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How to Build and Trade Strategies
How to Build and Trade a Trend-Following Strategy
Talking Points:
- Traders should look to match their strategy with the appropriate market condition.
- Trends can be attractive since a bias has been witnessed in that particular market.
- In this article, we show how traders can begin to develop their own trend-trading strategy.
To anyone trading in markets, it’s often advisable to have a strategy of some type to go about doing it.
After all, just ‘guessing’ isn’t likely going to work out too well for anyone speculating in markets over the long run. Having some idea for the type of situation one is looking for can be extremely helpful. With a strategy, traders can look to focus on situations in which the market may be giving them the best probabilities of success.
After discovering the necessity of a strategy, traders will often go on to seek the ‘best’ strategy that they can find. This can be an elongated process for some folks, as many traders are often looking for something that doesn’t exist: They’re looking for the strategy that rarely (or never) loses.
This just doesn’t exist.
Regardless of how strong a strategy ever might be, it will never be 100% predictive of market movements. The future is opaque with or without a strong strategy. A good strategy can simply allow the trader to focus on higher-probability setups and situations in an effort to win more money than they lose; so that they may be able to net a profit.
Markets will often exhibit one of three different conditions, and traders are often best served by matching their strategy with the appropriate market condition.
In this article, we’re going to focus on the most popular condition: Trends.
Trend Trading
Of the three possible market conditions, trends are probably the most popular amongst traders; and the reason for that is what we had alluded to a little earlier.
The future is opaque, and price movements are unpredictable. By simply recognizing a trend, the trader has noticed a bias that has shown itself in the marketplace. Maybe there is improving fundamental data for that economy; or perhaps it’s a central-bank driven move on the back of ‘Yen-tervention’ or another round of QE.
Trend Trading
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Whatever the reason, a bias exists in the market and that’s visible from the trajectory on the chart. The alluring part of this is that if that bias continues, the trader might be able to jump on the trend, and let the market do the heavy lifting of moving the position into profitable territory.
Another attractive aspect of trading with trends is that the speculator can look to employ the age-old logic of ‘buy-low, sell-high.’ It’s not enough to simply buy an up-trend, or to sell a down-trend. Traders are often best served by waiting for the up-trend to pull back before buying (or waiting for a down-trend to rip higher before selling), in an effort to enter the position as cheaply as possible.
This way, if the trend doesn’t continue, the trader can exit the position quickly before the loss becomes too unbearable. But if the trend does continue, the trader might be able to profit by three, four, or five times the amount they had to initially risk to enter the trade.
How to Build a Trend Strategy
Many of the most popular indicators can be helpful when designing a trend strategy. And to take technical analysis a step further when designing a trend-trading approach, many traders will look to utilize multiple time frame analysis in order to get multiple looks at a trending market.
When utilizing multiple time frame analysis with a trend-trading strategy, traders are often going to look to the longer time frame to find and diagnose the strength of the trend. This can be done in a multitude of ways. Some traders will prefer to do this without any indicators at all, using price and price alone.
Other traders will look to one of the more common indicators, the moving average. There are a lot of different flavors and types of moving averages, but the goal is all the same – to show us a ‘line-in-the-sand’ as to whether price movements are ‘above-average’ or ‘below-average’ for a given period of time.
Moving Averages can help traders diagnose and trade trends
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After the trend has been diagnosed, the trader can then plot the entry into the position; and for that, there are a multitude of options available.
Entering into the Trend
There is an old saying that goes: ‘The Trend is your friend… until it ends.’
This one line pretty much sums up the quandary that traders are faced with when trading trends. While a bias has been exhibited in the marketplace, and may continue; there is no such thing as a ‘sure-fire trend continuation setup.’
So, when the trend doesn’t continue, the trader is often advised to look to mitigate the loss so that a reversal doesn’t damage their trading account too badly.
In an effort to be as precise as possible, many traders will move down to a lower time frame in an effort to get a more detailed look at the move inside of the larger-term trend.
Price Action can help traders diagnose and trade trends
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Traders can also look to use indicators to plot an entry, under the premise that the longer-term trend may be at the early stages of its continuation; and can be entered upon with the shorter-term chart.
There are numerous indicator options for this premise. Many traders will look to oscillators such as RSI or MACD to trigger the position. Other popular options are MACD, Stochastics, CCI, and the moving average crossover.
Traders looking to speculate with the trend want to focus ONLY on signals that move in that direction.
So, for instance, if an up-trend has been found on the longer-term chart, then the trader is only looking to buy. If they are looking to sell, then it’s not a trend-trading strategy any longer as the trader is looking for a reversal (or a swing) that doesn’t agree with the longer-term trend direction.
Types of Trend-Trading Strategies
The future is unknown; and nobody has a crystal ball that will magically foretell tomorrow’s price movements. But the fact of the matter is that biases do exist, trends do take place (for a reason), and in many cases those trends may continue.
If traders want a more objective way of trading with trends, they can look to implement an indicator like RSI to trigger the position after the trend has been graded on the longer-term chart with Price Action.
Traders looking to use indicator-based strategies can take this a step further with the logic utilized in my ‘fingertrap’ scalping strategy. In such the strategy, moving averages are used to grade the trend on a longer time frame, and a moving average/price action crossover on the shorter time frame is used to trigger in the direction of the trend. While this is designed as a scalping strategy, traders can certainly swap out the time frames to make the logic of the strategy operable on a longer-term basis.
-- Written by James Stanley
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Trading the Break
Talking Points:
- Breakouts emanate from range-bound markets as new information pushes prices higher or lower.
- These breaks can often be accompanied with increased volatility that can prove devastating
- Risk-Reward ratios are of the upmost importance, so traders can mitigate the damage of false breakouts while maximizing the reward of successful entries.
Since future price movements are, in essence, unpredictable; identifying with and trading in the direction of the trend gives the trader the chance to jump on the side of any bias that may have been seen in the market. And if those biases (trends) are to continue, the trader can potentially make three, four, or five times the amount they put up to risk.
Unfortunately, trends don’t always exist. More common is the condition with which prices aren’t displaying some element of a bias; when prices move in a range-bound fashion for an extended period of time. And because there is a lack of a bias, knowing how to trade in these situations can be quite a bit more difficult. But traders have two choices: They can trade as if the range is going to continue, or they can trade the range in the expectation of a breakout of those range-bound prices.
In this article, we’re going to delve deeper into trading the breakout.
Breakouts come from ranges
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Breakouts
When prices do break-out from a range, the movement can be fast, violent, and extremely large. Imagine a rubber band being pulled all the way back, until eventually it pops; that’s somewhat similar to what can happen when a breakout takes place.
Trading a breakout is not for the faint of heart. Often the breakout will come from a news event, or a data announcement, or some other reason that causes traders to push prices being the previously defined support and resistance levels.
It often takes more than one attempt to catch a breakout
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It’s this extreme pickup in volatility that makes trading breakouts so difficult; as the accompanying price movements can swing dangerously in both directions, and there will be many instances in which support and/or resistance get broken, only to see prices reverse and move in the opposite direction. This is the dreaded ‘false breakout.’
Because of the heightened volatility around such events, and given the risk of false breakouts; traders often need to focus more heavily on risk and reward while being more aggressive: cutting losers even quicker while also looking for larger profit targets when they find themselves on the right side of the trade.
Probabilities
As we discussed in our trend-trading article, whenever a bias has been seen in the market, the trader may be able to jump into the trade with the expectation of that bias continuing. Or to put it more simply, the trader may be able to get the probabilities in their favor simply by trading in the direction of the bias (or trend).
With a range-bound market, there is often no bias to be seen. Prices are caught between support and resistance. If prices get too high, traders sell: If they get too low, traders buy. To break out of these support or resistance zones, the market often needs a motivator of some type; like a news announcement.
And when we do get that eventual motivator, volatility picks up and prices begin moving much more wildly. This means that there are many occasions in which support or resistance will be broken during this onslaught of volatility only to see prices reverse and move in the other direction. These false breakouts can make trading this condition utterly frustrating; and this why new traders may be best served by focusing on the more formulaic trend-based market conditions.
Traders will often assign a lower probability of success to breakout strategies because of the aforementioned reasons. If a trader thinks they can usually win 1 out of every two trend trades, they will often look to win 1 of every 4 breakout trades.
And because breakouts have a lower probability of success, traders need to adjust risk-reward ratios accordingly: Looking at even tighter stops, and even larger profit targets.
In The Number One Mistake that Forex Traders Make, we advised looking for a minimum risk-reward of 1-to-1 (1 dollar sought for every 1 dollar risked). Because breakouts often have a lower probability of success, traders should look to be even more aggressive by seeking at least 2 dollars for every 1 dollar put up as risk.
To many, the juice is worth the squeeze
So, we’ve warned you against the risks of trading breakouts; a logical question that follows is often ‘why would anyone trade breakouts when there might be a trend somewhere that can be traded?’
Well, the beauty of the breakout is in the potential. When a breakout does work, the upside can potentially be huge (just like the downside is huge, but can be addressed or offset with tighter stops).
New trends often form from an initial breakout; and this is a very natural life-cycle in financial markets. Let’s look at an example to illustrate.
Most new trends start with a breakout
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It’s this outsized profit potential that make breakouts so enticing, and the fact that large movements can be seen in a very short period of time is what makes the condition so attractive.
How to Trade Breakouts
The key ingredient to trading a breakout is Support and/or Resistance. These levels that may see changes in order flow are the same prices that traders can look to enter upon breaks.
Pivot Points are an extremely common option for breakout traders. Traders can look to these price levels for potential breakout moves, while placing entry orders just outside of these prices so that once a pivot point yields to a price surge, the entry is initiated and the trader is in the position.
Another common option for trading breakouts is including the Price Channels indicator (often called ‘Donchian Channels,’ after famed breakout-trader Richard Donchian). Price Channels will show the highest high, and the lowest low over the past x periods (x being the number of candles input by the trader). When prices approach these levels, they may go on to make higher highs, or lower lows; and this is the essence of a breakout entry.
The same type of logic can be utilized around psychological whole numbers, or round levels like 1.3500 on EURUSD or .9000 on AUDUSD. These round-number price levels will often see a large number of stops or limits, and this can stop a trend dead in its tracks, at least temporarily. But when a subsequent approach towards that level takes place, the number of stops or limits may not be able to hold back the surge of selling (or buying in the case of an up-trend).
This leads to one of the more common ways of trading breakouts; incorporating price action and previous market movements into the analysis.
By noticing price levels at which the market has respected in the past, traders can look to place entries outside of those prices so that if a subsequent move towards those levels is strong enough – the position is opened.
This can be taken a step further to combine price action with other mechanisms of support and resistance, like psychological levels, or Fibonacci, or Pivot Points to seek out the ‘strongest’ levels of support and/or resistance. The fact that the market had honored those levels in the past via price action can serve as a form of confirmation that the price has had relevancy in the past; and if price approaches it again, it may not be as relevant in the future.
-- Written by James Stanley
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What You Need To Know About Your Trade Position Size Strategy
Talking Points:
-Why Traders Need to Focus on Position Sizing
-Martingale vs. Anti-Martingale Technique of Position Sizing
-Can You Maximize Profits By Adding To Losses?
Do you think if you’ve unfortunately placed five losing trades in a row that the next one is due to be a winner? If so, you’re likely prone to overleveraging that 6th trade, thinking it will be profitable. If it becomes a loss again, you will soon find your promising Forex career coming closer to an unnecessary end. Instead, it’s best to focus on calming potential frustrations as a trader and not place too much emphasis on one trade unless it’s winning big, in which you can look to take advantage of adding to that trade at opportune times.
Why Traders Need to Focus on Position Sizing
With a relatively fixed account balance to start trading any market, you must focus on the position size you will have on each trade. You’ve likely heard the phrase, ‘cut your losses short and let your winners ride,’ but many traders make a key mistake. That mistake is that they often add to losing trades trying to buy the bottom in a downtrend and do so with more leverage which is effectively known as the Martingale approach.
Many successful traders have a few key components of their trading strategy in common. For example in the book, Market Wizards, by Jack Schwager, most successful traders feel that any person can place a winning trade, but unless you can control risk, you have little chance at overall success. Here are some of my favorite quotes:
"You have to minimize your losses and try to preserve capital for those very few instances where you can make a lot in a very short period of time. What you can’t afford to do is throw away your capital on suboptimal trades."-- Richard Dennis
"Risk management is the most important thing to be well understood. Undertrade, undertrade, undertrade is my second piece of advice. Whatever you think your position ought to be, cut it at least in half."-- Bruce Kovner
Also interviewed in the book of Market Wizards, Dr. Van K. Tharp discusses the mental aspect around making decisions in controlling risk and reducing trading risk. Those are simply a few examples of many other traders who have come to realization that in due time, managing your position size to control market risk becomes more important than what triggers your entry into a trade. When we analyzed over 12,000,000 live traders in our Traits of Successful Traders report, we also found that position size / leverage were a key component of overall success.
Learn Forex: Position Size & Leverage Are a Key Determinate of Your Success
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Martingale vs. Anti-Martingale Technique of Position Sizing
There are two common position sizing systems that you should know about so that you can avoid one and consider the other. The most popular system is known as the Martingale, whereby you add to a losing trade in the hope of lowering your average entry price which requires a smaller move in your favor to break even. The Martingale entries are usually staged at fixed increments of 50 or 100 pips but as you’ll soon see, one small trade can soon wipe out your account.
The other system is known as the Anti-Martingale. An impressive number of fund managers and successful traders utilize the Anti-Martingale whereby you add only to winning trades. The Anti-Martingale takes on the assumption that adding to a losing trade will drain your account and you should only look to capitalize on a winning streak or trend and thereby, ‘let your profits run and cut your losses short.’
When you’re in the heat of the moment, the Martingale system feels like such an approach would work. However, from a mathematic model perspective, the Martingale leads to sure ruin eventually and all it takes is one strong trend that you’re on the wrong side of. Here’s a breakdown of the volatile equity swings that can take place when an account employs the Martingale system.
Learn Forex: Sample Account Which Increases Trade Size Only To Losing Trades
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This example shows a profitable example but it’s helpful to think on this question. What would happen if you had a string of 10 losing trades in a row? It could happen and if you were adding to each loss of 100 pips hoping that it would eventually turn around, then you could be facing a Margin Call due to the inherent fallacy of this strategy.
