicators can help point out the direction of the trend and can tell us if a trend actually exists.
Moving Averages
A Moving Average (MA for short) is a technical tool that averages a currency pair’s price over a period of time. The smoothing effect this has on the chart helps give a clearer indication on what direction the pair is moving… either up, down, or sideways. There are a variety of moving averages to choose from. Simple Moving Averages and Exponential Moving Averages are by far the most popular.
Ichimoku
Ichimoku is a complicated looking trend assistant that turns out to be much simpler than it initially appears. This Japanese indicator was created to be a standalone indicator that shows current trends, displays support/resistance levels, and indicates when a trend has likely reversed. Ichimoku roughly translates to “one glance” since it is meant to be a quick way to see how price is behaving on a chart.
ADX
The Average Direction Index takes a different method when it comes to analyzing trends. It won’t tell you whether price is trending up or down, but it will tell you if price is trending or is ranging. This makes it the perfect filter for either a range or trend strategy by making sure you are trading based on current market conditions.
Oscillators
Oscillators give traders an idea of how momentum is developing on a specific currency pair. When price treks higher, oscillators will move higher. When price drops lower, oscillators will move lower. Whenever oscillators reach an extreme level, it might be time to look for price to turn back around to the mean. However, just because an oscillator reaches “Overbought” or “Oversold” levels doesn’t mean we should try to call a top or a bottom. Oscillators can stay at extreme levels for a long time, so we need to wait for a valid sign before trading.
RSI
The Relative Strength Index is arguably the most popular oscillator out there. A big component of its formula is the ratio between the average gain and average loss over the last 14 periods. The RSI is bound between 0 – 100 and is considered overbought above 70 and oversold when below 30. Traders generally look to sell when 70 is crossed from above and look to buy when 30 is crossed from below.
Stochastics
Stochastics offer traders a different approach to calculate price oscillations by tracking how far the current price is from the lowest low of the last X number of periods. This distance is then divided by the difference between the high and low price during the same number of periods. The line created, %K, is then used to create a moving average, %D, that is placed directly on top of the %K. The result is two lines moving between 0-100 with overbought and oversold levels at 80 and 20. Traders can wait for the two lines to crosses while in overbought or oversold territories or they can look for divergence between the stochastic and the actual price before placing a trade.
CCI
The Commodity Channel Index is different than many oscillators in that there is no limit to how high or how low it can go. It uses 0 as a centerline with overbought and oversold levels starting at +100 and -100. Traders look to sell breaks below +100 and buy breaks above -100. To see some real examples of the CCI in action,
MACD
The Moving Average Convergence/Divergence tracks the difference between two EMA lines, the 12 EMA and 26 EMA. The difference between the two EMAs is then drawn on a sub-chart (called the MACD line) with a 9 EMA drawn directly on top of it (called the Signal line). Traders then look to buy when the MACD line crosses above the signal line and look to sell when the MACD line crosses below the signal line. There are also opportunities to trade divergence between the MACD and price.
Volatility
Volatility measures how large the upswings and downswings are for a particular currency pair. When a currency’s price fluctuates wildly up and down it is said to have high volatility. Whereas a currency pair that does not fluctuate as much is said to have low volatility. It’s important to note how volatile a currency pair is before opening a trade, so we can take that into consideration with picking our trade size and stop and limit levels.
Bollinger Bands®
Bollinger Bands print 3 lines directly on top of the price chart. The middle ‘band’ is a 20-period simple moving average with an upper and low ‘band’ that are drawn 2 standard deviations above and below the 20 MA. This means the more volatile the pair is, the wider the outer bands will become, giving the Bollinger Bands the ability to be used universally across currency pairs no matter how they behave. The wider the bands, the more volatile the pair. Most common uses for Bollinger Bands are trying to trade double tops/bottoms that hit an upper or lower band or looking to trade bounces off an outer band in the direction of the overall trend.
Bollinger Bands® is a registered trademark of John Bollinger.
ATR
The Average True Range tells us the average distance between the high and low price over the last X number of bars (typically 14). This indicator is presented in pips where the higher the ATR gets, the more volatile the pair, and vice versa. This makes it a perfect tool to measure volatility and also can be a huge help when selecting where we should set our stop losses.
