The Forex Strategies Guide For Day and Swing Traders 2.0
Updated and Expanded, 2014, 2015: Strategies and Methods for Conquering Conquering the World’s Currency Market
~by Cory Mitchell, CMT~ http://vantagepointtrading.com
© 2012, © 2014, © 2015 Cory Mitchell, CMT – All All rights reserved http://vantagepointtrading.com
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Governmentt Required Risk Disclaimer and Disclosure Statement Governmen This book is for informational informational purposes only and should should be used at your own discretion. The reader of this material agrees that they are acting of their accord and waive Cory Mitchell or http://vantagepointtrading.com of any liability associated with losses or hardships which may result from using information within this book. Trade at your own risk. The information provided here is of the nature of a general comment only and neither purports nor intends to be, specific trading advice. It has been prepared without regard to any particular person's investment objectives, financia l situation and particular needs. Information should not be considered as an offer or o r enticement to buy, sell or trade. You should seek appropriate advice a dvice from your broker, or licensed investment advisor, before taking any action. Past performance does not guarantee future results. Simulated performance results contain inherent limitations. Unlike actual performance records the results may under or over compensate for such factors such as lack of liquidity. No representation is being made that any account will or is likely to achieve profits or losses to those shown. By purchasing this book, you acknowledge ac knowledge and accept a ccept that all trading decisions are your own sole responsibility, and Cory Mitchell, www.vantagepointtrading.com or anybody associated with these entities cannot be held responsible for any losses that are incurred as a result. The risk of loss in trading can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial financia l condition. If you purchase or sell Equities, Futures, Currencies or Options you ma y sustain a total loss of the initial margin funds and any additional funds that tha t you deposit with your broker to establish or maintain your position. If the market moves against your position, positi on, you may be called upon by your broker to deposit a substantial amount of additional margin funds, on short notice in order to maintain your position. If you do not provide p rovide the required funds within the prescribed pre scribed time, your position may be liquidated a t a loss, and you may be liable lia ble for any resulting deficit in your account. Under certain market conditions, you may find it difficult or impossible to liquidate a position. This can occur, for example, when the market makes a "limit move." The placement of contingent orders by you, such as a s a "stop-loss" or "stop-limit" order, will not necessarily limit your losses to the intended amounts, since market m arket conditions may make it impossible to execute such orders.
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About the Author
This eBook is written by me, Cory Mitchell, a Chartered Market Technician (CMT), member of the Market Technicians Association, Canadian Society of Technical Analysts, and by extension the International International Federation of Technical Analysts. I’ve been a trader since 2005, pulling millions of dollars in profit out of the markets. I worked for six years as a proprietary trader for a trading firm(s), doing one of the toughest jobs on the planet (also the most fun) – extracting extracting profit every single month; if I didn’t make a profit, I didn’t get paid (no salary, everything was dependent on performance). These are forex trading strategies forged by relentless dedication to trading, and tens of thousands of trading hours and trades. In 2011 I moved my focus to trading independently, and helping others by sharing what I've learned. I freelance for and have been vetted by some of the largest financial sites in the world, including About.com (a top 100 site) and Investopedia, among many others. I am the founder of VantagePointTrading.com where I regularly post articles about trading. I usually write for a couple hours, helping others, and trade for one or two hours each day (that's all it takes). I spend my spare time rock climbing, on the running trails, training for the next fitness challenge, playing volleyball and golfing during the summer.
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Table of Contents Table of Contents......................................... ......................................................... ................................. .................................. .................................. ................................. ............................ ............ 5 Introduction & 5 Step Plan for Trading Succ ess (Read this all!) ................................ ................................................ ................................ ................ 10 1. Forex Basics................................... Basics................................................... ................................. .................................. .................................. ................................. ................................. ..................... .... 18 Understanding Foreign Exchange (FOREX) .................. ................................... ................................. .................................. .................................. ....................... ....... 18
Currency Pairs to Focus On ................................ ................................................. .................................. ................................. ................................. ..................... .... 19
Buying, Selling and Short Selling ................................ ................................................. .................................. ................................. ............................. ............. 21
The Bid/Ask Spread ................................. .................................................. .................................. ................................. ................................. ................................ ............... 21
Lot Sizes .................................. .................................................. ................................. ................................. ................................. .................................. ................................ ............... 23
Pip Value ................................ ................................................. .................................. ................................. ................................. ................................. ................................ ................ 23
Forex Market Hours and News ................................. ................................................. ................................. .................................. ................................ ............... 26
Leverage .................................. .................................................. ................................. ................................. ................................. .................................. ................................ ............... 28
Rollover ............................... ................................................ .................................. ................................. ................................. .................................. .................................. ................... 29
Order Types ............................... ................................................ ................................. ................................. .................................. ................................. ............................. ............. 32
2. Being Successful in the Forex Market .............................................. ............................................................... .................................. .................................. ................... 36 The Trading Plan ................................ ................................................. .................................. ................................. ................................. ................................. ................................ ................ 37
Risk Management ................................. ................................................. ................................. ................................. ................................. .................................. ................... 38
Position Size ................................. ................................................. ................................. .................................. .................................. ................................. .......................... .......... 39
Daily Risk ................................ ................................................. .................................. ................................. ................................. ................................. ................................ ................ 41
Forex Correlations................... Correlations.................................... ................................. ................................. .................................. .................................. ................................. .......................... .......... 43
What is a Forex Correlation? Correlation? ................................. ................................................. ................................. .................................. .................................. ................... 44
How to Use Forex Correlation Data........................................ Data........................................................ ................................. .................................. ................... 46
How Much Leverage to Use ......................................... ......................................................... ................................. ................................. ................................. ........................ ....... 49
How Much Forex Leverage – Leverage – Scenarios ..................................... ..................................................... ................................. ................................ ............... 50
Why Do Brokers Provide Such Huge Leverage? ....................... ........................................ ................................. ................................ ................ 52
Averaging Down .................................. .................................................. ................................. ................................. ................................. .................................. ................................ ............... 53 Pyramiding ................................. .................................................. .................................. ................................. ................................. ................................. ................................. ........................ ....... 54 Record Keeping ............................... ................................................ .................................. ................................. ................................. .................................. .................................. ................... 56 The Blissful Lack of Information ................................... ................................................... ................................. ................................. ................................. ........................ ....... 58 Moving Forward.................................. .................................................. ................................. ................................. ................................. .................................. ................................ ............... 59 3. Recommended Minimum Capital for Forex Trading (Day or Swing) ................................ ................................................. ..................... .... 61
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How Much Money Do I Need to Trade Forex? - Why It Matters ............................... ................................................ ........................ ....... 61 How Much Money Do I Need to Day Trade Forex? ................................. .................................................. ................................. .......................... .......... 62 ................................................ .................................. ........................ ....... 63 How Much Money Do I Need to Swing Trade Forex? ............................... 4. Pip Potential Relative to Spread – Spread – Day Trading Forex ........................................... ............................................................ ................................ ............... 66 Spread to Pip Potential Examples ............................... ................................................ .................................. ................................. ................................. ........................ ....... 68 5. Introduction to Swing Trading Tr ading and Day Trading Tr ading ................................. ................................................. ................................. .................................. ................... 71 Swing Trader or Day Trader? ................................. ................................................. ................................. .................................. .................................. ............................. ............ 72 Final Thoughts: Adapt Methods to Suit You .................................. .................................................. ................................. ................................. ....................... ....... 75 6. Picking a Forex Broker ........................... ........................................... ................................. .................................. .................................. .................................. ............................. ............ 76
How to Pick a Forex Broker – ask yourself the right questions ................................. ................................................. ....................... ....... 76 ............................................................. ............... 78 How to Pick a Forex Broker – does your broker offer this?. ..............................................
How to Pick a Forex Broker – don’t always trust reviews or other people’s opinions ................... 81 ............................... 81 How to Pick a Forex Broker – personally “test out” the broker(s) you choose ...............................
Don’t Take the “Bonus” ............................... ................................................ .................................. ................................. ................................. .................................. ..................... .... 82 7. Best Time to Day Trade Tr ade and Swing Trade ............................... ................................................ .................................. .................................. ............................. ............ 85
Open Major Markets Means Increased In creased Action ............................... ................................................ .................................. .................................. ................... 85 Best Time to Day Trade– Trade – EUR/USD, GBP/USD and USD/CHF ................................ ................................................ .......................... .......... 87 Best Time to Day Trade– Trade – USD/CAD................................ ................................................ ................................. .................................. .................................. ................... 90 ............................................... ................................. ........................... .......... 90 Best Time to Day Trade – AUD/USD and NZD/USD ...............................
Best Time to Day Trade – Other Forex Pairs ............................... ................................................ ................................. ................................. ..................... .... 91 Time of Day and Swing Trading ................... .................................... ................................. ................................. ................................. ................................. ........................ ....... 92 8. Introduction to Japanese Candlestick Charts ..................................... ..................................................... ................................. .................................. ................... 93 .................................................. ................................. ................................. ................................. ........................ ....... 94 Japanese Candlestick Creation .................................. ................................................. ................................. .................................. ................................ ............... 98 Japanese Candlestick Interpretation In terpretation ................................. The Secret Life of Charts ........................................... ........................................................... ................................. ................................. ................................. ........................... .......... 99 .................................................. .................................. ................................. ........................... ........... 100 The Bid/Ask Spread and Your Charts ................................. 9. Trading Chart Patterns ................................. .................................................. .................................. ................................. ................................. .................................. ................... .. 103 Chart Patterns to Focus On and How to Trade Them............................................... Them............................................................... ........................... ........... 104
The Triangle ................................. ................................................. ................................. .................................. .................................. ................................. ........................ ........ 105
Wedges ............................... ................................................ .................................. ................................. ................................. .................................. ................................. ................ 114
The Head and Shoulders Pattern................................ Pattern................................................. .................................. ................................. ........................... ........... 118
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Flags and Pennants ................................. .................................................. .................................. ................................. ................................. .............................. ............. 126
Trading with Multiple Profit Targets, Stops and Positions ................................. ................................................. ..................... ..... 132
Additional Chart Patterns ................................. ................................................. ................................. ................................. ................................. ................................. ................ 133
Double Top/Bottom, Triple Top/Bottom ............................... ................................................ .................................. ................................. ................ 133
Rectangle (Ranges) ............................... ................................................ .................................. ................................. ................................. ................................. ................ 139
Broadening Wedge..................................... Wedge..................................................... ................................. .................................. .................................. ........................... .......... 147
Finding Patterns .................................. .................................................. ................................. ................................. ................................. .................................. .............................. ............. 149 10. Trendlines, Horizontals and Shifting Markets ............................................. ............................................................. ................................. ...................... ..... 152 Horizontal Support and Resistance Guide ................................. .................................................. .................................. ................................. ........................ ........ 157 Trendlines Guide ................................ ................................................. .................................. ................................. ................................. ................................. .............................. .............. 159 Using Trendlines and Horizontals in Shifting Markets...................................... Markets...................................................... ................................. ................... .. 160 11. Combining Engulfing Candles with Trends ............................................ ............................................................. .................................. ........................... .......... 165 Recognizing Engulfing Candles ..................................... ..................................................... ................................. ................................. ................................. ...................... ..... 165 Using the Trend with Engulfing Patterns................................... Patterns.................................................... .................................. ................................. ........................ ........ 167 ................................................. ................................. ................................. ................................. ......................... ........ 171 Zeroing In on the Entry Point ................................. 12. Trading the News .............................................. .............................................................. ................................. .................................. ................................. .............................. .............. 175 Rules of the Strategy: .................................. .................................................. ................................. ................................. .................................. .................................. ..................... ..... 177
Trade Example ............................... ................................................ ................................... .................................. ................................. ................................. ..................... ..... 179
13. The Carry Trade...................................... Trade...................................................... ................................. .................................. ................................. ................................. ......................... ........ 181 What to Watch For ............................... ................................................ ................................. ................................. .................................. ................................. ........................... ........... 182 How You Make Money .......................... ........................................... ................................. ................................. .................................. .................................. ........................... .......... 185 14. Statistics and Averages Every Trader Should Track ..................................... ..................................................... ................................. ...................... ..... 188 Daily Range ................................ ................................................. .................................. ................................. ................................. ................................. ................................. ...................... ..... 189 Inner-Daily Range ............................... ................................................ .................................. ................................. ................................. .................................. .............................. ............. 191 Day of Week Averages ............................... ................................................ ................................... .................................. ................................. ................................. ..................... ..... 192 Homework ................................. .................................................. .................................. ................................. ................................. ................................. ................................. ...................... ..... 193 15. European Open Strategy ......................................... ......................................................... ................................. .................................. ................................. ........................ ........ 195 The Trade Set-up................................... ................................................... ................................. .................................. .................................. ................................. ........................... ........... 195 Trade Rules ................................ ................................................. .................................. ................................. ................................. ................................. ................................. ...................... ..... 198 Considerations and Performance ................................. ................................................. ................................. ................................. ................................. ...................... ..... 206 16. Truncated Price Swing Strategy ................................. ................................................. ................................. ................................. ................................. ...................... ..... 208
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Truncation Strategy Considerations ............................... ................................................ .................................. ................................. ................................. ................... .. 217 17. Channel Breakout Strategy ............................... ................................................ .................................. ................................. ................................. .............................. ............. 219 The Nature of Trends ............................................. ............................................................. ................................. ................................. .................................. ............................ .......... 220 2 20 Mini-Channel Breakouts ............................... ................................................ .................................. ................................. ................................. .................................. ................... .. 220 Stops and Profit Targets ................................ ................................................. .................................. .................................. ................................. ................................. ................... .. 223 Correction Channels................................. Channels................................................. ................................. .................................. .................................. ................................. ........................ ........ 227 18. Scalping Round Numbers ..................................... ..................................................... ................................. .................................. .................................. ........................... .......... 233 Scalping Round Numbers ............................................. ............................................................. ................................. ................................. ................................. ...................... ..... 233 19. The "Good-Bye Kiss" Strategy ......................................... ......................................................... ................................. .................................. ................................. ................ 237 Good-Bye Kiss Considerations.......................... Considerations........................................... ................................. ................................. .................................. ................................. ................ 241 20. Always Weigh the Probabilities.................................. .................................................. ................................. ................................. ................................. ...................... ..... 243 2 43 What are Realistic and Reasonable Re asonable Criteria? .................................. ................................................... ................................. ................................. ................... .. 246 21. Anticipating Chart Pattern Breakout Direction ............................... ................................................ .................................. ................................. ................ 248
What is Front-Running a Chart Pattern Breakout? ............................... ................................................ .................................. .............................. ............. 248 Anticipating a Chart Pattern Breakout ................................. ................................................. ................................. .................................. .............................. ............. 249 Guidelines for Anticipating Chart Pattern Breakout Direction ............................................ ............................................................ ................ 255 22. Interpreting Price Action: Velocity V elocity and Magnitude ................. .................................. ................................. ................................. ......................... ........ 257
Velocity and Magnitude: Why They’re Important ............................... ................................................ .................................. .............................. ............. 257
Analyzing Price Action: Magnitude ............................... ................................................ .................................. ................................. ................................. ................... .. 257 Analyzing Price Action: Velocity ............................... ................................................ .................................. ................................. ................................. ...................... ..... 259 Analyzing Price Action – How How to Use This Information ................................. ................................................. ................................. ................... .. 261 23. "Strong" Support and Resistance and the Crotch Strategy ......................................... .......................................................... ...................... ..... 262 Minor (inaccurate) Support and Resistance ........................ .......................................... .................................. ................................. .............................. ............. 262 STRONG Support and Resistance ........................................... ............................................................ .................................. ................................. ........................... ........... 264 The Crotch Strategy ................................. ................................................. ................................. .................................. .................................. ................................. ........................ ........ 268 The Crotch Crot ch Strategy S trategy and "Rangey" Pairs ...................................... ...................................................... ................................. .................................. ...................... ..... 272 Ranges in Similar Economies ....................... ........................................ ................................. ................................. ................................. ................................. ...................... ..... 273 Time of Day .............................................. .............................................................. ................................. .................................. .................................. ................................. ........................ ........ 275 24. The Trend Channel Trading Strategy ............................ ............................................. ................................. ................................. ................................. ................... ... 280 25. Psychological Pitfalls You Need to Understand .................... ..................................... .................................. .................................. ........................... .......... 286 How Not Losing Keeps K eeps You From Winning Wi nning ..................... ...................................... ................................. ................................. .................................. ................... .. 286
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Avoiding Losses ................................. .................................................. .................................. ................................. ................................. .................................. ................... .. 287
Losing Means Winning? ............................... ................................................ .................................. .................................. ................................. ........................ ........ 288
A Psychological Trick .............................................. .............................................................. ................................. ................................. .................................. ............................ .......... 288 Wanting to Be First In and Last Out ............................................. ............................................................. ................................. .................................. ...................... ..... 290 Protecting the Ego ................................ ................................................ ................................. .................................. .................................. ................................. ........................... ........... 290 2 90 On and Off Discipline .................................. .................................................. ................................. ................................. .................................. .................................. ..................... ..... 291 Don’t be Arrogant. Arrogant. Develop Confidence and S elf-control ................. .................................. .................................. ................................. ................ 292 Losing Objectivity ............................... ................................................ .................................. ................................. ................................. .................................. .............................. ............. 293 The “All In” Mentality/Revenge ............................... ................................................ .................................. .................................. ................................. ........................ ........ 293 Random Reinforcement ................................ ................................................. .................................. .................................. ................................. ................................. ................... .. 294 26. Active Trade Management ........................ ......................................... ................................. ................................. ................................. ................................. ...................... ..... 296 27. How to Incorporate All This Information .............................................. .............................................................. .................................. ............................ .......... 301 28. Bringing Everything Together into Your First Trading Plan ................................. .................................................. .............................. ............. 305
Swing Trading Plan ................................. ................................................. ................................. .................................. .................................. ................................. ........................ ........ 306 Specificity Matters ................................ ................................................ ................................. .................................. .................................. ................................. ........................... ........... 311 29. Checklist For While You Are Trading .................................. .................................................. ................................. ................................. .............................. .............. 314 30. False Breakouts - A GIFT to Active Traders.................................... Traders..................................................... ................................. ................................. ................... .. 317 31. Create Your Own Trading S trategies .................................. .................................................. ................................. ................................. .............................. .............. 321 Creating Strategies ................................ ................................................ ................................. .................................. .................................. ................................. ........................... ........... 321
What initiated the Move? ............................... ................................................ .................................. ................................. ................................. ...................... ..... 321
Look For an Exit ................................. .................................................. .................................. ................................. ................................. .................................. ................... .. 323
Money Management – Management – What’s the Risk? .................................. .................................................. ................................. .............................. ............. 323
See if it's Reliable .................................. .................................................. ................................. ................................. ................................. ................................. ................ 324
32. Meditation for Traders .......................... ........................................... .................................. .................................. .................................. ................................. ........................ ........ 327 What Meditation Is , and How it Relates to Trading ............................. .............................................. .................................. .............................. ............. 327 Using Meditation For Improved Trading ................................ ................................................. .................................. ................................. ........................... ........... 327
Improving Performance Meditation.................................. .................................................. ................................. ................................. ..................... ..... 329
Altering the Meditation ................................ ................................................. .................................. .................................. ................................. ................................. ................... .. 330 33. Trading Resources ....................................... ........................................................ .................................. ................................. ................................. ................................. ................... ... 333
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Introduction & 5 Step Plan for Trading Success (Read this all!) Whether you're an experienced trader or new to forex trading (or trading in general), throughout this book you'll find information that will help you profitably tackle the global currency market. It's my hope that with some effort, patience and discipline you'll be able to fruitfully create a trading plan and implement these strategies effectively...allowing effectively...allowing you to achieve your goals. While certain chapters may be of greater interest to you than others, read all the chapters, in order . Each will add to your market understanding, and be beneficial when building your trading plan (your plan of attack for the markets). Interspersed throughout throughout the book are insightful points on trading, which are missed if the material is glanced over. This book provides strategies for trading in any type of market, whether trending, ranging, volatile or sedate. It'll demonstrate how to determine which of these market environments is currently underway, underway, and when w hen the market shifts from one type of environment to another. The ability to determine shifts in the market will take time to master. In order to become a better trader you should understand these concepts before applying any of the strategies discussed. That means you should read the whole book before applying the specific strategies contained within it (see the 5-step plan below). Combine all the information, and don't just blindly follow the individual strategy rules I've laid out. You'll then need to go through the process of applying the strategies in the market, but only when combined with the knowledge you've acquired about general market movements by reading through the entire book. In other words, don't just read one chapter to nab a strategy...this won't help your trading over the
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long run. Understand market dynamics first, then start applying the strategies so you can better understand when a strategy should be used, and when it shouldn't. No chapter is complete on its own. All the t he chapters build on each other. To take full advantage of each strategy, and to learn how to employ them, you'll want to understand all the other chapters. Don't be in a rush; read it all.
It's one thing to see a pattern or trade after the fact, it's quite another to realize what's happening in the moment and execute the trade without hesitation. While you read, if possible, follow along on your own charts by pulling up any free chart website/platform, such as TradingView.com. As topics are discussed, find examples on the chart. Don't attempt to trade based on the information just yet; that'll come later. Instead, as you read, just look for examples so the information is better absorbed, and the reading becomes more of an interactive hands-on learning process. As you get to the end of the book you'll need to open a demo account ( or use a current one) and make trades in real-time, but with fake money. Demo accounts are a useful tool, but still fall well short of trading with real money. Trading is mostly psychology. I can't stress this enough. If a trader is bouncing from strategy to strategy, trading book to trading book, it's likely not their strategies which are at fault, but their discipline and psychology that need work. You'll have many tools and ideas for tackling the forex market (and other markets) after reading this book, yet it takes discipline to implement these methods as outlined. Failure in trading is rarely from a lack of sufficient knowledge. Failure results from a lack of discipline to implement, and stick with, a course of action once it's initiated. Following the plan for each trade is what matters, regardless of what occurs while the trade is open. Many traders have the discipline to execute a trade, but begin to crumble and abandon their plan once the trade is under way and gyrating between a profit and loss. Throughout Throughout the book you'll learn what's included in a
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trading plan, and build your own, so you don't ever have to question yourself before or during during a trade again. again. The demo account helps you get a feel for market movement, be able to spot market shifts and see trades in real-time, but it doesn't adequately mirror the psychological barrage of emotions which affect you when real money is on the line. Especially when losing money people have a tendency to begin blaming anything but themselves, resulting in a negative performance feedback loop. Instead, as a trader, you must take full responsibility for yourself, your education, your trading plan and following it. Watching your profits and losses gyrate up and down won't be easy. Your mind will want to give in to impulsive action, but doing so will sabotage your trading. Follow your original trade plan, and use the demo account to practice this skill. If you're unable to stick to a trading plan without changing that plan midtrade, you're not ready to trade real money. Trading real money only magnifies trading related psychological and disciplinary issues. When I was on the trading floor the expression “Maybe it’s the archer behind the bow...” was commonly used when a trader began to complain about the market, or blamed a strategy for their bad trade/day. In other words, we were saying “It's not the market's fault....adjust your attitude/outlook/plan...learn attitude/outlook/plan...learn from it, if there's something to learn, and then move on.”
No matter what happens, each trader is ultimately responsibility for their own actions, and must take 100% ownership of that fact. Taking full personal responsibility means being able to adapt, change, learn and grow; blaming external forces or events only leads to personal set-backs and an inability to fix problem areas. Accept the market as it is. Know that if you you put in the effort and practice to implement your trading plan, in a disciplined and risk controlled fashion, you stand a very good chance of becoming a successful trader. The effort and practice never ends though; it's an ongoing process, not a destination where all of a sudden
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you get to stop. As soon as you stop practicing and maintaining discipline, losses will mount. You may have bought this book to learn some winning strategies, yet a strategy is only a portion of a winning formula. The other required elements of the formula include being able to implement the strategy, knowing when to do so and managing risk/money. This brings us to the five steps for becoming a successful trader, and how you should use this book. There's a lot of information in these pages. The temptation will be to open a demo account right away (or use your current demo or live account), skip to the strategy chapters and start trying things out. Don't do this. Instead, trust a proven process — in in all fields, not just trading. You've likely already tried the approach above — grabbing grabbing a strategy and testing it out — but did that ultimately work? Below is a new approach. Commit to the following 5-step process while you read this book, and until your account is consistently growing each month. 1. Read this entire book before you place any live or demo trades. Instead of placing actual trades, follow along on some free charts, note examples, draw on the charts, watch how prices act, but don't trade. The human mind is impulsive. But traders can't be. If you want to be a trader you need to reign in that impulsive nature. This step is your first task: saying NO to something you want...which is to trade. You only get to trade after you've read this book (some chapters may require several read throughs). If you're already trading, and seeing success with the trading plan you trade, then continue to trade that plan. Don't implement the strategies discussed in this book into your trading plan until you've read the entire book though. 2. Once you've read the book your mind will be filled with ideas and strategies. This is the time to create your first trading plan. You'll know
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everything about risk management, placing entries/stops/targets and a whole lot of strategies and analysis tools that'll help you determine exactly where these entries/stops/targets entries/stops/targets should go. Choose a couple strategies you like and build your trading plan around them. What a trading plan is, and how it's constructed, is revealed in the chapters that follow. 3. With trading plan in hand, you're ready to begin implementing it...with a demo account. Open a demo account (this gives you a chance to test out brokers, as discussed in the book) and practice implementing your plan. This is the MOST important step. The temptation is to make a deposit and make live trades in an effort to make some money. This is short-sighted. It's easy to look at historical charts and pick out patterns and trades, or read the examples in this book. It's entirely different to see trades, and make trades, when the price is moving in real-time and everything to the right of the screen is unknown. Trading requires practice, and the strategies in this book require practice in order for them to be profitable. If you choose two strategies to include in your trading plan, at minimum you should practice them for at least two months. If you're profitable after two months in a demo account, open a live trading account and begin to implement your plan with real capital. If you're unprofitable after two months, then you either need more practice or you need to adjust your plan (step 4). If you're following the plan exactly, then it's the plan that needs work. If it's you that's not following the plan exactly, it's your discipline that needs work...you need more practice and need to discipline yourself into following that plan and never deviating. Building discipline is developed by practicing discipline...there's no shortcut.
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4. Adjust your plan. Initially when you create your plan you may not account for certain factors, or you realize your time and/or capital constraints don't allow you to implement the trading plan as you intended. When this occurs, go back to drawing board and re-construct your plan based on your demo trading experience. You'll also need to adjust your trading plan if you were unprofitable while practicing for for a number of of months in a demo account. Once you have a new plan, p lan, practice implementing implementing it again for another couple months. If you're profitable after implementing the plan for at least two months in a demo account, then move on to step five. If you're unprofitable, then repeat step four — adjust adjust your plan, make sure you're following it and practice implementation implementation until you're profitable in the demo account over a number of months. 5. Step five is opening a live trading account (according to the guidelines discussed in the "Choosing a Forex Broker" chapter). It should take two months or more to get to this stage. For many traders it'll be six months or more. This is the process of becoming a successful su ccessful trader; success isn't the result of just knowing a few few strategies. When I began trading it took six months until I was consistently profitable. Most of my trading friends took between six months and year before they were consistently profitable. profitable. You need to practice, and that takes time. If you rush it, you'll lose your money. Once you're consistently profitable there will be hiccups where you mess up or lose your discipline for a while. But usually, if you can become consistent once by following this process, you'll have the tools to become consistent again.
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That's the process you undertake if you want to be a trader, and it's the process you should sh ould commit to right now. Do you want to keep doing what you're doing and getting the same results? Or do you want to commit to learn, practice and adjust until you get it right? This is how you get it right, and if you never get it, then at least you haven't lost any real money trading. Trading is tough; if it was as easy as reading a book, and there are hundreds of books by great traders, then there would be a lot more successful traders. So something is obviously missing; successful trading isn't just about knowledge, it's about effectively being able to implement knowledge under adverse psychological conditions. The rest of the book gives you the knowledge, while the process above shows you how to implement that knowledge. That last part is the missing key in most books. You now have it. Knowledge is the door which I can offer you; walking through can only be done by you, and it requires your commitment to the five steps above, completed in sequence. No cheating. If you cheat, you cheat yourself out of experiencing your own full potential. A note about the charts in this book : The charts are from screenshots I've taken over the years. This means the charts aren't uniform in size or look. Instead of replacing all them with new examples, I've opted to keep many of these old charts, as they show times of different volatility across the years. During low volatility times it's hard to remember that pairs can move 300+ pips a day...every day...for weeks. Nothing stays static for long in the forex market, as the charts throughout the book show.
You'll also notice technical indicators on some charts. Don't be distracted by these. I don't use indicators, and indicators aren't used for any of the strategies in this book (except the odd one for reference). From time to time I put indicators on my charts to see if an indicator works better than just reading price action — upon upon which all the strategies in this book are based. So far, reading price action trumps all indicators.
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There's one "indicator" (not a technical analysis one) I use frequently, and it shows when global trading sessions start and end. Throughout the book you may notice some charts are yellow, others are beige and some are blue. I've set the indicator to mark the London session in yellow, yellow, the US and London overlap period in beige, and the US session (London closed) in blue. Other charts are just plain black or white. whit e. If that didn't make sense, it will shortly, as a s you move through the book and see some chart examples. The "session indicator" mentioned above is listed in the resources section at the end of the book. Now, let’s jump in, and may you find the answers you seek and the life you deserve.
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1. Forex Basics Find additional information at VantagePointTrading.com VantagePointTrading.com.. The site has frequent swing trade signals, based on a trading plan in this book, providing a continual source of examples so the concepts can be fully understood before trading.
Understanding Foreign Exchange (FOREX) The retail forex market offers many opportunities, yet it's a dangerous and confusing place for those who don't understand how it works. The forex, or foreign exchange market, is where the world’s currencies are traded. A currency is always traded relative to another currency. When we see “EUR/USD ,” the corresponding currency relative to the other. Let’s look at an example. example. rate is the value of one currency The EUR/USD is trading at 1.3600. The easiest way to understand currencies is is to view the first first currency, in this case the the EUR, as 1. So the rate, rate, 1.3600, is how much of the second currency (the USD in this case) it takes to buy 1 EUR. The first currency in the pair is our directional currency on a chart. If you open a EUR/USD chart (in your trading software or on a free platform such as TradingView.com) and the price is rising, the EUR is increasing in value relative to the USD. If the rate is falling, the EUR is losing value against the USD. Based on the example above, you may have the following questions: “What are the currency symbols, and what do they mean?” Also, no t all currency pairs are ideal for trading purposes, therefore traders commonly ask “What forex pairs should I focus my trading efforts on?”
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Currency Pairs to Focus On
There are many symbols representing the currencies of the countries (and zones) around the world, although for trading purposes there are only a handful you really need need to be aware of. of. These symbols and and their corresponding corresponding currencies are listed below. below. For most most short-term or active traders traders these are the currencies to focus on: USD = United States Dollar EUR = Euro (Euro Zone countries) JPY = Japanese Yen GBP = British Pound CAD = Canadian Dollar AUD = Australian Dollar CHF = Swiss Franc NZD = New Zealand Zealand Dollar Remember, each currency is traded relative to another currency, creating a pair . The following are heavily traded pairs and are therefore the most commonly used for speculative purposes.
EUR/USD USD/JPY GBP/USD USD/CHF USD/CAD AUD/USD NZD/USD EUR/JPY GBP/JPY
The list above shows currency pairs which are used for both day trading and swing trading. This isn't to say there isn't movement or profit potential in other
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currency pairs which aren't listed here. The list simply shows pairs which are heavily traded globally, and therefore acceptable for day or swing trading. In addition to the above pairs, swing traders can also trade the following pairs, which include combinations of all the major currencies: EUR, GBP, AUD, NZD, JPY, CAD, CHF and USD.
EUR/GBP AUD/CAD EUR/CAD EUR/NZD GBP/NZD AUD/JPY EUR/AUD EUR/CHF GBP/CHF CAD/JPY AUD/NZD AUD/CHF CHF/JPY CAD/CHF NZD/JPY GBP/CAD GBP/AUD NZD/CAD NZD/CHF
These pairs can also be day traded, but only if your broker offers low spreads and the current volatility warrants trading in the pair. The spread and volatility are discussed later. While there may be potential outside of these pairs, these lists should provide more than enough trading opportunities. There's little reason to trade
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obscure currency pairs when we have all these to choose from. Day traders need to be especially careful about which pairs they trade, which is why the recommended list for day traders is smaller.
Buying, Selling and Short Selling
In the forex market, one currency is always traded relative to another. If you buy the USD/CAD, you've bought b ought the USD and sold the CAD. Traders will often say they're “long” the currency that was boug ht. Similarly, if you sell the USD/CAD, you've sold the USD and bought the CAD. This is commonly referred to as being “short” or "shorting" the USD/CAD. Buying and selling selling occurs on every transaction. This is confusing at first, yet remember the first currency listed in the pair is the directional currency on the chart. If the price of the EUR/USD is rising and you think the upward direction will continue, you'll buy the EUR/USD hoping to sell it at a higher price later. If the price of the EUR/USD looks like its heading lower, then you sell the EUR/USD hoping to close the position for a profit at a lower price later on. In the forex market traders buy or sell at any time, without restriction, making (or losing) money whether a currency pair rises or falls in value. Become familiar with the terms selling , shorting and and short , as they'll be used throughout the book, as will buying, long and going long . Understanding these terms will become easier as we progress through examples.