Learn Forex: Sample Account Where Martingale Meets String of Losing Trades
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You can easily get into trouble with the Martingale approach when you think that a trend can’t continue. Of course, it wouldn’t take long to find multiple examples of times when an imbalance in monetary policy caused a huge shift in the market and a new trend is born. Here is a recent example of USDCAD which pushed 650 pips in a few months without retracing more than a hundred pips on its push higher until recently.
Learn Forex: The Recent USDCAD Trend Shows How Quickly the Martingale Can Blow-Up
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This argument against the martingale approach whereby you add to losing trades begs a simple question. If this system is so popular, is there any situation where it does work? In my experience, there are two scenarios where Martingale can work. In a strict range bound market, it can work well but one breakout out of the range against your positions will wipe you out in due time. The second scenario is if the trader has unlimited capital.
Can You Maximize Profits By Adding To Losses?
Adding to your losses is a harmful strategy that can work in the short-term but has a very poor long-term track record. If your trade is losing, the most likely scenario is that your analysis was off or your timing was off but either way, it’s costing you money to stay in the trade and the best move is to exit the trade until the waters calm and you can make sense of the overall landscape. To grow your account, you should be advised to focus only on trading in a way that has a mathematical probability of growing your account and not trading to prove that you’re smart. If you take your trading beyond the p/l and make a winning or losing trade as emotional validation, then you could quickly become a martyr of your own faulty analysis.
Happy Trading!
---Written by Tyler Yell, Trading Instructor
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How to Trade Ranges
Talking Points:
- Traders are often best served by using the strategy most applicable to the prevailing market condition
- Ranges occur when prices are caught between support and resistance
- In this article, we teach traders how to approach and trade range-bound market conditions
In our last article, we looked at Trading Breakouts, and in the article before that we showed you How to Build and Trade a Trend-Following Strategy. In this article, we’re going to address the market condition that comes up the most often: The Range.
There is a reason we saved this condition for last. Ranges can be difficult to trade, and many traders will eschew ranges to trade in trending or breakout conditions. As we explained previously, trends display a bias that the trader might be able to latch on to; and breakouts offer massive upside potential when they work… but ranges don’t offer either of these features.
Ranges take place when prices find themselves caught between support and resistance. And when this happens, traders can address the range on one of two ways. They can trade for the range to continue, which means that up-side is limited (by the other side of the range); or they can look for the eventual breakout from the range that may turn into a new trends. The picture below will illustrate further:
Do you want to trade the range to continue, or to look for the breakout?
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If you want to look to trade the breakout from these range-bound periods in the market, please take a look at the article, Trading the Break in which we teach traders to do just that. In this article, we’re going to further investigate the art of trading the range.
Trading Ranges
Many traders will ignore ranges because the perceived profit potential may be limited. After all, if we’re trading a range by buying support, then we’re reasonably looking to close the position at resistance. This would be a limited-upside type of proposition, and that may not seem nearly as attractive as a trend or a breakout where the trader can potentially look for 3 or 4 times their risk amount if they’re able to get on the right side of the trade.
But, the range is the market condition that we, as traders, will likely encounter the majority of the time.
Ranges can develop in numerous ways. We may see a short-term range towards the top of an up-trend, as buyers and sellers fight to control the next trend. Or perhaps a long-term bout of indecision creates congested price movements that stay bounded between support and resistance levels. Whatever the context might be, if prices are bound between support and resistance then the trader is seeing a range-bound period in the market.
And if the trader is going to trade for the range, then they need to make absolutely sure that they manage their risk properly; because a breakout moving in the opposite direction of the trader’s position can amount to a monstrous loss as that breakout may turn into a new trend that continues to drive against the traders equity line.
Trading Ranges requires stops in the event that a breakout takes place against the trader’s position
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How to Find and Trade Ranges
The goal when trading ranges is similar to the goal when trading trends: To buy low, and sell high.
The only other real requirement for a range is that price action needs to be bound between support and resistance, giving the trader the idea that if previously established support and resistance remain respected, the trader may be able to see a profitable position.
One of the difficult aspects of doing this is that prices will rarely adhere to an exact identical price as support or resistance; and often ‘zones’ around supportive or resistant prices are much more applicable. This is where price action analysis can bring considerable benefit to the trader.
We discussed how traders can look for and trade ranges with price action alone in the article, How to Analyze and Trade Ranges with Price Action.
In the article, we teach how you can use recent price action to produce a strategy with a technical setup such as we’ve outlined below:
Zones of Support and Resistance can make trading range-bound conditions more feasible
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Traders can also look to incorporate additional elements of support and/or resistance in the range including pivot points, Fibonacci, or psychological whole numbers; but it’s important that traders have seen a price action swing around that particular price, thereby validating that level as a price with which the market has respected, and may respect again in the future.
Taking Range-Trading a Step Further
No range lasts forever. Breakouts come from ranges, and breakouts can lead to new trends. So traders can use this information to their advantage when trading in a range.
Let’s say, for instance, that a trader buys support with anticipation of a range continuing. But when prices move to resistance, the trader takes a second look at their profitable position, and decides that they may want to stay in the trade in case a breakout takes place to the up-side.
Well, if the breakout doesn’t come in, and if the range fills in as the trader had originally anticipated; they can watch all of their profit drain away and maybe even more if the trade runs to their stop.
This would be a bad way of trading a range.
What can be done, however, is some position management in the event that a breakout may occur. Rather than closing the entire lot when the price moves up to resistance, the trader can look to close a portion of the position so that, if prices do reverse – at least they’ve taken some profit out of the trade. But if the breakout takes place, they have a remaining part of the position that can reap those rewards.
This would be similar to scaling out of the trade, and if the breakout happens to turn into new trend, the trader can go into the new trends with a hearty profit floating in the trade, which can be used to initiate a new position in the event should the trend continue.
Traders can also look to adjust their stops to break-even, so that if the breakout doesn’t turn into a new trend, and prices reverse – the trader can be taken out of the remainder of the position at their original entry price.
-- Written by James Stanley
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How to Find the ’Best’ Currency Pair to Trade
Talking Points:
- Whether traders are speculating in trends, ranges, or breakouts – currency pair selection can bring significant value.
- While the major pairings can offer considerable volatility, they may not be the best markets for traders to voice their opinions
- We walk through two ways that traders can perform Strong-Weak Analysis: Manual, and Automated through the StrongWeak App
Options are abundant in the currency market…
While a few major pairings dominate the volume from many traders in the currency market, the value of finding the best possible pairing to execute your strategy cannot be understated. While the major currency pairs can offer significant volatility and fast movements, they may not be the best pairs to voice a trader’s opinion with. If you’re not familiar with the ‘major’ currency pairs, they are outlined below:
The Major Currency Pairs:
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These are the most popular currency pairs that are traded by forex traders, and if you’d like to learn more on the topic, Walker England penned this article entitled ‘Understanding the Forex Majors.’
But are these the best pairings to focus on? Let’s walk through an example together.
Let’s say that a trader was expecting strength in the British Pound, so they decided to buy GBPUSD. And let’s say that good news comes out for The United Kingdom, which should equate to British Pound strength; only the US Dollar saw even more strength than the Sterling, and instead of moving higher as you had expected, the pair moves lower.
So –in essence: You were right – but you still LOST in the trade because the Dollar got stronger than the British Pound.
When traders force themselves to only trade the major currency pairs, it’s similar to ‘trying to fit a square peg into a round hole.’
Let’s take the above scenario from another perspective:
Same as above, you expect the British Pound to increase in value, so you want to buy Sterling. But instead of just blindly buying GBPUSD – you search for the most optimal pair to do it with. So, after some perusal, you find that the Canadian Dollar has been extremely weak (more so than the US Dollar); and you decide that you want to marry up what you think is a strong GBP with a weak CAD.
And let’s consider that this time, you were wrong… and the British Pound didn’t see strength. Well, as long as the CAD remained even weaker than British Pounds – you can still win.
So, by focusing on the most optimal pairing, the trader stands the chance of being wrong and still winning in the trade.
Because every currency pair includes two economies being traded against each other, traders are best served best by analyzing botheconomies in an effort to match a strong currency with a weak one. Traders want to look to eliminate the instances of being right, but still losing; while increasing the chance of being wrong and still winning.
How to Separate the Strong from the Weak
As you can imagine, pair selection is a key tool of the FX trader; and as such we’ve tried to provide a litany of resources to assist traders with the analysis.
Strong-Weak analysis is a process with which traders can look at, and accordingly grade a single currency’s strength and/or weakness against each of the other individual currencies. This is the process that the trader in the above scenario that would lead the trader to look at buying GBP against CAD as opposed to the US Dollar, and this is how traders can begin to focus on the optimal pairings for their goals.
There are two ways to do this analysis. The manual, long-form method for doing this analysis was outlined in the article entitled How to Separate the Strong from the Weak. With a charting package and just a little bit of math the trader can build a table such as below:
Strong-Weak Analysis can be performed manually with a spreadsheet and charting package
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We walk through the application, as well as popular usages of the application, in this video embedded into the brainshark medium. After clicking on the link, you’ll be asked to input information into the ‘Guestbook,’ after which you’ll be met with a 12-minute video that further explains the app.
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3 Types of Forex Analysis
Talking Points:
- Three general forms of analysis that traders use
- Find one or a combination of styles that fits your personality
There are several different ways to analyze the FX market in anticipation of trading. Though categories of analysis may be plentiful, keep the end goal in sight which is to use the analysis to identify good trading opportunities.
We will look at the three main areas of analysis and how to learn more about them. Then, try out each of these areas to determine which of the three methods or combination of the methods works well for your personality. The three areas are:
- Fundamental
- Technical
- Sentiment
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Fundamental
Forex fundamental centers mostly around the currency’s interest rate. Other fundamental factors are included such as Gross Domestic Product, inflation, manufacturing, economic growth activity. However, whether those other fundamental releases are good or bad is of less importance than how those releases affect that country’s interest rate.
As you review the fundamental releases, keep in mind how it might affect the future movement of the interest rates. When investors are in a risk seeking mode, money follows yield and higher rates could mean more investment. When investors are in a risk adverse mentality, then money leaves yield for safe haven currencies.
Technical
Forex technical analysis involves looking at patterns in price history to determine the higher probability time and place to enter and exit a trade. As a result, forex technical analysis is one of the most widely used types of analysis.
Since FX is one of the largest and most liquid markets, the movements on a chart from the price action generally gives clues about hidden levels of supply and demand. Other patterned behavior such as which currencies are trending the strongest can be obtained by reviewing the price chart.
Other technical studies can be conducted through the use of indicators. Many traders prefer using indicators because the signals are easy to read and it makes forex trading simple.
Sentiment
Forex sentiment is another widely popular form of analysis. When you see sentiment overwhelmingly positioned to one direction that means the vast majority of traders are already committed to that position.
Since we know there is a large pool of traders who have already BOUGHT, then these buyers become a future supply of sellers. We know that because eventually, they are going to want to close out the trade. That makes the EUR to USD vulnerable to a sharp pull back if these buyers turn around and sell to close out there trades.
---Written by Jeremy Wagner, Head Trading Instructor, DailyFX Education
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Trader Styles and Flavors
Are you a medium-term technical trader that uses automation software to place your Forex trades, or are you more of a long-term fundamental trader that places discretionary trades?
Neither?
With so many different ways to trade, it’s difficult to keep track of them all.
Traders come in all styles in flavors which is the topic of today’s discussion.
Technical vs. Fundamental
Technical analysis is the art of studying past price behavior and attempting to anticipate price moves in the future. These are traders that focus solely on price charts and often times incorporate indicators and tools to assist them. They look at price action, support and resistance levels, and chart patterns to create trading strategies that hopefully will turn a profit.
Fundamental analysis looks at the underlying economic conditions of each currency. Traders will turn to the Economic Calendar and Central Bank Announcements. They attempt to predict where price might be headed based on interest rates, jobless claims, treasury yields and more. This can be done by looking at patterns in past economic news releases or by understanding a country’s economic situation.
Short-Term vs. Medium-Term vs. Long-Term
Deciding what time frame we should use is mostly decided by how much time you have to devote to the market on a day-to-day basis. The more time you have each day to trade, the smaller the time frame you could trade, but the choice is ultimately yours.
Short-Term trading generally means placing trades with the intention of closing out the position within the same day, also referred to as
“Day Trading” or “Scalping” if trades are opened and closed very rapidly. Due to the speed at which trades are opened and closed, short-term traders use small time-frame charts (Hourly, 30min, 15min, 5min, 1min).
Medium-Term trades or “Swing Trades” typically are left open for a few hours up to a few days. Common time frames used for this type of trading are Daily, 4-hour and hourly charts.
Long-Term trading involves keeping trades open for days, weeks, months and possibly years. Weekly and Daily charts are popular choices for long term traders. If you are a part-time trader, it might be suitable to begin by trading long term trades that require less of your time.
Discretionary vs. Automated
Discretionary trading means a trader is opening and closing trades by using their own discretion. They can use any of the trading styles listed above to create a strategy and then implement that strategy by placing each individual trade.
The first challenge is creating a winning strategy to follow, but the second (and possibly more difficult) challenge is diligently following the strategy through thick and thin. The psychology of trading can wreak havoc on an otherwise profitable strategy if you break your own rules during crunch time.
Automated trading or algorithmic trading requires the same time and dedication to create a trading strategy as a discretionary trader, but then the trader automates the actual trading process. In other words, computer software opens and closes the trades on its own without needing the trader’s assistance. This has three main benefits. First, it saves the trader quite a bit of time since they no longer have to monitor the market as closely to input trades. Second, it takes the emotions out of trading by letting a computer open and close trades on your behalf. This means you are following your strategy to the letter and are not able to deviate. And third, automated strategies can trade 24 hours a day, 5 days a week giving your account the ability to take advantage of any opportunity that comes its way no matter the time of day.
---Written by Rob Pasche
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3 Points of Validation for Any Price Breakout
Talking Points:
-The 3 Components to Validate a Breakout
-The 3 Components Applied to GBPUSD & Prior Breakouts
-1 Question to Help You Avoid a Bear / Bull Trap
“An important rule in trading is that time is much more important than price.”
-Mark Fisher, The Logical Trader
Few things are more exciting to a trader than a price breakout. Many questions rush to mind as you wonder if you’re on the cusp of the world’s next hottest trend or if this will be the move that makes your week, month, or year. However, it’s best to calm down when you first recognize the price break and look for a 3 developments of a break to confirm that the breakout is worth a risk of your capital.