Support/Resistance
Pivot Points
Being one of the older technical indicators, Pivot Points are one of the most widely used in all markets including equities, commodities, and Forex. They are created using a formula composed of high, low and close prices for the previous period. There is a central pivot line and subsequent support lines and resistance lines surrounding it. Traders use these lines as potential support and resistance levels, levels that price might have a difficult time breaking through.
Donchian Channels
Price channels or Donchian Channels are lines above and below recent price action that show the high and low prices over an extended period of time These lines can then act as support or resistance if price comes into contact with them again. A common use for Donchian channels is trading a break of a line in the direction of the overall trend. This strategy was made famous by Richard Dennis’ Turtle Traders where Dennis took everyday people and was able to successfully teach them how to trade futures based on price channels.
---Written by Rob Pasche
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3 Methods to Identify Trend Resumption
Talking Points:
- Why Focus on Trend Continuation?
- What Does A Common Correction Look Like?
- How to Identify the End of a Correction & Resumption of Trend?
“He that spits against the wind, spits in his own face.”
Benjamin Franklin, 1774
Traders often love to trade a good story. Who blame them? Few things are as exciting as a story that makes sense and price action that mathes the story as you collect the pips.
Why Focus on Trend Continuation
Trend continuation is where a majority of trend traders enter trades and make money. However trends correct or end. This even develops with trends that come with great stories.
Over the last 12 months, there have been a handful of stories that have populated the headlines of DailyFX which have made for excellent trades. Some of the few that come to mind are the Emerging Market Scare or Canadian Dollar Plummit in January. The Resilient Euro in the last few month of 2013. The Weak USDOLLAR through the No-Taper Call by the Fed on September 18th, 2013. The weak Yen trade through the first half of 2013.
Learn Forex: USDCAD & EMFX Corrections Have Been Frustrating
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However, trends come to an end. Even if the trend will eventually resume, which we hope it does, trends will at least temporarily correct as profits are taken. This is where the uncomfortable discipline of patience becomes a must as trend traders wait out the correction before the trend resumes.
What Do Common Corrections Look Like?
Corrections can take many forms. The most common correction is known as a 3-wave correction or zig-zag in Elliott Wave terms but there are more complex corrections as well. The more complex corrections are known as triangles like the one that developed on USDJPY from the end of May ’13 and lasted 5-months before USDJPY tracked higher in late October.
Learn Forex: The Unfriendly USDJPY Correction of Mid-2013
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Trend traders are right to fear complex corrections like a triangle. Correction often due trend traders little favor but to waste time and eat up capital as they hope to catch a breakout. Thankfully, there is a simple correction that is easy to spot and easy to wait for it to break that was earlier introduced as the zig-zag correction. If a correction is not easily recognize, it is often best and most profitable to leave it along until a clear breakout develops.
Learn Forex: Multiple 3-Wave Corrections Have Developed on GBPUSD
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How to Identify the End of a Correction & Resumption of Trend?
There are 3 ways that can help you confirm the end of a correction. While none of these are guaranteed to bring about an incredible trend resumption, they will signal that the momentum is back with the trend. The three methods listed in order of least aggressive to most aggressive are; price breaks of a corrective highs in an uptrend or corrective lows in a downtrend, corrective price channel breaks, and an RSI-break back in the direction of the prior trend.
A price break is what you saw above with the GBPUSD chart. Quite simply, you want a lower high to break in the direction of the preceding trend. This proves to you that short trades against the uptrend are likely getting out of the trade for fear of trend resumption or stops getting hit which can make trend resumption more likely. This method has prevented more bad trades than I can count and for that I’m very thankful for this method.
Learn Forex: Corrective Price Breaks In Direction of the Trend
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Corrective channel breaks help you see when the ceiling of resistance is soon to break in a downward correction. Allowing channels to light your path can be a simple way to make sure you’re not trying to buy the bottom but rather waiting for the market to confirm your analysis. When a price breakout takes place in the direction of the prior trend, you can place a trade above the channel break.