The Bid/Ask Spread
The bid/ask spread causes a lot of confusion for new traders, and can also result in losses simply because the trader doesn't understand how their orders are being executed. It's also possible to misinterpret price charts because of the bid/ask spread. The EUR/USD is a popular trading pair, and does the highest trading volume most days. The EUR/USD generally has a one to three pip spread with most
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brokers. If the bid price is 1.3601, with a three pip spread the offer would be 1.3604. The pip is the smallest unit of currency. Most currency pairs have four decimal places (five if the broker offers fractional pip pricing), except for JPY currency pairs which have two: 98.15 (or three, 98.153, if fractional pip pricing is used). If you want to buy a currency pair you'll always have to buy at the offer price, and sell at the bid price. In the EUR/USD example above, if you want to go long (“long” means “ buy”) you pay the 1.3604 rate. If you sell immediately after going long, your sell price is 1.3601. You lose three pips without the currency pair even moving. The spread is equivalent to a commission being charged by a stock broker. In the forex market most retail brokers don't charge commissions, rather they force you to pay the spread. This is how forex brokers make their money. Most forex brokers now offer “fractional pip ” pricing. This means there's five decimal places in the rate of most currency pairs, and three in the case of Yen (JPY) related pairs. The EUR/USD for example may have a bid price of 1.36056. This means instead of paying 1.3606 (the non-fractional price) you'll pay 4/10 of a pip less, just as an example. Fractional pip brokers typically have smaller spreads than fixed spread brokers; always trade with a fractional pip broker . There are also ECN brokers. These brokers offer access to spreads as low as 0.0 pips, though usually it'll be 0.1 pips to 0.4 pips. For this you'll pay a commission in the neighborhood of $2US to $4US for each 100,000 lot traded (more on what a "lot" is shortly). ECN brokers are recommended for day traders trading on short time frames, such as 1-minute charts. By the end of the book you'll have a good idea if that's going to be you.
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Lot Sizes
In the stock market, a standard lot is 100 shares. In the forex market we also trade in lots, except that a lot is a certain dollar amount of currency. A standard lot is 100,000 worth of currency. A mini lot is 10,000 worth of currency. A micro lot is 1000 worth of currency. Some large institutional brokers don't allow micro or mini lot trading, as these lot sizes are primarily used by retail traders. Trade through brokers that allow a llow mini and micro lot trading. Even if trading a large account, being forced to trade only standard lots limits the number of positions taken and doesn't allow you to fine tune your risk and positions sizes. Having the option to trade mini and micro lots is a big advantage — you you can still take large positions, but also small ones if you wish. When trading a standard lot account the minimum trade size is much bigger, therefore you don't have the trading flexibility that you have with a mini or micro lot account.
Pip Value
A pip has a value attached to it, and that value will vary depending on the currency pair you're trading. The pip value of certain pairs fluctuates as the rate of the pair changes. This means drastic changes in the rate of a currency pair will greatly affect the pip value, which must be considered when calculating risk and ultimately position size. The EUR/USD is the most heavily traded currency pair and has a fixed pip value. No matter what the rate of the currency pair is (for example it could be 1.25356 or 1.89222) the value of the pip is the same. In the EUR/USD the pip value (in US dollars) on a micro lot ($1000) is $0.10. Each time the rate moves one pip, if you're holding a one micro lot position,
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you'll see your profit/loss adjust by $0.10, depending on if the move is favorable or not. The pip value of a mini lot ($10,000) is $1, and the pip value of a standard lot ($100,000) is $10. Currency pairs that have the USD listed second in the pair, such as EUR/USD, GBP/USD, AUD/USD, NZD/USD all have the same pip values as indicated above. Other currency pairs have a fluctuating pip value, based on the value of the currency. currency. For instance, the pip value of a mini lot ($10,000) in the USD/CAD is $1 / USD/CAD rate. In other words, it's $1 divided by the current USD/CAD rate. As the USD/CAD appreciates, the pip value is less. If the USD/CAD drops in value the pip value increases. When trading a US account (you deposited US dollars to open the account) the pip value is determined in US dollars even if you're trading a pair that doesn't have the USD in it. For example, if you're trading the EUR/GBP the pip value of a standard lot (100,000) in US dollars is $10 x GBP/USD rate. The list below shows how each pip value (standard lot) is calculated for different pairs.
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Forex Market Hours and News
The forex market is open 24 hours a day from 10 PM Sunday night (GMT) to 10 PM Friday night (GMT). There are many opportunities to trade throughout the day, yet not all strategies will work at all times of the day. The chart below shows when various markets are open throughout the day in different parts of the world, based on the 24-hour clock.
Note: All Times is EST EST
To see when markets are open based on your own time zone, go to http://www.forexmarket http://www.for exmarkethours.com/mar hours.com/markethours.php kethours.php.. From the drop down menu select your time zone and click "Go." The chart will update and provide the open and close times of the major sessions based on your time zone. Since brokers are located all over the world, your personal time zone may not match the time zone on your charts. Make sure the time in the green box (on the site above) matches the current time on your charts. In this way you can mark off when sessions begin and end on your charts. The markets shown on the figure above are high impact markets. When these markets are open it greatly affects the currency pairs associated them. I recommend trading currency pairs which have at least one currency (from within the pair) “open for business” when day trading. For example, the EUR/USD currency pair is most active during the London and/or New York sessions. It's likely to be especially active during the four hour overlap period when both these markets are open and trading the pair. During the
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London and/or US session is the ideal time to trade this pair. When London and New York banks are are closed for business, business, there's less opportunity. opportunity. To see how each pair acts throughout the day in terms of volatility, see the http://vantagepointtrading http://vantage pointtrading.com/daily-forex-stats .com/daily-forex-stats.. This topic is also covered more extensively in Chapter 7: Best Time to Day Trade. Forex market price react significantly to planned economic news releases (and surprise economic events as well). Economic news is released at scheduled times throughout the week. Forex brokers often provide a news feed that alerts you when news is coming out. Also, many sites display a global economic calendar so you're aware of all news events beforehand, and can prepare for news which has a market impact. Only being aware of one country’s news events isn't enough. Make sure the economic calendar you're viewing shows all significant global news events that may affect the currency pair you're trading.
A significant news event for the Euro zone is likely to impact not only the EUR/USD, but also the USD/CHF, GBP/USD and potentially others. Here's an economic calendar that shows scheduled economic events in all the major currencies: http://www.dailyfx.com/calendar . Be sure to adjust the time zone. Events marked "High" importance (usually colored red) deserve special attention. Avoid trying to predict how a pair will move based on a scheduled high importance news event. Stop day trading at least five minutes before the highly important news event. After the highly important news is released wait at least three or four minutes before day trading again. This gives the market time to choose its direction based on the news, and we avoid getting caught in wild price swings which could cause significant losses. Trading the news is covered in Chapter 12 , “Trading the News”.
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Leverage
Leverage is what makes the forex market attractive. Leverage is borrowing money and adding it to your own so potential profits are increased. While no one is likely to borrow money to increase losses, this also occurs. All transactions are magnified, both good and bad, when leverage is employed. Let’s look at a quick example of what leverage is: Assume you have $10 and are offered a trade where you can make 10%. You accept this trade, make 10% and now you have $11 (attained by $10 + ($10 x 0.1) = $11). Now, let’s assume you went to a friend, and asked to borrow an additi onal $90 for making the trade. You now have $100, and accept the trade making 10% on the full $100. You now have $110 (attained by $100 + ($100 x 0.1) = $110). You return $90 to your friend and are left with $20. Based on your original $10 investment, the return on your money is 100% (instead of only 10%)! You doubled your original investment by borrowing and making money on the larger amount. Had you ended up losing on the trade though, you may have lost your friend's and your own money. The forex market allows you to do this. FX (forex) brokers commonly give from 1:1 up to 400:1 leverage. This means that for every one dollar you deposit you can receive up to $400 in capital to trade with. This is beginning to change ch ange due to stricter regulation. For instance, in the US traders are limited to 50:1 leverage, which is still more than most traders will need as you'll discover over the next couple chapters. Let’s assume you choose to have 100:1 leverage in your account , and you deposit 1000. You'll have 100,000 100,000 in total buying buying power you can make make money off of.
To open a position worth 10,000 means you put up 100 in margin (with 100:1 leverage). This is your good faith assurance assuranc e of the trade, and as long as you 28
maintain 100 in unused capital in your account that trade can stay open (and of course you can exit at any time you wish, whether with a profit or a loss). If you take too large of a position using leverage, and the market moves quickly against you, you could lose more money than you have in the account. If this occurs, you'll need to deposit more into the account to make up for the loss. Certain brokers have provisions and safeguards which prevent this from happening, but it's important to understand the legalities of using leverage and the risks associated with it. This should never, ever, happen. Throughout the book I'll drive home that money and risk management are the most crucial elements to successful trading. I tell you the maximum you can risk on each trade, and how to calculate it. There's generally no interest charged for using leverage in forex trading, although there is rollover . Some brokers do charge for the use of leverage though, and it's also possible to open accounts which have no interest or rollover. Be sure to read through all the legal documents when opening an account as each broker may have slightly different policies.
Rollover
Brokers commonly “rollover” positions in your account. This is so the trade isn't actually “settled,” w hich would require taking possession of the currency you purchased. Since nearly all retail traders are trading for speculative reasons, and not because they wish to actually receive the physical currency they purchased, roll-over is an automatic process.
Rollover means that each day you'll be credited or debited the difference in the interest rates between the currencies in each pair you're holding. This isn't interest on the leverage your broker has provided to you. If one country has an interest rate of 4% and another has a 2.5% interest rate, this difference is credited or debited from your account depending on if you're long or short the higher interest rate currency, respectively. respectively. 29
Rollover is credited or debited each day at 5 PM Eastern time. It doesn't matter if the position is open for two minutes or 23 hours; a position held at 5 PM is considered to be held “overnight” and is subject to an interest rate credit or debit. Day traders should be aware of this fact, as holding a position for only a few moments around 5 PM can be an advantage or disadvantage depending on what the position is. Let’s look at an example of how this works each day. Say you buy the GBP (British Pound) and sell the USD (United States Dollar). In other words, you buy the GBP/USD pair. Assume the following interest rates in these economies: GBP = 4% and USD = 1%. There's a 3% interest rate differential.
If you hold this position for an entire year (and interest rates don't change) you'll make 3% interest on the value of the position. The value of the position is the full position, not just the margin which is used to maintain the position. Since markets fluctuate, the interest you receive won't be exactly 3%, but is a rough approximation. If you go short the GBP/USD (sell GBP, the higher interest rate, and buy USD, the lower interest rate) you'll lose, or be debited, roughly 3% interest on the full value of the position if you hold it for a year. When you use leverage, the effect of roll-over is substantial. Assume for a moment you buy $10,000 worth of the GBP/USD and receive 3% in interest per year for holding the position. That's $300 per year in interest income. But you're not required to put up the entire $10,000. If you use 100:1 leverage, you're only required to put up $100 of your own funds for the trade. Therefore, interest alone gives you a 300% return on invested capital because of the use of leverage — you you get $300 for your $100 investment. This also works in reverse though. If you're short the GBP/USD in this example, your capital is rapidly depleted as you're debited the interest rate differential each day. About one third of the way through the year, even if the
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exchange rate hasn't moved against you, you'll have lost $100 due to leverage. If you hold the position an entire year, you'll lose about $300 even if the exchange rate doesn't move significantly against you. Of course the exchange rate is always moving, and therefore the trend of the currency must be considered when making trades as well. Trading decisions shouldn't be solely based on roll-over, as movement in the exchange rate can easily offset any gains or losses accrued because of roll-over Most brokers provide up to date information on how much the credit or debit will be if you hold a position overnight. Therefore, you don’t need to calculate anything; your broker should provide you with all the information you need. Also, the calculated value is unlikely to be what the broker actually credits or debits from your account. Rollover, like the spread, is a situation where brokers take a bit for themselves, so rollover rates vary from broker to broker. For those who wish to manually calculate the roll-over debit or credit, the following formula is used, where the “base currency” is the first currency listed in the pair and the “quote currency” is the second currency listed in the pair. Position size in dollars X (base currency interest rate – quote currency interest rate) / 365 days X current base currency rate = daily rollover interest debit or credit. Using the formula, if you're long $100,000 of the EUR/USD at 1.3030, the EUR interest is 3% and the US interest rate is 1.5% you can calculate how much of a credit you'll receive per day (what the broker gives you may vary slightly): $100,000 X (0.03 – 0.015) 0.015) / 365 X 1.3030 = $5.35 Credits and debits occur automatically and no action is required on your part. Every time you hold a position over night, you'll see a credit or debit appear in your account activity.
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Keep in mind the currency markets are fluctuating all the time, so the credits and/or debits are separate from capital gains made on the movement of the currency. For tax purposes track interest and capital gains separately — this this should be easy to see in your account history report. Tax laws vary by country and region; consult a tax professional on how to report your forex interest and capital gains in your region. Since banks/markets are closed on Saturday and Sunday, the interest for these days is made up on Wednesday (usually). Positions held on Wednesday at 5 PM EST are subject to three days worth of interest credits or debits. Interest rates change over time. Watch for changes in interest rates, as a change in these rates shifts the bias of buyers and sellers, both in the short-term and the long-term. Strategies involving rollover and interest rates are covered in Chapter 13, “The Carry Trade.”
Order Types
Next, you need n eed to know how to place orders and manage trades. Platforms have come a long way in recent years and are quite user friendly. Most retail platforms use “Buy” and “Sell” buttons which are used for instant execution (confirmation may be required depending on platform set-up) at the current ask or bid price. Placing a buy or sell at the current market price is called a "market order." Recall from earlier, that “Buy” means you're buying the first currency in the pair, expecting the the price to rise on your charts. It also means you'll be buying buying at the “ask” price. “Sell” means you're selling the first currency in the pair, expecting the price on your charts to drop. It also means you'll you'll sell at the “bid” “bid” price.
You then have other elements of a trade to consider, such as quantity (position size), stop loss, and profit target. Position size or quantity is how much
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you want to buy/sell, and is determined by a simple formula covered in the next chapter. A stop loss is an order placed at a price where you know you're wrong about the trade. Where to place stops is covered in more detail throughout the book. The stop loss is protection from excessive losses; if the market moves to the stop loss price, the position is closed at a loss. This is so you don't lose more than is warranted on any one trade. And since the stop is placed with the broker, it'll execute even if you're not around or don't have your trading platform open. You can also set a profit target order. How to calculate and use profit targets is covered in detail throughout the book. A profit target is a price which, if hit, will close the position (or part of the position) at a profit. It's a price you expect the pair to move to which will give you a profit. A profit target closes your position, if the target price is hit by the market, even if you're not around or your platform is turned off. What if you only want to buy the EUR/USD if it breaks out of the trading range it has been in? Such a breakout could be 10, 33, or 226 pips away from the current market price...and the breakout happen while you're away from your computer. In this case you'll place a “pending order.” A pending order may or may not get executed; it'll only execute if the price you set for the order is reached by the market. Here's the basic run down of how to use pending orders. This may sound complex when written, but in your trading platform all you need to do is fill in the blanks (entry price, stop loss and target) target) on the order form with the price price levels you want. The software does the rest. Buy Stop : Used to buy the currency (pair) at a price higher than the current market price; only if the market moves there is the order executed. For instance, if you wish to Buy the AUD/USD at 1.0621 and currently it trades at 1.0522, place a
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if the market goes to that price your order is executed Buy Stop order at 1.0621 — if and you'll have bought (be long) that currency pair. Why use it? There may be a big resistance level up there, and you only want to buy the pair if it breaks through that resistance level at 1.0620…hoping it will trigger another move higher. A Buy Stop is also used as a stop st op loss order for a short position. Buy Limit : Used to buy the currency (pair) at a price lower than the current market price; only if the market moves to that level is the order executed. For instance, if you wish to Buy the AUD/USD at 1.0220 and currently it trades at 1.0430, place a Buy Limit order at 1.0220 — if if the market goes to that price your order is executed and you'll have bought (be long) that currency pair.
Why use it? A price range (discussed later) may be present, and you only want to buy along the lows of the range. Or the pair is trending higher and you want to buy when the price p rice pulls back, assuming that the trend will continue higher after the pullback. A Buy Limit is also used as a profit target for a current short position. Sell Stop : Used to sell the currency (pair) at a price lower than the current market price; only if the market moves there is the order executed. For instance, if you wish to Sell the AUD/USD at 1.0225 and currently it trades at 1.0380, place a Sell Stop order at 1.0225 — if if the market goes to that price your order is executed and you'll have sold (be short) that currency pair.
Why use it? The pair may be dropping but is approaching a crucial support level. You're not sure if the level will hold, so you only want to enter a short position if it breaks through the support sup port level, hoping it'll trigger a further decline. A Sell Stop order is also used as a stop loss order on a current long position. Sell Limit : Used to sell the currency (pair) at a price higher than the current market price; only if the market moves there is the order executed. For instance, if you wish to Sell the AUD/USD at 1.0300 and currently it trades at 1.0200, place a
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Sell Limit order at 1.0300 — if if the market goes to the price your order is executed and you'll have sold (be short) that currency pair. Why use it? The trend may be down and you want to get short, but decide to wait for a rally higher to get short hoping the downtrend will then continue after the rally ends. A Sell Limit order is also used as a profit target order on a current long position. With pending orders you can also set an expiry date. This is an option you may wish to use. If an expiry date isn't set the order will remain pending until canceled or filled. If there's a time constraint the trade needs to take place within, be sure to set an expiry date. For example, if you only day trade, make sure all orders are canceled at the end of the day, or set all your orders to expire at the end of the day. Be aware of all outstanding orders in your order log, and make sure you still want them. If you don't, cancel the orders immediately to avoid the possibility of getting filled on the order in the future. Conditions change, so stay on top of any pending orders orders you have outstanding. outstanding. If you're going to be away from your trading platform for a long period of time, make sure pending orders are canceled and/or they have a stop loss and profit target attached to them.
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2. Being Successful in the Forex Forex Market Being successful in any market requires discipline and hard work. In order to be successful you must have the discipline to follow through on the trading plan you set out for yourself. The trick is, the trading plan has to be set out before trading, not during. This is why most novice traders fail – they don't create a plan for their trading success. They don't properly plan out their trades. Before every single trade you should know:
What the entry point is (and criteria required for entry). What the stop loss level is (the exit criteria for a losing trade). The size of the position (based on account size and anticipated risk). Where/how to exit a profitable trade (what criteria need to materialize to take a profit, and what's the profit target?).
In other words, you need to answer all these questions:
“How and why are you entering?”
“How and why will you exit?”
“How much capital will be put at risk?”
Most traders only consider the entry point, which probably has the least impact on trading success of the factors mentioned above. How you exit and manage your trades is more important than the entry. The exit is where profits are locked in or losses are taken. Well planned entries are important too though. Each factor is a crucial element in successful trading. All the factors go hand in hand. When any of these elements are neglected, your trading suffers.
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The Trading Plan All the preparation for trading is done before a trade is even made. The preparation is even done before a trade is found. A Trading Plan is a written document which states exactly how to trade with regard to entries, exits and risk management. The three areas cover everything including stops, trailing stops, profit targets, targets, how money is is managed and position size. Within your trading plan, lay out how you're going to enter a trade. Are you going to enter as soon as the price crosses a barrier on our chart (this is the method I use)? Or are you going to wait for the bar to close before you enter the position? What time frame are you going to trade on? Are all signals going to be traded? Or is a filter going to be used? An example of a filter would be: “A signal is traded only if it aligns with the overall trend" (the plan must also cover how you determine trends in this case). Alternatively, you may decide to trade every signal you see without filtering the signals at all. You won't be able to effectively answer these questions yet, though by the end of the book you will. The 5-step plan outlined in the Introduction advised to read through the entire book and then start building your trading plan. Once you've learnt a strategy and decided how to implement it, it can then be included in the trading plan. All the rules for how strategies are implemented, and how the resulting positions are managed, should be written down and strictly followed. Consider all possible contingencies when making the plan. As information and knowledge is attained from real trading, the Trading Plan is fine-tuned to reflect your newly acquired data. Yet, once in place, the Trading Plan should be followed and not significantly altered until the Plan has been proven faulty. If you continually change your trading approach after every few trades, it's impossible to get a true sense of what works and what doesn’t.
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While we often think we have great memories about what works and what doesn’t, unfortunately this isn't the case. If we don’t follow a plan we're destined to keep reliving our mistakes, and creating new ones. Successful trading becomes apparent over many trades, not only a few. Continually adjusting your Plan or strategies means your trading results are likely to become random. A continually changed plan means that even though “work” is being put in, you'll you'll have little to no advantage over the person who puts puts in no effort at all. You're both flip-flopping between strategies. This approach offers little competitive advantage. We choose a Plan and certain strategies because they provide us with an advantage over many trades. If you continually change your approach you lose that advantage. Even the best systems and strategies have losing trades. A losing trade, or even several losing trades in a row, is no reason to start from scratch or change your methods.
Risk Management
The methods outlined in this book work on different time frames, yet the methods and time frame used must suit your personal situation. For example, if you don't have a lot of capital, you're limited to short term trading. This is because the stop levels (discussed shortly when we get to Position Size) are too large on longer term charts and will expose you to too much risk. Leverage is a double edged sword. For traders with little capital, leverage combined with taking on too much risk per trade can mean a trading account is quickly and easily wiped out. When considering how you'll enter the market, and also your stop levels, be realistic about what you can reasonably do in the market with the capital you have. Don’t risk more than 1% of your trading account on a single trade. The risk on the trade (the difference between the entry and stop price) multiplied by the position size shouldn't be more than 1% of the capital in your account.
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As you progress, the risk should decline to less than 1%. Professional traders rarely risk more than 1% of their capital on a single trade, and generally only risk a fraction of this. Why risk only 1% of your account on a trade? When you risk only 1% of capital you'll survive even a long string of losing trades. Even great trading systems have losing trades; you need to plan in advance for this fact . Risking 1% (or less) means we can lose 10 trades in a row and still have almost all our capital intact. Several winning trades will make those losses back. On the other hand, if you risk 10% of our capital on each trade, and lose 10 trades in a row, your money is gone (or very close to it). After depleting the account so much there's almost no hope of regaining your original capital. Don’t put yourself in this position by taking big risks on each trade. Risking a small amount on each trade still creates great returns over the course of a year. In fact, risking only a small amount on each trade has a far, far, FAR greater chance of producing solid returns over the course of a year than risking a lot per trade. The trader who risks too much per trade never n ever lasts long and usually completely wipes out their account...it's only a matter mat ter of time.
Position Size
Determining proper position size will greatly affect your long term sustainability in trading. To determine position size you must first know your entry and stop loss prices. The stop loss should s hould be at a logical price which is out of range of normal market movements. If hit, the stop loss lets you know you're wrong about the direction of the market — at at least for the time being. The strategies discussed throughout the book tell you where the entry and stop loss levels are placed. Don’t risk more than 1 % of your capital on a single trade. Less than 1% is better. Your risk is determined by a maximum dollar amount which is less than 1% of the account, or by using a fixed maximum percentage, such as 0.5%, of whatever your current account value is. Using the maximum percentage is
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recommended. It's also recommended you risk the same percentage — as as close as you can get, without going over — on on each trade. If your account is $5000, you can have a maximum loss of $50 if you risk 1% of your capital on the trade. Let’s say you choose a stop which is 50 pips below your entry buy price in the EUR/USD. From this information determine your proper position size. You can take a maximum of one mini lot. Why? If your stop is hit, you'll lose 50 pips X $1pip value X 1 mini lot, or $50, which is your maximum loss (each pip is worth $1 when trading a mini lot in the EUR/USD). Note: Recall, from the Pip Value section in the prior chapter that the pip value of each currency pair may be different. Therefore, make sure you know the dollar amount each pip is worth in the currency pair you're trading so the position size is calculated accurately.
Taking one mini lot on this trade allows you to have an ideal stop (this will be different different for each trade) and keep keep your risk in check. If you choose choose a bigger stop (risk) on the trade, your position size decreases. If you have a smaller stop on the trade, your position size can increase. As your account grows your position size can also increase as you're able to risk more capital on each trade. This is because 1% of $10,000 is larger than 1% of $5000. With the larger account, you can take on larger positions while still keeping your percentage risk in check. Experience doesn't equate to taking larger positions. Only when experience is producing profits and growing your capital is position size increased proportionately to the growing growing account. Position size only grows when the account is growing, and position size should decrease if the account declines in value. With a $500,000 trading account you may not want to risk even 1% on a trade. So instead of risking $5000 (1% of the account) you may choose to risk only $2000 instead. The method method above is still used. If $2000 is is your maximum loss and your risk on the trade is 50 pips, it means you can take 40 mini lots or 4 standard lots on this trade.
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The formula is: # of lots X pip value X risk in pips = total risk in $
Plugging in the numbers from the above example: 4 standard lots X $10 X 50 = $2000 or 40 mini lots X $1 X 50 = $2000 Whether you risk a percentage of your account on each trade, or choose a fixed dollar amount you're willing to lose, the method above is employed to determine the proper position size. The position size is based on the stop level which is ideal for the trade, and should limit the risk of the trade to less than 1% of your capital. capital. Each trade may may have a different position position size (1 lot, lot, 3 lots, 22 lots, lots, etc) and use a different risk level (15 pips, 40 pip, 225 pips, etc) depending on the dynamics of the trade set up. As you go through the strategies in the book, you'll discover where to enter trades and where to place both stop losses and profit targets. It's up to you to control your position size so you're only risking a small portion of your account on each trade. Only take trades where risk can be limited to 1% or less of the account capital.
Daily Risk
If you're going to day trade, it's recommended that you not only control the risk on each trade, but also your risk each day. Some days the market is erratic, and no matter which strategy you use or how you try to adjust, the market is going to take your money. This is the reality of trading; it doesn't have to happen often, but it will happen.
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Maybe something personal is going on and you aren't totally focused, or there's no structure to the market and you lose trade after trade. On such days, admit the market has beaten you, and stop trading. Exactly when you'll stop trading is defined in your trading plan. I know many traders who stop trading if they lose their first three trades in a row. Risking about 1% of your capital on each trade that means you've lost 3% of your capital. After you've read the entire book and start trading (first a demo account then live trading), I recommend only risking 0.5% on each trade, and setting your daily risk limit at 3%. That way you can lose 6 trades in a row before you're forced to quit for the day. Once you have a track record and are profitable, set your daily risk limit (daily stop) at slightly more than what you make on your average profitable day. Say, on average, you make $300 on your winning days. Make $300 your risk limit for the day. If you lose $300 while day trading, stop for the day. The risk limit is imposed to make sure that no single day ruins your week or your month. I've seen traders lose everything because they were upset, unfocused, or just couldn't admit they were wrong. Don't let this happen to you. There's always tomorrow. If you lose your specified amount in a day, close all positions, get away from your trading screen and go do something else. It's also recommended you employ a "loss from top" threshold. Your loss from top threshold is the same figure as your risk limit, except it only applies to the highest point of profit you've accumulated so far in the day. Confused? Here's an example. Assume you've imposed a daily risk of $300 on yourself. If you lose this amount in a day you stop trading. But instead of losing, you start out the day on a tear, winning several trades in a row and you're now up $900 (based on closed trades). The $300 dollar loss rule still applies, except now it's applied to the $900 (your highest profit point). If you drop down to $600 in profit, quit trading for the day.
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See how it works over several trades: Start of day: Profit is $0 so daily stop is -$300 After 1 Trade (winner): Profit Profit is $100 so daily stop is -$200, because +100 - 300 is -200. After 2 Trades (loser): Profit is $50, daily stop stays at -$200 After 3 Trades (winner) Profit is $200, so daily stop is -$100 After 4 Traders (loser) Profit is $100, daily stop stays at -$100 After 5 Trades (winner) Profit is $300, daily stop at $0 After 6 Trades (winner) Profit is $500, daily stop at $200 After 7 Trades (winner) Profit is $700 daily stop at $400 After 8 Trades (loser) Profit is $600, daily stop stays at $400 After 9 Trades (loser) Profit is $500, daily stop stays at $400 After 10 Trades (loser) Profit is $400, daily stop is $400, STOP TRADING. The loss from top protects you from losing your maximum (in this case $300) when you've started out the day profitable. Usually hitting the loss from top means you've lost several trades in a row, which indicates you're off your game or the market structure has changed and isn't conducive to the strategies being used. Daily risk limits and loss from tops are useful tools for day traders. A daily stop loss is mandatory; a loss from top is recommended. These tools stop you from doing significant damage to your account in a single day. Define exactly how you'll limit your risk, and how you'll implement these rules in your trading plan.
Forex Correlations After addressing position size and trading plans it's important to look at a related topic — forex forex correlations. For reasons which will become clear shortly, taking a long position in the EUR/USD and GBP/USD, when these pairs are highly 43
correlated (and they often are), is essentially like taking two of the same trade. Not exactly of course, though we'll cover this topic in a moment. If you want to effectively manage your trades and be aware of when you may be inadvertently increasing your risk, then you should be aware of forex correlations. At http://vant http://vantagepointtrading.com/ agepointtrading.com/daily-forex-stats daily-forex-stats you'll find forex correlation tables updated regularly for hourly, daily and weekly data. Correlation tables are also available at https://www.mataf.ne https://www.mataf.net/en/forex/too t/en/forex/tools/correlatio ls/correlation n . Forex correlation correlation stats may seem daunting, but a basic understanding of correlations goes a long way toward toward helping you you to become a better trader. trader. Not understanding forex correlations correlations can be disastrous.
What is a Forex Correlation?
A correlation is a measure of how much one currency pair moves with another. Correlations measure between -100 and +100, the former meaning they move in exact opposite directions, and the latter indicating they move in exactly the same direction. Assume you wish to know the correlation of the EUR/USD and the GBP/USD. Quite often these pairs will move in a similar fashion, although not exactly. If two pairs move in a similar way they'll have a + correlation. Therefore, the EUR/USD and GBP/USD may have a +70 correlation on an hourly time frame, +83 on a daily time frame and +86 on a weekly time frame (just an example, correlations correlations fluctuate). When pairs move in the opposite direction of each other, they have a negative (-) correlation. The EUR/USD and USD/CHF are usually negatively correlated, and may have a -87 correlation on the daily time frame, for example. A +100 correlation correlation means two pairs move in exactly the same direction. A 100 correlation means the pairs move in exactly opposite directions. A correlation of 0 (zero), or a small + (positive) or – (negative) (negative) number, means the pairs have no
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real correlation and if they do happen to move together on occasion it's more likely to be random than anything significant. A correlation of +35 or -41, for example, means the pairs don't have a strong correlation, and one pair isn't likely to provide much information about the other. Correlations change all the time. The statistics on the aforementioned sites are updated regularly to reflect the forex correlations between pairs. The correlations are presented in a matrix as shown in the figure below, and are presented for hourly, daily and weekly data. Daily Forex Correlation Correlation Table – August August 30, 2013
If we look down the EURUSD column we can see the EUR/USD is highly correlated to the GBP/USD at +85.7, and almost perfectly inversely correlated to the USD/CHF at -97.6. The NZD/USD also has a strong inverse correlation to the USD/CAD at -86.6. To find what the correlation is, look across from the NZD/USD row to the USD/CAD column, or look down the NZD/USD column to find the USD/CAD row. Either method produces the correlation between the two pairs you're comparing.
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Below are some guidelines and uses for forex correlation correlation data.
How to Use Forex Correlation Data
If you have multiple positions that are highly correlated (positive value over 70), those pairs move somewhat in tandem. This means you may be overexposed to one currency, even though the risk on each position is managed.
Say for example you risk 1% on a EUR/USD long trade, trade, and then decide to risk 1% on a USD/CHF short trade. trade. This is essentially the same trade. Since the pairs are strongly inversely correlated, as the EUR/USD goes down the USD/CHF goes up (and remember you're short the USD/CHF) — you you lose on both (or make on both if they move the other way). I'd consider this the same trade, and a violation of my trading rules; I'm basically risking 2% (not 1%) of my account on this multimulti position trade. trade. The same situation applies if I go long the GBP/USD and also go long the EUR/USD. Since these pairs are strongly positively correlated, by going long in both, I overexpose myself. If the market moves against me I lose on both trades, not just one. To rectify the situation, risk 0.5% on each trade, or pick one trade with the best set-up or reward potential. When I'm taking multiple trades at one time, ideally I want the correlation between all my positions to be weak. Let's look at the correlation table again to find some trades:
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Assuming I get viable signals in the pairs, I'm fine taking trades in the EUR/USD, in addition to positions in the EUR/JPY or GBP/JPY (choose one or the other since these pairs are highly correlated to each other), USD/CAD, AUD/USD or NZD/USD (once again, choose between USD/CAD or NZD/USD since these two pairs are highly correlated to each other). If I already have positions, I check the correlation to see how my current positions interact with the potential new position. I want trades that move independently of each other (for the most part). In this way if I lose on one position I can still win on the others, but if my positions are all correlated and I lose on one, losses in the others are more likely. The exception is if I want to hedge. Hedging is when you take one position which will likely lose while another gains, or gains while another loses. Occasionally you'll get signals in two pairs and the pairs will form a hedge. That's fine, because you'll likely lose on one but win on the other, and our wins are bigger than our losses. You can hedge a long trade trade with a long trade trade in another pair that has a high (below 80) negative correlation. You can also hedge a long trade trade with a short trade trade in another pair that has a high (above 80) positive correlation, or vice versa.