Learn Forex: If GBPUSD Breaks, Here Are Key Levels
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The 3 Components to Validate a Breakout
It’s very easy to fall into the trap of focusing only on the initial break of a key support or resistance level. After all, many traders are told to think of support as a price floor and if that floor gives, then price will fall and similarly price will likely rise when a high price, or resistance is broken. Unfortunately, markets do not work in that manner where a price going one pip past a key level means the markets are forever changed. In fact, you can often see price sometime peak past an old key level only to reverse and trap many hungry and impatient traders into a move.
The 3 key components that can help you validate a break out is simple. First, you look for price to break the level that was known as support or resistance. A price break is usually the only definition of breakout trading.
Learn Forex: The Inability of a Breakout to Hold the Close Should Cast Doubts
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Second, you want to see if the close can honor and hold the breakout. The logic behind this thinking is that if price pushes higher but the close is significantly lower than the breakout than the conviction was low. If conviction is low then the bullish momentum is ripe for a reversal as many large traders may have already taken their profits on the prior rally.
Third, if price breaks the key level and if the close can hold the breakout, then you want to give a specified period of time to show that the market honors this new level. If you’re trading on a daily chart, you can look for 3 days after the close honors the new breakout. If you’re on an intra-day chart, you can use a fraction of your preferred time-frame to validate the intra-day breakout. If the market honors the new level by not trying to push it down, then you can take that at as a signal to be looking for entries in the direction of the breakout.
To sum it up, you want to see 3 things to validate a breakout:
- Price-break
- Closing in favor of the breakout
- Pre-determined time in new price zone
The 3 Components Applied to GBPUSD
We’ve just covered that for a breakout to be a higher-probability and less frustrating trade, you should look for 3 components. The 3 components, break-close-hold, will help you see a likely follow through of the breakout. Of course, as a trader, if the breakout doesn’t follow through, you can lose money in a bull trap if you bought on the break alone without a close and hold.
Learn Forex: GBPUSD Only Has 1/3rd of Breakout Validations Thus Far
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What you’ll see above on the GBPUSDchart, where we’re looking to validate the breakout, is based on the 2011 high. This is applied to a daily chart but can be used across multiple-time-frames. We have seen a few price breaks in mid-February, but we’re yet to see the close above 1.6747.
In addition to awaiting the close above the 2011 high, a validation would be better confirmed if price could stay in the new-zone for a pre-set amount of time. You’ve seen the first chart with two major levels above 1.6745 that would come into focus if the 3 rules hold therefore, it’s OK to be patient with those targets in view. The first big target, the 2009 high is 300 pips away followed by roughly an 800 pip target with a corrective high of 2008.
1 Question to Help You Avoid a Bear / Bull Trap
To improve your performance as a trader, you need to be able to honestly ask and honestly answer some key questions. If you’re targeting breakouts, like I do, then there is one question I’d like to leave you with. The question:
“Has this breakout proven itself with a time element and not just a price element?”
As a trend trader, I focus on time as much as price. The time of the trend is what makes trend trading indicators like Ichimoku to be such a helpful system. Whichever system you choose, looking for further validation of a breakout can be a prudent and helpful way to trade breakouts.
Happy Trading!
---Written by Tyler Yell, Trading Instructor
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How to Direct Your Strategy based on Market Condition
Talking Points:
- Traders should look to focus their strategies in appropriate market conditions.
- Multiple time frame analysis can offer a ‘bigger-picture’ view of a market.
- Traders can choose to trade trends, ranges, or breakouts based on their analysis.
In our last article, we looked at The Life Cycle of Markets. As we discussed, markets will often display one of three major market ‘conditions,’ which can greatly denominate the manner in which that trader should look to speculate.
Trends show a bias that has been displayed in the market place; and when a strong trend is available, the trader’s job is simple: To trade in the direction of that trend. If the trend is up, the trader should look to buy; and if the trend is down, the trader should look to sell.
Unfortunately trends don’t always exist; and when that often entails congested, range-bound price movements as bulls and bears both fight to take over control of the market in search of the next trend. These range-bound environs can be more dangerous, and given the limited upside that might be available, many traders will often eschew trading the range; instead waiting for the inevitable breakout that may end the range and lead into a new trend.
The Varying Tonalities that a Market May Show
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In this article, we’re going to discuss how traders might look to focus their strategies on the appropriate market condition.
The Benefit of Multiple Time Frames
The value of being able to get a ‘bigger picture’ view on a market cannot be understated. To think of the value of multiple time frame analysis, think of trading in a currency pair like buying a home.
If you’re going to buy a home, you’re likely going to want more of an overview than simply driving by and getting a quick glance. This is like trading a currency pair when only seeing one time frame.
When buying a home, you’ll likely want to get out of the car and walk around to ensure that the back yard isn’t in complete disarray. You want to check the foundation to make sure that you’re not going to have exorbitant repair expenses in your future. You want to get as much information as is feasibly possible to make the most intelligent purchasing decision that you can.
Trading in a market isn’t all that different, the more information you have the more of an informed decision that you can make.
In The Time Frames of Trading, we offer some common time frames based on desired holding time.
Multiple Time Frame Intervals for Trend Diagnoses/Entry
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If a trader is looking to hold a position for a few hours to a few days (commonly called ‘Swing Trading’), the four-hour chart can be the optimal time frame for entering positions.
And if the four-hour time frame is being used to enter positions, the daily chart can be used to gauge the trend (or lack thereof); so that the trader can ensure they are focusing the optimal approach on the prevailing market condition.
Or perhaps a longer-term trader wants to use the daily chart to enter trades. Well, then the weekly chart can be used as the longer time frame to guide the trader’s decision-making processes.
The benefit of using a longer time frame in the decision as to which strategy to utilize is that the trader can take more information into account, getting an idea of the ‘bigger picture’ before executing on their strategies.
Gauging Trend Strength (or lack thereof)
Once a trader has determined the time frame with which they want to look to grade the prevailing trend, focus can then be diverted to investigating the strength of that trend.
Price Action is a popular mechanism for doing so. Traders can simply look as to whether a market is in the process of making ‘higher-highs’ and ‘higher-lows.’ If this is taking place, then the trader is witnessing an
up-trend, and can look to move down to the shorter time frame in an effort to buy as efficiently as possible.
The picture below shows how a trader using price action can look to buy on the shorter time frame:
Price Action can be Beneficial in Grading Trends, and Plotting Entries
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Another popular way of grading trend strength on the longer-term chart incorporates the ADX indicator. ADX, or the Average Directional Index is an indicator created by J. Welles Wilder that was designed specifically to grade trend strength. The downside of this is that it doesn’t show which direction the trend might be moving, only whether the trend is ‘strong’ or ‘weak.’
Traders can use the ADX indicator on the longer-term chart to determine whether or not a trend is being seen in the market. If values are reading over 30 on ADX, then traders will often look to execute trend-based strategies.
The Average Directional Index (ADX)
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If readings are under 30, then traders will often look to employ range or breakout strategies.
Now that the Trend is determined, what’s next?
The shorter time frame is where the trader will often look to enter into the market based on the analysis on the longer time frame.
If a trend was found on the longer time frame, the trader’s job is to find a way to enter in the direction of that trend. On the lower time-frame, the trader can look to buy up-trends cheaply, or to sell down-trends expensively. This can be done with price action; or traders can look to incorporate indicators to offer a ‘trigger’ in the direction of the longer-term trend on the shorter time frame. Some common indicators for triggering positions on the shorter time frame are MACD, Stochastics, and the Commodity Channel Index (CCI).
The Commodity Channel Index Can Offer Numerous Entry Opportunities
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If a Range-bound market condition was seen on the longer time frame, the trader has another decision to make before deciding how to enter: Does the trader want to trade continuation of the range, or the eventual breakout?
The logic of the range-bound entry and the breakout is directly opposite: Trading ranges entails selling highs, and buying lows (in anticipation of the range continuing), while trading breakouts involves buying new highs and selling new lows (with the expectation of the breakout bringing new highs or new lows into the market). We cover how traders can look to approach ranges in more depth in the article, How to Trade Ranges.
If trading for the break, traders can look to place entry orders slightly outside of support or resistance levels so that once a new high or low is printed, the trade is entered and the trader can look for new highs or lows. We talked about how this can be done in the article, Trading the Break.
If traders are looking to trade the range, an oscillator can be used similarly in the way that a trader would buy or sell in a trend (with the notable exception that up-side is limited). In both trends and ranges, traders want to look to ‘buy low’ and ‘sell high.’ The same types of tools can be used to determine when to buy and when to sell; MACD, Stochastics, and CCI are all popular mechanisms to trade in range-bound market conditions just as they are with trends.
-- Written by James Stanley
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2 Common Strategies for Trading FX
Talking Points:
- Range trading strategy is popular for buying low and selling high
- Trend following strategy is one of the most widely used strategies
- Explore these different styles in a free demo account
There are many benefits to trading FX such as a tremendous amount of liquidity with low transaction costs and margin requirements. The 24 hour nature of FX trading opens the door to a variety of strategies from day trading to position trading to range trading to trend trading.
There are so many different styles and flavors of FX traders, that they truly are too many to discuss each one. For now, we’ll start off with the two strategies that are the most common. The reason they are the most common is because they are opposite of one another…range trading and trend trading.
Range Trading
Range trading is a simple strategy where a trader will buy a currency on sale with the expectation that the valuation will come back towards a longer term average. This strategy may also be referred to as mean reversion and is similar to value investing.
Forex Strategy: How to TradeRanges
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One key to this strategy is identifying those price points that are more favorable for you. That means identifying a price level to enter where sellers stop selling and buyers are more likely to start buying. These price points are generally obtained by identifying levels of supply (resistance) and demand (support). Support and resistance levels can be easily obtained by performing technical analysis on the chart. Indicators and oscillators can help you time entries as well.
Trend Trading
The second main strategy is trend following.
One of the most common strategies used by new and experienced traders is a trend following strategy. Trend following simply means identifying the direction prices have generally been moving, then place trades in that same direction.
Trend following is popular because strong trends tend to produce the largest results. Many times, those strong results came from moves in the direction of the preceding trend. Though there are several benefits, here are two benefits of trend trading.
Forex Strategy: Trading Strong Trends
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Fortunately, trading trends is simple. The ease of identifying trades is in large part why new and experienced traders utilize some form of trend analysis in their trading plan.
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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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Order Types for Forex
Talking Points:
- There are 3 basic classifications of order types for Forex
- Market orders execute at the current price
- Entry orders are set away from the market to execute at a later time
A trader has many tools at their disposal in order to trade the strategy of their choosing. These tools come in the way of different orders that allow the trader to enter and exit the market at their convenience. Today we will look at three of the prevailing order types used by Forex traders.
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Market Orders
The market order is probably the most basic and often the first order type traders come across. Just as the name implies, market orders are traded at market! This means if you want to get into the market immediately, you can trade a market order and be entered at the prevailing price.
Typically scalpers and day traders rely on market orders to enter and exit the market quickly, in accordance to their strategy. To find out more about trading with market orders, read through the material at the DailyFX University linked below.
Entry Orders
The next order type is the entry order. These orders are unique in that they can be set away from present market prices. If price trades at the price selected, the entry will enter the market and open a new position. There are many benefits to trading with entries, including not having to be in front of your computer to execute your orders!
Normally entry orders can be used for breakouts or with other strategies that demand execution when price passes a certain point. To learn more on trading entry orders click the link to the FXCM University below.
Stops & Limits
Stops and limits are orders that everyone should familiarize themselves with. While stops and limits are technically entry orders, they deserve special attention due to their importance. In Forex a stop is an order used to manage risk being placed away from the positions entry point. Likewise Limits are placed away from entries but are used as an order to take profit.
Since Stops and Limits in Forex operate differently from Stop and Limit orders in the equities market we suggest reading up on their uses.
The only way you can get comfortable with using different types of orders is to practice trading with them.
---Written by Walker England, Trading Instructor
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All About MACD
Talking Points:
- While no indicator is perfect, they can help traders address probabilities in a market
- Moving Averages can be helpful, but often lack an active signaling mechanism
- MACD takes trading with moving averages one step further
The journey for most traders starts in a similar way…
Traders are drawn to markets because of the potential. And like anything else in life, most people understand that training and education are vitally necessary parts of success. Most will then act on this understanding, and will begin learning the ‘tools of the trade.’
And that is where the quest will begin…
In the FX markets, Technical Analysis often receives a heavier portion of this focus and there are a couple of different reasons for that. This journey of learning technical analysis can be a short couple of days or might take years or even decades. Regardless of how the trader approaches learning Technical Analysis, one thing that is fairly uniform is that the ‘common’ indicators are learned first before more advanced studies like price action or Elliot Wave.
These are the indicators like RSI, or Stochastics, or Pivot Points. And what will often happen is that after a trader learns how to use the indicator, they also learn that the indicator isn’t a panacea, and is from time-to-time, incorrect.
Does this mean that the indicator is worthless and can’t be used?
Absolutely not! It merely reiterates what all of us should know about markets going in… which is that markets are unpredictable no matter how you approach them.
Rather, trading is but a series of probabilities; and indicators can be helpful tools to look to trade with those probabilities.
In this article, we’re going to examine one of the more versatile indicators that is also one of the first discarded by new traders in their initial trading education: MACD.
The MACD Line
MACD is an acronym that is short for Moving Average Convergence Divergence, which is really just a long and drawn out way of saying it measures the relationship of moving averages.
The moving average is, in-and-of-itself, a very formidable indicator. It’s easy and simple and it just averages the last X periods worth of closing prices. The moving average is often the very first indicator learned because of how simple it is to teach and understand. And the benefits of trading with a moving average can be very clear and apparent, especially if the indicator is being used for trend analysis.
But, trading with a moving average doesn’t always work; and so traders will then learn the benefit of the moving average crossover. By adding a second moving average, we stand the chance to be able to ‘slow down’ the indicator signals. Whereas trading with one moving average entailed buying or selling when price crossed over, the crossover waits for one moving average to cross another before triggering a signal.
But, once again – this doesn’t always work. And this is where MACD comes into play. Traders wanted a way to try to enter the position at the early stage of a move… far before a moving average crossover might take place.
So, rather than watching moving averages, these traders plotted the difference between the averages as an oscillator (shown below).