Learn Forex: GBPJPY is testing a Corrective Channel Top Right Now
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Lastly, an RSI is a surprisingly effective albeit aggressive bet. The reason I say aggressive is that a complex correction can still unfold after an RSI break therefore, this method is better for day traders who are comfortable exiting the same day they enter the trade. Regardless, you look for a trendline break of the RSI Oscillator to show you a momentum swing back in the direction of the prior trend.
Learn Forex: RSI Trendline Breaks Can Help You Identify the End of a Correction
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Closing Thoughts
For most traders, correction are better left alone. It’s important that you have patience to trade well and now you know multiple tools to help you identify trend continuation. Once the correction is over and the trend has resumed, make sure you manage your risk!
Happy Trading!
---Written by Tyler Yell, Trading Instructor
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How Trading Outside Of the FX Majors Can Ignite Your Trading
Talking Points:
-The Attraction of Only Trading Majors
-The Benefit of Trading Crosses
-A Current Set-Up With AUDCAD
A majority of the news coverage you’ll see on DailyFX and other sites will revolve around FX Majors. This information
is excellent for building a keen understanding of what are strong or weak currencies. However, you will be putting a major limitation on your trading opportunities if you only focus on the FX Majors.
The Attraction of Only Trading Majors
Many traders will state that they will only trade a major currency pair such as EURUSD, USDJPY, or GBPUSD. This mindset is understandable as you’re likely to see a clear majority of coverage on these currency pairs. However, this limited view of trading opportunities can be a major mistake that can be easily remedied by looking at currency crosses or non-FX majors.
Learn Forex: Current Open Interest at FXCM
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You can see above that at any given time, the open interest on FXCM’s book of client trades are concentrated around 4 trades. The concentration of open trades are often skewed in favor of EURUSD around 30%, Gold or XAUUSD around 15%, a similar reading for GBPUSD, and USDJPY around 10%. Other majors command much less attention like AUDUSD, NZDUSD or USDCAD sitting around 5-7%. This imbalance, regardless of the technical opportunities, appears to be due to familiarity of majors and others wanting to trade what everyone else is trading.
The Benefit of Trading Crosses
My trading strategy has evolved over the years. A major part of my trading system’s evolution is looking for the “low-hanging fruit” in the FX marketplace. If you’re part of DailyFX on Demand, our 8-hour daily program that allows you to trade alongside seasoned traders, you’ll often see me run through an intra-day strong/weak analysis which seeks to divide the strongest and weakest currency pairs among the G10.
Learn Forex: Typical Strong / Weak Rating (Listed Weakest to Strongest)
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You can likely find a great boost in your trading by doing something similar. If you’re unfamiliar with taking a strong / weak approach, you’ll learn that the reasons for one currency becoming the strongest and another the weakest are many. However, strong /weak relationships often develop from an imbalance in monetary policy or interest rate guidance from a central bank along with a technical tipping point.
Here’s a question that often goes through my mind when I think about someone asking me what opportunities are available on EURUSD or GBPUSD vs. EUR-crosses or GBP-crosses.
Why would you want to trade two very weak or two very strong currencies?
Of course, it’s your money and you can trade what your heart desires. However, I can’t imagine trading two very weak or two very strong currencies. A current example is USDJPY. The JPY has resumed weakness after it topped out in early February 2014 around 100.72. Unfortunately, the upside is limited and even if the weak JPY resumes, an even weaker USDOLLAR could upset those banking on JPY weakness taking on its 2013 form.
Learn Forex: USDJPY vs EURJPY Displays The Difference
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On the other side of the spectrum, what if both currencies are very strong. While we haven’t seen a scenario with USD being strong since early January, we have seen an example of EUR & GBP both being rather strong. With a scenario of two strong currencies, you will often see two economies that have extremely supportive fundamental data at the same time and technically, you’re likely to see a range. With a strong / strong scenario, the stronger currency of the two will be which ever has had the most recent news announcement which makes the cross an unfavorable scenario for a trend following swing trader.