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By taking these directional trades based on the positive or negative correlations, you hedge your risk. This means the pairs move in an opposite fashion. Based on the correlation matrix I could go long the EUR/USD and also long the USD/CHF as a hedge. Both positions must be longs (or both shorts) in order to form the hedge, since the correlation is strongly negative. As one goes up the other goes down; any losses in one pair will likely be at least partially offset by the other. I could also go long the the EUR/USD and short the the GBP/USD (or vice versa). The positions must be opposite to form the hedge since this correlation is strongly positive. Just because two pairs are highly negatively or positively correlated doesn't mean they'll completely “offset” each other's losses or gains . Since each pair moves a different amount (more or less volatile), volatility is another factor which must be considered when looking at hedging. Correlation is focused on direction, not necessarily magnitude. Volatility studies are also available at http://vantagepointtrading http://vantage pointtrading.com/daily-forex-stats .com/daily-forex-stats.. Here's another trading application for correlation data. Imagine you see a trade setup in the EUR/USD. Since you know the GBP/USD is often correlated, you know that a setup may also be forming in that pair. A quick glance lets you know. If both pairs have a setup you can choose choose the one you you like best, based on on lowest risk, highest reward potential, strength (for longs) or weakness (for shorts). Correlations give you options for picking trades which have similar, yet slightly better, trade setups.
Correlations fluctuate over time. Be aware of what current correlations are and make decisions based on that (if required). Don't attempt to predict what correlations correlations will do in the future.
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Forex Correlation Summary
This is a brief introduction to correlations. It's recommended traders educate themselves further on correlations and acquaint themselves with basic statistics. Pick up an entry level college text book on the matter (can often be found secondhand for cheap) and work through the material. It'll help in your risk management and understanding of other market concepts. Correlations can affect your risk without you knowing it. You may be accidently making highly correlated trades and taking on too much risk, or you may accidently be hedging yourself, thus making little headway in producing profits because because you're actually risking too little. little. Refer to the correlation pages mentioned to be aware of current correlations. See how positively and negatively correlated pairs interact with each other. You may find correlations help you control risk, find alternative trading strategies and alert you to potential dangers or opportunities. opportunities.
How Much Leverage to Use With some forex brokers offering up to 500: 1 leverage, it's little wonder why “How much forex leverage?” is such a common question especially among new forex traders. Most traders realize leverage is a double-edged sword, magnifying profits as well as losses. To answer the question “How much forex leverage?” we' ll look at examples for different account sizes and trading styles. The examples provided in this section assume money management rules are followed and only 1% of deposited capital is risked per trade, as risking more than this on one trade isn't recommended.
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How Much Forex Leverage – Scenarios Scenarios
The easiest way to discuss leverage is to look at some examples using different combinations combinations of account size and trading style. $10,000 account – swing swing trader
If swing trading, stop losses are likely to be bigger (in pips) than a day trader’s (as well as profit targets) so this needs to be accounted for. Based on the account size the trader can risk $100 per trade (1% of 10,000). If a trade develops which has a 300 pip risk the trader can take 3 micro lots, which results in a $90 risk. In this case really no leverage is needed. Taking a trade such as this means $3000 (value of 3 micro lots) is deployed and the account balance more than covers such a transaction. If this scenario matches your situation, but you often take multiple positions at the same time, then you'll want some leverage. Leverage levels such as 10:1 or 15:1 should suit your needs. By the end of the book you'll have a good idea of the appropriate leverage level based on the strategies you like and wish to practice. $10,000 account – day day trader
Since a pair like EUR/USD usually moves between 90 and 120 pips a day (may expand or contract beyond this range), most day traders shouldn't risk more than 10 pips on a trade, or up to 1/3 of the daily range on the very high end. Risk more than that and the potential profit may not be enough to compensate for the risk. Losses on individual trades should be kept to 1% of account size or below. A trade with 25 pips of risk means the trader can take 40 micro lots or 4 mini lots, which equates to a risk of $100 in the EUR/USD.
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4 mini lots is $40,000 — the the account is only $10,000 — so so some leverage is needed. Risk is well controlled so in this case leverage is a great asset to this strategy. If this is how you trade, you may end up having multiple positions with similar risk levels at the same time. If you have 5 similar positions, then $200,000 in capital is needed. Therefore, you need an absolute minimum of 20:1 leverage. Take the leap to 40:1 or 50:1 to make sure you have room for taking multiple trades. If your account is a different size, or you trade in a slightly different fashion, use the approach above to determine the amount of leverage you need. $50,000 account – scalper scalper
Sticking to not risking more than 1% of deposited capital, this scalper can risk up to $500 per trade. Scalpers usually risk a small amount (in terms of pips) on each trade. Let ’s assume this trader risks 10 pips on a trade. That means in the EURUSD they can take 50 mini lots or 5 standard lots. If they lose 10 pips on 5 standard lots they've lost $500 or 1% of the account. 5 standard lots cost $500,000, so leverage is required to take such a position. It's also quite possible this trader has multiple positions at any given time. If up to three positions are held at a time, then $1,500,000 is needed to open the positions. Therefore, this trader needs at least 30:1 leverage. For a bit of extra room, 50:1 to 75:1 is recommended (if available). Leverage Scenario Summary Summary
Based on these examples of risking a maximum of 1% of the account on a trade, and even having multiple positions out at the same time, there's little need to be over 100:1 leverage…and even that's high for most traders . If you need to use 200:1 or 400:1 leverage just to trade, you're likely undercapitalized and should wait to begin trading until you have more trading capital available. available.
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Dramatic Dramatic events occur and liquidity can dry up, making positions impossible to liquidate at the stop loss price. Such events expose you to more risk than anticipated. If you're leveraged to the hilt when a drastic situation occurs, your account could be wiped out. Use as much leverage as needed, while still trading in a risk-controlled manner.
Why Do Brokers Provide Such Huge Leverage?
If you're wondering why brokers offer leverage of up to 500:1 the answer is simple. It entices traders to invest only $100 (or so) and try to gamble their way to profits. There are thousands of traders who will open an account for a couple hundred bucks, and since most of that money will be eaten up by the broker's spread or commissions, it is easy money for the brokers. A micro lot costs $1000, a mini lot $10,000 in a pair such as the EUR/USD, so opening an account for less than $1000 means the trader needs leverage just to buy the smallest increment available. And since most new traders come to the forex market with delusions of grandeur it's likely they'll risk far more than 1% of their account on each trade. Leverage provides a way to do that. Insanely high leverage allows people to swing for the fences in the hopes of hitting a couple winners. It rarely happens. Don't be afraid afraid of leverage. Use it, as leverage is a valuable valuable asset. Just use it wisely. Keep your risk per trade below 1% of your personal capital.
Summary – So So how much forex leverage?
Once you've learned some strategies, you'll be able to calculate how much leverage is needed for your account size and the typical trades you'll be taking. Many traders find they actually don’t need much leverage, but having some is fine, especially if you're likely to have multiple positions open at one time. If you're a
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swing trader it's almost imperative to have multiple positions open at any given time in order to grow your account consistently. As a day trader, you may only trade one pair (one position at a time), in which case you may not have multiple positions since the shorter time frame frame makes them harder harder to juggle. juggle. There will always be another trade, so there's little need to pile into one trade, risking a lot and requiring excessive leverage. For most of you, 50:1to 100:1 leverage is way more leverage than you require.
Averaging Down Down Don't add to a position when it's losing money. This is called “averaging down” and is extremely dangerous. Mainly this is because it's highly likely to increase the originally anticipated risk of the trade. A losing position shows that so far you're wrong about the market, and the trade therefore doesn't warrant additional capital being directed to it. Averaging down is considered negative because when a trader does it, they're increasing their risk and refusing to admit they're wrong – throwing throwing good money after bad. Averaging down also shows you're getting emotionally involved, and far worse, you're deviating from your original plan. If you're going to risk 50 pips with one lot on a trade and you're now showing a loss of 60 pips, adding to your position defeats the entire premise of planning and managing your risk. Your losing trades should be exited when originally planned...not added to. There's always another trade — no no point doubling down on a trade which is losing money. Averaging down may work a few times, as markets do move back and forth. It's the time that it doesn’t which leads to catastrophe. A maximum of 1% should be risked on any one trade, ideally less than 1%. If you cancel your stop, and double your position when you're down 3% it gets ugly fast. What if it keeps dropping? If you add again, a quarter of your account could be gone in no time.
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There's no plan here; these actions are based entirely on emotion, and emotional traders don’t make money over the long ru n. As a general rule, don't average down. There's no reason to. There will always be other trades. Take a loss when your plan requires it and then move on. Later on certain strategies or concepts will be introduced which could give the illusion of averaging down. Casting a Net with Orders for example, discussed later in the book, is a method of trading where you don't pick one price as an entry and/or exit, but rather average into (or out of) the position at multiple prices. This is very different than averaging down, as the approach is methodical and planned; the potential risk is calculated and weighed before the trade is made, not during.
Pyramiding Pyramiding is a way of adding to your position — making making it larger — when when the trade is showing a profit. If a trade is showing a profit large enough for you to move your stop to the entry price, then you can add to the position. You can do this because the current position is now riskless — your your stop is at your entry price. In a sense, it's like making a new trade, but instead you're adding to your current position, and will once again risk about 1% of capital on the additional position. This process allows you to increase potential gains on winning trades, while not increasing your original risk. To clarify, assume your original position had a 1% risk, but the price has moved enough in your favor that you can move your stop to the entry price of the position (when to do this is discussed at the end of the book in Active Trade Management, but for now just grasp the concept), making it riskless. You add to the position, making it larger, and again risk 1% of capital on the additional portion of the position. You now have a larger position, though your risk is still the same as when the trade started.
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As an example: You buy 1 lot of the EUR/USD at 1.3600, and place a 50 pip stop at 1.3550 (50 pips of risk on one lot). The position moves in your favour and is now showing a 50 pip profit (trading at 1.3650). You move your stop to breakeven (1.3600). You then buy another lot at the current rate of 1.3650 and place a 50 pip stop at 1.3600. You now have 2 lots, and both lots have a stop at 1.3600. One lot was purchased at 1.3600 and another at 1.3650. If the price retreats to 1.3600 and the trades are stopped out, you'll only lose 50 pips on the second lot and none on the first. 50 pips was the original risk of the trade. If the price continues to rise, for every pip movement above 1.3650 (this is where the second lot was purchased) you'll make double what you would've made if you only kept the original one lot position. Pyramiding maximizes gains when you're right, and the price continues to move in your direction. The downside is that instead of breaking even on one lot after moving your stop to your entry price on the original trade, if you have pyramided pyramided and the price hits your stop, you'll lose money on any positions purchased at a higher higher price. In the example above, if you only kept the original position you'd move the stop to breakeven, and if it's stopped out (the stop on the trade is hit) the net result is $0 — your your exit is the same price you entered the trade. If you purchase a second lot at a higher price and the stop is hit, the result is a 50 pip loss on the second lot purchased. A potentially “flat” trade became a losing trade in an attempt to maximize profit be pyramiding the position. In the event the price goes to 1.3700, and you only have the original lot you make 100 pips. If you pyramid using the method and numbers above, you make 100 pips on the first position, and 50 pips on the second lot purchased. Thus, you earn an extra 50 pips by pyramiding. If the position continues go in your favour you'll earn even more, yet your risk is still limited. Continuing with this example, with the price now at 1.3700 you move your stops to 1.3650, and then purchase another lot at 1.3700 which also has a stop at 1.3650. You now have 3 lots, with an overall average price of 1.3650 (you bought
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at 1.3600, 13650 and 1.3700 which averages to 1.3650). You can't lose money on this trade, yet if the price continues to rise you make triple for every pip movement above 1.3700. If the price moves back to 1.3650 you don't make or lose anything. If the price goes to 1.3750 and you exit the trades, you'll make 150 pips on o n the first lot, 100 pips on the second lot and 50 pips on the third lot. A total of 300 pips profit, and when you you purchased purchased the last lot your total risk was zero (breakeven). If the rate moved to 1.3650 after purchasing the third lot, the trade nets $0 (flat trade). Had the third lot not been purchased, and you exited the two lots at 1.3650, you would've made 50 pips. It's only advantageous to add to a position if the trend continues in the direction of your trades and money is made on each incremental addition to the position. Of course you can’t know if the trend will continue before making the decision to pyramid or not. So there's there's most assuredly a trade off. off. Pyramiding Pyramiding is recommended in strong trends, as it allows you to maximize profits on a continual move in a particular direction. Pyramiding Pyramiding is difficult in weak ttrends rends or during choppy price action. The strategies and analytical tools within this book, if studied and practiced, aid you in identifying high probability times to fully capitalize (possibly pyramiding) on market moves, and when to trade cautiously. ca utiously. Ultimately, pyramiding is a personal choice; it doesn't need to be done, though it also doesn't need to be avoided. If pyramiding is something that's appealing, it should be incorporated into the Trading Plan in association with a strategy which is highly effective, proven and will benefit from pyramiding p yramiding..
Record Keeping Record your results and keep trading notes to be successful in the forex market. Writing down what trades you're making — when is very when and why — is important. It provides you with insights into what times are more profitable for a strategy, or if certain currency pairs are more profitable than others. It's important to also write down if you see a trade set- up but opt not to trade it. “ Why did I not
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trade it?” By recording everything you may learn that trades you're not taking for some reason could actually be profitable. This process, while requiring a bit of time, is an important part of trading. If you have no record of what has worked and what hasn't, how can you alter your plan to become more more profitable? You won’t be able to! Recording information on a spreadsheet is an exceptional tool for analysis down the road. I recall one time I was working on a new strategy for the USD/CHF, GBP/JPY and EUR/JPY. The two latter pairs were very volatile during this time and resulted in spectacular short-term gains. The USD/CHF on the other hand failed to trigger trades, and when it did the gains were mediocre, at least compared to the returns of the other two currency pairs. I recorded all the results in a spreadsheet, and after one month analyzed the data. In my mind I was sure that the GBP/JPY would be the best pair for the strategy because it was the most volatile and provided the most pips when the strategy worked. It turned out that EUR/JPY had the highest total profit. Also, the EUR/JPY was less volatile, and exposed me to less risk on each trade. Therefore, it came out ahead of the GBP/JPY for that particular strategy. When other criteria were analyzed, the uneventful (in my opinion at the time) USD/CHF then became a star performer. It had very few losses, although gains were smaller. Maximum draw downs (biggest losing trades) were must less than the other pairs. Since the pair had proven it was less risky based on the strategy, it was easy to see that if I took slightly larger positions in the USD/CHF (but still keeping the risk below 1% per trade) it would likely outperform the other two currency pairs. By recording trade information I was able to see that by increasing the lots traded in the USD/CHF I could increase gains to the levels of the other pairs. The lack of volatility, an apparent weakness, was turned into strength by increasing the number of lots traded.
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This of course is only an example, and the characteristics of currency pairs continually change, which requires the constant recording of new trade data and recalibrating. Data doesn't need to be analyzed each day, or even each month. Analyze it when the currency pairs are no longer acting as they were when you originally analyzed the data, or analyze your trading results at a set interval that works for you, such as every two months. Recording and analyzing trade information provides you with an edge because you're able to adjust and fine tune your trading based on actual results and statistical data. There are great programs and websites that track t rack and analyze your trades for you. http://www.myfxbook.com/ is one example. Connect your account to it and it tracks your trades, and breaks down your trading into various statistics. This is a great additional tool, but it doesn't replace your personal record keeping. Myfxbook doesn't know the trades you pass up, which can drastically affect performance...only performance...only you can record record that. I recommend using a program like Myfxbook though, as it shows which hours you're profitable in (especially useful if day trading — stop stop trading during hours you don't make money), which pairs you make the most money with and profitability profitability by b y day of week. This tool can save you a lot of money: avoid trading at times or in pairs where you consistently lose money. Simple as that.
The Blissful Lack of Information We're a news-driven society; most people watch the news and try to anticipate how the events of the day will affect the markets. Similarly most traders do this, watching CNBC constantly as well as scouring financial websites for "guru opinions" on the markets and trade signals. s ignals. If you want to be a successful trader, don't do any of this. Ignore other's opinions on the markets, and don't watch the news while you trade.
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If you choose to keep up on the events of the world, then so be it, but don't let other's opinions affect how you trade. Didn't you buy this book to get strategies and learn to trade for yourself? If so, then you're on the right track, because trading is about implementing a defined set of protocols when certain market conditions materialize. Nowhere in this book will you find a strategy that says "Buy when soand-so on CNBC tells you to." Your only job as a trader is to implement a strategy as best you can; acting according to the guidelines you've laid out for yourself, which you'll learn by reading this book. Once you've made a trading plan that plan is all that matters. The world could be crumbling, but you stick to that plan. Even if I call you myself and yell "You need to get long the EURUSD right now!" Your response should be "Thanks for letting me know, but I have my own plan plan to follow ." Don't let anyone throw you off course. Ignore news which could result in you not following your plan. Avoid the market opinions of others unless their ideas align with your trading plan. Once you have strategies you like, focus only on that. Your search is over. Implement your strategies; there's no need to seek out opinions from others. The only news you should track is planned economic news releases. These are listed on an Economic Calendar and are discussed more thoroughly in the Trading the News chapter. As either a day or swing trader, we don't care what these actual numbers are, and I encourage you to not even look at them or listen to commentary on them. Analyzing these numbers/news won't improve your trading. Instead, simply be aware of when these events are as they can cause big moves in the market, and it's best to avoid trading for about five minutes before and a couple c ouple minutes after the release. After the planned news release, we can jump back in and implement our strategies.
Moving Forward The following chapters cover strategies which are used with the guidelines and principles discussed so far. Some strategies require that you add your own “flavour” to them. This is because some s ome short -term strategies may not work w ork exactly
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the same from one year, or even one month, to the next. The concept may still be sound, but how the strategy works may change. Alternatively, volatility or lack of it, may conceal a signal which was easily seen before. Regulation changes, laws and other factors also shape how markets act and may erase a strategy in its present form from the market. Sound trading principles last forever, but a strategy may need to be tweaked from time to time, to adjust to an overall shift in market/investor psychology. As you read and implement these strategies, personally test each one before using it. Strategies should be adapted to current market conditions and shouldn't be trusted blindly. As discussed in the Introduction you should follow the five step plan: read this entire book, formulate an initial trading plan based on strategies you like, practice in a demo account for several months, re-tweak the plan if needed and repeat prior steps until consistently profitable. Only then do you commence to live trading with a finely-tuned trading plan. Each new strategy added to your arsenal should be vetted through this same five step plan.
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3. Recommended Minimum Capital for Forex Trading Trading (Day (D ay or Swing) Which broker you choose, trading platform, or strategy you employ are all important, important, although how much money you start with will be a colossal determinant in your ultimate success. Not all traders are alike, and not everyone trades the same way. A day trader may not need the same amount of money to start trading as a swing trader does. The amount of money you need to trade forex is also determined by your goals — are you looking to simply grow your account, or do you seek regular income from your forex trading?
How Much Money Do I Need to Trade Forex? - Why It Matters Does it really matter if you start an account with $100 or $3000? Yes! One of the most significant issues new traders face is being undercapitalized. Forex brokers are guilty of fostering such an environment by offering to open accounts for as little as $5 in some cases...although the minimum opening balance is usually about $100. If you want to start trading, it's likely because you want an income stream. Well, you aren't going to have much of an income stream if you start with $100. Since very few people are patient enough to let their account grow, they'll risk way too much of their capital on each trade trying to make an income, and in the process lose everything...likely everything...likely several $100 $100 deposits in this this case. I'm a firm believer in never risking more than 1% of capital on a single trade (getting sick of hearing that yet?). If your account is $100, that means you can only risk $1 per trade. In the forex market that means you can take a one micro lot position, where each pip movement is worth about $0.10 (depending (depending on which pair
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you're trading), so you'll need to keep the risk to less than 10 pips. Trading in this way, if you have a good strategy, you'll average a couple dollars profit a day. While this will build your account slowly, most traders don't want to make a couple dollars a day, they want to build their account much faster and therefore will risk $10 or $20 per trade — sometimes sometimes more — in in an attempt to turn that $100 into thousands as quickly as possible. This may work for a time, but will inevitably result in an account balance of $0. The other problem with trading forex with such a small amount of money is that it offers almost no flexibility in your style of trading, or the trades you can take. If you deposit $100, and follow proper risk management protocols, you can only risk 10 pips if you take a 1 micro lot position. You pretty much have to be an active day trader. With a 10 pip stop there's no way you can swing trade, or even day trade many pairs, since you'll easily be stopped out by normal market fluctuations fluctuations before a big move happens. Traders are far better off to save up more money before opening a forex account; having adequate funding is essential to trading properly.
How Much Money Do I Need to Day Trade Forex? If you want to day trade forex, I recommend opening an account with at least $1000, preferably $5000. With a $1000 account, and risking no more than 1% of your account, you can risk $10 per trade, and can likely make about $20 to $25 per day. This assumes you make 5 trades a day, win on average 3 of them, lose $10 on the losers and make about $15 on the winners. If you make more on the winners, then your income will be a bit higher. If make more trades, and maintain the same win ratio, your income will also increase. With a $3000 account and risking no more than 1% of your account on each trade — $30 $30 or less — you you can make about $60+ per day, based on the trading scenarios above.
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With a $5000 account, you can risk up to $50 per trade, and therefore you can reasonably make an average profit of $100+ per day. This is possible because let's say you risk about 10 pips per trade, so you can take a position of about a bout 5 mini lots ($1 per pip movement), which will lose $50 or make about $75 if your average gain is 15 pips. Of course you won't win every trade, but if you win 3 out of 5, you've made yourself $125 for the day. Some days you make more, and some days you make less. With a $5000 account you can start to create a decent stream of daily income. If you allow the account to grow to $10,000 you can make roughly $250 per day. These are rough estimates; some of the strategies in this book will only result in a few trades a week, while others could be used to produce many trades a day. Each strategy also has a different reward-to-risk ratio. In the scenarios above it's been assumed that we're risking 10 pips to make 15 pips on the winners (as an example) — a 1.5:1 reward-to-risk ratio — but usually we'll be looking for trades that offer a 2:1 or 2.5:1 ratio. It's possible to start an account with a smaller amount, such as $500. If doing so make a commitment to grow the account for at least a year before withdrawing any money. If you do this, and don't risk more than 1% of your account on each trade, you can make about $12 per day to begin with, which over the course of a year will bring your account up to several thousand dollars.
How Much Money Do I Need to Swing Trade Forex? Swing trading is when you hold positions for one day to a few weeks. This style of forex trading is suited to people who don't d on't like looking at charts constantly, or can only monitor the market for about 30 minutes a day to seek out trading opportunities. With swing trading, you're trying to capture longer term moves and therefore may need to hold positions through some gyrations before the market actually gets to your profit target area. You'll often be trading with at least a 25 to 50 pip+ stop,
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and attempting to make 50 to 75 pips+ on your winning trades. If you go for bigger gains, such as 300 pips, your trades will likely last several days or more (depending on volatility). If you select trades that have a 50 pip stop, the absolute minimum you can open an account with is $500. This is because you can risk $5 per trade; trading one micro lot (about $0.10 per pip movement) with a 50 pip stop the risk is $5. Since trades may last a few days, you're likely only to make about $10 or $12 every couple weeks. At this rate it could take a number of years to get the account up to several thousand dollars. Ideally, start with $2000. With this starting balance you can take at least 1 micro lot in pretty much any swing trade setup, in any pair, that you see. A $2000 account means you can risk $20 per trade, which is 200 pips with a micro lot. Find trades with only 50 pips of risk and you can take more lots, or open multiple positions. With $2000 $2000 or more more you start to get get some flexibility. flexibility.
How Much Money Do I Need to Trade Forex - Final Thoughts In percentage terms the figures provided above represent phenomenal growth. But remember we're using leverage. A 1% move in the market can be turned into a 50% gain using 50:1 leverage. Some traders make the mistake of thinking that because it's possible to turn $500 into thousands relatively quickly, it's just as easy to keep exponentially growing a larger account ("Why aren't good traders trillionaires?"). Psychologically, most traders find a trading level they're comfortable with, and they maintain that trading account balance, withdrawing any money over that balance as their income each month, thus the account doesn't grow anymore. Once you have a reached an account level that produces an income you're happy with (varies from person to person), the need and desire to make more diminishes.
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Also, as the account increases to six figures or more (sometimes sooner), brokers will typically reduce the leverage available. Whether psychological or because of the limitations limitations of the market, smaller accounts can be grown more quickly than large accounts ($50,000 or more). Be realistic about what you expect from your forex trading. How much money you deposit plays a crucial role in how much you'll likely make when you follow proper risk management. If you're willing to grow your account slowly, you can begin with as little as $500, yet starting with at least $1000 is recommended no matter what style of trading you do. If you want to make an income from your forex trading open an account with at least $3000 for day trading, or $5000 for swing trading. Most unsuccessful traders risk much more than 1% of their account on a single trade; this isn't recommended. It's possible for even great traders and great strategies to witness a series of losses. If you risk 10% of your account and lose 6 trades in a row (which can happen) you've significantly depleted your capital and now you have to trade flawlessly just to get back to even. If you risk only 1% of your account on each trade, 6 losses is nothing. Almost all your capital is intact, you're able to recoup your losses easily, and are back to making a profit in no time. As the examples above showed, it's still possible to make great percentage returns risking 1% of your account, or less, on each trade. The above scenarios assume that your average profit is about 1.5 times your risk, and that you'll win about 60 percent of the time. These statistics vary drastically depending on the strategy being traded, although although a 60% win rate is quite common for an accomplished trader (will be lower for beginners). Your ability to stick to a strategy, assess market conditions, decide when to trade a strategy, and when not to, will ultimately determine your success. How much money you trade with is where it all starts, and will set you out on the right path, or the wrong wrong one.
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4. Pip Potential Relative to Spread – Day Trading Forex In chapter 1 we looked at some currency pairs to focus on. These are generally the most liquid currency pairs and have the tightest spreads. Unfortunately, when you're choosing which forex pairs to day trade, it's not as simple as picking the pair with the tightest spread, or greatest daily average movement. Especially when day trading, the spread has a significant impact on your long term success. success. Think of it this this way: if a currency pair moves on average 70 pips a day, and the spread is 4 pips to get in and out (8 pips total) you're paying pa ying more than 11% of the daily range. That is very large obstacle to overcome. If the price is moving 250 pips a day and the spread is 4 pips, that's better. There's is more opportunity for the cost (spread). Yet, as volatility contracts, say from 250 pips down to 90 pips per day, traders often continue to trade the same way they did when the daily range was larger. This can be costly; there are times when it's highly beneficial to not trade, or to look for different pairs which have higher potential revenue compared to the spread. This also means the pair with a lower spread isn't always the best for day trading. If a pair has a 3 pip spread (6 pips to get in and out) and a 100 pip daily average movement, 6% of the daily range is unattainable (because it's your cost). If a pair has a 4 pips spread (8 pips to get in and out) but has a daily range of a 150 pips, 5.3% of the daily range is unattainable. unattainable. The revenue potential is higher in this case compared to the former, even though the spread is higher. Establish a baseline for all the currency pairs you trade (method below). Which pairs you trade is laid out in the trading plan. Also specify at what times you'll trade each pair (this is covered in detail later on). During certain times of day volatility is greatly reduced, so during those times the spread is too much of a
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factor and that pair shouldn't be traded. Also, due to market conditions certain times will be volatile, and other times not. When a pair is too quiet, don’t trade. If the spread is costing too much of the daily range, wait and save your money for better opportunities. opportunities. This chapter mostly applies to traders using non-ECN brokers. If you're using an ECN broker, your spread will be extremely small, and therefore the spread isn't typically an issue. You still should be b e aware though of when volatility is contracting, so you're only taking trades that have a high probability of hitting your profit target. Even with a small spread, if a pair isn't moving, it isn't worth trading. If you're a swing trader, trader, then this chapter chapter also isn't relevant. The longer time time frame of the trades means the spread usually isn't an issue. An exception is when volatility is very low — the the spread could have an impact and it's best to avoid trading in these low volatility pairs.
Establishing a baseline is easy: 1. Find the daily average range of each pair traded (use 10+ days of price action). Calculate the daily average range by subtracting the low price of the day from high price. Use a 10 day (or more) Average True Range (ATR) indicator for a quick reference. Ideally though, I recommend you record your own daily stats. You can also find useful forex stats for each pair at http://vantagepointtradi http://v antagepointtrading.com/daily-forex-stats ng.com/daily-forex-stats 2. Take note of the spread (if fixed) or the average spread (if not fixed/variable) during the times you trade. 3. Divide the spread by the daily average to get a percentage. If you're entering and exiting the same day, double the spread, since you'll pay it twice.
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Quickly calculate these figures at least once a week, as these ratios will change constantly. Be aware when volatility drops as it may be time to move to another pair/strategy, tweak the strategy, or sit on the sidelines. Be aware of the spread — if if it drops or increases this could dramatically affect the ratio. Day traders also don’t usually trade 24 hours a day. If you only trade the US session — and and positions are entered and exited during that session — then then you should only use statistics from the US session. This means you're only concerned with the average spread and volatility during the US session, so track the US session high minus US session low.
It's for this reason I recommend you keep track and record your own statistics on the pairs that are relevant to you. If you're allowing trades to run from one session to another, then using 24 hour data is fine. In this case one of the easiest ways to get the daily average movement is to use an Average True Range (ATR) indicator. Set the indicator for 10 or more days and that'll tell you how much, on average, the pair moves in a day (when viewing a daily time frame on the chart). By regularly tracking the ratio of profit potential to spread, you'll see that just because some pairs are very liquid and heavily traded doesn't mean they should be traded all the time. It'll also show that some less heavily traded pairs can be very advantageous advantageous to day trade. trade.
Spread to Pip Potential Potential Examples Assume you're trading the EURUSD and aren't concerned if your order fills during the European, US or Tokyo session, therefore using 24 hour data is fine. Look to your ATR indicator which is set to 10 or more days. The current reading is 0.0126, which tells you that the average movement of the EURUSD is 126 pips per day.
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You also know the spread you pay is fixed at 2 pips, for example. If the spread you pay is variable, use an average or an estimate. That provides you with the first two steps in the calculation. Then run the calculation. 4 pips (2 for entering and 2 for exiting) / 126 = 4/126 = 0.0317 or 3.17%. Looking at the spread in this way puts it in a very different context. Many traders view the spread as costing nothing, but that's not true. Every time you pay the spread you give up profit potential. The more profit potential you give up, the more costly each trade becomes and the harder it is to make consistent daily profits. For instance, consider the USDJPY which for a chunk or 2011 and 2012, moved only 30 to 50 pips per day. If the spread on this pair is 2 pips, that means a single day trade is costing 4 pips. Even if the pair is moving 50 pips per day, the cost of trade is very high in percentage terms of daily movement: 4 / 50 = 0.08 or 8% Merely by entering and exiting, 8% of the daily range has been paid. Also, keep in mind that the daily average movement is for a 24 period . If you only trade during certain times of the day the pair could move far less, and your cost could be much greater. For example, if you trade the US session, and the pair is only moving 30 pips during that time, paying 4 pips to get in and out is costing you 13.33% of the movement you're likely to see during the US session. You must determine in advance how much you're willing to pay and at what level you'll stop trading a pair if there isn't enough volatility to warrant paying the spread. When day trading, you shouldn't be trading pairs with a reading higher than 7%; less than 5% is preferred (this applies to the 24-hour period). Either there isn't enough volatility, your spread is too high, or both. This may seem like a lot of work simply to gain some information and insight. It is work, and it takes discipline to stay on top of these factors. Would you run a business without being aware of what your costs and profit potential are? Of course not, you would drive your business into the ground in no time. That's 69
exactly what happens to most traders. They forget the simple things, like monitoring the profit potential potential (daily movement) in a pair, and the cost of making a trade. Tracking this sort of data lets you know when it's worthwhile to trade and when it isn't. It's therefore more important than any day trading strategy, because this tells you whether you should even be day trading that pair in the first place.