MACD measures the spatial relationship of exponential moving averages
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In this example, a 13 (in green) and 34 period (in blue) EMA is shown on the price chart. Notice when the two moving averages cross (highlighted with the red circle), MACD correspondingly crosses the ‘0’ line.
As the distance between the moving averages grows larger (or diverges), MACD moves lower to illustrate the growing difference that’s being seen in the EMAs.
On the flip side, when prices move higher, MACD will begin moving higher to reflect the convergence of the Exponential Moving Averages. If price moves high enough, MACD will eventually go up and over the ‘0’ line, and if prices can continue moving higher, the distance between the 13 and 34 period EMAs will also grow, and MACD will again show that divergence (this time to the up-side with an increasingly large MACD value).
This is the MACD line, and it’s the heart-and-soul of the indicator. But, at this point, there is no difference between the MACD line and a simple moving average crossover.
The Signal Line
The MACD line can bring a lot of value, in-and-of-itself, but it’s far from a panacea. After all, MACD is just the spatial relationship between those two EMAs, and if that’s what one wants to trade for, why not just follow a couple of moving averages?
The next part of the indicator is a key element to trading with MACD, and this is called ‘the signal line.’ The signal line is a moving average applied to MACD. By default, the signal line is usually a 9 period EMA; but this is really up to each individual trader. So, the signal line is a moving average based on the difference between two other moving averages. While this may sound confusing, do not worry – most charting packages can do this for you fairly easily and you don’t have to perform the mathematical computations for each.
By applying the signal line, the trader opens up the possibility of entering the trend far before a crossover of the 13 and 34 period moving averages would usually allow.
As an example, take a look at the previous setup we had investigated when MACD crossed down and under the ‘0’ line (and when the 13 and 34 period EMAs had crossed); but this time we’re going to apply the signal line to MACD.
MACD crossover with signal line will takes place far sooner than the crossover of Moving Averages
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This is the benefit of MACD: The fact that it may allow for an earlier entry into a trend is what makes this such a phenomenal indicator. Sure, it won’t work all-of-the-time, but this is trading and there is nothing that works all-of-the-time.
MACD can make for a fantastic indicator in strategies because of just this feature; and if often functions best as a ‘trigger’ into positions in trend-based strategies.
The Histogram
The last part of the indicator is a further extension of the mathematical relationship between all of these moving averages.
The histogram measures the difference between the MACD line, and the signal line. When MACD crosses the signal line, the histogram goes to a value of ‘0.’
The Histogram measures the difference between MACD and Signal lines
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As you can see in the above image, as the MACD and the signal lines converge or diverge; the histogram will reflect this properly. As MACD falls further underneath the signal line, the histogram will print lower to reflect this growing difference.
As MACD crosses over the signal line, the histogram will crossover ‘0’ and will continue to move higher as long as MACD continues moving higher above the signal line.
---Written by James Stanley
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MACD as an Entry Trigger
Talking Points:
- MACD can be helpful as a timing indicator to enter positions, as a ‘trade trigger.’
- MACD can be an entry trigger in many types of strategies. We outline three below.
Having a strong trigger in a trading strategy can be a very important component. After all, to have a bias and to blindly buy or sell to trade on that bias can be categorized as haphazard; and in some cases that may be a bit of an understatement.
Having a trigger helps with timing the entry into a position. It won’t be perfect, but this is trading an perfection is impossible in the first place. Rather, a strong trigger is a way that traders can look to increase the probabilities of success by allowing the market to begin showing the trader what is wanted before any position is ever entered.
Let’s look at a few examples below to illustrate in more detail.
Using MACD with a Fundamental Approach
Many fundamental traders eschew technical analysis for one reason or the other. This isn’t to say that technical analysis is better or vice versa; these are just two differing ways of analyzing a market. But, the best way is often to try to include them both, and something like a MACD entry trigger can be a best friend to a fundamental trader.
Let’s say that a trader has a bias on the market. This can be any bias: Perhaps the trader expects the S&P to begin tumbling lower… or maybe the trader is expecting the Aussie to shoot to the moon on the back of a cheap dollar and stronger than expected Chinese data. Whatever the case and whatever the bias, the trader can wait to enter the position until the market appears more primed for their idea to come to fruition.
The trader can simply watch the 4-hour chart to get a MACD entry signal in the direction that they are looking to trade
The trader can even look to manage the position via MACD after the first trade is placed.
If a contrarian MACD signal shows up (MACD crosses down and under the signal line while in a long position or vice versa); the trader can look to close the long position until another bullish trigger takes place.
Traders can use MACD to trigger in direction of their bias
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Using this type of approach can allow the fundamentals trader to get potentially higher probabilities of success since they’re waiting for the technical environment to agree with their fundamental bias before triggering into the position.
Using MACD as a Scalper/Day-Trader
Just as the Fundamental-based trader can use MACD to trigger trades in the direction of their bias, scalpers and day-traders can look to do the same on very short-term charts.
Shorter-term traders can use the hourly or four-hour chart to look for trends or biases in the marketplace that may be operable for their purposes; and then can look to enter position with MACD crossovers in price movements in that direction.
Scalpers can use longer-term trend analysis and shorter term MACD entries in direction of trend
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The MACD trigger can be investigated on the five or fifteen minute charts to look for quick entries in the direction of slightly longer-term swings.
MACD Triggers as Part of a Broader-based Technical Strategy
Traders can also look to implement a MACD trigger in conjunction of additional technical methods of analysis.
In the 4-hour trader, we looked specifically at that type of strategy.
Traders can use a longer time frame chart, such as the daily chart, to investigate trends and determine any relevant biases that may exist in the marketplace.
Once the trader has determined the direction that they want to trade in a market given the trend found on the longer-term charts, they can then go down to the shorter time frame chart to wait for a MACD signal in the direction of that trend.
Multiple time frame analysis can bring enormous benefit to the trader.
The longer time frame provides the ‘bigger picture’ view of any biases or trends that may exist in the marketplace; and the MACD trigger on the shorter time frame can allow the trader to focus on high-probability setups in which the longer-term bias may be coming back into the market.
--- Written by James Stanley
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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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What is the ’Best’ Time Frame to Trade?
Talking Points:
- Traders should look to utilize time frames based on their desired holding times and overall approach.
- New(er) traders should begin with a longer-term approach, and longer-term charts.
- Traders can look to move to shorter-term charts as experience, and success allows.
One of the most important aspects of a trader’s success is the approach being utilized to speculate in markets. Sometimes, certain approaches just don’t work for certain traders. Maybe its personality or risk characteristics; or perhaps the approach is just un-workable to begin with.
In this article, we’re going to look at the three most common approaches to speculate in markets, along with tips for which time frames and tools can best serve traders utilizing those approaches. In each of these approaches, we’re going to suggest two time frames for traders to utilize based around the concept of
Multiple Time Frame Analysis.
When using multiple time frame analysis, traders will look to use a longer-term chart to grade trends and investigate the general nature of the current technical setup; while utilizing a shorter-term chart to ‘trigger’ or enter positions in consideration of that longer-term setup. We looked at one of the more common entry triggers in the article, MACD as an Entry Trigger; but many others can be used since the longer-term chart is doing the bulk of the ‘big picture’ analysis.
The Long-Term Approach
Optimal Time Frames: Weekly, and Daily Chart
For some reason, many new traders do everything they can to avoid this approach. This is likely because new, uninformed traders think that a longer-term approach means it takes a lot longer to find profitability.
In most cases, this couldn’t be further from the truth.
By many accounts, trading with a shorter-term approach is quite a bit more difficult to do profitably, and it often takes traders considerably longer to develop their strategy to actually find profitability.
There are quite a few reasons for this, but the shorter the term, the less information that goes into each and every candlestick. Variability increases the shorter our outlooks get because we’re adding the limiting factor of time.
There aren’t many successful scalpers that don’t know what to do on the longer-term charts; and in many cases, day-traders are using the longer-term charts to plot their shorter-term strategies.
All new traders should begin with a long-term approach; only getting shorter-term as they see success with a longer-term strategy. This way, as the margin of error increases with shorter-term charts and more volatile information, the trader can dynamically make adjustments to risk and trade management.
Traders utilizing a longer-term approach can look to use the weekly chart to grade trends, and the daily chart to enter into positions.
Longer-Term approaches can look to the weekly chart for grading trends, and the daily chart for entries
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After the trend has been determined on the weekly chart, traders can look to enter positions on the daily chart in a variety of ways. Many traders look to utilize price action for determining trends and/or entering positions, but indicators can absolutely be utilized here as well. As mentioned earlier, MACD is a common ‘trigger’ in these types of strategies and can certainly be utilized; with the trader looking for signals only taking place in the direction of the trend as determined on the weekly chart.
The ‘Swing-Trader’ Approach
Optimal Time Frames: Daily, and Four-Hour Charts
After a trader has gained comfort on the longer-term chart they can then look to move slightly shorter in their approach and desired holding times. This can introduce more variability into the trader’s approach, so risk and money management should absolutely be addressed before moving down to shorter time frames.
The Swing-Trader’s approach is a happy medium between a longer-term approach, and a shorter-term, scalping-like approach. One of the large benefits of swing-trading is that traders can get the benefits of both styles without necessarily taking on all of the down-sides.
Swing-Traders will often look at the chart throughout the day in an effort to take advantage of ‘big’ moves in the marketplace; and this affords them the benefit of not having to watch markets continuously while they’re trading. Once they find an opportunity or a setup that matches their criteria for triggering a position, they place the trade with a stop attached; and they then check back later to see the progress of the trade.
In between trades (or checking the chart), these traders can go about living their lives.
A large benefit of this approach is that the trader is still looking at charts often enough to seize opportunities as they exist; and this eliminates one of the down-sides of longer-term trading in which entries are generally placed on the daily chart.
For this approach, the daily chart is often used for determining trends or general market direction; and the four-hour chart is used for entering trades and placing positions.
The Swing-Trader can look at the daily chart for grading trends, and the four-hour chart for entries
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But indicators can absolutely be used to trigger positions on the four-hour chart as well. MACD, Stochastics, and CCI are all popular options for this purpose.
The Short-Term Approach (Scalping or Day-Trading)
Optimal Time Frames: Hourly, 15 minutes, and 5 minutes
I saved the most difficult approach for last.
I’m not sure of exactly why, but when many traders come to markets – they think or feel like they have to ‘day-trade’ to do so profitably.
As mentioned earlier, this is probably the most difficult way of finding profitability; and for the new trader, so many factors of complexity are introduced that finding success as a scalper or day-trader can be daunting.
The scalper or day-trader is in the unenviable position of needing the move(s) with which they are speculating to take place very quickly; and trying to ‘force’ a market to make a move isn’t usually going to work out that well. The shorter-term approach also affords a smaller margin of error. Since less profit potential is generally available, tighter stops need to be utilized; meaning failure will generally happen quite a bit more often, or else the trader is opening themselves up to The Number One Mistake that Forex Traders Make.
To trade with a very short-term approach, it’s advisable for a trader to first get comfortable with a longer-term, and swing-trading approach before moving down to the very fast time frames. But, once a trader is comfortable there, it’s time to start building out the strategy.
Scalpers or day-traders can look to grade or evaluate trends on the hourly chart; and can then look for entry opportunities on the 5, or 15 minute time frames. The one minute time frame is also an option, but extreme caution should be used as the variability on the one-minute chart can be very random and difficult to work with. Once again, traders can use a variety of triggers to initiate positions once the trend has been determined, and we showed how to do this with MACD in the article, Scalping with MACD.
Scalpers can look to the hourly chart to grade trends, and the 5 or 15 minute charts for entries
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---Written by James Stanley
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The 3 Step EMA and Renko Strategy for Trading Trends
Talking Points:
- Many Forex traders use weighted moving averages, called EMA’s, to trade currency pairs that are trending.
- Determine the direction of the dominant trend direction with a 200 period EMA.
- Use price crossing a 13 period MA as both an entry trigger and manual trailing stop
Developed in the 18th century in Japan to trade rice, Renko charting is a trend following technique. It is excellent for filtering out price “noise” so traders can catch a major part a given Forex trend. It was believed that the name “Renko” originated from the Japanese word ‘renga’ meaning ‘brick’.
Similar to Kagi and Point and Figure charting, Renko ignores the element of time used on candlesticks, bar charts, and line charts. Instead, Renko focuses on sustained price movement of a preset amount of pips.
For example, a trader can set the bricks for as little as 5 pips or as many as 100 or more. A new brick will not be formed until price has moved 100 pips. It could take 24 hours for a new brick to form or it could take just a few hours. However, no bricks will form until the preset limit is achieved.
Learn Forex – NZD/USD 4-Hour Renko Trend & 200EMA
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As you can see in the NZDUSD Renko chart above, each brick represents 10 pips of price movement. A 4-hour chart is used to actually load enough price data to be able to identify the direction of the trend.
Green colored bricks are bullish, while red-colored bricks are bearish. Remember that the size of the brick can be setup when you first go through the steps of creating Renko chart. Swing traders may use 50 or 100 pip bricks to represent some fraction of the average daily trading range. While scalpers and day traders may look at 20, 10 or 5 pip bricks.
Find the Trend Direction
Renko charts can incorporate many of the usual technical indicators like stochastics, MACD, and moving averages. Today’s strategy will marry up Forex Renko charts with a 200 Exponential Moving Average (EMA) to find trend direction. Very simply, if price is trading above its 200 EMA, then the trend is up. If price is trading below its 200 EMA, then the trend is down.
This filter will give us a directional bias much like a compass or GPS. We will look to only take long trades when the Renko bricks are trending above the 200 EMA. On the other hand, in a downtrend, if the Renko bricks are trending below the 200 EMA, then the trend down. Forex traders will only look to short the market. One of the biggest mistakes swing traders make is entering trades that go counter to the dominant trend.
Learn Forex – NZDUSD two-Brick Renko crossover entry signal
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When to Get In
After the dominant trend direction is determined, traders can use the simplicity of Renko charts with a single 13 period EMA as a ‘trigger’ to signal an entry in the direction of the major trend. First, wait for at least two green bricks to appear above the 13 EMA. Then enter long on the appearance of the second green brick above the 13 EMA.
Exiting for Profit and for Loss
Once a trader is “triggered” into the trade, a protective stop can be set one-brick size below the 13 EMA. As long as the bricks remain above the 13 EMA, we look to stay with the trend. Just as the 13 EMA can get you in a new trade, the same EMA can be used to stop out a winning trade locking in profits.