A Potential Set-Up With AUDCAD
Referencing the open interest pie chart above, you don’t even see AUDCAD. This means that a small amount of FXCM traders, likely less than 3%, are considering this opportunity that has a favorable fundamental and technical set-up in the near term. We’ve recently come off of a very favorable week of fundamental data out of Australia that brought a developing Ichimoku set-up for AUDUSD. On the other hand, Canada had a dismal employment report.
Learn Forex: AUDCAD Break Could Push Cross Higher
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While the overall trend is down, given we’re trading lower than the March 2013 peak, the resurgence of the AUD brings focus to AUDCAD upside. Technically, the cross just cleared the all-important 1.00 parity level (dotted-line on the chart above) has us looking higher in the next few weeks to the 1.03 level where resistance could be found via the Fibonacci technique. Most importantly though, it brings about a clear technical trade idea on a pair not normally traded which could bring a distinct edge to your trading that other’s do not have because they only look to one or two currencies.
Closing Thoughts
This AUDCAD set-up just shows you how trading outside of the FX Majors can open up trading opportunities you may have not considered before. If you keep your focus only on the majors, it’s possible that they could only present unfavorable technical or fundamental pairings which could limit the opportunities that are available in the FX market week in and week out.
Happy Trading!
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Three Ways to Trade USDJPY Rectangle Pattern
Talking Points:
- The Forex rectangle price pattern is a continuation pattern.
- Since the 300 pip drop from the January highs above 105.30, USDJPY has been locked in a rectangle
- There are three ways to trade a rectangle
Forex currency pairs spend a majority of their time in ranges. These ranges take on a variety of shapes and sizes; diamonds, wedges, triangles and rectangles. These consolidation patterns can stretch out for hours days and weeks. “The longer the base, the higher the race,” is a cliché often used by traders to describe these extended consolidations. The Forex rectangle is on such pattern that offers traders three ways to trade them; breakout above resistance, breakout below support, and range trading.
Learn Forex: USDJPY Daily Chart Rectangle
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Typically, the rectangle pattern is made up of a clearly defined resistance line formed by connecting at least two swing highs. The top of the rectangle acts as a ceiling for price. The forex rectangle also has support line made up of at least two swing points. By measuring the height of the rectangle and projecting that height above resistance and below support, traders can determine breakout price targets. Notice in the chart above how USDJPY price action is contained between the boundaries of the rectangle.
The first way that someone can trade this rectangle is by entering long at the 101.19 to 102.00 support zone in order to trade the range. They would place a stop around 100 pips. Range traders would then look to take profits at the 103.88 rectangle top. If USDJPY reaches the 103.88 resistance zone, range traders may enter short for a move back down to the support zone with a 100 pip stop above the entry.
The second way to trade this a rectangle pattern is by trading the breakout above resistance. Breakout traders will look to enter long when price breaks above the 103.88 resistance zone that formed the top of the rectangle pattern. Bullish breakout traders may look to reduce the amount risked by placing a stop at the midpoint of the rectangle pattern near 102.00 and targeting 106.51.
The third way to trade the USDJPY rectangle is by waiting for price to close below support in the 101.12 to 101.00 area. A protective stop loss can be placed in the middle of the range around the 102.00 area and targeting the yearly pivot point at 99.08. The yearly pivot is also the 100% Fibonacci extension target of the USDJPY drop from the 105.42 high to the February lows of 100.76 and retracement to 103.75.
Since USDJPY entered the rectangle from the top, there is a bias for a bearish breakout. However, price can do what is wishes. If you do choose to trade a breakout above resistance or below support, wait for a closed candle that appears outside the range before entering the trade. In this way, you can reduce the chance of being caught in either a bull trap or a bear trap.
---Written by Gregory McLeod, Trading Instructor
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An Introducation to Trading Strategy
Talking Points:
- There are three basic types of traders
- Traders should develop techniques to fit their trading style
- Once you have a trading plan, practice to perfect your strategy
Each trader must develop their own unique trading style. Normally traders will choose a style based off of the times they trade and the assets the select for trading. Ultimately these strategies will fall into one of three categories. Today we will briefly review the basis of range, trend, and breakout trading and what traders implementing these strategies look for.