It never was my thinking that made the big money for me. It always was my sitting. Got that? that? My sitting tight! tight! - Jesse Livermore
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5. Introduction to Swing Trading and Day Trading Before moving into the more technical aspects of the book, let's look at swing trading and day trading. Each trader is encouraged to trade the way they're most comfortable with. It's likely traders will classify themselves as a swing trader, day trader...or possibly both. For those who don't like holding positions overnight, then day trading is pretty much the only option. Trying to force a different trading style onto a personality that won't accept it is a sure way to burn out, or experience poor performance. On the other hand, traders who can’t stand to stare at a screen all day, or monitor each gyration of the market, are more likely to be swing traders. Day trading is taking positions during the day, and exiting that position within the same day. In the forex market, day trading needs a somewhat more dynamic definition than a day trader in the stock market might receive. A stock day trader will generally trade a specific market while it's open, and that is it. A forex day trader can trade any time during a 24 hour period; he or she can trade the European open and the US close, just the European session or just the Tokyo session. Day traders don't hold positions overnight though — whatever whatever their personal “night” may be. Positions are taken and exited within the same trading day, with the number and duration of trades varying drastically from trader to trader. Some day traders incorporate roll-over into their strategy, and some choose to exit before roll-over occurs. By the end of the book you'll know what to do in different situations. Scalpers are a form of a day trader that trade small moves over and over again, often with large positions since the risk (in pips) is also kept small. If you wish to be a scalper, open an ECN-style trading account. An ECN account is
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actually recommended for all day traders. Brokers and ECN accounts will be discussed a bit later. Some day traders may make many trades a day, or only a few. It really depends on what the trader enjoys, and which strategies they utilize from this book Swing traders on the other hand, may trade each day but don't necessarily close their positions each night. Their trades last from a single day to a week or even months (depending on the time frame used for the trade setup). Swing traders can be very active, trading multiple pairs and thus opening and closing different trades throughout the week, or they may simply focus on one or two pairs, having an entry or exit signal only once or twice every couple weeks. While traders often compartmentalize themselves into a group — day day trader or swing trader — the the strategies of one group are often applicable to the other (and vice versa). Unless a strategy involves a particular hour or time of day, most of the strategies that follow can be applied to any time frame. When you decide to be a swing trade, day trader or both, make sure you choose an approach which you enjoy, find easy to stay disciplined with and that suits your circumstances.
Swing Trader or Day Trader? There are some limitations and advantages for both swing trading and day trading. While someone may wish to be a day trader or a swing trader, a few things may stand in the way of successfully accomplishing that, and these issues must be dealt with before trading commences. Day trading requires the trader have very fast broker execution and fast reflexes to catch quick moves. This becomes more pivotal as the time frame for trades decreases. A scalper attempting to grab 7 or 10 pips can ill afford to spend
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30 seconds typing in an order. Orders need to be teed up and filled in an instant. That means setting up the platform so it can handle quick executions. It also means going through a broker that provides quick execution —a “no dealer desk” ECN style broker (more on this next chapter). The spread is more of a factor the smaller the trade time frame becomes. If your broker is charging you a three pip fixed spread on the EUR/USD (that's very high!) it will be hard to profit by attempting to capture small 7 to 10 pip moves. Some brokers don't even allow scalping, and institute rules which don’t allow traders to exit positions within two minutes of the entry, for example. Use an ECN broker and none none of this is an issue. issue. Prospective day traders must legitimately ask themselves if they're setup to effectively day trade (when the times comes, after reading this book), or if their current circumstance is likely to pose problems. Due diligence is required in preparing to make day trades, especially if you require rapid fire execution to capture quick moves. It should also be noted that while a demo account may provide some idea of how a day trading system will work, the platform may perform very differently under live conditions where slippage (orders not executing at the price you expect), liquidity and platform latency ("lag") issues become an actual concern. If a day trader is well prepared for day trading, it's a lucrative endeavour. Small accounts benefit from day trading, as day trading provides a way to capitalize on small moves while risking less than 1%, but capturing those moves over and over again. Swing traders generally don't need to worry as much about execution, the spread or latency issues. When a trade lasts a couple days or a week, a pip or two doesn't make a big difference. That also means swing traders don't need rapid execution, although setting the platform up so trades can be executed quickly when needed is encouraged.
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Given the length (in time) of the trades, swing traders must always put out profit targets targets and stop orders on their positions, positions, as it's quite possible the level could be hit while they're not watching the market. Stops and target are also a lso used by day traders, but since day traders are watching their screens, they can also manually exit trades if they wish. The major advantage of swing trading is that it doesn't have to take up a lot of time. Once a strategy (or several) is mastered and a trading plan is in place, charts are scanned quickly each day for trade candidates. This may only take several minutes a day depending on how many pairs are scanned. Orders are then set and the trader walks away. Unfortunately, this “easy money” approach is what lures many traders into swing trading undercapitalized, and without a proper method. Swing traders are generally going to require a larger stop loss (in pips) than a day trader. Even though position size can be adjusted, the swing trading account needs to have enough capital in it to handle the larger stop losses and still not risk more than 1% of the account on a trade.
With regard to time commitment, those starting out and those who haven't mastered their emotions and trading plan need to put in much more time studying charts and understanding their own tendencies than a few minutes a day. It's true that 10 to 20 minutes a day is all it takes to manage positions and find new swing trades, but there's work which occurs outside “analysis” time. Record keeping was discussed in a prior chapter and the trader must stay on top of what's working and what isn’t. Trading is a full time job during the initial sta ges of the learning curve, whether swing or day day trading. But most of those hours aren't spent actually trading; they are spent practicing the strategies and exercising discipline. Once profitable methods are established and enough internal work has been done to actually follow through on a personal trading plan without deviation, only then does trading become a part time time job. Personality also plays a pivotal role in whether you'll be a swing trader or a day trader (or both). Some traders love to make lots of trades, even while swing
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trading, and may sit in front of their computer all day. Others only want to look at the markets for 10 minutes a day. Traders who are open to both day trading and swing trading get the best of both worlds. Sometimes day trading strategies are employed and at other times swing trading tactics. Having the best of both trading styles means more work is required though. The trader must be comfortable trading on multiple time frames and also must develop a comprehensive trading plan to account for day trades and swing trades, potentially occurring at the same time.
Final Thoughts: Adapt Methods to Suit You Whether swing trading, day trading, or both, the bottom line is to make sure you're prepared (financially, technologically and emotionally) for the endeavour. Use strategies that align with your personality and allow you to reach (eventually) the realistic goals you have for yourself and your trading. In that light, as you read through the rest of the book, keep an open mind. While certain sections cater more to day traders and others to swing traders, realize there's potential for both types of traders within these chapters. A small tweak and/or simply a time frame change can transform a day trading strategy into a swing trading strategy or vice versa. It won't work with all the methods outlined in this book, though it will for many. If a strategy doesn't initially appeal to you — for for whatever reason — still still read it through. When you've read through the book, come back to that strategy as something you learned in another chapter may help you implement that strategy better. Whether you swing trade or day trader (or both), the choice you make and what you do every day should align with who you are, your resources and your goals.
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6. Picking a Forex Broker Once you've finished with this book you'll need a forex broker, first for your demo account and the then hopefully your live account, once you're consistently profitable in the demo. Choosing a forex broker is essentially the biggest trade you'll ever make in your forex career. You're trusting all your trading capital to these people, so don't take the choice lightly. Below you'll find some steps for how to pick a forex broker that's right for you. You'll also learn how to test that broker out, what you can and can’t trust, and things to consider before handing over your money.
How to Pick a Forex Broker – ask yourself the right questions Have an understanding of what you need from your broker. This narrows the field of brokers to a handful which suit your needs. Consider your resources, trading style and how you move your money around.
One of the main factors to consider is whether you want to trade micro, mini or standard lots. If you have under $10,000, trade with micro lots. Only look for brokers that offer micro (1K lot or 0.01 lot) trading. Different brokers will also have different deposit minimums — this this is an easy way to narrow down brokers based on the funds funds you have available available for trading. trading. Also, some brokers impose a maximum on the amount of money you can have in a micro or mini account. That seriously stinks if the broker bumps your account up the next l evel and won’t let you trade in small increments anymore. For instance, let’s say you open a micro account with $900. Since each pip movement is only $0.10 (approx) you can control your risk and only risk 1% ($9) of your account on a given trade (90 pip stop). You do well and soon your account is at $1000... and BAM, your account gets switched a mini lot trading 76
account. Now each pip movement is $1 (assuming they no longer allow you to trade micro lots). With a $1000 account there's no way you can control your risk properly anymore. You can only risk 10 pips in order to keep your risk to 1% of your account per trade. That greatly restricts your trading style and forces you to trade more actively. You're being forced to deviate from the very risk management that was helping you be successful. Make sure there's no limit on how much you can have in your micro or mini account, or that you can trade these smaller increments even when using a standard account. For the record, I recommend Micro lot trading for anyone with under $10,000 to deposit. Micro lots allow risk to be fine tuned and for position size to be managed precisely. In my opinion, $10,000 is the bare minimum for trading mini lots. And $100,000 is the bare minimum for trading standard lots. This is especially true for swing trading. If day trading, you may be able to trade these these bigger lot sizes with less than the the recommended capital capital in your account...but why? There's no upside to limiting yourself to only trading mini or standard lots.
Some brokers don't allow scalping. If you want to scalp, make sure the broker allows it. If unsure, email the broker before opening a demo account. If you're day trading, this may still be an issue, since some of your trades may end up being considered considered scalps. If you're you're going to swing trade trade this isn't an issue. issue. If you're executing a significant number of trades (or small pip movement trades), get a broker which offers tight spreads, as the spread is a cost. Ask yourself how many trades you expect to do per day, per week, or per month. You'll have a good idea after you've read the book and started on your trading plan. The more trades you do, the more spreads you'll pay. If you only do the occasional longer-term longer-term trade the spread isn't a significant factor. If you want to trade a lot, and capture small gains, open an ECN account with an ECN broker. ECN brokers have the tightest spreads but charge a small commission on each trade. Since the commission is less than the spread, day traders benefit from
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using an ECN account. The spread offered by each broker varies; all ECN brokers aren't equal. Shop around for the best deal, heeding the additional criteria mentioned below.
You'll also want to consider HOW you're going to fund and withdraw from the account. This is a big one…especially the withdrawal aspect as this i s often where traders run into problems. Learn how deposits and withdrawals are made (methods), processing time, and if there are any limits imposed. A common limit is that if you deposit by credit card you can only withdraw (via credit card) the same amount (or less) as the initial deposit. Therefore, you may wish to use a broker that will mail checks, wire funds or offers payment services such as PayPal or Skrill, or one of the many other web payment services out there. Ideally, you need a broker that provides a deposit and withdrawal method that works for your personal circumstance.
Now that you've determined some of the things you want, we move to the next step which is what the broker can offer. There are so many brokers out there, and the market is largely unregulated (slowly changing as many brokers are now becoming regulated). regulated). This means the trading experience varies greatly from broker to broker. Choosing a broker is an individual process, as each broker focuses on certain things that will appeal to some traders, but not others.
How to Pick a Forex Broker – does your broker offer this?
Competitive Spreads : In forex trading there's often no commission. Instead, traders pay a spread (difference between bid and ask price) when making a trade. Some brokers offer fixed spreads, while others offer a variable spread. For instance one broker may offer a fixed 3 pip spread on the EURUSD at all times (this is very high!). Another broker may offer a variable spread which fluctuates between approximately 1.0 pip during high volume times and 2.5 pips during low volume times. The spread that's paid has a huge impact on profits, especially when day trading or doing lots of trades. The lower the
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spread the better. Sometimes that comes at a cost though…such as being constantly re-quoted (discussed shortly).
ECN forex brokers charge you a commission on each trade, though generally provide much lower spreads. With some ECN brokers, the spread is almost zero. Paying the commission is typically worth it to save one pip or more on the spread. For longer-term traders this isn’t a big deal, however for scalpers and day traders, an ECN broker with a typical spread near zero (0.1 or 0.2 pips on major pairs) is highly advantageous. In the "middle" are STP accounts. These are accounts which offer instant execution, like ECN accounts, except STP accounts don't typically have commissions. Instead the spread is slightly higher than an ECN account, but lower than a typical forex account. Because the conditions are more favorable in ECN and STP accounts, the deposit minimum is typically higher than for a basic forex account. Expect to deposit at least $1000, often $2000+, to open an STP account, and more for an ECN account. The accounts you can open for $50 or $100 (and this isn't recommended anyway, based on what you've read so far), or even $1000 or less, often have the worst trading conditions (highest spreads and day trading abilities may be limited). Not only are you undercapitalized, but you're trading at a disadvantage compared to better capitalized traders. It's highly recommended all traders, day or swing, use an ECN or STP account. ECN is best for day traders, while swing traders should use an STP account, yet can also use an ECN account.
Few Re-quotes: A re-quote is when you place an order and the price changes and you get “re -quoted”. A message pops up asking you if you want to proceed at the re-quoted price. This is a big deal for day traders; the delay can ruin your entry and the trade, or keep you in a losing position longer than you need to be,
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resulting in a bigger loss. That said, it can be annoying to anyone if it happens a lot. Also, constant re-quotes draw the listed quotes and spread into question. If a broker is showing a very tight spread, but constantly c onstantly re-quotes, then they're not actually giving you that spread even though they're advertising it. Therefore, you want a broker that offers a competitive spread and actually lets you trade at the rate you see. ECN and STP accounts don't have re-quotes, you're simply filled at the prevailing rate rate when your order order gets to the market. market.
Safety: A major concern for traders is being able to get their money out of their account. It doesn’t matter if you make a killing in the markets , if your broker scams you, or your money gets caught up somewhere, it was all for naught.
I've had issues with regulated brokers, and have had great experiences with unregulated brokers. That said, regulated brokers are under more scrutiny than their unregulated counter-parts, so choose regulated brokers over the alternative. Ideally, choose brokers regulated by financial authorities in the U.S., U.K., Canada, Australia, New Zealand or Japan, or other well established financial markets. Many brokers are regulated in Cyprus, although when there are problems with regulated brokers, it's usually with these ones. Stick to opening accounts which are regulated in countries with good economies and established financial markets.
Customer Support : If you need help with something, your broker should be there for you. To make sure they are send a few emails to customer service asking about something. This is just to make sure they're listening to you and they seem to know what they're talking about. Also make sure the broker has live chat or phone support so you have quick access to help if something goes wrong and you need to speak with someone quickly. Test out the customer support by sending emails and trying out chat support before you make a deposit. Don't be coy about this, you really need to test them. The last thing
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you want is to open an account and then get no response to your queries and questions.
How to Pick a Forex Broker – don’t always tr ust ust reviews or other people’s opinion s While reading about forex brokers in forums, on websites and in reviews is of value, it can also be totally inaccurate. Brokers may post their own reviews, and what I find more often is that traders will bash brokers simply because they lost money at trading. Since more than 90% of active traders who try trading lose money, it's no wonder so many traders blame their broker. It's much easier to blame someone someone else than accept personal personal responsibility. responsibility. I don’t trust reviews. The best way to test a broker is to read what you can on the broker’s website , to make sure they offer what you need. Then, follow the steps below to "test out" the broker. Just like trading, avoid taking short-cuts. Do your own due diligence rather than blindly trusting someone else’s opinion. Reviews and information on a particular broker may be a starting point, though you need to test that broker out for yourself.
How to Pick a Forex Broker – personally “test out” the broker(s) you choose Open a demo account with brokers you think you'll like – brokers that offer what you personally require. Demo accounts aren't exactly like live-trading, although you'll get an idea of the spreads, customer support and whether you like the platform. If you like the demo account and everything else is in-line (see sections above) then proceed to open a live account, but follow these steps in doing so:
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Always make a small initial deposit with a new broker (don't take any bonuses or "free money"). Make several trades. These are very small orders, just to test out the software and see how quickly orders go through. Unless your trading plan is completed and has proven profitable over the course of a number of months, this step is not actually about trading. Just place a few orders with very tight stops and targets to see how the trading platform operates and how quickly orders go through. This process shouldn't cost you more than several dollars. Make a withdrawal for a portion of the funds you have in the account. If everything goes smoothly, deposit more the next time and continue to work up until you feel comfortable the process is reliable.
Nothing is limiting limiting you to using only one broker either. Consider separating your funds between two brokers (if you have a larger amount of capital); use one broker for swing swing trading and and the other for day day trading, as an example. example. Each broker is different, so if I like what I see and read about a broker I'll try them out with a small amount and slowly add more capital, up to my full amount, if things go smoothly. This process can take months sometimes. If you're following the 5-step plan for successful trading, taking a few months for this process is fine. During this time, practice implementing and refining your trading plan. Once you trust the broker you're dealing with and have deposited your trading capital, hopefully you'll be close to finalizing your trading plan and trading with real capital. Be sure to read all the fine print when opening an account.
Don’t Take the “Bonus” While a bonus may seem nice upfront "Deposit $5000 and get $1000 free in bonus capital!" don't be fooled. fooled. Accepting a bonus will complicate things down the road when you go to withdraw funds. Nothing is really free about these bonuses.
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The broker isn't going to give you free money unless they think they can make it back. What happens is that you now have a $6000 balance showing in your account, and after some profitable trading your account is now at $6500. You decide to withdraw $500. But your broker says you can't, because $1000 in the account is theirs (until you have met the specific trading requirements which will make it yours). Since it's possible you could lose all the money in your account, they don't let you withdraw any, because they want to protect their $1000. If it sounds too good to be true, it probably is, and there's always a catch. Send a note to the broker when you open your account that you don't want a bonus. For more details on the type of issues you're likely to run into when taking a forex bonus, and why it isn't worth accepting in the first place, check out the article Why You Shouldn't Take the Forex Bonus From Brokers .
Final Word on Choosing a Broker Don't take the decision lightly on which broker to use. You may actually opt to try out a few brokers, and end up trading with all them. Do your research online, but read reviews with some skepticism. Disgruntled traders may bash a broker because they lost money, but that isn't the brokers fault. f ault. Positive reviews may also be written by employees employees of the brokerage. brokerage. The best approach is to test a broker yourself, once you have come to the conclusion that they're offering what you need. Start with a demo account, and email support (multiple times) to see how accessible they are. If all goes well, deposit a fraction of your trading capital. Make some live trades and attempt a withdrawal. If the experience is positive, continue to add capital, repeating the process above. These withdrawals withdrawals and trading transactions transactions may cost several several dollars in fees/losses, but knowing you can access your money with ease is worth the few dollar cost.
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Stick to brokers regulated in major global financial centers, and avoid brokers regulated regulated in places you've never heard of, or or that have volatile volatile economies. Finally, never take a bonus. As traders we make our own money and grow our accounts the proper way. Accepting a bonus only complicates things down the road.
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7. Best Time to Day Trade and Swing Trade Don't let the 24-hour market fool you. When it comes to day trading, not all hours within the 24-hour period are equal. Attempt to trade a trending strategy when major markets affecting that pair aren't open and you're trading against the odds. Unless a strategy explicitly states otherwise, if you're going to day trade the strategies in this book, it's recommended you do so during the hours discussed below. The best time to day trade the forex market is dependent on the forex pair you're trading; certain pairs are more heavily traded at different times around the globe based on which markets are open. For simplicity, we'll look at the best time to day trade popular currency pairs, such as the EUR/USD, GBP/USD, USD/JPY, USD/CAD, AUD/USD, NZD/USD and USD/CHF. I'll also show you how to find the best times to day trade other forex pairs not covered here, as well as monitor the above pairs for changes in their volatility, which may affect day trading.
Open Major Markets Means Increased Action As a basic guideline, forex pairs are most active when one or both of the markets associated with the pair are open for business. bus iness. For example, the EUR/USD is most active when European banks and/or when US banks are open for business. Exact times of heightened volatility will be addressed shortly. If neither the European or US banks are open, then the EUR/USD will have less transactions occurring and will be “quieter.” Here are the market hours for major markets around the world. Please accommodate for day light savings time.
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Forex Market Hours in GMT
Forex Market Hours in EST (New (New York)
During the week there's always a market open somewhere, allowing you to trade 24-hours a day. If you get lost converting all the time zones and figuring out which market is open and when, there's a great little tool which shows current times in different time zones as well as the market hours for different time zones: http://www.forexmarket http://www.for exmarkethours.com/mar hours.com/markethours.php kethours.php..
Your Day Trading Style If you day trade the strategies in this book, it's recommend you trade them during the times below (unless a strategy says to do otherwise). Below I discuss the most active and volatile trading times in each forex pair, and the best time ti me of day to day trade trad e forex if you're an active a ctive trader seeking s eeking volatility and trending opportunities .
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The volatility charts below are updated daily on: http://vantagepointtrading http://vantage pointtrading.com/daily-forex-stats .com/daily-forex-stats.. I recommend checking these stats and charts at least once a week, to make sure the hours you're trading are still the most active, and to be alerted to any significant volatility changes which may affect the strategies you're employing.
Best Times to Day Trade Forex… The charts below show the hourly volatility of each pair, showcasing which times of the day are best for day trading forex. All charts below are based on a 30 week average. While volatility changes over time, the hours of the day that are most active don't change significantly. significantly. For example, overall volatility may increase or decrease, but 1200 to 1500 is still likely to be the most active time of day in the EURUSD, as shown below. Times listed are GMT. Be aware of Day Light Savings Time if it affects you.
Best Time to Day Trade – EUR/USD, GBP/USD and USD/CHF These are all European currencies traded relative to USD, and are most active at similar times.
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The EUR/USD is most active between 0700 and 1600 GMT. While this is an active time overall, the most active time is between 1200 and 1500; if you only have a few hours to trade, start and stop trading at these times respectively.
The GBP/USD is most active between 0700 and 1600 GMT. While this is an active time overall, the most active time is between 1200 and 1500; if you only have a few hours to trade, start and stop trading at these times respectively. The hour from 0800 to 0900 GMT is also very active.
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The USD/CHF is also most active between 0700 and 1600 GMT. While this is an active time overall, the most active time is between 1200 and 1500 GMT; if you only have a few hours to trade, start and stop trading at these times respectively.
Best Time to Day Trade – USD/JPY Since Japanese and US markets are open at different times, the most active times of the day are spread out.
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The USD/JPY is most active from 2400 to 0200 GMT, 0600 to 0800 GMT and 1200 to 1600 GMT. The latter period is better than the former two. The entire area has been highlighted (yellow) between 2400 and 1600 GMT as a potential time to trade, although this isn't highly recommended. If you only have a couple hours to trade, focus on 1200 to 1600 GMT.
Best Time to Day Trade – USD/CAD Canada is situated above the US geographically, therefore, these country’s markets are open at the same time.
The most active time to trade the USD/CAD is between 1200 and 1600 GMT.
Best Time to Day Trade – AUD/USD and NZD/USD Australia and New Zealand share some economic similarities and geographical proximity, and therefore the AUD/USD and NZD/USD experience similar trading conditions during the day.
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The AUD/USD and NZD/USD and NZD/USD see increased volatility between 2400 and 0200 GMT, 0600 to 0800 GMT and the most active part of the day is between 1200 and 1500/1600 GMT. The latter period is recommended over the former two.
Best Time to Day Trade – Other Forex Pairs To figure out the best time to trade other forex pairs, go to http://vantagepointtrading http://vantage pointtrading.com/daily-forex-stats .com/daily-forex-stats.. Under “Pair Volatility” click on any forex pair to see a chart like the ones shown above.
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Locate the most active time(s) for day trading that pair, and quiet times to avoid. Unless a strategy directs otherwise, trade the above pairs at the times mentioned. If trading other pairs not discussed above, then only trade the pair during the most active time day. We want movement for our strategies.
Time of Day and Swing Trading There are specific times you should day trade; swing trading is more flexible. If you're using a 4 hour or daily chart, then you don't need to worry about when you place trades. Many of my swing trade orders are placed when the US and Europe are closed so when these market opens, and volatility increases, those orders are filled. You can also set your swing trade orders while major markets are open. Ultimately, it shouldn't affect your results too much when you place orders for swing trades. As a guideline, I recommend that you place swing trade orders at about the same time each day. Set a bit of time aside each day where you look through your charts and set out trades. This way you're looking at the market in the same "state" every day when you place your trades (and can spot tendencies). If one day you place swing trades while Europe is open and then the next day you place trades while Europe is closed, the price bars you're looking at the far right of your screen are likely to be quite different. Will it affect your trading? Maybe, maybe not. Swing trading is more flexible, and you you can put out trades whenever you like, though strive for consistency. Trading is a business, and should be treated like like one. I put my swing trade orders (entry, stop and target) out after the US has closed but before Europe opens. If trade setups develop, I may place additional swing trade orders at other times, yet I always check my charts and look for trades between the US close close and the European European open.
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8. Introduction to Japanese Candlestick Charts Japanese Candlesticks are one of the most widely used chart types. The charts show a lot of information, and do so in a highly visual way, making it easy for traders to see potential trading signals and perform analysis with greater speed. Here we'll look at what Japanese Candlesticks are, how the "candles" are created and basic candlestick interpretation. Understanding these charts will be useful going forward, as most of the chart examples in this book are candlestick charts.
Japanese Candlestick Charts Japanese Candlesticks show the high, low, open and close price for a currency pair, as well as highlight whether the pair finished higher or lower, over a specific period. Candlesticks are used on all timeframes — from from a 1 minute chart right up to weekly and yearly charts. When information is presented in such a way, it makes it relatively easy to perform analysis analysis and spot trade signals. signals.
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Figure 1. Japanese Candlestick Candlestick Chart - EUR/USD 5 Minute Minute
Candlesticks use two colors, such as green and red, blue and red, or white and black. The charts on FreeStockCharts.com use a green and red color scheme (by default, but this can be changed) for the Japanese Candlesticks. Change the chart type to candlesticks and the colors to red and green preferably.
Japanese Candlestick Creation Color is important in Japanese Candlesticks. A green bar (sometimes blue or white) indicates the price closed higher than the open price of the bar. A red bar indicates the price closed lower than the open price of the bar. The bars can also be colored based on how they closed relative to the prior close. To understand how this works, let's look at how each bar is constructe c onstructed. d.
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Figure 2. Japanese Candlestick Candlestick Green and Red Candles Candles - EUR/USD 5 Minute Minute
Each candle provides information on the open, close, high and low of a currency pair's price. Each candle reflects the time period you've selected for your chart. For example, in figures 1 and 2, a 5 minute chart is used, which means each candle shows the open, close, high and low price information for a 5 minute period. When 5 minutes has elapsed, the bar is "complete" a new 5 minute candle starts. The same process occurs whether you use a 1 minute chart or a weekly chart. The open and close are marked by the "fat" part of the candlestick. This is called the real body, and represents the difference between the open and close. If the close is higher than the open, the candle is green; if the close is lower than open, the bar is red. The open or close aren't necessarily the high or low price points of the period though. The high and low prices for the period are marked by a "tail" or "upper shadow" and "lower shadow." The high point of the upper shadow shows
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the highest price the currency pair went during that period, and the low point of the lower shadow shows the lowest price the pair went during that period. Figure 3 shows the basic construction.
Figure 3. Japanese Candlestick Candlestick Construction Construction
If there are no upper or lower shadows, it means the open and close were also the high and low for that period. Occasionally, you'll see bars that are nearly all upper and/or lower shadow, with very little real body.
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Figure 4. Japanese Candlestick Candlestick Long Shadows Shadows - EUR/USD 1 Hour
Figure 4 shows several examples of candlesticks with long shadows. Let's focus on the one in the blue box. The upper shadow reflects the highest price hit in this one hour period, the lower shadow shows the lowest price hit during the hour, and the small red real body shows that the price closed marginally lower than it opened. To see the exact prices of the open, close, high and low you can click on a candlestick on FreeStockCharts.com to see a pop-up, which provides you with all the info. Figure 5 shows information for the same bar addressed in figure 4. If you're using MetaTrader, click your mouse wheel anywhere on your chart to pull up a "crosshair." Place the crosshair over a price bar and the high, low, close, open and date of the bar will appear along the bottom of the trading platform.
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Figure 5. Japanese Candlestick Candlestick Info Box
For some tips and tricks on using MetaTrader 4, see MT4 Tips and Tricks — Making MetaTrader MetaTrader 4 Trading and Analysis Analysis Easier : http://vantagepointtrading http://vantage pointtrading.com/archives/10 .com/archives/10148 148
Japanese Candlestick Interpretation Due to the highly visual construction of candlesticks, there are many candlestick patterns which traders use for analysis and to establish trade signals. Some of these are discussed later in the book, although for now there are general principles that that anyone new to Japanese Japanese Candlestick charts should should understand.
A long real body indicates stronger pressure than a small real body. For example, a long green body represents stronger s tronger buying pressure than a small green body. A long red body represents stronger selling pressure than a small red body.
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Shadows are used to determine what group of traders — buyers or sellers — are strongest at the close of a candle. While not always, it's quite possible the strongest group at the close of the prior bar will be strongest heading into the next bar/time period. A long lower shadow indicates sellers tried to push the price down, but ultimately the buyers succeeded in pushing the price back up and were strong at the close. A long upper shadow indicates buyers tried to push the price up, but ultimately the sellers succeeded in pushing the price back down and were strong at the close.
The Secret Life of Charts Japanese candlesticks are useful, although you should be aware of one drawback which actually applies to pretty much every type of chart out there, not just candlesticks. Within each bar you see in hindsight the market was gyrating back and forth, but the bar/candlestick only records r ecords the open, high, low and close for f or time period. Much more took place within the bar than the high, low, open and close. If a trader only looks at historical data, breakouts (discussed in the strategies that follow) may appear clean and easy to trade, yet in real-time the market may move back and forth over the breakout point (all within one bar). When the bar closes, it looks like a clean breakout occurred, but in real-time maybe it wasn’t. Price bars in hindsight are a summary of what happened, and reveal a lot, but they don’t reveal everything. This is why practicing in a demo account is required before you move to live trading. Looking at charts and examples isn't the same as trading the real-time market.
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It's for this reason I don't wait for candles to complete with any of the strategies contained in this book (unless specifically stated). Price bars/candles are d own bar, and then the next bar starts to rise r ise arbitrary. For instance, if there's a big down dramatically, if it crosses above the open of the previous down bar, to me that's a bullish engulfing pattern (this pattern is discussed in later chapters); if that's my trigger, I enter the market without waiting for the candle to complete. It's possible the market could drop right then, and in hindsight the engulfing pattern wouldn't be seen, yet in real-time it happened — this this is the secret life of charts. This is also the reason why many back-tested methods which are optimized on historical data do very well in theory, though crash and burn in real-time trading. The forex market is a continuous market, and the closing prices of bars aren't particularly useful. In the stock market, there's a definitive close each day, which makes the closing price more important. In forex, we don't have that, so don't give the closing price of a random bar much respect; trade in real-time, as trade signals occur (you'll learn lots soon) and don't worry about whether a bar has finished/completed finished/completed or not.
The Bid/Ask Spread and Your Charts The Bid/Ask Spread discussed earlier in the book explained how the spread works in the forex market. As a trader, you can lose money without the currency pair even moving, simply because you always pay the offer price (higher price) when buying, and sell at the bid price (lower price).
When you first start trading the forex market you may be confused by why some of your limit orders or stop orders get executed and others don't. When you look at your charts it appears you should've gotten into a trade, but didn’t. Or other times you get into a trade when the price never reached your entry price on the charts. What’s going on??? The simple reason situations like this occur is that forex charts by default, only show the bid price. If the current bid price is 1.5410 on a particular currency pair, the rate on the chart will show 1.5410. At this point the offer is actually at 100
1.5412 (if there's a two pip spread), but this latter level isn't shown on the chart, only the bid bid price is shown. As the bid price moves moves up or down, down, so does the “current” rate on the chart. If you're looking to enter a long position with a buy order at 1.5412, the order will only be “triggered” if the offer price hits 1.5412. If the spread is three pips and the pair is currently trading at 1.5430, this means the price on the chart needs to move down to at least 1.5409 to trigger this buy order. If the chart (bid price) shows the price only dropped to 1.5412, your order won't fill because the offer price as that time is 1.5415, which is still above your buy price of 1.5412. It's also possible that a buy order is executed at a level above where wh ere the chart shows the rate went. Consider a chart which shows the high price of the day at 1.5400. If you bought precisely at that moment, the offer price is actually 1.5403 (assuming a three pip spread). Therefore, you'll be in a long position at 1.5403, even though the chart shows that the pair only went to 1.5400 (bid price). When you sell, the charts are accurate. Sell orders always go through at the bid price, and the bid price is what you see on the chart. An entry order to sell at 1.5410 is executed if a bar on the chart shows the market moved to 1.5410. If the low for the price bar is 1.5410, and you place an order to sell at 1.5409, the order isn't executed. The important thing to remember is that charts, by default, almost always reflect the bid price. Buy orders go through at the offer price, and sell orders go through at the bid price. Factor this in when placing orders for entries and stops. Many charting platforms allow the bid and offer offer to appear on the chart. This can help you better understand how the spread works when you first start trading. To toggle this option in MetaTrader 4 right click on an open chart, select
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Properties, click the “Common” tab , from the options check the “Show Ask Line” and click “OK.”
Japanese Candlesticks Candlesticks - Final Word Japanese Candlestick charts are the preferred choice of many traders, since the price moves are easy to see and trade signals can be spotted quite quickly. Play around with the free charts offered on FreeStockCharts.com to get a feel for candlesticks and how to trade with them. Being comfortable with with the basics of candlesticks makes the rest of the book easier to understand, and the chart examples will make more sense.