Traders will need to manually move the stop one brick-size below 13 EMA and the current price brick. You can see in the example above how the combination of Renko and the 13 EMA helps traders stay with the trend a longer time.
---Written by Gregory McLeod Trading Instructor
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How to Trade a Triangle after a False Breakout
Talking Points:
- GBPJPY broke out of a 967 pip symmetrical triangle that had a target over 180.00
- The advance from the breakout point of 171.13 was halted at 173.56 and price turned down
- A new triangle can be drawn taking into account the new swing points created by the false breakout
Forex symmetrical triangles are important price patterns relied on by traders to identify periods of consolidation ahead of an anticipated large breakout. Traders like using triangle price patterns because they have risk to reward parameters which are easy to determine from the pattern itself.
Not only can the stop be placed just outside the pattern, but a limit can be determined by measuring the height of the pattern and projecting this distance in pips from the breakout point. This is called a measurement objective.
Thomas Bulkowski in his book, Encyclopedia of Chart Patterns stated that symmetrical triangles meet their upside targets 66% of the time. However, the recent GBPJPY triangle that was posted in my March 4th 2014 article was part of the 33% of triangle breakout failures.
Learn Forex – GBPJPY Symmetrical Triangle False Breakout
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As you can see in the chart above of the GBPJPY symmetrical triangle, a breakout happened at 171.13. Initially, wide ranging candlesticks breaking above the top of the symmetrical triangle may have led traders to believe the up move had more to go. However, the doji candlestick pattern was joined by a bearish candlestick forming a Japanese candlestick evening star pattern at 173.56 capped this rally.
From this point, we can see an acceleration in bearish price action as a series or red candlesticks form Bullish breakout traders are now caught in what is called a “bull trap” in the 167.60 area. Stops are triggered and longs are shaken out. Today, we see a strong surge in yen weakness and GBPJPY rebounds. The question now is, “Should traders give GBPJPY another chance?”
Learn Forex – GBPJPY Daily Chart Revised Symmetrical Triangle
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A New Triangle Emerges
If the fundamental and technical reasons that existed when the trade was made still exist after a stop out, then we would consider re-entering the trade. However, forex triangle traders may make modifications to the initial triangle in order to take into account the new swing highs and swing lows.
First of all, the new swing high which was created by the false breakout is connected to a higher previous high. Next, the new swing low which was created by breakout below support is connected by an upward sloping trend line from the previous swing low. The result is a new symmetrical triangle with new buy and sell parameters. New limits are set as well.
How to Trade this New Triangle
The breakout method for trading a symmetrical triangle has not changed. However, the triangle has become bigger. Despite the big GBPJPY big 350-pip run-up today to 171.05, GBPJPY is another 250 pips from making a confirmed triangle breakout. Triangle resistance is at 172.70 area making a long GBPJPY trade too early of a proposition now.
If and when GBPJPY trades above 173.56, a stop can be placed beneath the last swing low of the triangle at around 167.40 with an upside target of 183.91. On the other hand, a close below 167.40 would trigger a sell signal for a bears to trade the triangle south with a target of 156.75.
After the last false breakout, traders may ask GBPJPY to “show them the pips” with a confirmed triangle breakout before going long GBPJPY a second time
---Written by Gregory McLeod Trading Instructor
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How to Trade the EURJPY Double Top
Talking Points:
- The Double Top is bearish price pattern that consists of two peaks with a trough in between forming an M-shape.
- The double top’s height in pips is used to project the distance of a bearish breakout.
- EURJPY has formed a double top price pattern on the daily time frame chart.
Chart patterns, like the forex double top are warning signs that the current trend is about to reverse. In the double top, a bullish surge forms the first peak. Next there is a profit taking decline that ends at a level of support. As price rebounds from this level, bargain hunters and other buyers jump back into the market anticipating a move to new highs.
However, as price returns to the general area of the last peak, buying momentum starts to evaporate. Price struggles with the old high and traders start dumping their positions. Price’s failure to make a new high sparks bearish sellers to come en masse to drive prices lower.
Learn Forex – Double Top Diagram
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As we can see in the Forex Double Top diagram, the signature M-formation illustrates bears taking control of price action. However, the goal for the sellers is to drive price below the neckline. This would confirm that this pattern is, in fact, a double top. It is at that red circle that Forex traders will look to enter short.
Remember those bargain hunters that got long earlier? Well now those stops are located below this neckline. Stops that protect long positions become sell orders at market when price touches them. This push through neckline creates the acceleration that the sellers are looking for. Usually, the height of the forex double top can be projected from the neckline to determine a price objective.
Learn Forex – EURJPY Daily Chart Double Top
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A Real Time Example: EURJPY Daily Chart
Now that you have seen a textbook double top chart, let’s look at current trade setup. In the EURJPY daily chart we see a strong 660-pip rally that ended on 3/7 at 143.77. Next, a 50% profit-taking decline took price to the 139.93 level before bargain hunters jumped on board for a ride to new highs. However, the EURJPY advance stalled on 4/2 just shy of the old high. Price began falling back to the neckline found in the 140.00 region. Though not a textbook double top, some leeway can be granted when comparing the peaks.
EURJPY is holding a trendline in the 140.00 area. Round numbers can be formidable areas of support. In this case, we would want to see price break and close below the 140.00 area and the neckline. It may pay to wait for the price action to confirm the double top pattern. If our price is not hit, then we will need to look for another trade as our entry criteria was not hit.
Sometimes, after a breakout, price returns to retest the breakout point. This would be a favorable entry as the stop could be placed above the last swing high. Again the key is not to jump in early but wait for convincing confirmation.
Taking Profit
The height of this EURJPY Double top pattern is approximately 382-pips. From this we can project a target of 135.81. However, there is a bit of support circled on the chart at 136.20 that could be strong enough to turn prices upward. In sum, the forex double top should be viewed with much suspicion until confirmation is shown. Once price closes below support, the move down can be a rewarding one.
---Written by Gregory McLeod Trading Instructor
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The 3 Step No-Hassle Breakout Strategy
Talking Points:
- Volatility breeds breakout trading opportunities.
- 24-period Donchian Channel on an Hourly chart can give us medium term trade entries.
- Stops can be set opposite of the channel break using 1:2 risk and reward ratio.
While trend trading makes up the bread and butter of my personal trading account, I also employ a breakout strategy that has yielded positive results. It’s true that breakout strategies require more time and energy than longer term trend strategies, but breakouts are easy to trade when you have set rules to follow.
The ideal breakout trade is on a currency pair that has exhibited a high level of volatility and then breaks a key support or resistance level. Pairing this type of opportunity with a sound money management plan can result in a trading edge. Today, we are going to lay out this simple, no-hassle breakout strategy in 3 steps.
Step 1: Look for Volatility
Not all market conditions are ripe for breakout trading. We need to first find the pairs that have shown the most volatility.
Learn Forex: DailyFX Technical Analysis - Volatility
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The image above shows volatility highlighted in red. A 0% reading means a pair has shown almost no volatility while a reading of 100% means the pair has shown an extreme level of volatility. For the purposes of breakout trading, we recommend a reading of 75% or greater. So we need to make note of each pair with volatility above 75% before we move on to our charts.
Step 2: Find Trade Entries Using Donchian (Price) Channels
Support and resistance levels are subjective and can vary from trader to trader. So to more clearly define our entry levels, we use Donchian Channels or Price Channels.
Once installed, you will find the Donchian Channel on your indicator list. The following are what settings we will use for spotting entries on an Hourly (H1) chart.
Learn Forex: Donchian Channel Settings
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Once applied, we will see two blue lines on our chart, one above the price and one below. These lines will act as our trigger for placing a trade. If an hourly candle closes above the top blue line, we initiate a buy trade at market. If an hourly candle closes below the bottom line, we initiate a sell trade at market. Nice and simple.
Step 3: Easy Exits Using Stops and Limits
No strategy is complete without an exit strategy. Fortunately, the Donchian Channel can assist in setting one up. We first want to focus on our stop. I recommend setting our stop loss beyond the other side of the channel. So if the price broke below the bottom line and created a sell trade, we would set our stop a few pips above the top line. If price broke above the top line and created a buy trade, we would set our stop a few pips below the bottom line. The image below shows an example of a recent sell signal on the GBPUSD with a stop loss set above the top line.
Learn Forex: GBPUSD Breakout Trade
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After we have set our stop above the upper channel line, we want to set our limit twice as far as our stop. So if our stop was 55 pips away from our entry, we would set our limit 110 pips away. The goal is to give us a 1:2 risk reward ratio which is an important piece of a winning strategy.
Give Me a Break
Trading breakouts doesn’t have to be hard. Once we know what rules to follow, everything falls into place. We want to find a volatile currency pair, witness a break of the 24-hour Donchian channel, and set a stop loss beyond the channel with a limit set twice as far. Feel free to email me with any questions you have.
Good trading!
---Written by Rob Pasche
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How Oscillators Can Show You If You
Talking Points:
- The Value of Oscillators
- The Pain of Trading Against The Trend
- How Price Action & Oscillators Behave Counter-Trend
“Most trend pullbacks follow just enough of a climax to make traders wonder if the trend has ended and trap traders out of entering on the pullback. Also the trend reversals are just good enough to attract and trap Countertrend traders. If you trade Countertrend, you are gambling, and although you will often win and have fun, the math is against you, and you will slowly but surely go broke. Countertrend setups in strong trends almost always fail and become great With Trend setups..."
-Al Brooks, Reading Price Charts Bar by Bar
Oscillators can be one of the most valuable tools in a trader’s arsenal. A big reason for its value is that very few tools can help you see a great risk: reward set-up when a price action correction is coming to an end. Put in other words, an oscillator helps you see the exhaustion of a move so that you can enter near the exhaustion point of a prior trend.
However, it would be a disservice to you if you were led to believe that a stretched oscillator was a great entry.
Unfortunately, after many new traders learn about the benefits of oscillators, they believe they’ve received the golden key to trading profits and start buying low and selling high. A few steps back from the chart though and you’ll quickly see that only side of the trade is worth taking based on how price action reacts to an unwinding oscillator.
Learn Forex: Trading With the Trend Is Always Preferable
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The Pain of Trading Against the Trend
The problem with trading against the trend is that it works every now and then. However, as a trader, it’s easy to agree with the words of John Maynard Keynes who said, “Markets can stay irrational longer than you can say solvent.” This sounds like someone who thought they had sold the top only to find they entered against a very strong trend that has no intention in stopping soon.
From talking to thousands of trader’s over the years, I’ve recognized a handful of reasons for trading against the trend. While this is not a definitive list, I’ve seen these three play out over and over again:
- The excitement of being right while everyone else is wrong
- The thought that the trend is overbought and due for a deep set-back
- The feeling that the biggest money will be made on the big turn
It’s not wrong to feel this way. However, for most, it’s not profitable to trade this way and they’re falling prey to mental biases as opposed to good analysis. The reason that countertrend trading can be unprofitable for many to trade is because if you enter emotionally, you often exit emotionally. Exiting emotionally is a nice way of saying that you exit after a lot of your capital has been eaten up on a bad trade from the start.
How Price Action & Oscillators Behave Counter-Trend
As you can see from the chart above, the oscillator often moved from extreme high to extreme low. Extreme lows are usually anything below 20 and extreme highs are usually anything over 80. Extreme highs are deemed to be overbought markets ready for a turn lower and extreme lows are deemed to be oversold and due for a bounce higher.
Learn Forex: Find Out if Price Rises Proportionally To the Oscillator
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This chart brings a little more detail but the idea is clear. When you’re trading with an oscillator and you realize that price action is correcting disproportionally to the oscillator you’re trading against the trend. If you hold onto this type of trade then you could get steam-rolled when the oscillator unrolls back in the direction of the overall trend. Given the recent 500+ pip move in AUDUSD higher, if price unwinds disproportionally to the oscillator, then it may be best to get out of a short trade or consider rejoining the AUDUSD trend higher while managing your risk.
Happy Trading!
---Written by Tyler Yell, Trading Instructor
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How to Combine Fibonacci and RSI for Trading Ideas
Talking Points:
- Use Fibonacci to identify levels of support and resistance
- Use the Relative Strength Index (RSI) to confirm when a turn may be taking place
- Enter the trade with at least a 1:2 risk-to-reward ratio
Fibonacci retracement ratios have been used by traders for many years. The ratios can identify hidden levels of support and resistance as it identifies areas where a partial retracement may reverse. For those unfamiliar with Fibonacci, the common retracement ratios are 38.2%, 50%, 61.8%.
As traders are learning about the Fibonacci ratios for the first time, the next logical question the students ask is “how do I know which ratio to focus on?”
It is a good question and the market’s price action will provide a clue if a particular Fibonacci retracement ratio is likely to be respected creating a market turn.
Said another way, rather than blindly entering into a trade because it hit a particular retracement ratio, how about if we let the market provide us confirmation signals that it is likely to turn?
We can use the Relative Strength Index (RSI) to help us confirm if a Fibonacci ratio is repelling prices.
Learn Forex: RSI Confirmation of a Fibonacci Retracement Level
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As we can see above, the USD/JPY has the three Fibonacci retracement levels added to the chart (horizontal blue lines). The first level, the 38.2% level, barely resisted prices.
However, we can now see that the 50% level is providing some resistance. Additionally, the RSI is showing divergence which is a bearish signal as well.
Divergence is where the price makes higher highs, but the oscillator makes lower highs. Divergence means that momentum is slowing. Slowing momentum into a resistance level is a good recipe for a trading opportunity.
When prices fell below the black support trend line, which is further confirmation that the temporary uptrend is losing momentum. A trader would enter on a break of the black trend line, then place the stop loss just above the recent swing high.
Look to take profits at a distance at least twice the size of the distance to your stop loss. This will give you a 1:2 risk to reward ratio.
Let the trade evolve until it reaches your stop loss or take profit level.
Risk a small portion of your account balance, less than 5%, on all open trades.
Good luck and happy trading!
---Written by Jeremy Wagner, Head Trading Instructor, DailyFX
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Overbought vs. Oversold and What This Means for Traders
Talking Points:
- Overbought means an extended price move to the upside; oversold to the downside.
- When price reaches these extreme levels, a reversal is possible.
- The Relative Strength Index (RSI) can be used to confirm a reversal.