Range Trading Strategies
First, range traders use technical analysis to trade sideways moving markets. This is done by identifying price trading horizontally between two areas of support and resistance. Once these values are found, traders can begin to trade between them. Normally ranges are known to occur during times during of low volatility.
The benefit of trading ranging markets is that traders can take a directionless trading strategy. This means range traders will look to initiate both buy orders (at support) and sell positions (as price reaches resistance). As well risk can be clearly defined to exit ranging positions in the event of a price breakout.
Learn Forex: US Dollar Range
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Breakout Strategies
A Price breakout occurs when price action either rises above resistance or drops below support. Normally a breakout is preceded by a consolidating pattern or sideways movements such as a range mentioned above. Savy traders that are aware of these conditions can quickly adapt their trading plan and be prepared to take advantage of the next market move with a use of an entry order while waiting for a breakout.
The advantage of this style of trading is that breakout t traders have the ability to trade with entry orders. This means even if you are not in front of your computer, entries can be set to enter the market if price breaches a certain level. The idea is to enter the market on a surge in price in the direction of market momentum. In the event that price continues to consolidate these entry orders can easily be deleted and traders may then look for trades elsewhere.
Learn Forex: EURUSD Daily Breakout
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The Retracement Strategies
Lastly, trend traders look to take advantage of strong directional movements in the market. Trading a retracement is probably one of the most popular methods of doing so. Retracements traders will wait patiently for a pullback in the trend and then enter into the market. In the uptrend depicted on Gold below, this would allow traders to buy at a cheaper price, as opposed to entering the market on a breakout towards higher highs.
Retracements can also be timed using oscillating indicators such as CCI pictured below. These indicators use overbought and oversold levels to time momentum turning back in the direction of the trend. For more information on trading with CCI be sure to take advantage of DailyFX’s training course through Brainshark. The course is free and after clicking the link below sign into our ‘Guestbook’. You will be met with a series of videos including other strategies involving the CCI Indicator!
Learn Forex: Gold Overbought & Oversold with CCI
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---Written by Walker England, Trading Instructor
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How to Identify and Trade Market Swings
Talking Points:
- Trend traders can wait for swings against the trend before entry
- Pullbacks in price allow traders to buy the market at a lower price
- An identified swing high or low can be used for setting risk and taking profit
Traders should first look for market direction, before implementing their favorite trading strategy. If a market is trending, traders can wait for a market swing to provide excellent opportunities for placing new entries in the market. Today we will look closer at market swings and how they can be traded by trend traders.
What is a Market Swing?
A market swing is a direct reference to the price action being displayed on the graph. Since price rarely heads in one specific direction, a swing helps define the changes in price. A swing high is looking at the current high displayed on a graph, while a swing low represents the current outstanding low. Normally these swings also help define the trend, if the swing highs are getting higher and the lows are getting higher as well that is a sign of a strong uptrend.
Below we can see an example of the swing high and swing low during an uptrend, on XAU/USD(Gold). Price has been trending upward culminating in price forming a swing high at $1,391.37. From this point, price has pulled back this week to form the current swing low in price which stands at $1,320.40. So now that you know how to spot a price swing, let’s look at how we can take advantage of them.
Learn Forex: Gold with Swing Highs and Lows
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Trading Retracements
Normally traders look to trade swings back in the direction of the trend. These swings against longer term momentum are known as retracements and can allow traders some excellent trading opportunities. Much like in the example with gold any pullback in an extended uptrend can be seen as an opportunity to buy into the market at a cheaper price.
To execute a retracement strategy on a market swing, traders will look for price to put in a new swing low in an uptrend. An entry can then be made when momentum returns back in the direction of the primary trend. Many traders prefer to use an oscillator to time this portion of their strategy by using an indicator such as CCI, MACD or RSI. Risk can also be contained using market swings. In our example stops can be set under the swing low. In the event a lower low is printed, our trend is at least temporarily concluded and all positions should be vacated.
Learn Forex: Entries Using a Swing
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Take profit levels in an uptrend can also be based around an identifiable swing high. As the trend resumes positions can be exited near the denoted point on the graph. Once the trade has concluded, traders can then wait for the next market swing to plan a new entry!
---Written by Walker England, Trading Instructor
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