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9. Trading Trading Chart Patterns Chart patterns are a good introductory strategy to learn. Since many traders have heard or read about them, let's dig a little deeper into what chart patterns are and the various ways they're traded. Chart patterns provide a way to spot trading opportunities, plan where to take profits (targets) and set stop loss levels. They're a basic strategy though, so as you progress though the book you'll realize chart patterns are just part of the ebb and flow of market movements. Being able to spot chart patterns and having an idea of how to trade them will aid you in effectively implementing the other strategies in this book. Chart patterns are geometric shapes created by connecting, or encasing, price bars using trendlines (available via drawing tools in almost all charting platforms). Like a “connect the dots,” chart patterns are a visual way of seeing potentially predictable market behaviour unfold. Patterns repeat and do so very often, although the result isn't always the same. A pattern can breakout and move to upside one time, breakout and move lower another time and the next time the pattern is broken broken the price moves moves right back into the the pattern — a false breakout. While chart patterns aren't a perfect predictor of future price movements — no method is — by isolating a pattern you're given a couple of highly probably scenarios which are likely to play out. The pattern gives you a precise way to trade a scenario once it occurs. There are several common patterns you'll see regularly on price charts. As your eyes become trained, you'll see these patterns on all forex pairs and time frames. The patterns aren't limited to forex either; chart patterns occur in stocks, commodities, bonds and other financial markets as well. Commonly discussed chart patterns include trading ranges (also known as rectangles) as well as double tops/bottoms. There are others though, including an 103
assortment of triangles, wedges, head and shoulders, flags and pennants. Less well-known is the broadening wedge. For the chart patterns that follow, I frequently refer to stop loss or entry levels as "just above" or just below" a price or point on the chart. For entries, just above or just below means 1 pip. In terms of stop loss orders, just above or just below means 1 pip when day trading, and 5 pips when swing trading. In all cases, remember to add the spread if applicable (re-read The Bid/Ask Spread and Your Charts in the prior chapter if unclear on how the spread affects orders).
Chart Patterns to Focus On and How to Trade Them The chart patterns outlined in this section are fairly simple to see and trade using the methods discussed. These patterns include triangles, wedges, head and shoulders, flags and pennants, all which provide profit potential that's greater than the anticipated risk. To trade a chart pattern you'll need to know how the pattern looks, how to draw the pattern on your chart (the trendlines of the pattern), where to enter, where to place stop loss orders (stops) and where to set s et profit targets (targets). As you look at the examples given, you may notice that at times a trendline is drawn along the extreme highs and lows of the price moves within the pattern, and at other times the lines are drawn right through a price bar/candle. When drawing trendlines to create chart patterns, use “lines of best fit.” Patterns don't always form perfectly; sometimes the price will stall before reaching a trendline, and other times it'll slightly penetrate it. That's fine. When you draw patterns, simply try to make it the best fit to the price action you can. That's all you can do — and it still works well for trading purposes. All trading software has drawing tools which allow you to draw horizontal, vertical and diagonal lines on your chart. If you're unfamiliar with drawing tools check out TradingView.com to test out charts, tools t ools and indicators for free. Use the
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tools to outline trading action so you can see the patterns clearly. The lines define breakout points, and also also “contain” the price until the breakout breakout occurs. The drawn lines signal the breakout points, that's why it's important to draw the lines using the suggestions above — use use price points running along (or near) highs and lows which define the pattern using “lines of best f it.” If you see several ways a pattern can be drawn, draw all the variations on your chart. Doing so provides you with more than one profit target. If trading two or more lots, exit one lot at each profit target. That's why I recommend traders open micro or mini accounts, as the trade size is much more customizable. Instead of taking one standard lot ($100,000) you can take 10 mini lots ($10,000 each), and exit those lots at different prices if you wish — much much more flexibility. Before delving into the chart patterns, here are two guidelines for trading them:
L et patte patterr ns de develop velop.. Don’t assume a pattern will develop just because it looks like the price may be starting to form a chart pattern. Later we'll discuss head and shoulders patterns; once the left shoulder and the head have formed, it's easy to fall into a trap of anticipating the right shoulder and the ensuing breakout move lower. This is an unprofitable habit to get into it. Let the market develop and don’t assume a pattern is in place until it actually is.
Don’t assume a breakout or the breakout direction. Certain patterns do have tendencies, but there's no need to anticipate or guess the breakout time or direction. When the breakout actually occurs you can trade it, based on the direction the price is moving. Patience is a key virtue to have in trading.
The Triangle
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Triangles are symmetrical, descending or ascending. Although, for trading purposes it doesn't matter which one you're trading — all all triangles have the same entry criteria, stops and profit targets. A symmetrical triangle forms when the price action is continually making lower swing highs and higher swing lows. The trendlines along the top and bottom of the price action are converging, c onverging, creating a triangle. The thickest part of the triangle is how our profit target is calculated. The distance in pips between the swing high and swing low, at the thickest part of the triangle, is added/subtracted to the breakout price. The breakout price is where the currency pair crosses above or below the trend line. A symmetric triangle looks like this:
The light grey lines provide a measure for the profit target. The thick part of the triangle is projected out from the breakout point to give a potential exit price (profit target). Breakouts can occur along either the upper or lower trendline. The longer the price stays within the triangle, the lower the risk on the trade. This is because the stop loss for the trade is placed on the opposite side of the formation as the breakout, and a triangle continually narrows. If a breakout occurs to the upside, a stop is placed just below (1 pip when day trading, 5 pips when swing trading) the lower trendline. If a breakout occurs on the downside, a stop is placed just above the upper trendline. 106
This method has a larger reward than risk. Our profit target is always based off the thickest part of the triangle, yet our risk diminishes over time as the price action moves toward the apex (where the converging lines meet) of the triangle. Very rarely does the pattern hold all the way to the apex, a breakout normally occurs before this happens. The same principles apply to an ascending or descending triangle. Profit targets are based off the swing high and low at the thickest part of the triangle, and stop levels are placed outside the triangle on the opposite side of the breakout. Ascending Triangle:
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Descending Triangle:
Above are images of how ascending and descending triangles look. An ascending triangle occurs when the swing lows in price are moving higher — higher higher lows — but the swing highs are reaching roughly the same price area. The descending triangle has progressively lower swing highs, yet the swing lows reach roughly the same price area. Since our profit target is calculated the same for all triangles, here's an example using some simple numbers with a symmetric triangle. triangle. The formation f ormation also provides us with with our stop level on on the trade.
The widest part of our triangle is 1.50 – 1.40 = 0.10. This is added to the breakout price when it occurs. Our breakout occurs at 1.45, so our target is 1.45 + 0.10 = 1.55. Our stop loss is placed just below 1.4300, which is the low of the triangle at the time of the breakout.
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After you've entered the trade, if your stop is based on a sloped line, you can adjust the stop over time to track the line. With this method, over time, much of the risk on a trade is eliminated (other methods for reducing risk on trades are discussed later in the book)...as long as the price continues to trade in the direction of the breakout. In the example above, the stop is originally placed at 1.43, though over time could be moved to the apex of the triangle — near near 1.44 to 1.45 — as as the line continues to slope. If trading a daily chart, the intersecting price point of that line will change daily, providing you with the new stop level. If trading a 5 minute chart, the sloped trendline produces produces a slightly adjusted adjusted stop level every 5 minutes. Adjusting the stop isn't required . If you like the original reward to risk ratio, leave your original stop level as it is. Moving the stop along a sloped trendline is one method you can use if you like, but isn't mandatory. For those who are risk adverse, this method reduces the risk. The downside is you'll occasionally get stopped out prematurely. That's to say, if you hadn’t adjusted the stop you would have made money, yet because you adjusted the stop you lost money or broke even. The reverse is also a lso true though: adjusting the stop may save you money if the price turns against against you.
If you like to adjust the stop to limit risk, then do it; if you like using the original stop, that's also fine. One method isn't necessarily better than the other in my experience, although one method may be better suited to your individual trading style and personality. Day traders that are watching the trade can adjust the stop using this method with greater ease than a swing trader. If you're a swing trader, you can either leave the stop alone (no adjustment) or adjust the stop loss periodically when you do your daily review of your trades (and look for other setups). Let’s look at a trading example to see how a symmetric triangle could be traded in the forex market. This example also shows how you draw the pattern around the price swings that form.
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USD/JPY 15 Minute Chart
In the example above, notice the USD/JPY pair is forming a symmetric triangle pattern to right of the green vertical line. The price swings are converging as the more recent swing highs are lower than former highs, and the recent swing lows are higher than the former lows. The highlighted blue price shows the price of the pair at the time this snapshot was taken — 98.59. 98.59. The high within the pattern is 99.05, although we'll round it down to 99.00. The low occurred at 98.20. This means our profit target is 80 pips; 99.00 - 98.20 = 0.80. At the time this snapshot was taken, the breakout price on the upside was 98.68. If the price moves above this level the trendline is penetrated, indicating a breakout and an entry. A downside breakout occurs if the price moves below 98.35 — the the lower trendline. Since the lines are sloping, the breakout prices will change over the time. In the case of a symmetric triangle, upside breakouts occur at a lower and lower price over time as the line slopes down. Downside breakouts occur at a higher and
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higher price as the line slopes up. For ascending or descending triangles, the breakout price price only changes on the side side of the triangle triangle with a slope. slope. Add/subtract 80 pips (the height of the triangle) to the upside/downside breakout price to determine our profit target. The price broke out of the triangle at at 98.55 to the upside (a couple hours after this snapshot, so the breakout price had changed slightly), providing a target of 98.55 + 0.80 = 99.35. This target was hit soon after, resulting in a profit. A stop was placed at 98.40, just below below the opposite trendline at that point. 15 pips were risked to attain an 80 pip profit. This pair actually reached a price of 99.72 before quickly falling; so the profit target was exceeded by b y a significant margin. You may have noticed on the chart example above that the lower trendline extends further down than what was used in our profit target calculation. Often within a triangle we have multiple profit targets. We could use the levels discussed above for one profit target, and also use additional levels levels in this chart for a “more aggressive” profit target. target. Since the low at the very base of the trendline is 25 pips below the low we used in our original calculation, we can add 25 pips to the former profit target. If we did this, we would exit at 99.60, close to the high of the move. If multiple profit targets are used, it's recommended that at least part of the position is exited at the more conservative profit target. This allows for a profit to be locked in on the trade. The more you practice, the more patterns you'll see. Often there's two or more interpretations of the triangle (or other pattern). No interpretation is necessarily right or wrong. Rather, mark each interpretation on your chart, and decide which you like best (based on the information you'll attain from this book), or simply use multiple entries or profit targets to satisfy each interpretation interpretation of the chart pattern. Let’s look at an ascending triangle which formed on the AUD/USD daily chart. The formation on the daily chart provides an opportunity for swing traders, and day traders as well, as the breakout gains momentum.
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AUD/USD Daily Daily Chart
The AUD/USD formed a large ascending triangle formation after a period of heightened volatility. The formation was a consolidation c onsolidation before another potentially big move. The high of the formation, marked by the horizontal h orizontal red line, is 1.0387 and low is 0.9667 (start of ascending red line). The breakout occurred from the pattern in the middle of January and proceeded to move higher from there. Calculate the profit target by taking the difference of the high and low of the triangle and adding it to the breakout point. In this case: 1.0387 – 0.9667 0.9667 = 0.0720. This is added to the breakout point: 1.0387 + 0.0720 = 1.1107 which is the price target. The stop for the position is placed just below the ascending trendline. When the breakout occurred, the stop for the position would have been placed at 1.0160. There's 227 pips of risk for a potential profit of 720 pips — the the potential profit is more than three times the risk.
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In this case, the breakout was to the upside. That won't always be the case. Had the breakout occurred to the downside you would've entered a short trade as the price pierced below the ascending trendline, and placed a stop just above horizontal trendline. The profit target is calculated the same, except in the event of a downside breakout, subtract the 0.0720 from the breakout price to get the price target for the move lower. If you look closely, you can also see a smaller ascending triangle within the pattern shown above. This pattern can also be used us ed to calculate a profit target, and if trading multiple lots, a portion of the position can be exited at the profit target based on the smaller pattern. The rest of the position can be unloaded at the target indicated by the larger pattern. The smaller pattern is shown below.
AUD/USD Daily Daily Chart
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In this case, the upside breakout point stays the same because the line is horizontal, yet our profit target is smaller based on the smaller formation — the the ascending line has a higher starting point than the larger pattern discussed prior. For the smaller pattern, the high of the formation remains 1.0387 but the low is 0.9862. These levels produce a triangle height of 1.0387 – 0.9862 = 0.0525. Add the height to the breakout point to attain the target price: 1.0387 + 0.0525 = 1.0912. When the breakout occurred your stop would've been placed at 1.0250. Based on this stop price, your risk is 137 pips, with a potential target of 525 pips. That's a good risk/reward ratio. Ultimately this pair reached a high of 1.0856 before commencing a four month decline. None of the targets were reached, even though the trade was showing an almost 500 pip profit before it reversed. The example is included to highlight an important point:
In trading you'll never be right every time. Chart patterns aren't a flawless system. At times your profit targets won't be achieved, and frustratingly sometimes the target will be narrowly missed. For this reason I encourage traders to “round down” their profit targets. Take a bit off the initial calculations in order to make the profit target more achievable. By doing so, not only is it more likely the target will be reached (hit), the reward to risk ratio usually remains favorable. By the end of the book you'll have additional methods for taking profits, or reducing risk, even when a target isn't reached.
Wedges
Wedges are traded in a similar way to triangles, though the formation is slightly different. Let’s first look at the similarities: profit targets are based off the swing high and low at the thickest part of the wedge; the entry is a breakout of the formation’s trendlines; the stop loss is placed on the opposite side of the breakout, but with a variation. variation. 114
Wedges are structured similar to triangles, except the entire structure of a wedge is sloping either up or down. In the case of a descending wedge, both the upper and lower trendlines are descending and moving towards each other. In the case of an ascending wedge, both trendlines are rising and moving towards each other. Rising/Ascending Wedge:
Falling/Descending Falling/Descending Wedge:
Below is an example of a descending wedge. Both trendlines are falling and the price fluctuations are narrowing, resulting in the lines moving towards each other as they fall. fall. As mentioned near the beginning beginning of this chapter, chapter, you may notice the lower trend line doesn't run exactly along the lows of all the price bars. This is
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fine. The market doesn't always move in perfect harmony, so you must “fit” your trendlines as best you can to the price action.
EUR/USD 15 Minute Chart
An upward break of the wedge occurred at 1.3260. 1.3261 is therefore the entry price, and a stop loss is placed at 1.3245 — just below the low price price within the wedge — resulting resulting in a 16 pip risk. Since the lines are sloping down in this case, we don't place our stop outside the pattern (below the lower trendline) because this exposes us to more risk than is required (stop would be down around 1.3230). Calculate the profit target by taking the difference between the high and low at the thickest part of the wedge. The high is 1.3435 and the low is 1.3330 (rounded), so the difference is 105 pips. Don’t see the high and low points? Look to where the trendlines begin. Your profit target is therefore 105 pips above the breakout price. price.
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The profit target you'd set in your trading software is 1.3260 + 0.0105 = 1.3365. This target was hit a short time later and once again provided potential profit many times greater than than the risk. Using the price low or high within the pattern for the stop loss works well as wedges are usually reversal patterns. Once an upside breakout occurs from a descending wedge, it's unlikely the price low recently witnessed will soon be revisited. When a downside breakout occurs from an ascending wedge, the price high in the pattern also isn't likely to be re-visited for some time. A downward sloping wedge will typically breakout to the upside, and an upward sloping wedge will typically break to the downside. There's little need to assume the breakout direction though. The breakout will eventually occur and there's ample time to get in and make a profit. Also, a wedge is a trend. Until the price breaks out of a wedge pattern, that trend is tradable (in the direction of the trend) using trend trading methods you'll learn later. Here's a drawn example of a wedge pattern to clarify how this pattern is traded.
The wedge is sloping upwards, so more than likely the breakout will be to the downside, though we don't need to assume that. The price breaks below the ascending wedge pattern at 1.3525, providing the short sh ort entry point (1.3524). A stop
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is placed above the recent high in the pattern, in this case at 1.3560. The width of the wedge at the widest part is 50 pips (1.3550 - 1.3500), so that's subtracted from the breakout price, for a price target of 1.3475 (1.3525 - 0.0050). As a more advanced concept, notice how the overall price trajectory was down (on the left of the drawing) and therefore the wedge in this particular case was just a pullback against that longer term downtrend. The overall downtrend, and the fact the price broke below the wedge, were good reasons to take this trade. The one poor thing about this trade is the risk to reward. We're risking about 35 pips to make 50. Ideally our reward to risk should be 1.5:1. This drawing represents a trade that's slightly below that. The risk/reward ratio makes it a marginal trade, yet in light of the overall trend and breakout direction, it's an acceptable position to take.
The Head and Shoulders Pattern
A head and shoulders pattern is two higher swing highs, followed by a lower swing high, with retracements in between each high point. The pattern is considered complete and tradable once the price retraces (pulls back) off the lower high and falls below the lows of one or both retracements, or falls below the “neckline” of the formation. Later on in the book, other strategies are covered which could potentially get you into the trade sooner. s ooner. The neckline is a small trendline which connects the two retracement lows within the formation. This line is generally sloping, as the retracement lows won't typically hit the exact same level. The following drawing shows a head and shoulders pattern, with two thin pink lines representing two different entry points based on the two possible methods.
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The head and shoulders topping pattern shows the market is losing steam; the latest price action (right shoulder) failed to reach the level of the head, and then fell below the retracement lows and neckline of the formation. You can sell when the price passes below the neckline (sloped thin line), and/or you can sell when the price passes below the low of the right retracement (horizontal thin line). As the drawing shows, this formation often sees a pullback. The pullback is an upward move following the breakout. This pullback provides a third possible entry point. Since it's not always possible to take multiple positions because of capital limitations, it's recommended that you take one position at either the neckline or the retracement low of the right side. Either entry is typically fine. The neckline gives a better entry price in some instances (such as this example); though in different scenarios it may offer a worse entry price. If the neckline is downward sloping, the neckline entry would be below the horizontal (right retracement low) entry point; in that case, use the horizontal entry point.
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Take one position when the price passes through the upward sloping neckline or passes below the right-side retracement low within the formation. You can also take positions at both, keeping in mind the total risk for the trade shouldn't exceed 1% of your account. This is your main position; it's taken so you have a position to potentially potentially profit profit from the likely price decline. This position is likely to show you a relatively quick profit, but a pullback happens quite often, erasing that profit...in the short-term. If you wish, you can add to the position on this pullback, after it starts to head back down. If the additional trade is taken, use the Pyramiding approach discussed in Chapter 2 so the total risk on the trade never exceeds 1% of the account. That's how entries are made, though you also need a stop level. Your stop level determines your risk, and lets you know if you can take a trade at more than one of the entry points. If the risk of having more than one position exposes you to losses greater than 1% of your account, you shouldn't take more than one position. If you can only take one trade, determine the stop level first, then choose which entry — the the right-side retracement low or neckline — to to use. If you're comfortable potentially missing a trade, you may also opt to wait for the pullback to occur (after the breakout), and trade that. The risk on the head and shoulders pattern (in pips) is the difference between the entry price and the top of the right shoulder. Thus, your stop is placed just above the right shoulder. It's placed there because if the price moves back above the right shoulder, it's no longer a head and shoulders pattern. The profit target for the formation is the height of the pattern subtracted from the breakout point. If the distance between the head and lowest (of the two) retracement levels is 400 pips, subtract 400 pips from the breakout point and that's the profit target. Since head and shoulders can take place over a long time, and cover a lot of chart area, extreme conditions may make this profit target unlikely to be achieved. As you'll see in the chart below, if the market moves far beyond what it normally
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does, such a move may not happen again. In such a case, you'll need to adjust your profit target using more conservative numbers from within the formation. formation. This is true of all chart patterns. If an extreme event occurs which is unlikely to occur again, yet impacts your stop, profit target or entry price, you need to adjust your trade(s) to compensate. If a major news event plunges a pair 400 pips in an a few hours, when in a normal day it only moves 100 pips, you need to compensate and assume that 100 pip movements are more likely than 400 pip movements. If you use the 400 pip move in your calculation, your profit target(s) is unlikely to get hit, and your stop price may also be exposing you to to too much risk. risk. The following example is used to show where stop levels are placed, as well as go over entries and profit targets. The following example isn't a perfect formation like the drawing. Formations aren't always "pretty," and we need to adapt to them.
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EUR/JPY 4 Hour Chart
This is an ugly chart. The head and shoulders pattern is created by extreme volatility, well beyond normal. After the left shoulder (which is actually a double top formation, which we'll discuss later) there's a massive sell-off where prices plunge more than 600 pips in a matter of days. The price surge up to the peak that forms the head is equally spectacular. The head and shoulders pattern is visible but when we to go to create a neckline (the trendline which connects the low at 126.50 and the low at 131.00) and extend that line upwards, it actually passes above the right shoulder (this neckline isn't shown on the chart). The neckline isn't a viable entry point in this case; an alternative entry point must be used. The left side of the formation is extremely volatile and shouldn't be used in our entry criteria or profit targets. The right side of the formation shows a return to 122
more normal market behaviour behaviour (for this time) and is more rational to use for entries and profit projections. In this case, use the low after the head (right retracement low) as the entry point. This is marked on the chart as an “Entry Point.” When the price moves below this low, after the right shoulder has occurred, occurred, enter a short trade. The entry occurs on 04/15. Place a stop loss just above the right shoulder. The profit target for this trade cannot be based on the extreme lows and highs of the formation, as the low on the left side was due to extreme volatility which we can't assume will repeat. Trades must be based on typical market behaviour, not extremes, since most days we're dealing with the typical. Focus on the right side of the chart pattern to establish a profit target. First, measure the distance from the head to the low created after the head (the right "armpit") to find the height of the pattern: 137.50 – 131.00 = 650 pips (these figures are rounded for ease of use). Then, take our breakout point which is 131.00 and subtract the 650 pips, giving us a price target of 124.50. On 04/26 the market reached an ultimate low of 124.38 (not on the chart). The profit target was reached. This trade resulted in a risk of 350 pips and a profit of 650 pips; a reward almost two times greater than the risk. This reward to risk ratio is typical of head and shoulders patterns. Avoid trades where the reward to risk approaches 1:1, for example you're risking 50 pips to make 55 pips. This example was given to show that markets don't create perfect patterns all the time. Look at a pattern and ask yourself if the profit target and entries provided by the pattern are rational? Was the movement within the pattern relatively relatively normal, or was there extreme volatility that caused price surges (or plunges) which are unlikely to happen again? Equally of note, there will be times of almost a lmost no volatility; possibly around a holiday or during certain times of the day. It's not wise to assume that the lack of volatility will continue once regular trading resumes. During times of extreme volatility it's reasonable to assume volatility will die down as time progresses.
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Extreme lack of volatility also won't last forever, being replaced by higher volatility. There's also a head and shoulders bottoming pattern, called an inverse head and shoulders. For the inverse pattern everything is reversed and the same methods apply. This formation is a low (left shoulder), followed by a retracement up, a lower low (the head), followed by a retracement up and another swing low which doesn't reach the low of the head (the right shoulder). The price then breaks above the high of the retracement, or through a trendline connecting the retracement highs within the formation (neckline). In the drawing below, the horizontal entry point — the the right-side retracement high — is is a better entry point than the neckline. Since the neckline is sloped upwards, if used, the trade is entered later than it needs to be. The right-side retracement high is the prudent entry point because it provides a lower entry price and results in fewer pips at risk. The stop is placed p laced just below the right shoulder.
The following is an example of an inverse head and shoulders pattern.
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USD/CHF 4 Hour Chart
The inverse head and shoulders pattern can be seen developing on the left hand side of the chart above. The bottoms of the left shoulder, head and right shoulder are marked with small red horizontal lines. When connecting the “armpit” highs of the pattern, the neck line is slanted upwards to a significant degree and doesn't provide a useful entry point. The horizontal line drawn along the top of the right armpit is of value, signaling the breakout and completion of the bottoming process (horizontal white line) — this this is the entry point.
The entry is made at 0.8959, as the price crosses above the white horizontal line. The stop loss is placed below the right shoulder, at 0.8755. The target is the height of the formation added to the breakout price. The high of the formation is
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0.8958 and the low is 0.8568, for a difference of 390 pips (the height of the formation). Add the height to the breakout price of 0.8958 (entry is at 0.8959) to provide a target target of 0.9348. The risk was 205 pips for 390 pips in potential profit. This is close to a 2:1 reward to risk ratio; a respectable trade.
Flags and Pennants
Flags and pennants are excellent trade candidates, as they're generally small patterns meaning relatively small stops (in pips) and quick profits. Flags and pennants are formed when the market consolidates in a narrow range after a sharp move (the flag/pennant “pole”). They're seen on all time frames and consist of 7 to 20 bars. Let’s look at flags first, then pennants. about 7 A flag is a narrow trading range which occurs after a large price move. Here's an example of a flag formation.
AUD/USD 15 Minute Minute Chart
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The flag is marked on the chart with horizontal green lines as the market consolidates after a run up. In this case, both the lines are horizontal. It's also common to see flags that slant upwards or downwards. Enter long when the price moves above the highs of the flag (upper horizontal line). Enter short when the price moves below the lows of the flag (lower horizontal line). Stops are placed just outside the flag on the opposite side of the breakout. If the lines are sloping, stop levels and entries will change slightly over time. Profit targets are established using two different methods. One method is conservative, likely resulting in a quick profit. The other method is more aggressive and seeks a larger gain. The first profit target is based off of the height of the flag consolidation. If the distance between the parallel lines which form the flag is 30 pips, then the profit target is the breakout price +/- 30 pips. Because the market is tightly wound after a strong move, these profit targets are often hit quickly, then exceeded. To capture larger profits, base your p rofit target off of the “pole.” In doing so, you're estimating the breakout will result in a move of similar magnitude to the move that preceded the consolidation. Look at the example for the flag pattern and you’ll see that the flag (consolidation part) is roughly 40 pips high. An initial profit target is placed 40 pips from the breakout price, on either the upside or downside. This targets are marked by the green lines along the very right hand-side of the chart. The second profit target is based on the preceding move (pole) into the flag consolidation. From the very start of the preceding move at 0.6980 to the high at 0.7130 the move measures 150 pips. If the price breaks higher, our profit target is 150 pips from the low of the flag consolidation. consolidation. The profit target is 0.7090 (low of of the flag) + 150 pips = 0.7240.
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If the breakout is downward, our target is 0.7130 (the high of the flag) – 150 150 pips = 0.6980. Flags are considered continuation patterns, as the breakout is often in the direction of the preceding move. In my own trading I haven't found this to be the case, and have abolished the notion from my mind. With that said, a breakout in the opposite direction of the preceding move deserves special attention. If a break occurs in the opposite direction of the preceding move, knock off the height of the flag consolidation from the profit target. For the chart example above, move the second target up by 40 pips. Recall the consolidation was 40 pips, so we knock that off of the profit target. This makes for an adjusted profit target of 0.7020. This only occurs if the breakout is in the opposite direction of the preceding move (pole). Why we alter the profit target for reversal moves is discussed further in the pennant patterns patterns section below. If the breakout occurs in the same direction as the preceding move (the pole), no alterations are made to profit targets and you’ll simply use the methods outlined prior. Below is another example of a flag formation, using a 30 minute chart. Notice the aggressive move higher in the USD/CHF, with the pole measuring 91 pips. A flag then develops as the pair moves sideways within an 18 pip range. The pair then breaks higher, providing us with an 18 pip target above the breakout price — the the conservative target — and another target 91 pips from the low of the — and flag — the the second target. The 18 pip target is quickly hit. The second target is missed by a few pips later that day, though is hit the following day as the pair continues to rise. Ellipses mark when the targets were hit.
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USD/CHF 30 Minute Chart
Pennants are similar to triangles, except much smaller. Pennants, like flags, follow a large swift move (the pole), whereas triangles don't have this prerequisite. A pennant is a consolidation in which the price action continually narrows. Flags seem to be more common than pennants To trade a pennant, enter when the price moves beyond the pennant boundaries outlined on your chart. Place a stop loss just outside the th e opposite side of the pennant. Because the lines are sloping towards each other, your entry price and stop price will change over time. Risk diminishes the longer a breakout takes, as your entry price and stop level are moving closer together as time elapses. Pennant profit targets are calculated the same way they are for flags. The only difference with a pennant is that your initial profit target (or conservative target) is based off the price highs and lows at the thickest part of the pennant. The second profit target is calculated the same way it is for flags — based on the length of the move preceding the pennant formation.
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Here's an example of a pennant formation. formation.
USD/CHF 15 Minute Chart
Notice the sharp decline followed by the pennant formation — a consolidation in which the price begins to converge with higher lows and lower highs. The highlighted blue number shows the current price of 1.0939. At this point in time, the breakout price is 1.0950 on the upside and 1.0925 on the downside. The high point of the pennant is 1.0960 and the low is 1.0910. If a break were to occur at this point in time, the initial profit target would be 50 pips (calculated by 1.0960-1.0910) plus or minus the breakout price. If the prices were to breakout right now, the initial targets are 1.0950+50 pips =1.1000 on on the upside and 1.09101.0910- 50 pips = 1.0860 on on the downside. The second profit target is calculated the same as it was for flags. The start of the move is 1.1045. Why 1.1045? 1.1045 is where the price starts to fall and doesn't retrace. Many traders may use 1.1055 because that's the very top, yet you
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can see the price fell from there then rallied a bit, and the fell again from 1.1045. Using this type of logic to discern what levels to use in your profit calculations will wil l give you more accurate results. 1.1045 is the high and 1.0910 is the low, which means the pole is 135 pips in height. Based on breakout direction your targets are 1.0925 + 135 pips = 1.1060 in the event of an upside breakout, and 1.0950 – 135 135 pips = 1.0815 in the event of a downside breakout. Remember the target is projected from the top of the pattern (at the time of the breakout) in the case of a downside breakout, and projected form the bottom of the pattern (at the time of the breakout) for an upside breakout. Since both lines of the pennant are sloping, your target will slightly change as each new bar forms within the pennant, just as the breakout level also changes. In this example the preceding move (pole) into the pennant was down. If the breakout is upwards, you’ll want to alter the second profit target by deducting the height of the pennant (50 pips) from the profit target. If an upside breakout occurs, our adjusted upward target is 1.1010. If the breakout is to the downside, make no alterations to the profit target. Why adjust the second target when the price breaks out in the opposite direction of the preceding precedin g move? If you you don’t adjust adjust the price target, the price has to move all the way back to starting point of the formation (the beginning of the pole) in order for your your profit target target to be hit. Why's that a problem? The start of the formation is likely a support/resistance area, which could prevent the target from being hit. By adjusting the target, you move it out of that resistance/support resistance/support zone, making it easier for the price to reach the target and increasing your chances at a profitable trade. The chapter "Strong" Support and Resistance and the Crotch Strategy digs deeper into why this adjustment is made.
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Trading with Multiple Profit Targets, Stops and Positions
With chart patterns, as well as other strategies outlined in this book, at times you'll have multiple profit targets, potentially have more than one stop loss to choose from, or may be trading multiple positions. You may be wondering how to juggle or manage multiple profits targets or stop levels. The easiest way to utilize multiple targets and stops is open two (or more) positions. To keep things flexible, instead of buying one lot of the EUR/USD for $100,000, buy two mini lots of $10,000 each, five times. Instead of one position for $100,000, you have five positions for $20,000, and can attach a profit target to each position (various stop aren't recommended, pick one, and stick to it). Since these positions are essentially the same trade, they still fall under the guideline that no more than 1% of capital should be risked on a given trade. Each position has its own profit target (if desired). In this way you can exit at different profit targets, locking in profits along the way as the market movements unfold. If you only trade one lot due to capital limitations, or to maintain risk exposure, choose beforehand which profit target calculation you'll use and stick to it. With any pattern, if you're unsure of which prices to use in your profit target calculations, always opt for those that provide a more conservative profit target. It's far better to make 100 pips on a trade, then to try to make 120 pips and end up with nothing. Always ask yourself whether the profit target is based on reasonable price movements, and try to avoid using extreme or uncharacteristic price fluctuations fluctuations in your calculations. Be smart, not greedy.
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Additional Chart Chart Patterns Below are patterns which can be more difficult to trade because the methods required to effectively trade them are more subjective and will take (more) practice to master. There are traditional ways of trading these patterns, which are briefly addressed and will work on occasion, though the alternative methods discussed are superior to the traditional t raditional methods.
Double Top/Bottom, Triple Top/Bottom
Double and triple tops occur when a pair is topping out and the pair is expected to fall, if the pattern completes. A double top is when two swing highs reach approximately the same price high, with a retracement in the middle. The pattern is complete, and traditionally a sell trade is entered, when the currency c urrency pair falls below the low price of the retracement between the two highs. A triple top is similar to a double top, except there are three peaks with retracements in between them. The pattern is complete when the price falls below the retracements (like a head and shoulders pattern we can draw a neckline, or use just the right-side retracement low as our breakout level); a sell order is traditionally entered when this occurs. Here is an example of a double top.