Like many professions, trading involves a lot of jargon that is difficult to follow by someone new to the industry. It’s our job as instructors to fill in as many knowledge gaps as possible to make the education process as simple as possible. Today, we will take a look at what it means for a currency pair to be overbought or oversold, and most importantly, what trading opportunities arise from these situations.
Overbought vs. Oversold
These two terms actually describe themselves pretty well. Overbought describes a period of time where there has been a significant and consistent upward move in price over a period of time without much pullback. This is clearly defined by a chart showing price movement from the “lower-left to upper-right” like the chart shown below.
Learn Forex: USDJPY Hourly Chart – Overbought
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The term Oversold describes a period of time where there has been a significant and consistent downward move in price over a period of time without much pullback. Basically a move from the “upper-left to the lower-right.”
Learn Forex: USDCHF Hourly Chart – Oversold
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Because price cannot move in one direction forever, price will turn around at some point. Currency pairs that are overbought or oversold sometimes have a greater chance of reversing direction, but could remain overbought or oversold for a very long time. So we need to use an oscillator to help us determine when a reversal is actually occurring.
Reading the RSI
There is a quick tool you can use to gauge overbought and oversold levels, the Relative Strength Index. For a full explanation for how to use the RSI, click here for a FREE video course. The premise is simple, however. When RSI moves above 70, it is overbought and could lead to a downward move. When RSI moves below 30, it is oversold and could lead to an upward move.
Learn Forex: Relative Strength Index, Overbought and Oversold Levels
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But, we must be patient before we enter our trades, because sometimes the RSI can stay overbought or oversold for quite awhile. The worst thing we can do is try to pick a top or a bottom of a strong move that continues to move into further overbought or oversold territory. So we must wait until the RSI crosses back under 70 or crosses back above 30.
Learn Forex: Relative Strength Index, Overbought and Oversold Levels
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The image above shows the RSI clearly breaking above the 70 level resulting in an overbought reading, but we do not want to immediately sell because we do not know how far price could continue to rally. We want to wait until the RSI falls back below 70 and then place our sell trade. This gives us a better entry and a higher probability trade.
When the RSI falls below 30, same rules apply. We want to wait until the RSI crosses back above 30 before we place a buy trade.
Putting RSI to Work
Good trading!
---Written by Rob Pasche
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Why Traders Lose Money
Talking Points:
- There is a large chasm between trading and analysis.
- Analysis can assist with winning percentages, but this doesn’t always equate to profitability.
- Traders need to learn to manage risk if they ever hope to be consistently profitable.
While the title of this article can have broad implications with numerous explanations, we’re going to do our best to reduce the answer to this query to the most logical and basic explanation.
When a trader first gets started, it might be hard to imagine how getting control of losses can seem an impossible task. It may even feel like the cards are stacked against you… situations in which you’re right in your analysis, yet you still lose on the trade and watch capital disappear from your trading account.
So, a natural question is why some traders consistently make money while others lose, even when they’re right. That is what we will be investigating in this article.
The Difference between Trading and Analysis
Many new traders come to the market with a bias or point-of-view. Perhaps this is built from a background in economics, or finance, or maybe just a keen interest in politics. But one of the biggest mistakes a trader can make is harboring the expectation that ‘the market is wrong and prices have to come back.’
But let’s face it: Markets are unpredictable, and it doesn’t matter what type of analysis you use. As new information comes into the market, traders and market makers price it accordingly; because these folks don’t want to lose money just as much as you don’t want to lose money.
Is this to say that analysis is worthless? Absolutely not: It merely means that analysis is only a part of the equation of being a successful trader. Analysis is a way to potentially get the probabilities on the trader’s side, even if just a by a little bit; a way to maybe get a 51% or 52% chance of success as opposed to a straight-up coin flip.
Good analysis, whether it be fundamentally-driven or technically-driven, can be right a majority of the time. But no form of analysis will ever be right all of the time. And this is the reason that there is such a large chasm between analysis and trading.
In analysis, it doesn’t matter how wrong you are when you aren’t right. In trading, this matters quite a bit. Because even if you’re winning on 70% of your trades, if you’re losing $3 for every trade in which you’re wrong but only making $1 every time that you’re right, you’re still losing. It might feel good, because 70% of the time you’re walking away from your positions with the feeling of success; and as human beings this is something we generally strive for (to feel good).
The example below shows how bad risk management can destroy even a strong winning percentage of 70% success.
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But logically, it doesn’t make sense to embark on this type of endeavor because the goal of trading is to make money; not necessarily to just ‘be right’ more than 50% of the time.
How to actually trade analysis
First thing first, traders need to crystallize what their actual goal is in trading in markets; and point-blank, that goal should be to make money.
After that, traders need to expect that they will, at times, be wrong.
So given these two facts, the next logical assumption is that without being able to control the damage from those instances in which we’re wrong, the prospect of profitability is a distant one.
So risk management isn’t just a preference or a style of trading: It’s a necessity for long-term profitability. Because even if you’re winning 90% of the time, the losses on the other 10% can far outstrip the gains that are made on the 90%.
I fully realize this isn’t necessarily exciting information. When I teach risk management, rarely do a see a student-trader ready to burst out of their seats to go and manage some risk. Most people want to hear about entry strategies, and analytical methods to try to get those odds of success tilted even higher in their favors.
But until a trader learns to manage their risk, much of this additional work is a moot point. Because as long as the risk exists that one bad position can and will wipe away the gain from many other ‘good’ positions; that trader is going to struggle to find profitability.
So, to properly trade analysis one needs to first observe proper risk management. Because trading isn’t just ‘guessing’ and ‘hoping’ that we get it right. Profitable trading is implementing analysis while properly managing risk factors; implementing a defensive approach so that when one is wrong, the losses can be mitigated and when one is right, profits can be maximized.
How can one begin to use ‘proper’ risk management?
We’ve already encountered one of the biggest mistakes of risk management, and that’s controlling the size of the losses relative to the size of the gains.
The solution is simple; implementing it not as much. As human beings, we often follow our gut instincts or our ‘feelings.’ But in trading, we have to keep the bigger picture in mind. When we place a trade, we often try to win on that one trade. This can keep traders holding on to losers for far too long, and closing out winners way too quickly.
Traders can adjust strategies to focus on lower-risk, higher reward types of setups
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The way to fix the Top Trading Mistake is to simply look to make more when you’re right than you lose when you’re wrong. That’s it. This can be done by setting stops and limits on every trade that is placed to reinforce that minimum 1-to-1 risk-to-reward ratio.
Unfortunately, risk management isn’t as simple as just setting a stop and setting a limit. After all, if a trader takes on a position that’s way too large relative to the size of their account, even if using a 1-to-2 or 1-to-3 risk to reward ratio; that one trade could completely wipe them out.
This is similar to the advice of ‘not putting all of your eggs in one basket.’ And while this concept is simple for equity investors that have seen stock prices fall off-of-a-cliff, highlighting the fact that investing in just one stock can be so dangerous, traders should look at the art of speculation in a similar light.
--- Written by James Stanley
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Learn Forex: Finding Trends in Trendless Markets (Part 2)
Talking Points:
- Elliott Wave Principle can guide us on where we are in a trend
- EUR/CAD is displaying three different patterns rooted in Elliott Wave that suggests this down trend has just started
- Price may bounce temporarily into resistance, look to sell the bounce
This is the second part of this article series. The first part was regarding the strong trend the Chinese Yuan, which is now available to trade.
The objective of this series is to find tradable trends when the market appears to be stagnating. Trend following is one of the most popular strategies used by new and experienced traders. When market volatility dies down, the old trends tend to move sideways creating frustration for the trader. There are strong trends out there and this series will help shine a light on those trends presenting tradable opportunities.
Today’s opportunity is with the EUR/CAD. There are three patterns appearing at different time frames suggesting a meaningful top is in place and that more downside potential remains.
Learn Forex: EURCAD Trend Shifts Down
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From a 4 hour price chart, it appears the EUR/CAD has carved out an ending diagonal. In this case it is a bearish pattern that suggests prices will likely fall towards the origination of the pattern at 1.4900. Keep this level in mind as we zone in on smaller time frames to fine tune our entry and exit plan.
Learn Forex: 2 Different Time Frames Forming 5 Waves Down
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From the high on March 20, 2014, prices clearly fell in five waves in impulsive fashion to a low of 1.5003. So far prices have only partially retraced the high from March.
The Elliott Wave Principle illustrates that trends move in a five wave impulsive fashion and corrects in three waves (the blue labels above and the corrective waves labeled as A-B-C). Therefore, with a five wave move lower, this suggests that the trend may be shifting from up to down with a minimum target of 1.4900 which was the origination of the ending diagonal pattern (first chart).
Upon closer inspection, we can see how the price action over the past two days has yielded clue of a bearish trend. Zooming into the tan boxed area, we can see another smaller degree five wave move lower (green labels). All of these patterns suggest the EUR/CAD pair has likely put in a top with an initial target of 1.4900.
The Trade Set Up
Therefore, our trading opportunity is to short the EURCAD in the 1.5200 to 1.5230 zone. Our stop loss will be just above the April 27 high at 1.5320. Look to take profits near 1.4900.
Therefore, if we risk 90 pips with an opportunity to make over 300 pips, this provides us with better than a 1-to-3 risk-to-reward ratio.
If you need help on determining a trade size appropriate for your account size, register to take this free Money Management course. Towards the end of the course, you will be given an opportunity to download a free app that will help you determine what trade size to make based on your account size.
---Written by Jeremy Wagner, Head Trading Instructor, DailyFX
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How to Trade Short-Term (Day-Trade)
Talking Points:
- While short-term trading is attractive, it can also be dangerous.
- Short-term traders will often exercise poor risk management, and this can have very negative consequences.
- We share a strategy that can be used to trade short-term momentum with a focus on risk.
For every 10 traders that come to markets, at least 7 of them want to ‘day-trade,’ or as we call it in the forex market, ‘scalp.’ Even though many of these traders are still learning the market or are very new to trading, they know they want to embark on short-term trading.
The rationale behind this desire makes sense. After all, for most things in life the biggest rewards are for the hardest workers; those exhibiting the utmost of control and discipline long enough to properly implement their plan or strategy.
But trading is much different in the fact that this ‘greater control’ that might be offered by short-term time frames introduces other, more difficult variables into the equation of a trader’s success.
Many of the reasons that traders lose money become even more difficult to contend with when ‘scalping’ or ‘day-trading.’ And if these traders are making other mistakes, such as using too much leverage or inappropriate strategy selection that top trading mistake can become even more problematic.
So, first and foremost before we get into the process of short-term trading, I want to specify that this is often the most difficult way for new traders to get started. Preferably, new traders will start with longer-term charts and approaches that may be more forgiving, and as they gain experience and comfort they can then elect to move into faster time frames.
The Biggest Challenge of Short-Term Trading
The biggest challenge of short-term trading is the same as the Top Trading Mistake. Too few traders looking to scalp actually do so correctly, under the incorrect presumption that trading on really short-term charts gives them enough control to trade without stops
While keeping your finger on the trigger may give you more control, it means absolutely nothing if prices gap against your position or if a really big piece of news comes out that completely de-rails your trading plan. So, even though you may be watching price action on a five or fifteen-minute chart, protective stops are still needed.
Further to this point, traders need to be able to focus on winning more when they are right than they lose when they are wrong. To put this another way, just because one is trading very short-term, it doesn’t mean that they can ignore The Number One Mistake Forex Traders Make.
This can be a huge challenge on really short-term charts where near-term price movements are unpredictable. But it’s not impossible. In this strategy, I’ll attempt to show you a way to do this.
An additional concern is variance. Per statistical analysis, the less information that is being analyzed in a data set, the less ‘reliable’ that information becomes. If we’re looking at longer-term charts, such as the daily or the weekly charts, quite a bit of information is going into the formation of each individual candle. On a very short-term chart, the opposite is true. Significantly less information goes into each candle, and thereby each candle is less reliable as a forecast of future candle formations.
The Strategy
With all of the above being said, trading on short-term charts is still possible. It just requires that traders utilize even more control and discipline over their trading approaches and risk management. For new traders that often struggle with risk management, or staying disciplined; the results can be disastrous. But if those boxes are checked, traders can look to exert the upmost of control over their approach with shorter time frames.
But just because we’re trading on shorter-term charts, does that mean we want the entirety of our analysis to be performed on those time frames? Absolutely not. We can still incorporate analysis from longer time frames into our approaches in an effort to get the best probabilities of success.
The indicators that I add are the 8 and 34 period exponential moving averages, based on the hourly chart but plotted on the 5-minute chart (shown below).
Multiple time frame analysis can help traders see the ‘bigger picture’
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These indicators act as a compass for the strategy, helping to see what’s taking place with a longer-term time horizon. If the faster 8 period moving average (based on the hourly chart) is above the slower 34 period moving average (also based on the hourly chart), then the strategy is looking to go long, and to only go long. As long as the hourly 8 period EMA is above the hourly 34 period EMA, only buy positions are entertained.
The hourly moving averages work like a compass, showing traders which direction to trade the trend
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Once the trend has been identified, and the bias has been obtained, the trader can then look for entries in the direction of that trend; looking for momentum to continue on the 5-minute chart as it has been displayed by our hourly-moving averages.
And when looking to buy, we ideally want to ‘buy low’ or ‘sell high.’ So, just because the trend is up and we’re looking to buy, it doesn’t mean we want to blindly do so. We still need a ‘trigger’ for the position, and for this, we can incorporate another exponential moving average.
The trigger for this strategy is another 8 period exponential moving average, but this one is built on the shorter-term five-minute chart.
When price crosses the 8-period five-minute EMA in the direction of the trend, the trader can look to buy in anticipation of the ‘bigger-picture’ trend coming back in force.
The ‘trigger’ in the strategy is when price crosses the 8-period five-minute EMA in the direction of the trend
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The large benefit behind the strategy is that just by the very act of price moving in the trend-side direction over the shorter-term EMA, traders are buying or selling short-term retracements in the direction of the momentum.
Risk Management
The most attractive part of the strategy is that it allows for traders to ‘buy cheaply’ in anticipation of bullish momentum, or to ‘sell expensively’ in anticipation of bearish momentum.
When prices make those short-term retracements, they create swings in price action. And per price action logic, of up-trends making ‘higher-highs’ and ‘higher-lows,’ traders can look to place the stop for their long position below the previous ‘higher-low’ so that if the up-trend doesn’t continue – the trader can exit the position for a minimal loss.
Stops for long positions go below the prior period’s opposing-side swing
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In the case of short positions, traders would want to look to place stops for short positions above the previous ‘lower-high,’ so that if the down-trend does not continue, the short position could be closed in an effort of mitigating the damage as much as possible.
In my opinion, this is the most attractive part of this type of strategy. It allows traders to attempt to avoid The Number One Mistake that Forex Traders Make even though very short-term charts are being used to trigger positions.
If momentum does continue in the trend-side direction, the trader could be in a very attractive position as prices continue to move in their favor.
Position Management
If the trend does continue, should the trader just sit on their limit order and wait for the sound of the cash register to ‘cha-ching?’
No way. When trading on short-term charts, things can change VERY quickly, and it’s the day-trader’s job to manage that risk.
When the position gets in the money by the amount of the initial stop (a 1-to-1 risk-to-reward ratio), the trader can look to move the stop to break-even so that, worst-case scenario should prices and momentum reverse, the trader puts themselves in a position to avoid taking a loss.
At this point, the trader can also begin ‘scaling out’ of the position. Since a 1-to-1 risk-to-reward has been realized, the trader is actively attempting to avoid The Top Trading Mistake; and should momentum continue in the trend-side direction, the trader stands to profit considerably more.
As prices continue in the direction of the trader’s position, additional pieces of the trade can be closed or ‘scaled out’ as prices move in their favor.
The goal is to get the ‘average out’ from the strategy as large as possible, and if momentum is to continue, this strategy can allow the trader to do just that.
After the stop has been moved to break-even, and the initial risk is removed from the position; traders can even look to add-to the trade with new positions or new lots in an attempt to build a larger position with a significantly smaller amount of risk.
--- Written by James Stanley
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Forex Education: Old Resistance Turned New Support
Talking Points:
- One common trading tip is using broken resistance as new support
- AUD/JPY offers a better opportunity because of confluence of support near the same price zone
- USD/CNH is retesting old resistance turned new support, but that retracement isn’t deep enough for a good risk-to-reward ratio
Technical traders would suggest that identifying levels of support or resistance is a foundation to which a forex trading strategy is built upon. As a result, technical traders spend many hours identifying levels of support and resistance on a chart to trade from.
Newer traders are intrigued by the ability to identify areas of buying and selling pressure on a chart. These levels of support and resistance can act like a floor (support) or ceiling (resistance) for prices. Eventually, these levels will break which offers up a new trading opportunity.
Today, we will look at two examples of resistance and how it acts like new support when broken. In the illustrations used, we will also see how one of the examples presents a stronger opportunity than the second example. Let’s get started!
AUD/JPY Finds Confluence of Support
The first example we’ll look at today is the chart that presents the better opportunity of the two illustrations. This is because we have a confluence of support near the same price level. Not only has the old resistance turned new support, but we also have a support trend line passing through the same area. This is providing an extra layer of support that makes it more difficult for prices to push through.
AUD/JPY Bounces at Old Resistance
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On the chart above, we see the AUD/JPY found resistance near the same price level in November 2013 and March 2014 near 94.50. Prices did eventually pierce this resistance level of 94.50 and broke higher. Traders who missed the initial break can wait for prices to return to the point of breakout. In this case, traders can wait for prices to return to 94.50 and consider a long position.
In addition to this old resistance acting like new support, there is a support trend line converging upon the same price zone. This provides an added layer of confirmation on the trade that prices are likely to be supported and bounce. As a trader, give me good opportunities at good risk to reward ratios and I’ll be a happy camper.
In this instance, traders could look to initiate a long position near 94.50 placing their stop loss just below the recent swing low (near 94.15). The first target would be the area near the previous highs of 96.00.
USD/CNH Retraces to Old Resistance
The second example is similar in that prices have retraced to an old resistance level. However, the second example is not as strong of a trading opportunity because we don’t have the added confirmation of another support level in the area.
Chinese Yuan near Old Resistance
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The second illustration is for the USD/CNH.
As we can see above, the two blue arrows represent areas of former resistance that may act like new support. Prices have sold off and are near that level of support at 6.2200 - 6.2225. It is possible we will see a reaction higher, though I wouldn’t expect the bounce to materialize into anything significant.
That is because this level of support is NOT as strong as the AUD/JPY illustration. When applying the Fibonacci retracement levels to the chart, prices have yet to retrace 23.6% which is considered the minimum retracement of a healthy uptrend. Therefore, we need to look to lower levels of support as being our stronger levels of support.
Therefore, look for the 38.2% retracement level near 6.17 to provide more meaningful support. At that point we can implement a “buy the dip” strategy.
---Written by Jeremy Wagner, Head Trading Instructor, DailyFX
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2 Methods to More Patient Trading
Talking Points:
- One common mistake in trendless markets is impatience
- Use conservative amounts of leverage even though market movements are slow
- Analyze longer term chart patterns for perspective and bias
If you hang around trading communities long enough, you’ll hear the wiser traders encouraging the newer traders about trading with patience and removing emotions.
It sounds simple, especially if you are practicing with a demo account. However, see what happens to your patience when your money is on the line!
A few weeks ago, we covered three common mistakes traders make during trendless markets and how to correct them. Over the next few minutes, I want to expand on the third mistake noted in that piece to help equip you with two actionable methods that can promote more patient trading.
One common mistake of traders during trendless markets is that they become impatient and close their trades prior to the stop loss or target being reached. During trendless markets, patterns and waves are slower to develop which breeds the impatience we feel.
To balance that impatience, practice these two methods below.
“Remember the clever speculator is always patient and has a reserve of cash.” Jesse Livermore
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Use Conservative Amounts of Leverage
We assume that trades which have historically reached their profit targets quickly should continue indefinitely into the future. Therefore, if prices aren’t hitting their targets quickly, it must obviously not be a good trade so we exit prematurely.
This impatience is in part due to expecting the next trade to be a big home run. As a result, we’ll place a trade size a little larger than normal so as to squeeze a little extra juice out of the trade in case it goes nowhere. However, during this process, the trader ends up risking a significant portion of their account on the outcome of that one trade.
Remember, a 25% loss requires a 33% return to get back to break even. If a 25% loss in a fast moving market is difficult enough to overcome, imagine how challenging it would be to overcome a 25% loss in a slow moving market. Therefore, de-emphasize each trade and think of the next trade simply as the first of ten trades rather than the next homerun.
You can reduce the emphasis by implementing less than 10x effective leverage. Effective leverage is simply taking the total notional trade size and dividing it by your account size. The result will indicate how many times you have your equity levered. According to our research, we recommend implementing less than ten times effective leverage.
Incorporating smaller trade sizes and less leverage will alleviate the stress of having to produce a profitable trade. As a result, you’ll be more likely to let the trade develop and let the trade evolve in the way the patterns indicate.
Analyze Longer Term Patterns
Another way to become more patient is to remember what the longer term chart patterns are suggesting.
Recently, I had been trading the USD/MXN extensively and the movement was quite choppy. It had been a while since I stepped back to review the daily chart. Since it had been several months, the pattern on the daily chart cleared up which affected my near term bias on the trades.
Sometimes, we can get caught up in the minutia of the day to day. Then, we forget what the longer term patterns are suggesting and lose that perspective in trading.
That is the benefit you get with longer term chart analysis. Longer charts help you develop a bias of direction. With each trade you make, there should be some method of determining a bias.
For example, trend traders look at the longer term trend and filter their trades accordingly. Range traders will see the longer term levels of support and resistance and make buying decisions near support and selling decisions near resistance.
The point is that the market tries to lull us to sleep, yet the longer term patterns are still playing out. What better time is there to analyze charts than while the markets are slow!
Learn Forex: USD/CNH Daily Chart
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There are several good longer term patterns exhibiting the potential for something big to happen. Keep an eye on GBP/AUD, USDOLLAR, AUD/NZD and Silver.
In summary, train yourself to be more patient by utilizing less than ten times effective leverage and occasionally reviewing longer term charts for perspective.
Good luck and happy trading!
---Written by Jeremy Wagner, Head Trading Instructor, DailyFX
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The More Intelligent Trailing Stop
Talking Points:
- Trailing Stops can reduce risk but increase the chances of being stopped out prematurely.
- Manually trailing our stops each time there is a new swing high/low reduces this whipsaw effect.
- An Asymmetrical Fractal can provide guidance on when to move our stop.
During my simple strategy webinars, traders often ask me if I use trailing stops. When I tell them that I manually trail my stops, it is usually followed by several seconds of silence. It’s not that I don’t think people can be successful with traditional trailing stops (there are many successful traders that do), but for me personally, I like to set my stops around support and resistance levels to reduce my odds of getting stopped out.
This article will discuss the issue I have with traditional trailing stops, how I personally trail my own stops, and a handy tool to make this method extremely simple to follow.
The Flaw in Trailing Stops
Trailing stops are a more advanced type of stop loss order that adjusts itself to a more favorable rate as a trade moves in our favor. The result is a reduced stop loss (reducing risk) that is based solely on how price moves. It is at that moment that a traditional trailing stop shows its flaw. The stop moves to a level based on how far a trade moves in our favor, rather than moving based on key price levels. All support and resistance analysis previously performed is thrown out the window as our stop moves freely to a random level X pips away from the currency pair’s high water mark.
Therefore our stop we set beyond the most recent swing low will suddenly move to a level above the swing low and be at much greater risk of being hit by a sudden downward whipsaw.
Learn Forex: Trailing Stop Getting Whipsawed on USD/CNH
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Manual Trailing Stop
So what can we do about trailing stops’ tendency of getting stopped out too early, but still have the benefits of reducing our risk during the life of our trades? The secret is in manually trailing our stop losses ourselves, always basing our stops around support and resistance levels along the way. A rare example of having your cake and eating it too. Let’s take a look.
Learn Forex: Manual Trailing Stop in an Uptrend
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The image above shows the same trade we placed on the USD/CNH, but with much better results. Rather than using a traditional trailing stop that blindly moved up as price moved up, we moved our stop only when a new swing low was created. We set our stop below each new swing low as price progressed and were able to ride this monster uptrend 1500 pips before being stopped out.
It can take some time to be able to “eyeball” significant swing highs and lows and know exactly when a stop should be moved. Therefore, try out this handy tool that does all the hard work for us (see below).
The Asymmetrical Fractal
A fractal is a tool that draws an arrow on each candle that’s highest price is higher than the high of the two candles to the left and two candles to the right. It also draws arrows on each candle that’s lowest price is lower than the low of the two candles to the left and two candles to the right. It can be used to note potential turning points in the market, or in this case, can be used to identify swing highs and swing lows that we can base our stop off of.
Some settings will create less fractals than the traditional version due to the stipulation that the candle’s high or low price must be higher or lower than the previous 5 candles and the following 9 candles. Now that we see the asymmetric fractals on our charts, we can see their value immediately. Each time we see a fractal, that is a level where we could manually move our stop since it is a significant swing high or swing low. I’ve overlaid our fractals on to our USD/CNH chart used earlier to show how our manual trailing stop moved almost 100% in sync with the fractals created over the same period:
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The Buck Stops Where?
Hopefully, this article has given us a better way to trail our stops. We always want our stop to be beyond the most recent swing high or swing low, and the asymmetric fractals can help identify those levels.
Good trading!
---Written by Rob Pasche
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A Quicker Trade Signal Using MACD
Talking Points:
- The MACD and Signal line crossover gives traditional buy/sell signals.
- Histogram is the difference between the MACD and Signal line.
- We can enter when Histogram begins to get smaller rather than wait for a cross.
Most technical traders have experience using the more popular oscillators, RSI, CCI, and MACD, etc. But many traders I’ve taught are not aware of the alternative way to use the MACD. In this article we will discuss how to use MACD’s histogram to open trades and show how in many cases we can get a quicker entry than the traditional MACD method.
What Does the Histogram Represent?
The green histogram or “bar chart” included in the background of the MACD displays the difference between the MACD and Signal line. When the MACD is above the Signal line, the bar is positive. When the MACD is below the Signal line, the bar is negative. The actual height of the bar is the difference between the MACD and signal line itself.
MACD’s Histogram Construction
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The chart above shows what the Histogram represents. The first label shows how the MACD is higher than the Signal line. This creates a positive green bar that has a height equal to the difference of the two lines. The second example the MACD is below the Signal line. This creates a negative green bar that has a height equal to the difference between the two lines. We can also see that when the Blue and Red lines cross, the histogram flips from one side to the other.
How to Enter Based On the Histogram
So how can we read the histogram to generate trade signals? We first want to track the histogram as it moves away from the zero line, in other words, track it as its bars grow larger. The actual signal comes when the histogram no longer gets larger and produces a smaller bar. Once the histogram prints a smaller bar, we look to trade in the direction of the histogram’s decline. We can see an example of this in the chart below:
MACD Histogram Entry Logic
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The Sell signal on the left was created by four growing bars in a row followed by a fifth bar that closed smaller. Five bars later, we see the MACD line crossing below the Signal line which is a traditional MACD signal. This later signal would have missed a majority of the move that the Histogram signal would have caught. Therefore, using the histogram as a signal can earn us a greater number of pips.
The Buy signal on the right is a similar story. We saw four bars growing consecutively until a 5th bar was created that equaled the 4th. We want to wait until a bar is smaller, so the trigger would have been presented after the 6th bar closed. This buy trade came several bars before the MACD/Signal cross and gave us a better entry as well.
Once we are in the trade, we can use sound Money Management to close out the trade appropriately.
And The Rest is Histogram
This entry strategy is fairly straight forward and can quickly be adopted by a technical trader.
Good trading!
---Written by Rob Pasche
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Save Money by Getting Better Trade Entries
Talking Points:
- Learn how to ‘eyeball’ bullish and bearish trends.
- Trade pullbacks as identified by the Slow Stochastic.
- Set stops beyond closest support/resistance and set limits twice as far.
The Slow Stochastic is often an indicator I teach in our “Simple Trading Strategies” series and for good reason. It’s simple to understand, gives very clear trading signals, and can often lead to profitable trades. But something I don’t have time to do during those 30 minute long sessions is talk about market conditions and how that can play a role in whether a strategy is successful or not.
Today, we will cover how to identify trending markets and then apply the Slow Stochastic to get into trades during pullbacks.