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USD/CAD 1 Hour Chart
The example shows a double top in the USD/CAD, making two highs into the same price area. The pattern is confirmed when the price drops below the low of the formation. The highs in this case are very near 0.9960; the retracement low after the first high is at 0.9805 — your your entry price if the rate moves below it (which it does). Place a stop 5 pips above the high (for a swing trade, 1 pip for a day trade) plus the spread after after you enter the the trade. Such is the the traditional traditional method. The height of formation used to determine your profit target is 0.99600.9805 = 155 pips (figures rounded). The profit target is the entry price minus the height of the formation (since you're going short) 0.9805-0.0155=0.9650. If the tops don't occur at the exact same price, always use the lower high in your calculations for determining the profit target.
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To recap, the traditional stop order for a double or triple top formation is placed just above the highs of the pattern. Your profit target for the trade is the height of the formation (high-low) subtracted from the entry price (retracement low). For double and triple tops (and bottoms, which are addressed shortly) the risk and potential reward for a trade are the same because both are based on the height of the pattern. This makes trading double tops and bottoms in the traditional way both unattractive and not recommended. An alternative method, which I prefer, is to watch for a false breakout to the upside on the second (or third) top. If the second top moves just above the first high and then back below it both quickly and aggressively, enter short. Why? It's quite possible this could be a false upside breakout, leading to a double top formation. Place a stop just above the recent high (what we expect is the false breakout). Usually this trade has a very low risk, because the entry price is very close to the stop level. For example, if the original high(s) occurred at 1.5050, the price retraces to 1.4960, and then rallies to 1.5062 before falling back below 1.5050, the risk on the trade is only about 19 pips. You enter as the price drops back below 1.5050 — so so 1.5049 or 1.5048 — and and place a stop at 1.5068 which is 5 pips (plus the spread) above the new n ew high at 1.5062. Place an initial profit profit target just above the retracement low of 1.4960 — say say 1.4970 (The Crotch Strategy discussed later in the book gives you more information on where to place orders in the context of recent highs and lows). If the price continues to fall below the low of the formation (1.4960), place another profit target using the traditional breakout method described prior. The height of the formation is 1.5050 - 1.4960 = 90 pips (remember, we use the lower of the highs for our calculation). Subtract 90 pips from 1.4960 to get a second price target of 1.4870. To be safe, round the target up to about 1.4885 to increase the chances of the target being hit. It's recommended recommended you take some profit off the table at the initial target price.
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The AUD/USD provides a real-world example of this false upside breakout, leading to a double top scenario. A high was made at 1.0844 (first top), the pair corrects down to the 1.0598 (retracement low) and then rallies back above the first high to 1.0856 (second top) — highlighted highlighted in grey. This was a false breakout and quickly moved back below the high of the first top.
AUDUSD Daily Chart
As the market dropped back below the former high (1.0844), a short trade is taken, a stop placed just above 1.0856 and an initial target placed near the retracement low. I used an initial target of 1.0615 for trade, which is just above the retracement low. Some of the profits should be locked in at this level. Since the pair continued to fall below the retracement low of 1.0598, it's now a confirmed double top. Calculate another profit target based on the traditional
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method of taking the high(s) minus the retracement low and then subtracting that from the breakout price (retracement low). In this case, the target is 1.0844 (our lower high) – 1.0598 1.0598 (our retracement low) = 246 pips. This amount is subtracted from 1.0598 to produce the target of 1.0352. Since you’re entering near the top (or at least what we believe at the time to be a top) as the pair turns back lower, the risk is small and profit potential large — a good combination. Unfortunately, it's not as perfect a situation as it sounds. The pair could c ould drop a little and then keep k eep rallying. What looks like a potential double double top will often just end up being a blip within the uptrend. When trading this type of false breakout strategy, it's quite possible you'll see a number of small losses before catching a big winner. A big winner could result in a profit of 10 times our risk or more. In the example above, our risk is about 18 pips to make about 225 pips on the first chunk of our position, and more than 470 pips on the second chunk. Double and triple bottoms are traded in the same way, except you’ll be buying when there's a breakout to the upside using the traditional method, or buying when there's a false breakout breakout to the downside on the second or third bottom (alternative method). It's possible that the second (or third) low moves slightly below the first (or second) and then quickly moves higher again. This indicates a potentially false downside breakout and that a rally is forthcoming. A long entry is taken with a stop just below the most recent false-breakout-low. The first target is near the retracement high(s). high(s). If the pair continues c ontinues to rally, causing an upside breakout of the double/triple top pattern, the traditional target calculation provides an additional target price for the remainder of the position. The example below is a typical double bottom. The traditional profit target is established by taking the breakout point (retracement), minus the highest low
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(bottom). This number is then added to the breakout price to attain our profit target.
EUR/USD 1 Hour Chart
The highest low is at 1.3870. The retracement high between the lows is 1.4010. The height is therefore 140 pips. This is added to the breakout price of 1.4010, providing a traditional target of 1.4150. That target was surpassed the following session. In the above chart example, the second low didn't move slightly below the first, therefore, the false breakout entry method couldn't be used. If the second bottom had dropped below b elow the first, rallying quickly and aggressively back above, a long position would be taken. A stop would be placed below the recent false breakout low, and an initial target placed just below the retracement high — 1.3990 1.3990 138
for example. Exit part of the position at the initial target and if the price continues to rally above 1.4010, use 1.4150 as the next target (traditional).
Rectangle (Ranges)
Rectangle breakouts are traded in a similar fashion to the double tops/bottoms and triple tops/bottoms just discussed. The only difference is that a rectangle can occur anywhere in the price history and not just at turning points like double/triple tops and bottoms. Rectangles are consolidation periods where the market is deciding which way to go. The price moves up and down between a resistance and a support area. As long as the price remains inside those bounds, the pair is moving moving in an overall sideways sideways direction until until a breakout occurs. occurs. A range is easy to spot and the pattern is well known by most traders. The sideways movement of the rectangle draws in both buyers and sellers, trying to make an easy buck (rarely occurs) on the "easy to see" pattern. This results in a tug-of-war which can last for a long time and result in many false breakouts. The fact there are many people trading for a breakout, and others making trades based on the range continuing, means when a breakout does occur, it can be significant. Ranges have the potential to be profitable. You can capture profits while the range is in effect, moving up and down between support and resistance, or wait till the breakout occurs. Sounds easy enough, although in real time it's difficult to know when an actual breakout will occur, or if the range will continue. If you want to produce more consistent profits trading rectangles, you need an alternative approach. The following example shows a range.
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USD/CAD Daily Chart
If you decide to trade a range, it can be traded in several ways. You can buy at the bottom of the range, in the hope the range will continue. Place a stop several pips below the lowest price of the range. Place your profit target just inside the top of the range (you're attempting to capture most of the price range as profit). A more conservative profit target is just beyond the half way point (mid-way point) of the range. As the range continues, go short at the top of the range, with a profit target just inside the bottom b ottom of the range, or alternatively just j ust beyond the midpoint for a more conservative target. The stop loss is placed just above the high of the range. The problem with this method is that ranges are dynamic. If you look at the chart above, and this often occurs in the real world, each peak and trough tr ough occurs at a slightly different price. While the price is swinging back and forth and reversing at similar areas, rarely does the price move to the exact same spot as before. The
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profit targets are also based on the idea i dea the price will move to the opposite side of the formation, though it may not. The price may not make it all the way to range extreme(s), extreme(s), as the chart shows on several occasions. Trading this method isn't advised, though if you do decide to trade ranges in this traditional manner, here are some pointers which will maximize your odds:
When you buy at the bottom wait for the price to start moving higher again before going long. Don't buy while the price is still falling. You'll learn specific entry techniques later in the book which can be applied to trading ranges in this manner (or trend channels). Sell your long position near the middle of the range, as this gives you the best chance of getting out of the trade with a profit. When you go short near the top of the range, wait for the price to start moving lower again before going short. Don't short while the price is still rising.
The traditional breakout method for ranges is another strategy. When the price moves beyond the previous high or low point of the rectangle, a trade is entered in that direction. A stop is placed just outside the opposite side of the range. If the price breaks above the high of the rectangle (upside breakout), the stop is placed a few pips below the low price of the rectangle. If the price breaks below the low price of the rectangle (downside breakout), the stop is placed a few pips above the high of the rectangle. The profit target is the height of the range, added to the breakout point if the breakout is higher, or subtracted from the breakout point point if the breakout breakout is down. This method provides a reward to risk ratio that's roughly 1:1, because the stop and profit target are both based off the height of the range. If you trade this method, you'll need to be right more often than not in order to make a profit. Unlikely.
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The allure of the breakout is the possibility that the pair breaks out of the range and surges in one direction, reaping you massive a profit. This does — and occasionally happen. A range develops — say say 100 pips in height — and when the pair breaks out it surges 500 pips over the next n ext several days before pausing again. Unfortunately, this doesn’t occur often. If you study your charts, you'll see many, many, many ranges. The vast majority of those ranges will not end with a massive move after the breakout. You're more likely to find that if the height of the pattern was 100 pips, the next move is approximately 100 pips — sometimes sometimes less, sometimes more. Trading breakouts in an attempt to hit that homerun trade will likely wipe out your capital before that massive move comes along. a long. Trade based on the norm, not the exception. The reward to risk ratio on a traditional breakout is improved by reducing the risk which is taken on the trade. If you see a breakout occurring to the upside of the range, buy, then place a stop within the range just below a recent swing low. If you can’t find a swing low close at hand , skip the trade. Let’s look at another example in the USD/CAD.
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USD/CAD Daily Chart
First, notice how choppy and staggered the range is. While the overall direction is sideways, rarely do the price swings move to the exact levels seen prior. Also, if you look closely you’ll notice there are a re a number of false breakouts. I've marked on the chart a prominent one which occurred to the downside. Where I have placed the main support and resistance lines of the rectangle are also somewhat subjective — you you may look at the chart and think I should've put the lines at slightly different levels. Most ranges I've encountered in the forex market have these qualities. Try to put the reward to risk in your favor...when the upside breakout occurs, enter long, then spot an area within the range which is suitable for a stop. I've drawn two small lines and labelled them “Alternative Stops”. These lines mark
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swing lows within the range and a stop could be placed beneath either one. Placing a stop below the higher swing low is favorable, since it results in the lowest pip risk (difference between entry price and stop price). The height of the formation is 210 pips (1.0051 – 0.9841). 0.9841). The breakout and long entry occur as the price moves above 1.0051. Traditionally, a stop is placed below 0.9841, exposing you to slightly more than 210 pips of risk. Using the alternative stops at 0.9915 or 0.9950 0.9950 reduces the risk to approximately 136 or 101 pips respectively. respectively. This moves the reward to risk ratio closer c loser to 2:1, as your profit target remains 210 pips above the breakout price: 1.0051 + 210 pips = 1.0261. If you see a downside range breakout, sell and place a stop within the range just above a recent swing high. There may not always be one of these support/resistance levels close by ; if a stop level can’t be found that makes the reward to risk ratio more attractive, skip the trade. The potential reward should always be greater than the risk; take trades where the potential profit is 1.5 times greater, or more, than the risk. Even though the alternate-stop-breakout-method alternate-stop-breakout-method improves the reward to risk ratio on the trade, there's still the problem of false breakouts. Luckily, false breakouts are a re scenarios which present decent range trade opportunities once your mind is open to trading them. When the range highs and lows are well defined, a false breakout is likely to trap a lot of traders, and this presents a low risk, high reward trade (like double/triple tops/bottoms false breakouts). In a ranging environment, watch for the price to move slightly above former highs, and then move back below, preferably quickly and aggressively. Go short when the price passes back below the former high. Place a stop just above the recent false breakout high, and a target near the range low. "Near the range low" means the target is placed 25% of the range distance away from the range low. Confusing sentence, I know. If the range is 100 pips
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wide, and you go short at the top, your target is for 75 pips, or placed 25 pips from the range low. Also, watch for the price to drop slightly below former lows, and then rally back above, preferably quickly and aggressively. Go long when the price pushes back above the prior lows. Place a stop just below the recent false breakout low and a profit target near the top of the range. "Near the top of the range" means the target is placed 25% of the range distance away from the top of the range. If the range is 100 pips wide, and you go long at the bottom, your target is 75 pips, or placed 25 pips from the range high. I have relabeled the same chart from above to show how the false-breakout strategy could have been used on this pair.
USD/CAD Daily Chart
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In April of 2012, after moving sideways for the last several months the USD/CAD dropped below the prior low of the range. If the pair quickly move back into the range, it's a possible false breakout and we want to go long. The day after the downside breakout occurs (first red bar that drops through the red horizontal line), a green bar appears and price moves back above the horizontal red line (former range low). Enter long, just above 0.9841 (former low), labelled “Entry one” on the chart and place a stop below the recent low. I n this case, it's the low of the same green bar at 0.9805. Our profit target is near the top of the range, right near 1.000 which captures 75% of the range. The next day the price drops again and you're stopped out for a loss of about 36 pips as the price moves to a new low of 0.9799. A couple days later though, the price surges back above 0.9841 and you can enter long again —labeled “Entry two” on the the chart. The stop is placed placed below the recent low, now at 0.9799, so I would put the stop at 0.9794. Risk is approximately 47 pips. If you have multiple lots exit part of the position at the initial profit target (make 59 pips while risking 47 pips) and hold onto a portion of the position to see if an upside breakout occurs. If it does, place a target using the calculation from the traditional breakout method. Recall that the height of the formation is 210 pips (1.0051 – 0.9841, 0.9841, don't include the height of the false breakouts) and this is added to the upside breakout price of the entire range. Your next target is 1.0051 + 210 pips = 1.0261. With an entry point near 0.9841, you potentially reap a massive return for the 47 pips in risk. The point of the strategy is to capitalize on potential false breakouts — which which occur more often than actual breakouts. If another false breakout occurs in the direction opposite to a position you're holding, consider getting out. If you look closely at the USD/CAD chart, as the price moves through the upper red horizontal line in May, it moves above it and then drops below it on multiple occasions. The
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target of 1.00261 wouldn't have been achieved (if exiting the long based on the false upside breakouts). It's even possible, one or two short positions could have been taken, resulting in small losses, as the price action over several session made it appear the upside breakout may also be false. Even on this chart example (which looks great in hindsight at first glance), upon closer scrutiny isn't all it's cracked up to be. Even using the alternative methods, trading ranges can be difficult. Of the range trading strategies available, I believe the false breakout strategy is one of the better ones. The price is already reversing before we enter, indicating the range is continuing. Also, the false breakout likely trapped traders who now need to exit their positions, pushing the price in our direction. What I really like is that usually the risk is very small on these types of trades relative to the potential reward. You can be wrong quite a few times, and one winner more than makes up for it. As you progress through the book, and learn more about trends and price action, you'll get better at discerning which false breakouts you want to trade. For example, if the overall trend is up, you may only watch for false breakouts along the bottom of a rectangle to buy, because the longer-term momentum is moving in that direction. When the trend is up, breakouts to the downside are more likely to be false, and upside breakouts are more likely to be legitimate. The reverse is true for downtrends. When the trend is down, focus on false breakout along the top of the rectangle. This provides an advantageous entry if the price continues to fall, as the overall trend dictates.
Broadening Wedge
The broadening wedge is a hard pattern to trade and should be avoided. The reason it causes so many problems is that by the very nature of the pattern, it's composed of false breakouts. New highs are created, then quickly reverse creating new lows...and back and forth it goes.
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Like the (converging) wedges discussed earlier, broadening wedges may be sloping or sideways. Below is is an example of a sideways broadening broadening wedge. wedge. This formation is also be called a broadening triangle triangle
EUR/USD Daily
These patterns usually make several swings back and forth, before making a more sustained move in one direction. It's best to wait for the pattern to cease and make a more sustained move, then trade the ensuing trend. Broadening wedges show that volatility has increased and there's very little in the way of any trending activity to take advantage of. Trying to pick tops and bottoms can be difficult. The price will usually not align perfectly with the trendlines originally drawn (similar to the problem with rectangles). In other words, most traders would be wise to avoid trading in a currency pair that has this type of action occurring on the time frame they're trading.
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This pattern is mentioned only so you can spot it and avoid taking trades in pairs and on time time frames where the pattern is occurring. occurring.
Finding Patterns Some chart patterns (and ways or trading them) provide better opportunities than others, letting you enter the market in a way that offers greater potential reward than risk. When you’re starting out it’s not always easy to spot chart patterns, or trade them. This is why it's important to practice (before using real money) if you opt to incorporate these trades setups into your trading plan. You may find you spot the odd chart pattern, though not enough to provide regular trades. While lulls occur and you may not see a chart pattern for some time — especially especially on daily charts — usually chart patterns appear quite often, providing you with multiple trades in a single day, or several trade signals a week when swing trading multiple pairs on hourly or 4-hour charts. Chart patterns occur all the time and work equally well across different time frames, such as the 15 and 30 minute charts, hourly charts and daily charts (and all other times frames as well). If you're not finding chart patterns, it may simply be because you’re focusing too narrowly on one time frame, or one currency pair. In order to find chart patterns and trade them, here are some guidelines to follow:
Follow more than one currency pair. Some trading methods are meant for trading only one pair, trading chart patterns requires you trade more than one. Scan through at least several currency pairs to find patterns, and don't be afraid to trade them. Good day trading pairs for patterns include the EUR/USD, GBP/USD, USD/JPY, AUD/USD, USD/CAD, NZD/USD, EUR/JPY and GBP/JPY.
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Trade the patterns during the ideal times for day trading discussed in Chapter 7. If swing trading, you have all the other combinations of the EUR, GBP, AUD, NZD, JPY, CAD, CHF and USD. When swing trading, I flip through 28 pairs each night looking for trades. Always be aware of what type of trading environment a currency pair is in. If a pair is very quiet and has very little movement, even if it's a major pair, avoid trading the chart pattern until volatility increases enough to make it worth your while. while. This means during times of low volatility, you may drop a currency pair from your “watch list” and possibly add another pair which does have some movement.
Search multiple time frames. Day traders can scan all time frames 30 minutes or less; swing traders can scan all time frames 30 minutes or higher. Once you're aware of what patterns look like, this should take no more than 10 to 30 minutes total to scan through all the pairs and all the time frames (depending on how many you monitor). When you find a pattern, decide if it's tradable. Tradable means the stop level you place is within your risk tolerance, and the profit target for the pattern gives you more reward than risk. If using a non-ECN broker, look for patterns on a 5 minute chart or longer. Patterns occur on all time frames, although when dealing with patterns on 1 minute charts, the profit targets may not be large enough to compensate for the pip spread over the long run. This only applies if you're using a non-ECN broker. If you're using an ECN broker then the spread likely isn't a major factor, so smaller patterns and time frames can be traded. You still should have at least a 4 pip stop though — don't don't trade patterns smaller than that.
The above guidelines will help you find chart patterns and also decide which ones are worth trading.
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Chart Pattern Summary Chart patterns are a complete trading system because the formations provide you with visible entries, stops and a profit target(s). While the formations provide this for you, it's up to you to determine which patterns are within your risk tolerance to trade. No more than 1% of your account should be risked — the the amount — on you'll lose if your stop loss is hit — on any one trade. Risk is controlled by your stop levels and position size. Take a position size that allows the proper stop to be used and doesn't expose the account to more than a 1% potential loss. Write down a trading plan and record your trades. If you decide to include chart patterns in your trading plan, review the methods described for the particular pattern and create a plan for how you'll trade them and how you'll filter trades (Only certain time frames? Only certain pairs? Only certain patterns?). As you progress through the book, you'll learn more about market movements, which will also help you assess when you should trade a pattern and when you shouldn't. The market is dynamic and patterns won't always appear perfectly. "Non perfect" patterns are still tradable, but make adjustments for the pattern's anomalies. Trade based on what normally happens. Use stop loss orders to protect yourself against disaster. When possible trade multiple lots, so you can use multiple targets targets (if applicable) and lock in profits as a trade moves mov es in your favor.
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10. Trendlines, Trendlines, Horizontals and Shifting Markets Trendlines and horizontal support/resistance lines are related to the chart patterns discussed prior. prior. These lines offer us a context for the market we're trading, trading, and are used in conjunction with other strategies. Combined with other strategies, these lines are powerful in providing confirmation of trade signals or indicating that a move lacks conviction. Understand this chapter and practice using these tools before applying the other strategies discussed. Understanding price action is the most important concept you'll learn as a trader. It'll save you from applying your strategies at the wrong time and tell you when to take trading signals for high probability trades. This isn't all there is to know; you'll learn more about reading price action as you progress through the the book.
Before going in-depth on the use of trendlines and horizontals (horizontal support and resistance) these terms should be understood. An upward sloping trendline is drawn along price swing lows, which are progressively moving higher. A downward sloping trendline is drawn along price swing highs, which are progressively moving moving lower. lower. Examples are shown shown in the following following chart.
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EUR/USD Daily Chart
The upward sloping trendline marks an uptrend, which is simply defined as a series of higher swing highs and higher swing lows in price. If one of these conditions isn't present, it's possible a reversal may be starting. The downward sloping trendline marks a downtrend, defined as a series of lower swing highs and lower swing lows in price. Once again, if one of these conditions isn't present in the downtrend it may be undergoing a reversal — we'll we'll get to that later. When you hear “support” or “resistance,” often the person speaking/writing is referring to a “horizontal” level. Horizon tal levels are areas where the price previously stalled. If the price is in a range (rectangle), then the top of the range is a horizontal resistance level (market resists higher movement), and the bottom of the range would be a horizontal support area (market supports the price at that level). I differentiate between “horizontals” and support/resistance because support/resistance can be determined by many different methods. The price may not be anywhere near a former swing high or low, yet the price may still hit resistance or support respectively. Support and resistance areas are created all the time and old support and resistance levels are constantly being broken. Trendlines
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and horizontals are two ways of pinpointing support support and resistance. The following chart shows examples where important horizontal areas are marked.
EUR/USD Daily Chart
By drawing rectangles, we can easily see when a trend has moved into a more ranging type of environment. The rectangles clearly show the horizontal support and resistance levels. Anyone who has traded knows that making money isn't as simple as trusting support and resistance levels. Markets are constantly shifting. Where price had stalled before may not be where it stalls the next time it moves into that area. The EURUSD stops falling near 1.3750 on a number of occasions, though finally drops below it. A downtrend downtrend ensues, followed followed by another another range. During trends, horizontal support and resistance don’t matter much , as we expect these levels to be broken. In a downtrend we expect recent lows to be penetrated — this this must occur for the downtrend to continue. In ranging environments we expect support and resistance to have more of an impact, thus keeping price within the range. The following chart shows the transition from range, to trend and back to range.
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EUR/USD Daily
A trendline may not provide the exact level at which price stops, or the price may move just beyond a horizontal or trendline level. Just as the market shifts, you too must shift and adapt with it. Adapting to current conditions means you understand that just because you draw lines on your chart doesn't mean the price has to respect those lines. From time to time, you'll need to make adjustments to your drawings or place additional information on your charts as the market moves. Always draw both horizontal and trendline support/resistance levels, as it'll be easier to see s ee how the market is shifting from phase to phase — range range to trend to rea l-time as the price fluctuates f luctuates ; you'll see the moves develop range, etc. Do it in real-time and be able to determine when a small range is likely just a pause in a larger trend, or when a small trend is just a part of a larger range. You'll also see when a downtrend is transitioning to an uptrend, or vice versa, since the direction of the trendlines you draw will change. At any given time you'll have "micro" and "macro" factors affecting your chart, even when day trading. The macro factor is the dominant trend, range or
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market environment affecting the trading session or time frame you're monitoring. The micro factors are the short-term gyrations within the larger environment. If swing trading, the daily and 4-hour chart show the macro factors. Micro factors show up on the hourly and 30-minute chart. For day traders, the 30-minute or 15-minute charts reflect the macro picture, while the smaller time frame charts show the micro picture. Both the micro and macro are needed to trade effectively. effectively. Look back at the EUR/USD daily chart above. We can see that once the price broke below below the first support/resistance support/resistance zone (top (top white box) the overall trend is down. We then enter another consolidation phase (bottom white box); if you're not aware of the overall trend — macro macro picture — you you may make some potential mistakes while trading in this region (bottom white box). In the bottom box, note how the price makes a higher swing low (near the middle) then a higher swing high (as it pushes slightly above the box). Based on the guidelines that follow shortly, this is generally a bullish signal — an an indication that the market is going up. When we consider the macro trend, which is strong down, we don't want to buy based on that bullish signal, since doing so goes against the dominant down trend. Whenever you're considering which direction the trend is in, or in which direction you should trade, ideally you want to align yourself with the dominant trend, and use the short-term trends or ranges to get in to trades. The other strategies in the book provide the signals needed to do this. In this case, since the macro trend is down, favor looking for short entry signals, and filtering out buy signals. As mentioned, always draw lines on your chart to help you more clearly see the direction of the market. You may have a small uptrend, yet if it goes against a bigger downtrend, the small uptrend is not a signal to buy. bu y. More likely, depending on whether a valid trade signal develops, you're going to be looking to go short with the dominant trend.
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Take for example the downtrend between the two white boxes in the chart above. There's a small upward move, consisting of 4 green bars, which occurs during this downtrend. If you only focus on this and buy, you'll likely lose as the larger trend re-emerges to the downside shortly after. You'll learn how to t o use those little counter-trend moves as entry points later in the book. Look at the overall trend, trend, as it tells you the trade direction you should favor. The micro trends and ranges provide the opportunity to enter trades in your favored direction. The following is a guide on how horizontals can be used, followed by a guide for trendlines.
Horizontal Support and Resistance Guide Commonly referred to as support or resistance, it's a price level on a chart that has stopped the price from advancing in the case of resistance, and stopped further declines in the case of support. Support is a floor and resistance is a ceiling to the rate of the currency pair.
A horizontal line is drawn across the top of resistance points, and along the bottom of the support points. The more times the price moves to that area and bounces off of it, the stronger the support/resistance is. The harder and faster the price approaches and the harder/faster it bounces off a level , the stronger the level is. If the price has little clear direction and is trickling lower, then trickles back higher, the low that was just created c reated isn't likely a strong support level. It may become one if it's tested multiple times, though currently there's no evidence that a lot of buying was present at that level. On the other hand, if the price is plummeting at a steep angle, hits a level and reverses very hard in the opposite direction, that's likely a strong level since it stopped a big decline. The buyers at this level were tested by strong selling and the buyers won. Going forward we need to at least respect the fact those strong buyers may 157
still be at that level. It doesn't mean it'll always hold when the market moves back down to that support level. You should be b e aware that there are buyers there though, so taking a short position right above this level isn't wise. The same scenarios apply to resistance levels as well; don't take a long position — one right below a strong resistance level — one which caused a hard and fast price reversal. A strategy related to "strong" support and resistance is revealed later in the book.
The stronger and longer a support or resistance level lasts, generally the greater the velocity of the eventual breakout. Support and resistance levels aren't exact. Often each attempt to reach or breakthrough breakthrough the level will leave the price slightly short of, or slightly beyond (false breakout), what appeared to be the support/resistance level. When this occurs, draw a “support/resistance area.” This area isn't a specific price, but rather an area where prices move into and out of. This is very common once a level has been “tested” multiple times. Support and resistance areas are rarely exact, making it difficult to determine when a breakout is actually actually occurring occurring (recall the chart chart patterns Rectangles Rectangles section). Support which is broken will often become resistance, and resistance which is broken will often become support. It's common after a breakout for the market to move back toward the original breakout point. That point will often push the currency back in the breakout direction. The "Goodbye Kiss Strategy" capitalizes on this tendency, which you'll learn later. If the old breakout point offers no support/resistance, it's a sign the breakout may be a “false breakout.” A false breakout is simply a move which fails to follow through after a breakout. If the price breaks out of a triangle pattern moving higher, and then quickly retreats back inside the triangle, it's a false breakout — the the price failed to follow through in the breakout direction. 158
Failure to move beyond support and resistance levels shows the currency pair is within a range. Even within ranges there may be small trends, as the price moves back and forth towards the high and then the low of the range. If the range is large you can trade the trends within the range, as long as your profit targets compensate you for the risk. Always trade in the direction of the macro trend, unless a specific sp ecific strategy indicates otherwise. otherwise.
Trendlines Guide Trendlines connect price swing bottoms in an uptrend, and connect price swing tops in a downtrend. These provide us with an indication of where the price is likely to move back to on retracements (pullbacks).
When a trendline is broken (price drops through an uptrend line, or rallies above a downtrend line), it's an indication a reversal is possible. More evidence is needed though, as the trend may be just weakening, though not reversing. If an upward trendline is broken but the price stays above the prior swing low, then draw a new trendline. If the price breaks the upward trendline and also drops below the prior swing low, then a reversal is likely underway. If a downward trendline is broken but the price stays below a prior swing high, then draw a new trendline . If the price breaks the downward trendline and also rallies above the prior swing high, then a reversal is likely underway.
Since the market can be chaotic and doesn't usually move in harmony with previous moves, you may have to draw multiple trendlines reflecting the various trends which are underway. These trendlines will likely have different angles and may even go in different directions. directions.
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Often there are one or two (maybe more) major moves in a pair each day (for day traders). These provide you with your main trend(s) of the day. Your focus should be to trade in the direction of the main trend when possible. Shorter term intraday intraday trendlines can be used us ed to place entry and exit orders, stops, profit targets, as well as gauge when the main trend may be losing its momentum.
Using Trendlines and Horizontals in Shifting Markets By combining horizontal support and resistance with trendlines you’ll see when a trend is ending and may be moving into a range or vice-versa. A broken trendline doesn't always mean a complete reversal of the trend, rather it could mean a transition into a more ranging environment. After all, a trendline accounts for both price and time. If the time it takes for price swings to occur slows down, the trendline will be broken. This doesn't mean a reversal is imminent, but rather momentum is slowing. This slowing can take the form of sideways movement, or a pullback. We don’t know which it'll be— a viscous pullback or just lateral — so draw trendlines when you can connect two higher lows (uptrend) movement — or two lower highs (downtrend). When one of these lines is broken, draw horizontal lines at recent horizontal support and resistance levels. Similarly, if the pair is in a range, range, start drawing drawing trendlines as soon as the pair breaks out. out.
The following chart shows the end result of what a chart may look like at the end of the day (if day trading), though the concepts are applicable on all time frames. You want to know where support and resistance is likely to be. I have left all levels on this chart. In your own trading, you'll find that some lines can be deleted as time passes and they're no longer needed. This chart is of the SP-500 index and is used to show that this technique can also be used in other asset classes as well. I've used long horizontal lines to mark highs and lows. Some may find this beneficial for seeing minor and strong support and resistance levels, while others may find it distracting. After I'll show another
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chart where small horizontal lines are used which only extended until the price moves through them. This latter approach keeps the chart looking "cleaner." "cleaner."
SP-500 2 Minute Chart
Notice that the uptrend was dominant in the morning; morning; while I did draw some horizontal lines along swing highs, the price would pierce right though those lines on the next rally — this this is expected in a trend . When the price stops piercing resistance in an uptrend, or stops piercing support in a downtrend, that's a sign the market is likely entering a consolidation phase (more sideways movement) or going to pullback, which could result in a reversal. After about 10:30, the price moved mostly sideways through the afternoon. As the day progressed, I put multiple support and resistance levels on the screen (horizontal white lines). The inability of the market to move beyond those levels with any momentum showed us the market was in a range. Just before 3PM, the market broke above resistance and sustained the move. This allows us to draw another trendline, again showing a main upward trend. The retracement which occurred at approximately 3:30 PM came very close to the trendline, which would've already been drawn, providing us with a good entry for the move higher which occurred into the close. Strategies for this type of situation
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are discussed later in the book. Right now, the main thing to focus on is seeing how trends and ranges work and how this relates to support and/or resistance being broken or respected. respected. If that trendline would've broken, it would provide a signal that the market was losing steam. In that case, a drop below a prior support level would be needed to confirm the reversal signal.
During the day trendlines may need to be adjusted slightly or redrawn. Take for instance the sharp rise in the morning. Notice the trendline doesn't touch the first pullback just after the open (it should in real-time). This is because the line has been redrawn to accommodate later price action (remember we must draw these and adjust them in real-time for them to be of use). Just after 10 AM, the market moves sideways for several minutes. At no point was the uptrend in danger, as the market barely pulled back and came nowhere near a former price swing low. The line was redrawn to make it more accurate for future price action. Update the lines in real-time and redraw them to accommodate pauses in action or sideways movements.
Here's another example, which shows how crucial marking the charts with trendlines and horizontal levels can be.
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EUR/USD - 5 Minute Minute
From the EUR/USD 5 minute chart, we can see that the London session (highlighted in yellow) begins with an uptrend, marked by the upward trendline as well as the progressively higher lows (horizontal (horizontal lines). Later in the day, the price drops below the trendline (the more steeply angled trendline), which is a warning signal but not a clear sign of a reversal. The price continues to fall below the recent low (small horizontal lines on left), making it quite likely we're into a full reversal. Confirmation comes when the price also makes a lower high than the former swing high, allowing us to draw a new downward trendline, trendline, and new horizontal levels at the progressively lower highs.
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These lines — trendlines trendlines and horizontals — helped helped during the trend, letting us know it was still to the upside. The lines then notified us when a reversal was occurring, and then once against helped us see the new trend to the downside. Practice, practice, practice, practice. Mark up as many charts as you can like this. You may think you have a handle on it. Mark up a whole bunch of charts anyway. Learn to tell when the market is potentially shifting, when it's in a strong trend, and when it's reversing. This skill won't come from trading, it'll come practicing. Anytime there are swing highs or lows to connect, connect them. Then do it in real-time. Only when you have a firm grasp of this should you advance to the strategies that follow. Most of the following strategies require skill in assessing trends and trend reversals. This skill helps determine when a strategy should be used and when it shouldn't.
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11. Combining Engulfing Candles with Trends The engulfing candle trading strategy is easy to spot and provides a way to enter a trend at an opportune time. Using the trend and the engulfing candle as a trade trigger provides a powerful combination. combination. This strategy can be applied to any time frame or pair which is trending well. Avoid using it in pairs which are choppy or lack a trend.
Recognizing Engulfing Candles There are two types of engulfing candles, a bullish engulfing candle and a bearish engulfing candle. A bullish engulfing candle occurs when the “fat” part of an Up candle completely envelopes envelopes the fat part of a prior Down candle. The fat part of the candle marks the distance between the open and close of that bar, while the “ tails” mark the high and low. While there's no specific size requirement for an engulfing candle, typically both candles in the pattern should be substantial. For a bullish engulfing pattern, the down bar/candle should show strong selling and the following up bar should show strong buying.
Figure 1 shows an example of a bullish engulfing pattern in the AUDUSD. On my charts, up candles are green – the the close is higher than the open. Down candles are red – the the close of the candle is lower than the open of the candle.
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Figure 1. Bullish Engulfing Engulfing Pattern: Pattern: AUDUSD 1-Hour Chart A bearish engulfing candle occurs when the “fat” part of a Down candle completely envelopes the fat part of a prior Up candle. Figure 2 shows an example of a bearish engulfing pattern in the EURUSD.
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Figure 2. Bearish Engulfing Engulfing Pattern: EURUSD 5-Minute 5-Minute Chart
If you look back at figure 1, you’ll notice that right before the bullish engulfing candle pattern, there was a bearish engulfing pattern as well...and just before that another bullish engulfing pattern, all within four f our price bars. Engulfing candles occur often, which is why we need to add some sort of other filter to trade them. Use the trend as the filter.
Using the Trend with Engulfing Patterns Engulfing candles occur often. While its appearance signifies a sharp shortterm change in direction, many of these patterns aren’t of concern. In a trend there are impulse waves (strong waves moving in the trending direction) and corrective waves (smaller waves moving against the trend). Ideally, we want to enter trades during corrective waves, or pullbacks (preferably when they're ending), and then “ride” the next impulse wave for a profit. 167
The engulfing candle signals the pullback is over and the trend is about to resume. In the case of an uptrend, the bullish engulfing pattern signals the selling which occurs during a pullback is over and the buying is resuming. The trend doesn’t always resume ri ght away. We may simply get a small push in the trending direction before the pullback resumes. Losing trades occur, and that's okay as all losing trades can’t be avoided.
Figure 3. Bullish Engulfing Engulfing Candle Trading Trading Strategy in Uptrend Uptrend
For a bullish engulfing candle in an uptrend, place a stop loss 1 pip below the low of the engulfing candle. In the case of a downtrend, the bearish engulfing pattern signals the buying which occurs during a pullback is over, and the selling is resuming.
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Figure 4. Bearish Engulfing Engulfing Candle Trading Strategy Strategy in Downtrend Downtrend
For a bearish engulfing candle in a downtrend, place a stop loss 1 pip (plus the spread) above the high of the engulfing candle. Engulfing candles are simply an entry technique and don’t provide a profit target. For this entry technique, I typically use a 1.6:1 or 2:1 reward to risk ratio, in rare circumstances it can be extended to a 3:1 ratio. If you opt to use a 1.6:1 ratio and your risk is 10 pips on a trade, your target is 16. If you use a 2:1 ratio your target is 20 pips from your entry point; 3:1 is 30 pips from your your entry point. point.
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Which ratio to use is decided just before you make the trade, based on current market conditions. For a downtrend, choose the ratio which puts your target just past the prior low. In figure five, we have a bearish engulfing pattern in the NZDUSD. We enter short as soon as the pattern appears (white box) because it occurs during a correction higher within an overall downtrend. We place a stop above the engulfing pattern high and that gives us our risk — 50 50 pips. Based on this, we should use the 1:6:1 ratio for the trade because that'll put our target (small circled area) just beyond the prior low (dashed white line).
Figure 5. Bearish Engulfing Engulfing with Entry, Entry, Stop and Target
The same goes for an uptrend. Look for a bullish engulfing candle during a pullback lower within an overall uptrend. Place P lace your stop so s o you know kn ow what your risk is. Then use the ratio which puts your target just a touch higher than the last high of the uptrend. Usually this will be 1:6 or 2:1, but occasionally it could be
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more based on the dynamics of that particular trend and the size of the engulfing candle.
Zeroing In on the the Entry Point Point The traditional method of trading engulfing candles is to let candles complete before entering. That means once the engulfing candle finishes and a new one begins we enter the trade. But price bars are arbitrary. There's no relevance to the open or close of a 1, 5 or 15-minute candle. Watch for these signals in real-time and as soon as you see an engulfing pattern with the proper setup, trade it without letting the bar complete. For a downtrend, enter when the (potential) engulfing down candle moves below the low of the prior up candle (during a pullback). For an uptrend, enter when the (potential) engulfing up candle moves above the high of the prior down candle. This is a bit different than the traditional engulfing pattern, which only requires the fat part of one candle to engulf the fat part of the other. Figure six shows how this works in a downtrend.
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Figure 6. Forex Engulfing Engulfing Candle Trading Trading Strategy Entry Point Point
In the figure 6 the small horizontal red lines mark the entry point for short positions. There are a number of reasons for doing this. Mainly, a timed price bar is arbitrary in the forex market. There's nothing special about a 5-minute bar closing and the next one starting. Also, this entry reduces risk (in pips). Engulfing candles show a powerful change in direction. If we wait for a bar to complete, it may have already run significantly, significantly, which means our stop is bigger and our profit potential is diminished. Look back at figure 6. If short trades were entered at the close of the bearish engulfing patterns the trader would've received worse prices than entering at the prior candle low. low.
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Finally, we’re trading with the trend, so probability is already on our side. ore a bar closes doesn’t change our odds of success. Getting in bef ore
It's possible that when we look back at our trades, an engulfing pattern may not be present. By entering early there's a possibility that by the time the bar closes it's no longer a traditional engulfing pattern. Yet in real-time, the price exhibited the shift in momentum we were looking for and that's all that matters. The engulfing signal doesn’t necessarily have to come from one bar , either. Assume there's a downtrend and a pullback moving higher. Then a down (red) bar appears, but isn’t quite an engulfing candle. A few seconds after , another down (red) candle drops below the low of the up (green) candle. To me, this is a still a valid entry. Even though it was over a number of candles, it still shows the change in direction. Once again, traders need to rid themselves of the notion that there's something magic about the close of an intraday price bar, especially when forex day trading.
Incorporate elements from prior chapters to enhance the odds of these engulfing trend trades. Draw trendlines, and trade signals when the price pulls back to the proximity of the trendline. This helps filter many signals which occur when there isn't a trend present, or a pullback hasn't occurred. Figure 5 is a good example of this trendline approach. approach. The trend is down and the price pulls back into the vicinity of the trendline marking that downtrend. That's when to be watching for a bearish engulfing pattern. By using the trendline as a guide, we're assured of the trend direction (and the direction we should be trading) and that a pullback has occurred which is of significant magnitude.
Engulfing Candle Trading Strategy – Final Word The goal of the strategy is to isolate a trend and use engulfing patterns to signal the pullback is ending and the trend is resuming. We can also use multiple
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bars to signal the end of a pullback. There's no need to wait for the engulfing candle to complete. Once it has engulfed the prior candle, take the trade. Engulfing patterns don’t have a specific profit target. Use a fixed reward to risk ratio. Which ratio you use is determined by the market conditions. Stops are placed above the high of a bearish engulfing pattern, or below the low of a bullish engulfing pattern.
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12. Trading the News News events can be extremely volatile and result in irrational price movements, triggering orders placed way outside the pre-news price. Exercise extreme caution around the release times of major economic data. Most economic calendars show which events are significant and which ones aren't. Here's a good economic calendar: http://www.dailyfx.com/calendar . Be sure to set it to your time zone, so you know when events are scheduled. It's recommended that you don't trade for 5 minutes before or after high impact news releases. New releases can result in slippage: being filled at a worse price than an order order was set for. for. News events provide opportunity, opportunity, but enter trades after the volatility has subsided and the market has chosen its direction. Determining when to enter is the basis of this strategy. Other strategies in the book can also be used following a news release, though wait at least 5 minutes after the news release before deploying them. There are a few news announcements which cause big moves in the market. Interest rate decisions are one of those announcements. The Non-Farm Payrolls report (NFP) out of the US is another one. Other high impact news announcements are listed on the economic calendar, usually marked with red, "High" or 3 stars. These ratings indicate the news release often has a large impact on the price of pairs related to that currency, currency, like in the figure below.
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Set the calendar to your own time zone. Otherwise, you may end trading right through one of these announcements, which could be disastrous for a shortterm trader. These events provide opportunity but a trader shouldn't enter in the first couple minutes after the news is released. If no real volatility is generated, then no opportunities opportunities were missed anyway. If there is volatility, you can look to implement the news trading strategy detailed below. This strategy is geared towards the NFP report, although it's also applicable to other news events which cause a lot of volatility. The NFP report is released the first Friday of each month at 8:30 AM EST. The GBP/USD is the recommended trading pair for this event as it's very liquid (significant daily volume) and responds to the event with volatility. Below I discuss a simple strategy and an advanced strategy. I call the first strategy “simple” because there is little disc retion or subjectively involved in taking the trade. If we get a valid signal (based on the rules), we take it. This is fine, but my personal performance is better with the more advanced strategies discussed later on. That said, the advanced strategies are more subjective and may
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be harder for some people to implement. Therefore, practice each strategy and utilize the one you trade best with.
Rules of the Strategy:
Using a 5, 10 or 15 minute chart, wait for the first bar after the news event to elapse. elapse. A 15 minute chart chart is recommended. recommended. After 8:45, 8:45, using the 15 minute chart (8:35 if using a 5-minute chart), watch for the following criteria: After this wide ranging first bar occurs (usually covers a large price area), wait for an inside bar to develop before doing anything. An inside bar is a candle where the low and high are completely “inside” the price range of the prior bar. This may take several bars to develop or may occur right way. The appearance of the inside bar shows volatility has dropped and it's now safer to enter the market. Also, the volatility right at the news announcement doesn’t always tell you much. That movement is based on panic and loads of orders being triggered. Let the market digest the information for a few minutes. The calmer, more rational movements that follow provide much better clues as to the future direction of the pair. If the first bar following the news announcement a nnouncement isn't big (it should be at least 50 pips or more using a 15-minute cart), don't use this strategy.
Once you've isolated an inside bar, mark the high and low of that inside bar. If the price moves above the high of the inside bar, enter a long position. If the price moves below the low of the inside bar, enter a short position.
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Place a 30 pip stop. Alternatively, you can use the opposite side of the inside bar as your stop. For instance, if you enter long, put a stop 1 pip below the low of the inside bar. If you enter short, place p lace a stop 1 pip p ip (plus the spread) above the inside bar high. Make sure the stop is at least 15 pips, regardless of where the inside bar high or low is. If you use a stop smaller than this, you stand a very high chance of being stopped out, as the market is still likely to have ha ve some volatility. Take up to a maximum of two trad es. If both get stopped out, don’t trade any further signals using this method. The profit target is a timed target, not a price target. Since some news events can cause the market to move 300 pips and others will cause it to move 70 pips (or less), just as examples, we use a time target to attempt to capture the bulk of the move. Once a trend develops it'll commonly last till the lunch hour, or early afternoon. Therefore, exit the trade 4 hours after the entry. Cap the exit at 2:00 PM EST — by this time other factors may begin to shape the direction as the US market heads into the close. Examples of the timed exit: If you enter at 9:00 AM EST you'll exit at 1:00 PM EST. If you enter at 10:00 AM (normally entries occur before this if using using a 5 minute chart, though if using using a 15 minute chart, this is not unreasonable), you'll exit at 2:00 PM EST. If you enter after 10:00 AM, exit at 2:00 PM EST.
As with all strategies in this book, this strategy must be practiced. Watch several major news events and take notes n otes first. Understand how the news affects the market and how much the pair typically moves over a series of at least 5 news events. This process helps you determine if the strategy is working w orking in current (recent) conditions, or if another strategy in this book would be more suited to trading a certain news event.
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This strategy typically doesn't do well when overall volatility is low.
Trade Example
The chart below shows how this strategy is executed. The inside bar is marked with a box. When the price moves above the inside bar make a trade in that direction. The time on the chart is GMT, therefore the 13:30 represents the 8:30 AM EST news announcement and is marked by a vertical line.
GBP/USD – 15 15 Minute, Time is GMT
Stop is placed 30 pips below the entry price, marked by the horizontal black line. Alternatively, place a stop 1 pip below the low of the inside bar, if this makes the stop smaller than 30 pips. Exit the trade 4 hours after entry time: 1430 + 0400 = 1830. Trades won't work out this well all the time, but this trade resulted in a 160 gain, with a 30 pip risk: entry=1.4660, entry=1.4660, stop=1.4630 and and exit=1.4820. exit=1.4820. There are potentially many ways to trade the news (other strategies in this book), this is one way. It's relatively conservative conservative in that not a lot is risked, but still can capture large returns in a short time.
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As with all strategies in this book proper money management still applies. Don't risk more than 1% of your account on a single trade. This strategy is always being refined. For updates to the strategy, please see Simple and Advanced Non-Farm Payroll Forex Strategies on VantagePointTrading. Some of the refinements or upgrades to the strategy may require knowledge of concepts discussed later in this book.
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13. The Carry Trade The traditional carry trade — which which as day and swing traders we have no real interest in — is is when you borrow money in a low interest rate currency and buy an interest rate bearing asset in a high interest rate currency. For instance, as of November 2014 the Bank Rate in Japan is 0.1%, and the bank rate in New Zealand is 3.5%. Theoretically you could borrow in Japan at 0.1% and then buy treasuries or another interest bearing note in New Zealand and collect an approximate 3% return. Factor in 4:1 leverage (or greater) and you have a 12% (or greater) return for doing nothing...theoretically. nothing...theoretically. Reality as we know is a little different. For starters, consumers don't get the interbank rate on a loan from their bank. We're also assuming interest rates will stay the same, and we're assuming that the currency rate (the price) will stay the same. Neither will stay fixed for long, especially the currency rate (price of the currency pair). If the value of the Japanese Yen rises in this case, it will cost more New Zealand dollars (NZD) to pay it back, thus eating into your profit or causing a loss. On the other hand, if the NZD rises relative to the Yen (JPY), you have a win-win. You get the interest on your investment and because you're holding an appreciating currency it costs less to pay back the loan. You make interest and capital gains. That is the snapshot of the traditional carry trade, played predominantly by banks and major corporations, but generally not individuals. Individual traders can play it by taking advantage of the rollover credit they receive from holding a higher-interest higher-interest currency, but more on that shortly though. This background is given because there's an opportunity created by this phenomenon for for day traders traders and swing traders.
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Since the higher interest rates are attractive to investors/corporations/banks (for the reason discussed above) the high yielding currency does often get bought up, resulting in an interest gain and capital gain as the higher interest rate currency appreciates. The higher yielding currency involved in these trades is pushed higher, and the low yielding currency is pushed lower. It becomes very attractive because as long as people feel they can get out in time, or that the bubble won't burst, they collect the interest and capital gains. Remember, such transactions are often leveraged and involve hundreds of millions or billions of dollars when major banks, funds and investors investors around the globe globe are doing this. this. All good things must come to end. Carry trades can be huge, with billions of dollars bet on being able to make an easy profit and get out before it collapses. When that trend turns though, all hell can break loose and all these participants are forced to get out of their positions, or face big losses. That means an often sharp and quick reversal of the currency pair's price as investors clamor for the exits.
What to Watch For Unfortunately, finding a carry trade isn't as simple as it may appear. Just because a country has a high(er) interest rate than another doesn't mean there will be a large carry trade taking place. For instance at the time of this writing Japan J apan has the lowest interest, but other currencies such as the USD or CHF also have low interest rates near 0.25% and 0% respectively. These may also be candidates of carry trades. There are also many many other currencies currencies and countries countries which may see carry trades, but because they are less heavily traded they slip under the radar. Ultimately we're watching for currency pairs which contain a high interest country/zone AND a low interest rate country/zone. So as mentioned in the example prior, the NZD/JPY where NZD is 3.5% and JPY is 0.1% is a prime example. This is a currency pair to watch closely given these market conditions (all rates subject to change). There are also other things going on in the world, and in these pairs, so simply because a high currency pair rises doesn't mean a carry trade
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is going on. We're looking for sustained buying in a high-interest rate currency, relative to a low-interest rate currency that generally lasts for years. Interest rates may change periodically throughout the year. Those changes in interest rates have a profound effect on the current carry trades, and could also potentially start brand new n ew carry trades involving other currency pairs. As with all methods in trading, carry trades are dynamic. Watching charts and paying attention to shifts in price trends and interest rates is important. In 2002 AUD interest rates started to rise and did so until 2008, when we saw the financial meltdown. At this point rates fell from 7.25% to 3% within a year. For a day trader, a year is a long time. When the meltdown hit towards the end of 2008, and AUD interest rates began to drop, it took only 3 months for the previous 8 years of gains to be erased. It was fast, vicious and enormously profitable for short-term traders who watched this unfold, realized what was happening and acted on it, by shorting the AUD vs. the JPY. These are trends like any other, except there's usually much higher volatility as these carry trades unwind. Utilize any of the trend trading methods in this book to take advantage of these opportunities. opportunities.
AUD/JPY, Monthly Chart Chart
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Other factors come into play and the carry trade isn't the only input at work within a currency pair. The important take away is that when a carry trade is taking place the reversals are likely likely to be quick and aggressive, due to the large amount of money at stake. The crash in 2008 was due to a global issue, yet it's a great example of the power of the carry trade. There are also a few other things which need to be addressed. It may be questioned why in a time of panic money flooded into the Yen (chart above) and USD (chart below), both currencies that paid lower interest rates. During times of trouble wouldn't investors want higher interest to help protect themselves? The chart below shows the AUD/USD and we can see the sharp selloff of the AUD, or sharp rise in the USD, in 2008. The Yen and USD were both weak currencies heading into this meltdown, and the US was vulnerable to the financial crisis. So why did money flow so aggressively to these currencies?
AUD/USD, Monthly Monthly Chart
The answer is found in the carry trade. Higher yielding currencies are considered “risk on” tr ades. ades. Many traders are willing to speculate so they can
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potentially make the interest gains and capital gains. Low yielding currencies are a re considered “risk off” currency trades, meaning if you're in the low yielding you're giving up on the potential to make the higher interest rate. Therefore, when troubles were brewing, and interest rates were in question traders begin converting back to their lower yielding currencies forcing a high yielding currency sell- off. They want to be “risk off.” Similarly, if th e high yielding currency moves against someone holding a high yielding asset in that currency, they may be forced out of that trade or face big losses. Basically, there's a rush for the exits. Traders want to hold the higher interest currency, but can't.
How You Make Money Carry trades have been a factor in many of the major trends which have shaped the forex market in our time, and will continue to play a role in the future. Likely some of your best days and months as a trader will come from the opportunities presented when a carry trade unwinds. Not understanding what's occurring and/or fighting it, could mean you have some of your worst trading days or months. This type of unwinding doesn't happen often, yet when it does, you want to capitalize on it and not be frozen on the sidelines. The information is provided to give you a glimpse of the big picture. For day traders and swing traders taking advantage of this phenomenon is quite simple, both on the way up and the way down. Retail forex trading accounts generally give/take from the traders the difference between the prevailing interest rate of the currency pairs they're holding. h olding. This was discussed in “Rollover” in Chapter 1. A trader takes advantage of the higher yielding currency simply by purchasing it relative to a low yielding currency. If the Euro interest rate is 1% and the USD rate is 0.25%, by buying the EUR/USD currency pair you'll be credited with a small amount of interest, if you are holding that currency pair at 5 PM EST (a small interest rate differential like this isn't usually enough to cause a carry trade).
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Since banks/markets are closed on Saturday and Sunday, the interest for these days is made up on Wednesday. Positions held on Wednesday at 5 PM EST are subject to the extra days of interest credits or debits. Alternatively, if a person is short the EUR/USD (assuming prior mentioned interest rates) they'll be debited a small amount of interest at 5 PM EST for holding that position. By watching trends and also paying attention to the difference in interest rates, traders can ratchet up big returns. Taking part in the carry trade doesn't need to be a long-term commitment. Rather, commence with regular day (or swing) trading activities, and by taking a long position in a high yielding currency relative to a low yielding currency you can capture mini-trends and collect collect interest. Don't rely on the carry trade though...you're still only taking valid trade signals based on a sound strategy. If you can take trades in a pair that's trending, and collect interest as well, that's a bonus you should capitalize on. Leverage was discussed early in this book. Leverage in the retail market is often 20 to 100 times the capital in the account. If you can capture a 1% return from interest a year and you're leveraged at 50:1, effectively you'll make a 50% yearly return. Combine this with being aware of the major trends in these pairs and you can create a very profitable strategy. At no point do you want to try to capture the interest rate differential but lose on capital gains. Your ultimate goal is always to be on the right side of the actual trade and trend, the interest is only ever a “sweetener” for a trade, not the reason for it. Capital gains are your first goal. Capturing some interest may be a secondary goal. When that trend trend begins to break, break, forget about interest. interest. As you can see see from the chart examples above, when a carry trade breaks you can profit handsomely from the capital gains by trading the reversal, so don’t even think about tr ying to capture the interest. Always trade with the trend . Realize a large group of traders
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are caught on the carry trade, seeking small interest payments, yet will eventually be forced out by large capital losses. The biggest money comes when a high yielding currency breaks to the downside, as the carry trade unwinds. In this way you make money on the way up and the way down. How to be on the right side of the trade is the focus of this book, so hopefully you'll feel empowered with the tools provided in order to profit from this situation when it occurs. The purpose of this chapter is to provide a potential secondary income in your trading from interest, in addition to capital gains. Realize this is a popular strategy — and and when things are popular there's even bigger money to be made when they go out of style and the carry trade breaks. When the carry trade does break, you'll be shorting the higher interest rate currency, which means you'll be debited the interest rate for holding that short position overnight. Depending on the interest rate differential, the debit could be significant. Plan your trades with this in mind. Try to capture explosive moves that allow you collect your profit before 5PM EST. If you need to hold a short trade for a few days and pay the debit each night that's fine, though be aware of it. Be selective about taking swing trades you're going to be debited for. These debits erode capital gains.
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14. Statistics and Averages Every Trader Should Track One of my day trading students stated that his profit target was at such-andsuch a level. I asked why he had chosen this level, and he gave some reasons — good ones in fact. I then him asked ask ed what the probability was that he'd be able to get out at that price before the market closed? The markets were a couple hours from closing and while technically it did look like the rate was going to go there at some point, would would the rate do it on on the time frame frame he desired? He looked at me and shrugged his shoulders. I then asked “Do you want to be type of the traders that shrugs your shoulders, or do you want a method to answer that question?” He wanted the method, and hopefully you do too. Everything in life has a probability attached to it. It's not romantic and it isn't pretty, but almost almost everything can be reduced reduced to numbers. numbers.
Some of you may be saying "The forex market is open 24 hours during the week, so who cares if the profit target is hit now, an hour from now, or while I'm asleep?" Good point. Let me digress digress for a moment moment and point out out that some traders will enjoy implementing strategies which last several days, while other traders will pull their hair hair out and lose sleep sleep over a position or order order that's left left out over night. night. If you're strictly a day trader and want out of your positions, and your orders canceled, before significant markets close, you'll find this chapter especially helpful. If you're a swing trader, not minding trades that last several days or weeks, with orders pending all over the place, you'll still benefit from this chapter as it provides a reference for how long your orders may take to fill and how long your positions last. For both day and swing traders, the statistics discussed in this chapter allow you to pick better entry and exit points, as well as fine tune stop losses and profit targets (or filter out trades which are unlikely to complete on your timeframe).
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Understanding “daily average movements” and statistics is valuable information for a trader to possess. Here are some seemingly simple statistics that you should track, no matter if you sit at your computer all day, or set orders and walk away.
Daily Range The daily range is one of the simplest indicators. It's the high price of the entire span that a currency currency pair covers covers day minus the low price of the day . It's the entire in a 24-hour period. When we take the daily range and then average it over time, we can get a good indication of what a typical day should be like, in terms of volatility. For instance, if the average daily range of the EUR/USD for the last 100 trading days is 120 pips, we can reasonably assume that a typical day will involve movement of approximately 120 pips +/- a certain margin of error. Why is this important? Let’s say you see trade— it looks perfect. The EUR/USD has been moving up all day; it's already up 140 pips! There was no news out and you're about to go long. You then ask yourself “What is my profit potential on this trade?” An average is i s only an average, but on a typical day how much room is left for you you to profit? Not much, if any.
Since probabilistically there's not much (if any) profit to be had, the day trade isn’t taken, or if it is, the risk on the trade should be very small to accommodate for the low profit potential. Another scenario may be that the market has moved 80 pips, though the profit target requires the pair move another 100 pips. Is it likely the profit target will get hit? On a typical day — and and most days are typical — the answer is NO. In — the order for the target to be hit, the pair would need to move 180 pips in a day. Sure it could happen, but the odds are against it since the average in this case is 120 pips. There are atypical days, which are out of the norm. The prior chapter discussed carry trades, and if a major trend unwinds, you may see moves that are 189
three, four, or even five times their average daily movement (until the average begins to fully account account for the increase in volatility, volatility, at which point the average average will reflect current volatility). Such events do occur, yet on most days when you trade massive moves won't arise, and you're better off trading based on the statistical averages. By tracking daily ranges constantly, you'll also be aware when volatility is expanding or contracting. Thus you'll be able to adjust your trading methods to accommodate. If volatility is trending down (meaning daily ranges are getting smaller and smaller), you need to accommodate for it. Anticipate that tomorrow you may need to pull in your profit targets in order for it to be hit, you may also be able to decrease your stop because with reduced volatility. Using the strategies in this book, the adaptation should happen automatically, since targets and stops are based on price action. Price action action is what determines determines volatility in the the first place. place. Take the information the market provides, and adapt to it. That doesn't d oesn't mean you adjust your strategies per se, it means you adapt the strategy to the market conditions. The Average True Range (ATR) indicator is quite good at providing a snapshot of daily average movement. Using the indicator is the quick way, though I highly recommend you also keep track of the high, low, open and close of each session, so you can manipulate the data in a spreadsheet and get much better information out of it. This diligence (including looking at the charts and recording numbers yourself), over time, will help you to see market dynamics more clearly and potentially spot additional strategies, or trade-setups you otherwise would miss. Daily and hourly volatility stats are also available at http://vantagepointtrading http://vantage pointtrading.com/daily-forex-stats .com/daily-forex-stats..
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Inner-Daily Range The forex market is open 24 hours a day, yet you're not trading 24 hours a day. This is extremely important; it's also why I recommend you record your own data that's relevant to you, instead of relying on an indicator to provide a snapshot. I used to trade between 11 PM and 2 AM (my local time), which is when the European markets were opening. The daily range provided by an indicator or by news service providers wouldn't provide any insight into what I would be facing during this three hours of trading. Since my day only consisted consis ted of three hours of of trading, I recorded my own open, high, low and close for every session, starting at 11 PM and ending at 2 PM. After all, this was my trading day (for that particular strategy I used at that time of the day). This is what I call the “inner -daily range.” It's the part of the day you trade. You must know what the typical tendencies are of the pairs you're trading during this time. If you don’t, you've unnecessarily disadvantaged yourself.
I know what typically happens during the time I trade, yet there may be times when I want to leave an order out after my typical trading session is finished. This is where the daily range data discussed in the prior section comes in handy. I need to know what's within the realm of likely possibility for the rest of the day, while my order is out in the market. If I want that order to fill, I need to place it within a price range that's likely to be hit. By breaking down the day into its tendencies, you gain a lot of insight and a huge advantage. There are many potential applications which can be drawn from this data, and I recommend that you play with different calculations in a spreadsheet. Uncover some insights of your own for the pairs you’re trading and the strategies you’re using.
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Day of Week Averages On a certain pair you may find your 50 pip target is easily hit on Thursday, yet you're hard pressed to make 30 pips on a Monday. Each pair has different day of the week tendencies; some days have half the volatility of others. If you're trading each day the exact same way, you may find a pattern of better or worse performance on on certain days. If you look at average volatility over the last 100 days, for example, you'll see that each day of the week has its own average.
EURUSD Volatility Volatility by Weekday (in pips) pips) - 20 week average, November 2014 2014
Adjust expectations based on the day of the week. During this 20-week period for the EUR/USD a day trader could expect to make much more (due to the larger moves and more opportunity) Monday to Thursday, than they could expect to make on Friday or Sunday. Expectations also need to be tempered on a Monday, when compared to a Wednesday.
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The day trading the strategies in this book — based on price action — should should automatically adapt to higher or lower volatility. Be aware of it anyway, especially on low volatility days. The average weekday volatility is a more precise measure than average daily volatility. Avoid trades which require the price to move significantly outside its typically price range in order to reach your target. This topic was already addressed in the Daily Range section above, though now that you know each day of the week has its own tendencies, you can zero in further. If the price has already moved 40 pips when you take a trade on a Wednesday, you have lots room to potentially profit outside the already established daily range. On a Friday, the price is more likely to stay within the 40 pip range already established, unless there's a major news release scheduled. Like any other statistic, weekday volatility fluctuates over time. Visit http://vantagepointtrading http://vantage pointtrading.com/daily-forex-stats .com/daily-forex-stats for current stats, or record your own in a spreadsheet.
Homework I recommend that all students of the market have some knowledge of statistics. Standard Deviation, Variance, and an understanding of how averages are calculated should be the bare minimum a trader knows. It's also extremely beneficial to understand how the standard deviation and the variance relate to the average (mean). Whether the data is pulled from a significant or useful source is also extremely important. important. For instance, incorporating data from a very volatile time isn't prudent to day trading when volatility is low. Use data that's relevant to current conditions, and use that same data to determine when market conditions are changing. By understanding these concepts, you'll be better able to adapt the strategies described in this chapter to your own trading. I recommend picking up a college level statistics book, going through it and doing the exercises. Without doing so, you may miss what's between the lines; often the simplest things can create success or failure.
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For a "palatable" introduction to statistics, check out the book The Drunkards Walk - How Randomness Randomness Rules Our Lives Lives by Leonard Mlodinow.
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15. European Open Strategy The European Open Strategy is really a full day strategy, yet trade signals usually appear within a few hours of the European open. It's based on the daily average movement discussed in the prior chapter, and attempts to capture a significant portion of the daily average range. A similar idea could be adapted in other pairs, but I've only used it on the EURUSD or GBPUSD. Only implement the strategy in one pair at a time, as the EURUSD and GBPUSD are often positively correlated and implementing the strategy on both pairs is overkill. Use the strategy on the pair that has the largest average daily range. At times this will be EURUSD but usually it'll be the GBPUSD. Check http://va http://vantagepointtrading.com ntagepointtrading.com/daily-forex-stats /daily-forex-stats to see the daily average movement of forex pairs. These pairs are used as little trading activity takes place leading up to the European open. As Europe opens for business, traders and banks rush in and the pairs are actively traded for the next next 14 hours. Most of the daily action in these pairs occurs during the New York and London sessions. The European open gives us our first glimpse at how the day is setting up, and will hopefully provide a good entry point for taking advantage of the rest of the European and US session price movement.
The Trade Set-up The logic for our trade is based on the fact that we know most daily price candles have an upper tail and lower tail, and in-between we have the open and close. If we can enter a trade in the right direction on one of those tails, then we have the fat portion of the bar and the other tail as potential profit. For instance, the market opens and then begins to move higher for the next 45 minutes. It then
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reverses, after putting in a high 30 pips above the open. It has been about an hour since the market opened and the price just dropped back below the open price. Could the upper tail of the day have just been created? If we know the pair moves on average 120 pips per day (subject to change), and we assume the upper tail was created (30 pips), that means we're likely to move about 90 pips outside of the current 30 pip range during the rest of the day. Since we're assuming the upper tail is already in place, we want to enter a short trade to capture the rest of the daily range. The strategy is based on some assumptions. In thi s example we can’t know for sure if the high of the day (upper tail) is actually in place. The market could reverse course and make a new high, losing us money on the trade. Losing trades happen, which is why this strategy tends to work over a large number of trades — our winners are bigger than our losers. We also make the assumption the market will move 120 pips today. 120 pips is just an average, not what the market will actually move on a particular day. In light of the assumptions, we improve our odds by using more specific data. First, different days have different volatility. Thursdays may be less volatile than Tuesdays for example. This may change over time, which is why keeping — many daily statistics is so important — many strategies are built off such information. The following chart shows EURUSD Volatility by Weekday and you can see the weekday volatility difference. difference. On Tuesday we'll w e'll try to extract more profit than on a Thursday.