The Trend is Your Friend
Every trader has heard the phrase, “The trend is your friend.” This phrase describes traders that look for instruments moving consistently up or down and then trade in the same direction as the trend. If the trend continues, trend traders make money. If the trend reverses, trend traders lose money. In principle, this is easy, but in practice it is a little more difficult.
Properly identifying trends takes practice. We need to be confident in what constitutes a trend and what invalidates a potential trend. So the two things I look for are:
- A general move from lower left to upper right or from upper left to lower right.
- Higher swing highs and higher swing lows or lower swing highs and lower swing lows.
The following examples show charts identified as an uptrend and a downtrend using these two rules.
Learn Forex: Identifying an Uptrend
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Learn Forex: Identifying a Downtrend
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Using Slow Stochastic to Identify Pullbacks
Once we identify a chart that is trending up or down, we need to add our Slow Stochastic indicator to the chart. I prefer using the settings (15, 5, 5) rather than the default (5, 3, 3). These settings slow down the indicator further and provides (in my opinion) more reliable signals. In an uptrend, we want to take any Slow Stochastic buy signal that occurs in oversold territory, below 20. (In a downtrend, we want to take any Slow Stochastic sell signal that occurs in overbought territory, above 80.)
The image below shows a great buy entry on the GBPUSD where price was trending upward, pulled back resulting in an oversold Slow Stochastic reading, and then had a Slow Stochastic signal to buy in the direction of the upward trend.
Learn Forex: Uptrend with Slow Stochastic Entry – GBPUSD Daily Chart
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The image above shows the same trade we placed on the USD/CNH, but with much better results. Rather than using a traditional trailing stop that blindly moved up as price moved up, we moved our stop only when a new swing low was created. We set our stop below each new swing low as price progressed and were able to ride this monster uptrend 1500 pips before being stopped out.
It can take some time to be able to “eyeball” significant swing highs and lows and know exactly when a stop should be moved. But, there is a really handy tool that can be used to identify these levels more clearly.
Exit Strategy
No Strategy is complete without an exit strategy. For the trade example above, we will need to set our stop beyond the most recent swing low. I like to set my stop anywhere from 5-25 pips away from the low depending on the time frame and currency pair. With a trade size using sound money management rules.
For our limit, I suggest using a limit that is twice the distance as our stop. This gives us a positive risk:reward ratio of 1:2 with a breakeven win rate requirement of only 33%. So as long as we are correct on 1/3rd of our trades or more, we should at least be breakeven traders using this risk:reward ratio. Both the stop and limit used for this trade can be seen below.
Learn Forex: Downloading & Installing the Asymmetric Fractals Indicator
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Pulverizing the Pullback
In this lesson, we discussed the importance of identifying a trend, locating pullback entries and how to manage each trade moving forward.
Good trading!
---Written by Rob Pasche
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The 3 Step No-Hassle Range Trading Strategy
Talking Points:
- Low volatility opens the door to use range trading strategies.
- Pivot levels automatically give traders support and resistance levels to trade from.
- Stops and limits can both be set using pivot levels.
With the slow market conditions we have been seeing lately, trend strategies and breakout strategies have had a difficult time turning a profit. The strategies I have been running that made money from 2011-2013, have really struggled to keep their heads above water during 2014. So I’ve been on the lookout for ways to efficiently trade low volatility periods of time using range based strategies.
Today, we are going to cover a range strategy created specifically for current market conditions we are facing.
Step 1: Look for Low Volatility
As mentioned above, range based strategies work best in low volatility periods of time. So, our first order of business is to find the pairs that have shown the least amount of volatility.
Learn Forex: DailyFX Technical Analysis - Volatility
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The image above shows volatility highlighted in red. A 0% reading means a pair has shown almost no volatility while a reading of 100% means the pair has shown an extreme level of volatility. For the purposes of range trading, we recommend a reading of 25% or lower. So we need to make note of each pair with volatility below 25% before we move on to our charts.
Step 2: Find Trade Entries Using Pivot Levels
Pivot levels are one of the oldest forms of technical analysis. They were actually used by floor traders to easily keep track of important price levels before price charts became more readily available. Fortunately for us, we do not need to calculate these levels ourselves.
Learn Forex: Pivot Levels
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Our chart should now look like the one above, a single gray line with multiple green lines and red lines above and below. These lines will act as our trigger for placing a trade and for setting stops and limits.
Step 3: Entering and Exiting Using Pivot Levels
We need to identify the lines by their proper names. The gray line is called the “pivot” and is in the middle. The green lines above are resistance levels named R1, R2, R3 and R4 with the smaller numbers closer to the pivot line. The red lines below are support levels named S1, S2, S3 and S4 with the smaller numbers closer to the pivot line. Any of these lines can cause price to bounce.
For our entry, we are going to wait until either S1 or R1 are hit. If S1 is hit, that is a buy signal. If R1 is hit, that is a sell signal. The idea is that if markets are ranging, then they will snap back towards the mean if they move too far in one direction or the other. The chart below displays a classic buy signal when price hits S1.
Learn Forex: Buy Trade Setup - Using Pivot Level Range Trading
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“…If S1 is hit, that is a buy signal…”
Once the buy trade is placed, we set our stop loss at S2, with profit targets at the pivot and R1 levels.
In a situation where price reaches the R1 first, this would trigger a sell trade with a stop loss at R2 and profit targets at the Pivot and S1. Effectively, the inverse of the chart shown above.
Home, Home on the Range
When using the correct tools, we can trade any market. And when it comes to trading markets with low volatility, pivot levels are an easy way to open and close range-based trades.
Good trading!
---Written by Rob Pasche
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Breakout on USDCHF Backed by Sentiment Shift
Talking Points:
- The USDCHF has broken above its price channel.
- SSI has flipped to a negative value for the first time in a year.
- Potential Buy trade based on technicals and sentiment.
I wrote three weeks ago about the longstanding short trade I had on the USDCHF. Shortly after posting, the oldest trade I’ve ever held onto (49 weeks) was stopped out on what could be a reversal of a long term trend. Today, the USDCHF broke another significant level that adds more fuel to the bullish fire. Let’s look at the arguments for a USD/CHF long trade in the form of technical analysis and sentiment.
Breakout Leading to Long-Term Reversal?
The USDCHF has wasted little time in reversing from its low of 0.8700 up to the highs we are seeing now. It’s broken its two previous highs and has also broken out of a price channel formed from its previous swing lows (labeled in green below). The price has closed above this channel on a daily chart, which confirms the breakout. This move is what originally brought this trade idea into focus.
Learn Forex: Daily Chart – USDCHF Long Trade Plan
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I like a Limit just below the previous high on January 21st and a stop loss that is half that distance in pips from my entry. This gives us a 1:2 risk reward ratio which follows DailyFX’s money management principles. The stop is relatively tight, but I am comfortable with that considering the USDCHF could fall almost all the way back to 0.8700 without much support in its path. I’d rather we cut this trade quickly if it begins to move against us.
Sentiment Flipping Negative – Bullish Signal
The other signal supporting the trade idea above is what has been going on with DailyFX’s SSI, the Speculative Sentiment Index. Sentiment has been notoriously long the USDCHF for over a year while traders tried to “pick the bottom” during the downtrend. These retail traders were in a world of hurt up until 3 weeks ago when the potential bottom was hit.
For the last couple days however, sellers have begun to slightly outweigh buyers as price has risen. This means that long USDCHF traders are taking profit, and some traders are beginning to apply short positions looking for a move back in the direction of the long term trend. We can see in the sentiment chart below, as price has been moving higher, SSI has been moving lower and now is creeping into negative territory.
Learn Forex: Speculative Sentiment Index (SSI) on USDCHF
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The negative sentiment level, while not extreme on its own, is important considering how long it’s been since sentiment has been negative. If we see more and more sellers enter trades on the USDCHF, this would reaffirm the USDCHF buy trade since SSI is a contrarian tool. We look to do the opposite of the retail trading crowd with the idea that there is an edge in doing so.
The Falling Franc
The sudden shift in the USDCHF ended my longstanding short position, but could lead to a profitable buy position if the reversal is legitimate. With a classic breakout signal and sentiment levels backing the idea, I believe it is a trade worth considering. As always, please apply your own analysis before trading and email me with your thoughts and feedback!
Good trading!
---Written by Rob Pasche
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Gold Presses Fibonacci Wave Relationship
Talking Points:
- Triangles are consolidation patterns that tend provide clean technical levels to trade from
- Gold may be nearing a bullish reaction point that offers a trading opportunity to buy
- Try trading gold in a practice demo account
Gold appears to be consolidating in a sideways triangle for the past 12 months. This is a big consolidation pattern that offers some trading opportunities inside the triangle.
Look for the yellow metal to find support over the next several days and a potential $100 rise in the price of the gold.
The Anatomy of a Triangle
Triangles are consolidation patterns that allow prices to trade sideways in an effort to alleviate overbought and oversold pressures. In the case of gold, it has been working its way lower for the past three years and needs to consolidate those losses, which it has been doing in the triangle pattern.
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Elliott Wave triangles are made up of five waves inside the triangle with each wave being contained inside the previous wave. In the idealized example above, notice how wave ‘B’ ends BEFORE the beginning of wave ‘A’. Notice how wave ‘C’ ends BEFORE the beginning of wave ‘B’. This continues until prices squeeze together in five waves (A-B-C-D-E) then they eventually explode.
In the same idealized example above, it appears gold is closing in on the end of the ‘D’ wave which should yield a bounce higher in wave ‘E’.
Gold Analysis: Bulls have Fibonacci reasons to buy
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Here is the actually price chart of goal with the green triangle labels. There are two wave relationships that point towards the end of the ‘D’ wave ending near $1235 per ounce. Both wave relationships are expressed through alternating waves having a fibonacci relationship in length.
First, inside the green ‘D’ wave, you’ll see we have a blue a-b-c sequence. Many times, the length of wave ‘c’ will have an equality or fibonacci relationship to the length of wave ‘a’. In the case for gold, the length of blue wave ‘c’ equals blue wave ‘a’ times 61.8% at $1235 per ounce.
Secondly, green wave ‘B’ and green wave ‘D’ are alternating waves. If you take the distance of green wave ‘B’ and multiply it by 61.8% and project it for a distance on green wave ‘D’, it yields a price target of $1235 per ounce.
So we have two different alternating waves pointing to the same price target. This means there will likely be a reaction higher near $1235. If $1235 does fail, look to $1190-$1200 providing significant support.
The price target to the upside in this scenario would be $1340-$1390. So there is enough room to the upside to position towards the long side of the trade.
---Written by Jeremy Wagner, Head Trading Instructor, DailyFX Education
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Technical Patterns Show AUDUSD Risks New 2014 High
Talking Points:
-The Current Technical Juncture for AUDUSD
-200-DMA Could Support Price Further
-Price Patterns Favoring a 2014 High Is Coming
“[Michael Marcus] taught me one other thing that is absolutely critical: You have to be willing to make mistakes regularly; there is nothing wrong with it. Michael taught me about making your best judgment, being wrong, making your next best judgment, being wrong, making your third best judgment, and then doubling your money.”
-Bruce Kovner
AUDUSD plays a very important role in the FX Market. First, AUDUSD is often a key proxy for the risk-on sentiment that is prevalent among G10 currencies. If AUD is bid, risk appears to be favored as AUD is a high-yielding currency and is often bought as institutional and retail investors look to be pair more in an environment that favors risk and downplays risk-avoidance. If AUD is offered / sold, risk appears to be out of favor of many traders as they look to favor a safe currency like the USD, JPY, or CHF in preference over higher-yielding AUD, NZD or EMFX crosses. In other words, markets are emotional and AUD is at the axis of the emotions.
The Current Technical Juncture for AUDUSD
From April 2013 to January 2014, AUD was having a hard time finding any long-term buyers. There was a strong bear-market rally from August to October, but that was overcome and AUDUSD pushed new lows not seen since 2010. Now, a similar rally to the Fall ’13 rally is at play and we’re approaching a critical point on the chart that will bring light to whether the technical edge favors the bulls or bears.
Learn Forex: Will History Repeat
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From his chart alone, you’ll notice a few key things are at play. First, the move from the late January low of 0.8659 looks similar to the last bear-market rally that ended up in a 900 pip downtrend. Second, a trendline connecting the October ’13 top to the tops in mid-2014 are acting as resistance to the upside. However, a few factors favor the upside that could be more important and if broken with a close higher, could signal a move into 2014 highs soon.
200-DMA Could Support Price Increases Further
If the Forex market have any equivalent to a compass, it could very well be the 200 day moving average. In no uncertain terms, price above the 200-dma favors a further increase in price, which is common for an uptrend. Price below the 200-dma favors a further decline in price, which is common for downtrends.
Learn Forex: 200-dma on AUDUSD
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The yellow line above denotes the 200-dma. As you can see, price is currently above the 200-dma, which favors further upside in a trending market. If you look above (click on the chart for a better view), the 200-dma acted as resistance in October 2014 and effectively capped the move before resuming the downtrend that started in January 2014. This prior reaction to the 200-dma helps us to see the 200-dma as significant and if price continues to stay above the 200-dma, then further prices should be favored.
Price Patterns Favoring a 2014 High Is Coming
There are two patterns unfolding that are pointing to the potential for significantly higher prices should AUDUSD close above 0.9410. The two patterns are Elliott Wave Patterns and a bullish flag. Both of these patterns could see AUDUSD targeting between 0.9695-1.000.
Learn Forex: AUDUSD Patterns Favoring Higher Potential
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Let’s breakdown the two patterns so that you can see their trigger, stops, and targets. The trigger to enter is 0.9410 & the stop at 0.9200 is the same for both patterns. The only difference between the two are the potential targets and you can decide which you prefer based on how aggressive you want to be.
The first pattern is the Elliott Wave Pattern that look for a 5th wave to finish a common 5-wave pattern. A common Elliott Wave target is to look for wave 5 to equal 0.618% of the total distance traveled between waves 1-3. Projected from the end of W.4 near the 200-dma around 0.9200 would take us near 0.9695.
The second bullish pattern, known as a bull flag, which would be triggered on a break and close > 0.9410. The flag is a pattern made from a small correction after an impressive push higher that presumes another push higher. The bull flag target is based on the prior impulse distance projected from the flag low, which sits around 0.9200 bringing a target near parity of 1.0009
Happy Trading!
---Written by Tyler Yell, Trading Instructor
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