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EURUSD Volatility Volatility by Weekday (in (in pips) - 20 week average, February, 2012
Going back to our example, we can see that on Monday, Wednesday and Friday the average movement is about 120 pips. On Tuesday, it's higher so we'll try to extract a bit more, and on Thursday we'll settle for less potential profit. From the chart we can see that on average there's an upper tail, a lower tail and the middle potion (open-close). By isolating one of the tails we can enter a position and try to to take advantage of the rest of the daily range — there's there's usually about 2/3 or more of the daily range left to capture following the entry. Don't use this strategy on US or European holidays, as volatility is likely to be low and average daily statistics won't be relevant. If there's a lot of volatility prior to the European open, be sure to account for that when projecting profit targets as discussed below. If the GBP/USD moves on average 120 pips per day, and it's already moved 90 pips prior to the open, then activity wasn't low heading into the European session and this violates the whole premise of the strategy. Movement in the GBPUSD or EURUSD should be relatively calm for the few hours before the Europe market opens.
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Trade Rules The rules of the European Open Strategy are simple once the concept is understood, but requires regular monitoring of the daily statistics (especially volatility by weekday) so you can adjust the strategy to current market tendencies. 1. Mark the open of the London session on your chart with a horizontal line. Use 15 minute charts 2. The first two bars are of no concern. After the first two bars (30 minutes) the market must stay on one side of the Open price for at least another 30 minutes. If the market is see-sawing back and forth across the Open price during the first hour, avoid this strategy. 3. After staying on one side of the Open price for at least 30 minutes (after the first two bars) the pair must move back through the open price. 4. Enter as the price moves back through the open price by one pip. For instance, if the market opened and the price moved higher, then moves back down through the Open, go short when it moves below the Open price by one pip. If the market moved down after the Open, buy when the price rallies back above the Open price, assuming all other rules above have been met. 5. Put out a stop loss order a couple pips outside the recent high or low which was just established. The stop (in pips) shouldn't be much more than 1/3 of the average daily range (for that weekday). If the price moves more than 1/3 of the daily average range in one direction after the Open, don’t use t his strategy. If the pair on average moves 120 pips in a day, but rallies 60 pips after the open before falling back through the open price, don't take the trade. Too much of the daily movement has been exhausted, and your risk (60 pips) doesn't warrant taking a trade that's only likely to yield about 60 pips. If the daily average range is 100 pips, your stop shouldn't be much more than 33 pips; if the daily average range is 120 pips, your stop shouldn't be more than than 40 pips.
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6. Calculate a reasonable profit target. You're attempting to capture a large part of the rest of the daily range. Assume your upper tail is 30 pips after the Open, you just went short as the price moved below the Open, and the daily range is 120 pips. There's about 90 pips of profit potential available. Reduce this by about 20%, leaving you with a profit target of 70 pips. Put out an order for the 70 pip profit target. Here's a scenario: the market opens at 1.3000, goes up to 1.3030, drops below 1.3000, you go short at 1.2999, placing a stop loss loss at 1.3032 and a price price target at 1.2930. 1.2930. 7. Make sure the profit potential warrants the risk. If the target is much less than two times the risk, avoid the trade. Absolute minimum reward to risk is 1.5 to 1. 8. If target or stop isn't hit, exit the trade at 23:15 GMT. You'll have incurred a roll-over, roll-over, as this is 1 hour and 15 minutes after the US session ends. This may seem complicated at first, but once you become familiar with the trade setup it becomes second nature. Let’s look at an example.
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EURUSD 15 Minute Minute
Using the EURUSD 15 minute chart above we'll go through the steps of the European Open Strategy. On the chart I've marked the European session in Yellow and US session in blue (overlap period appears as light yellow). 1. When London opens at 8:00 GMT, draw a horizontal line which marks the open price. On this day the pair opened at 1.32514. 2. The price moves higher, during and after the first two bars, and stays — above the Open price for at least another 30 minutes. All good so far — there's a potential trade set-up if it drops back through the open. 3. The pair then moves down and drops below the open price. 4. Enter short at 1.32504 (a pip below the Open).
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5. Place a stop at 1.32847, two pips above the high that was just j ust established. Our risk is therefore 1.32847 - 1.32504=34.3 pips. The high is marked on the chart by a horizontal line. 6. This is a Monday, and from the weekday volatility statistics statistics we know our daily range is about 120 pips (this will change over time). If the upper tail is in place there's 120 pips - 34.3 pips = 85.7 pips of profit potential remaining. We take about 20% off to improve the odds of our target being hit, which provides a target of 70 pips . Our target price is thus, 1.32504 - 0.0070= 1.31804. This level is marked on the chart by a horizontal line. 7. The potential profit is about two times our risk. All orders are locked in. 8. Our target is hit just after the end of the US session. Rollover is incurred on this trade since the position is exited after 5:00 PM ET. As with all strategies you opt to include in your trading plan, paper trade the strategy first to get a feel for it, and see if it's profitable. If it doesn't work in paper/demo trading it, it may not be a good time for the strategy. Don't use real capital until you have a firm handle on the concept and it's showing consistent profits. Since the entry doesn't occur till at least an hour after the Open, it's easy to determine beforehand if there's a valid trade setup. After the hour (could be more), as the price approaches the Open you'll know what the stop level is. Subtract the stop (in pips) from the daily range leaving you with your estimated profit potential. potential. As long as the profit potential outweighs the risk (1.5:1 reward to risk absolute minimum), take the trade and set your stop loss and profit target immediately according to the rules of the strategy. Your stop or profit target may be hit in a matter of hours, or it may take all day. The profit target is based on the daily average range, which includes the whole 24 hour period. While most of the action takes place inside the European and US sessions, occasionally the target is filled after the US session ends. Exit at 23:15 GMT if your target or stop isn't hit within the European or US sessions.
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Through trading this strategy I've found exiting at 23:15 GMT to be favorable relative to holding on to the position longer, or exiting earlier if the stop or target hasn't been reached. This exact exit time is subject to change though — continually monitor statistics and see if you find a better time that works for you when this situation occurs. Next is a trade which may look like a signal, but isn’t. Under the following f ollowing conditions, no trade is taken.
EURUSD 15 Minute Minute Chart
The Open is marked with a black horizontal line (the dots aren't relevant). The first two 15 minute bars are of no concern, but overall the movement is lower. We then have a full 15 minute bar completely below the open (third bar inside the yellow highlighted area). If another 15 minute bar were to follow, completely below the open, then we'd w e'd have a signal. This doesn't occur. The bar with an “x”
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below it violates the rule. It pushes up through the Open too soon, nullifying the trade. There's a temptation to say "It's only a couple of minutes, so I should take the trade." I don’t recommend it. As you can see from this example, the market didn't have the opportunity to build up any steam for a reversal. It's more likely to chop back and forth, which it did for quite a while before dropping eventually. The time frame is only a guide — a minimum guide. After the first 2 bars (30 mins) we want the market to have picked a side and then stay there for at least another 30 minutes. As long as the price doesn't move too far on that one side of the Open, Op en, the market is potentially gaining momentum for a move in the opposite direction. Let’s look at another problem, using the chart below, which could trap traders with this strategy: the risk/reward.
EURUSD 15 minute Chart Chart
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The market moves lower off the open and stays down there for some time. The thick black line marks the open price, and on this day it took a long time to receive a signal. It took about 6.5 hours for the price to move back above the open. February 16 was a Thursday, and from our data we know that on Thursday the pair usually moves about 100 pips (subject to change, check for new stats). The pair opened at 1.3020 and made a low of 1.2973. Our stop is 1.3021 – 1.2971=50 1.2971=50 pips. Deduct this from 100 pips to get 50 pips as a potential target. To be conservative we reduce this value by 20%, giving us a target of 40 pips. Our risk is more than our reward, so the trade isn't taken! The target would've been reached and exceeded. It would've been a winner, and could make a trader question why they didn’t take the trade. T his strategy is based on averages and probabilities . On this particular Thursday the market moved close to 180 pips, much more than a typical Thursday. It's better to miss a trade, especially when the odds of the trade are against you, than to catch the odd winner but lose on the high probability trades. If the risk is too big for the likely profit, don’t take the trade. Here's another “good” signa l, and is the type of trade we're looking for. February 10 was a Friday; based on our statistics expect the pair to move about 135 pips.
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EURUSD 15 Minute Minute Chart
The EURUSD opens the session at 1.32535 (black horizontal line), drops and then rallies above the open during the second bar (we're not concerned with these first two bars). After the price stays above the Open for more than an hour you can anticipate a potential short trade...assuming the pair doesn’t d oesn’t move too high above the Open, and that it eventually drops back below the Open. As the pair moves back towards the open, note the high was 1.3283. As the pair moves back below below the Open we go short at 1.32525 1.32525 and place a stop at 1.3285, 1.3285, making our risk on the trade 32.5 pips. Since we know the pair moves about 135 pips, without even even calculating our profit profit target we know we'll be taking the trade. trade. Our profit target is 135 pips minus the 32.5 pips the pair has already moved, leaving us with 102.5 pips of potential profit left. Reduce this by 20%, leaving 82 pips. Subtract 82 pips from the Open price and generate a target price of 1.31715. Our profit target is well in excess of two times our risk. 205
This particular trade moved down aggressively and hit the profit target, resulting in an 82 pip profit for 32.5 pips of risk.
Considerations and Performance When the rules are followed the strategy performs fairly well. However, results are "streaky." Once the trade is "on," set the orders and forget about it. The strategy isn't time intensive, but the strategy does have a few pitfalls. The main issue with the strategy is the lack of signals. While it's possible to get four signals in a week, it's also quite possible a signal won't occur for a couple weeks. There are three main reasons why signals don't occur: 1. Choppy trading, moving back and forth across the Open price, in the first hour immediately lets you know you won't be implementing the strategy. 2. The market runs too far in one direction before correcting back across the open. The stop should be about 1/3 of the daily range or less, if it's more (as a result of a big directional move in the morning), don’t take the trade. 3. The pair never crosses back through the Open. On very strong days the market moves in one direction and doesn’t pull back. The third point we don’t need to worry about: if the market doesn’t cross back through the Open, there's no chance of getting a false signal. These very strong or very weak days are favorable for other strategies as well, so missing out on this strategy isn't a concern.
Around the time I considered writing this chapter, and then actually writing it, there were 32 trading sessions (there were also two holidays which aren't included in this number). A valid signal was produced in 11 of those sessions, s essions, with the other 21 sessions producing no signals based on the reasons mentioned above. Of the 11 signals, 8 were winners resulting in an overall profit of 437 pips. Average winner was 66.69 pips, and average loser was 32 pips. Three of the winners didn't hit the target in the European or US session and were exited at 23:15 GMT. Since I don't usually stay up to watch for this signal (I live in Mountain
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Time...the other side of the world) I've sporadically checked it over the years and the results are similar to those above, but fluctuate. At times the win rate over a couple month period will drop below 50%, and at other times be above 60%. Making sure the winners are bigger than the losers is crucial. Other market conditions, such as whether the market is ranging or trending doesn’t seem to matter. When a strong trend is occurring we often won't get signals because the market moves in one direction, or the signals occur in-line with the trend, resulting in a profit. What you'll mostly need to monitor is the daily average range; continually update your statistics, at least once a week, to stay on top of current average movements. If the daily average range begins to decrease below 100 pips per day the pair is likely not volatile enough to warrant the strategy. Beware when the daily average range is shrinking continually. If you pull up an Average True Range indicator and it's trending down strongly, this strategy will be hard to implement. Targets will rarely be hit because volatility is contracting day to day. In this type of environment, don't trade the strategy, or, be sure to reduce your profit target by several percentage points in order to accommodate for volatility being lower than it was in the past. past.
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16. Truncated Price Swing Strategy This day trading strategy can be used on its own, though should really be used in conjunction with other strategies. This strategy gets you looking at trends and reversals, and also introduces an entry technique — the the "consolidation breakout" — that's that's incorporated into many of the strategies strategies that follow as well. The strategy gets you into a move early, risk is relatively small and it aligns your trades with the trend (or with the potentially emerging trend). It's used to take advantage of the swings which occur every single day, so the strategy provides ample trade signals. While no system is perfect, this trading strategy often provides high rewards for the risk and shows you quite quickly if you're on the right side of the market or — saving not — saving you time so you can get out and move on to the next trade if it doesn't work out. Some potential flaws of this trading method are discussed at the end of the chapter. A truncated move, the basis of this strategy, is a price move that doesn't reach the previous price move extreme. There are truncated moves that indicate a trend is continuing, and those that indicate a reversal. In a downtrend, if a rally fails to reach the previous high, it's a truncated price move. In an uptrend if a pullback fails to reach the prior swing low, it's a truncated price move. In both these cases, the truncated price move indicates the overall trend is continuing. If the overall trend is up and a wave higher fails to reach the last swing high, it's a truncated price move and indicates a possible reversal, or a consolidation in price. If the trend is down and a wave lower fails to reach the low of the last swing low, it's a truncated price move and indicates a possible reversal higher, or a price consolidation. The truncated price moves in these last two cases violate the basic tenants of trends — higher higher highs and higher lows for uptrends, and lower highs and lower lows for downtrends — indicating indicating the trend is in jeopardy.
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I especially like this strategy near the open — the the European open, or during the European/US overlap period — but it can be used during any of the recommended recommended day trading times (see Best Times to Day Trade, Chapter 7) Assume the EURUSD opens at 1.3000 and drops 20 pips near the start of the European session, moves higher and then starts heading back to test the low at 1.2980. But this current price swing fails to reach that low before heading higher again. Simply put, we have a higher low — a truncated move — and and a potential trade. It provides a low risk opportunity to get long. The chart below shows the EURUSD on a 1 minute chart. This example took place not long after the London open.
EURUSD 1 Minute Chart Chart
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Focusing on the yellow area, which highlights the London session, the EURUSD moves lower, higher, makes a new low and then rallies back toward the former high...but it doesn’t make it there. That's what we're w e're watching for. The price stalls below the former high, and I've marked that area with a white rectangle. We know a short trade could be forthcoming, because if the price can’t push through the former high, it's likely to head lower, even if temporarily. A potential trade needs a "trigger." The trigger indicates exactly when a trade should be taken. This is where drawing a little rectangle around the price action helps. In this example a small range (rectangle) is created below the old high. A break below the rectangle (very short-term support) signals the truncation is in place and a short trade can be taken. While not all trades are this successful, the market moved aggressively lower after that small range was broken. To summarize, for an entry we're watching for any move that's heading to test a high or low, but does n’t make it there. Once the price stalls and starts to reverse away from the high or low, we're watching for a trigger which initiates our trade — this this could be a candlestick pattern (such as an engulfing pattern, discussed earlier in the book), or a collection of bars and then a breakout from those bars (consolidation (consolidation breakout). My preferred method entry is the consolidation breakout — I use it for many different strategies. In order to get a trade trigger, the price needs to pause just below a prior high or just j ust above a prior low so s o some very short-term sh ort-term support and resistance can form. Draw a rectangle similar to the one on the chart and await a breakout from from it. Stops are placed just above (1 pip plus the spread for day trading, 5 pips plus spread for swing trading) the truncated high or just below (1 pip for day trading, 5 pips for swing trading) trading) the truncated low which keeps the risk in pips usually fairly small (relative to the surrounding price action). In the example above, we enter short at 1.3020 and our stop is 1.3026. Add a couple pips, so the stop in this case is closer to 1.3028.
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The profit target for this strategy can be based on multiple factors. One option is to set the profit target at a location which presents a 2:1 reward to risk ratio. In the case above, our stop is 8 pips, so our target would be 16 pips from our entry price. If the price movement is a little sluggish, use a 1.75:1 target. If your stop is 8 pips, your target is 14 pips with this reward:risk ratio. Using a larger reward:risk ratio may result in a bigger profit, but the trades last longer and the target is less likely to be hit. Since signals for this strategy occur frequently throughout the day, getting in and out swiftly with a 2:1 (or 1.75:1) reward to risk is beneficial since you can quickly begin looking for another trade. Making two or three trades with a 2:1 reward to risk is better than making one trade with a 3:1 ratio. Take a quick profit and move on. I've used many other methods for exiting this trade, but often find that no matter what profit target method is used, the ratio normally ends up near 1:75 to 2:1, therefore, to keep things simple just use the 2:1 (reward:risk) ratio under most market conditions. In times when volatility is decreasing, use a slightly smaller target. The 2:1 reward to risk assumes the entry is actually attained near the actual price trigger (consolidation (consolidation breakout or engulfing engulfing pattern). Regardless of where the actual entry takes place (the price you get the position at) the stop st op should always be placed above the truncated high or below the truncated low and the profit target is then placed at a distance which is equal to two times the risk from the trigger/breakout point . Hopefully this is the same as your trade price, but if you happen to miss the entry point by five pips to due slippage or slow reflexes, the originally calculated calculated stop and profit target shouldn't be adjusted for this 5 pips. If you get a lot of slippage on your ord er, don’t adjust the stop and profit target to reflect it, keep the original stop and profit target. Just because you missed your entry point by five pips doesn't mean the strategy should be altered to suit your predicament. If you miss a trade, let it go. There will be others. We don't want to start chasing the price, as this increases our risk (based on where the stop should be placed) and decreases decreases the profit potential. potential.
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On the same day as the example above, three more signals pop-up (see chart below). For these, the trade triggers were engulfing patterns. Engulfing patterns, in addition to the “consolidation breakouts” method discussed prior, are a reliable trade trigger when using the truncated price swing strategy. A bullish engulfing pattern is when an up-bar completely envelops the prior down-bar after a downward move. A bearish engulfing pattern is when a down-bar completely envelops the prior up-bar after an up move. The set-ups and patterns are marked on the chart below — the the engulfing patterns are our entry signals and are marked by arrows on the chart.
EURUSD 1 Minute Minute Chart
Trade 2 is a lower high, and the trade signal is a bearish engulfing pattern. Enter short as the pair moves below the low of the former green bar. This gives a short entry price of 1.3012 (1 pip below the low of the green bar). The recent high 212
is at 1.3016 and our stop goes just above it, making it 1.3018 (6 pips of risk). The target is therefore, 12 pips below our entry price or at 1.3000. The market reaches 1.2997 so the trade is profitable. Trade 3 appears right after exiting Trade 2. An aggressive bullish engulfing pattern triggers a long trade, on a higher low (truncated price swing). Enter long at 1.3006, which is one pip above the former red bar. Stop is below the recent low (low of the bullish engulfing bar in this case) at 1.2997. Subtract one pip to make it 1.2996. The stop is therefore 10 pips and our target is 20 pips. Add the target to the entry price of 1.3006, giving a price target of 1.3026. The market reaches 1.30267 so the trade is profitable. Trades 4 and 5 happen quickly. For trade 4 we get a bullish engulfing pattern, but the market then moves lower losing us 6 pips. We're still watching for a higher low, as we remain well above the prior low (trade 3 in this case) at this time. Another bullish engulfing pattern occurs and we enter long for trade 5. We go long at 1.3010, stop is 1.3005 and our target is therefore at 1.3020. The market moves up to 1.30236 so this trade is profitable. This strategy worked well on this day using a one minute chart. You don’t need to use a one minute chart though; use a 5 minute or even a daily chart. The trade setups are still the same, as shown on the daily chart below.
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EURUSD Daily Chart
Regardless of the time frame, the rules are the same. You're looking for a higher low or a lower high and you want either a collection of bars which provide you with a trade trigger (consolidation breakout) or an engulfing pattern. In the case of the daily EURUSD chart above, the trigger is an engulfing pattern. The bullish engulfing pattern appeared right above the prior low, indicating a truncated move. Our entry point is 1.3090 as the “bullish” day surpasses the high of the former down day. Our stop is placed just below the recent low (5 pips below, since it's a swing trade) at 1.3000 (90 pips risk). The target is therefore 180 pips added to our entry price, to get 1.3270. This target is reached several days later.
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The chart below is a daily AUDUSD chart. I've highlighted the trend with a white line to show the simple structure of truncated price moves — in in this case there's a low, a move higher, a move down which creates a higher low and then a move back higher. Once you see the higher low, you want to trade the next move higher.
AUDUSD Daily Chart
If you can get a good entry into this wave higher you stand a very good chance of capturing a profit. In this example, many novice traders will wait till the price moves above the major high at approximately 1.04 to enter, but this entry gets you into the move too late. As long as the price remains above the former lower (a potential higher hi gher low) look for a trigger which signals a move back higher; the primary triggers are a consolidation breakout or an engulfing pattern. The chart below shows the zoomed-in version of the turning point on the AUD/USD daily chart above. I've drawn a blue box around the consolidating price
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action where the market stopped dropping for several sessions. Since the price is still above the former low we're looking for entry signals to go long (buy). In order to catch an up move we want to see some sort of bottoming process first. When the market moves sideways for at least three bars and then begins to move higher, that's the type of pattern we're looking for.
AUDUSD Daily Chart
Our entry candle is marked by the small arrow and our entry price is marked by the horizontal green line. On December 20 there's a big green bar which moves higher than the highest point in the consolidation — the the entry occurred at 1.0027. Remember signals are traded in real-time; don't wait for bars to close. On th December 20 , as soon as the price rose above the highest price in the consolidation, consolidation, a long trade is initiated. Our stop loss goes below the recent 0.9862 low, marked by the horizontal red line, making the stop 0.9857 (5 pips below the low). The risk is (1.00270.9857) 170 pips; our target is 2 x 170 pips = 340 pips, added to the breakout price, giving 1.0367. This target was hit a couple weeks later. 216
Truncation Strategy Considerations The main down side of this strategy is that you don’t know for sure if the pair is actually going to reverse. An uptrend is defined as “higher highs and higher lows” or in the case of a downtrend “lower lows and lower high s.” This strategy jumps the gun in that it only requires a higher low to be present into order to jump j ump into a long position, or only requires a lower high to enter a short position. That said, the trade set-up presents evidence the trend may be reversing (or continuing as the case may be) and the risk/reward indicates we can be wrong more often than we are right and still make a profit.
I advise focusing on short trades where the last swing low was lower than the former swing low, and the price is making a lower high. I advise focusing on long trades where the last swing high was higher than the former swing high and the price is making a higher low. In other words, trade in the overall trending direction. For example, in an uptrend when the price pulls back but stays above the former low. That's a signal I feel good about trading, and the target is likely to get hit. If the trend is up and then I get a lower-high and a trigger, that's a reversal signal (not a trend following signal). I may still trade it, but I'll often use a lower reward:risk such as 1.5:1 instead of the usual 2:1, because I want to get out quicker in case the uptrend re-establishes r e-establishes itself. Day trade the strategy only during the recommended day trading times for the specific pair you're trading. This pattern is very common. You'll see it a lot, which potentially means lots of trades. You may opt to filter some trades out. Applying a filter fi lter with this strategy can be useful. For instance, choose to only take long trades when there's a dominant up trend, or to only take short trades when an overall downtrend is present. This is where understanding the other chapters will help you, especially being able to gauge gauge shifting markets. markets. DON'T TRADE EVERY SIGNAL THAT COMES ALONG. Be selective and look at overall momentum. Be aware of the pair's daily statistics when day trading. If you get a trigger to go long when the EUR/USD is already up 130 pips
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on the day (and it usually moves 100) then the odds of your target being hit even further outside the daily range isn't very likely. Trade triggers and profit targets can also be customized based on the pairs you trade and patterns you notice. For example you may find a 2:1 reward: risk is just out of reach, so a 1.75:1 or 1.5:1 is more favorable. Alternatively A lternatively,, a pair may ma y be trending strongly, and 3:1 ratios are easily attainable for a time. Monitor conditions and adjust the strategy accordingly, typically though 2:1 reward to risk works quite well. In hindsight it's easy to see the market made a higher low and that a long position should've been taken, or a lower high was made so a short position should've been taken. In real-time it'll be unknown whether the market is going to reverse or just pause before continuing on its current course. For this reason the trade triggers are extremely important. From my experience the best trade trigger is when the market pauses for several bars, moving predominately sideways, creating a consolidation as shown in the examples above. We then wait for a consolidation breakout and pounce. Though, often there's no pause. The price simply snaps back the other way leaving you without a trade. The engulfing pattern allows you to capture some of those trades that the “consolidation breakout” trigger doesn't. Both these patterns (consolidation breakout and engulfing pattern) need to be watched for in real-time . If the trend in the AUD/USD is up, you'll want to watch for pullbacks in price in order to buy into that uptrend. As long as the rate is above the prior low you have a potentially higher low. If the trigger develops, then you'll enter into a long trade. Seeing the trigger developed several bars ago may provide some analytical insight, insight, but it's too late to be used for trading trading purposes. Learning when to watch for triggers, being able to see the trigger develop and then pouncing on those opportunities will eventually become second-nature to you. At first though, it may be hard to spot the patterns in real-time; with patience and practice it'll happen.
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17. Channel Breakout Strategy This strategy is based on trend trading. By using the corrections (countertrend moves) to signal the entry, this strategy gets you into the next trending move early. When you get in early your risk is limited and your profit potential is maximized. Watch a trend develop and you'll see pullbacks along the way — brief counter-trend moves that quickly disappear as the trend re-emerges. Entering on these pullbacks can be lucrative, yet most traders go about it the wrong way. They either enter too early when the pullback is still occurring — and and then have to hope the pullback soon reverses – or or they wait till the trend has clearly reestablished itself, but by then much of the trending move may already be over. The following strategy attempts to solve these issues. While it w on’t win every time, this simple correction breakout strategy will help you get into trending moves early, and with a level of safety, since the breakout signals the pullback is likely over and the trend is re-emerging. Trade signals are only taken in a strongly trending pairs. Incorporate your knowledge of trends to isolate when a trend is strong or when it's in jeopardy (more on this later in the book as well). There are two types of corrections we look for. One is called the minichannel and the other is the correction channel. A mini-channel is a very tight and relatively small channel which moves against the dominant trend. The correction channel is a larger structure. It's a pullback that's contained between trendlines forming a channel, and often has multiple price waves. Even though this is a larger structure on our charts, it should be smaller than the prior trending moves. Our goal is to trade with the trend, and wait for a breakout of the channel, signaling the price is moving back in the trending direction. Mini-channels are discussed first, because mini-channels can occur within correction channels. By knowing about both we can fine-tune our entry.
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The Nature of Trends A trend isn't a relentless move in one direction. A trend is a series of strong impulse waves in one direction, separated by pauses or smaller reversals (corrections) (corrections) in the opposite direction. A trend is composed of both impulse waves and corrections. No matter which time frame you trade on, you'll see the market move in 3, 5, 7… wave patterns. A three wave pattern consists of an impulse, a correction, followed by another impulse. A five wave pattern is an impulse, correction, impulse, correction then an impulse. Tack on another correction and impulse for the seven wave pattern. Look at a chart, and with a bit of practice you'll see every trend takes this configuration (figures below). Upon this little insight you can base a powerful strategy. Each correction — which which often appears as a mini-channel or correction — channel — provides a potential potential entry signal into the next impulse wave of the trend. trend. Corrections can take forms other than the channels discussed above. This strategy is only used if the correction takes the form of a channel. This method can be used for day trading or swing swing trading.
Mini-Channel Breakouts The chart below shows the EUR/USD from the open of the US session. From just after 8:00 AM EST till 10:00 AM EST a five fi ve wave pattern develops. I've highlighted it in black for demonstration purposes. The labeling with the numbers isn't important, but is used to show how trends develop in patterns of impulse, correction, impulse, impulse, correction, and so on.
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Figure 1. EUR/USD 5 Minute Minute Chart
Since we know that most of the time a correction is followed by a move back in the trending direction, we can look for corrections to provide potential entry points. Lines 2 and 4 are corrections against the dominant trend (lines 1, 3, 5). We know that line 2 is a correction because it covered less ground than line 1. In order for a trend to occur, a correction must be smaller than the prior impulse (trending) wave, otherwise the price doesn't progress. Wave 3 is much bigger than 2, which progresses the price to the downside. Wave 4 is much smaller than wave 3. Wave 5 is bigger than wave 4, but only marginally, which shows this trend is weakening, and the price did indeed reverse direction after that. We need higher-highs and higher-lows to create an uptrend, and lower-highs and lower-lows to create a downtrend. When one of those conditions isn't satisfied it warns of a trend reversal. Had a short-trade signal (discussed shortly) developed right after wave 5, the trade wouldn't be taken since wave 5 was very weak, barely making progress relative to wave 4 (the correction). Recall from the Chart Patterns chapter that this type of price structure is called a double bottom.
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Once the correction is found we draw lines along the highs and lows of the correction to create a mini-channel (see next chart). As the day continues an uptrend develops (multiple waves), interspersed with mini-channels. I've marked some of these mini-channels on the chart in black. b lack.
Figure 2. EUR/USD 5 Minute Minute Chart
By drawing the mini-channels on the chart, we provide ourselves with potential entry signals. s ignals. In the chart above there are strong st rong moves higher, followed by moves lower (mini-channels). When the price breaks back above the minichannel a long trade is taken. In a downtrend we'll have strong moves lower, followed by corrections (mini-channels) higher. A short trade is taken when the price breaks below below the mini-channel. Unfortunately, not every breakout results in a sharp move in the direction of the former trend, and it's very possible to get false breakouts since the channels are small and we must draw them in real-time. Drawing the channels is also subjective. Comparing charts with another trader at the end of the day, it's unlikely all the mini-channels would be marked the same. Corrections may not always take the form of well-defined channels; 222
corrections may be erratic, and not easily contained between lines. If the correction is more complex than a simple mini-channel like what's shown above, then don't use this strategy.
Stops and Profit Targets Targets To enter a trade using mini-channels look for a strong move in one direction (impulse), wait for a pullback, draw a mini-channel around it, then wait for the breakout to occur in the direction of the impulse. A chapter later in the book about Velocity and Magnitude will greatly aid in the profitable implementation of this strategy. Getting in is only part of the battle; you also need to control risk and plan for a profitable exit. To control risk, place a stop loss 1 pip below the most recent swing low which occurred just prior to a mini-channel breakout in an overall uptrend. Place a stop 1 pip (plus the spread) above the most recent swing high which occurred just prior to the mini-channel breakout in a downtrend. Your risk is the difference difference between the entry price and your stop price. Set your profit target at 1.5 to 3 times t imes your risk. In an uptrend, if your risk is 15 pips, place a profit target at 30 to 45 (2:1 and 3:1 respectively) pips above your entry price. 2:1 usually works well for a quick profitable trade. trade. The next chart shows shows an example with with stops and profit targets. targets.
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Figure 3. EUR/USD 5 Minute Minute Chart
The trade had a 5 pip risk, and therefore a profit target was placed 15 pips above the entry price. If you pay more than 2 pips on the spread then opt to trade slightly larger patterns, using a minimum of 6 pips or more for your stop.
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Figure 4. AUDUSD 5 Minute Minute Chart
The chart above shows another trade in the AUD/USD, which is in a strong overall uptrend. Draw lines around the mini-channel, and enter when the price moves higher out of that mini-channel. For this trade, the risk was near 7 pips and I used a target of 12 pips; a 1.7:1 reward:risk ratio, based on the volatility and tendencies of the pair at that time. There are four other corrections on the AUDUSD chart above where this correction strategy could have been used. This strategy provides many signals, and as trends end and new ones begin is where losses typically occur. When a trend reversal occurs though, often a truncated price swing will appear, providing a warning. Combine the strategy discussed in this chapter with the Truncated Price Swing Strategy and you have a
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powerful combination for trading trends and reversals, and identifying them as they occur. Grasping these concepts will take time. Reading about them isn't enough. Go through charts; put all your trend lines and horizontals on them, as well drawing lines around mini-channels. See how the market reacts to these lines, so you can eventually start determining which of these signals to take and which ones to leave alone. If the trend is choppy and not moving aggressively, then use a 1.5:1 reward to risk ratio, or avoid using this strategy all together. If the trend is moving strongly, then use a 2:1 ratio. 3:1 can be used in very strong trends, but use it sparingly. Better to lock in a profit than end up with nothing. Day traders using this strategy should only trade it during the Best Times T imes to Day Trade (chapter 7). For a mini-channel we ideally want three bars or more in the mini-channel. But this is subjective based on the timeframe being monitored. In figure 3 above the channel is only 2 bars, but that's on a 5-minute chart. If viewing a 1-minute chart the mini-channel is 10 bars, which is more than adequate for drawing a minichannel. Pick a time frame you're going to find signals on, and practice on. Develop rules for how many price bars a mini-channel needs. Once a mini-channel has formed with enough bars, it provides a potential trade signal. If there aren't enough bars to form a mini-channel, there's no signal, because the mini-channel is incomplete. Also, because different pairs are more or less volatile at different times of the day, a 3-bar channel may work well on a 4-hour chart in one pair, but for another pair waiting for 5 or 6 bars to create a mini-channel on a 4-hour chart works better. As with all strategies, some work is required for fine-tuning the method based on the pairs you're going to trade, and what time frame you're going to use.
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Correction Channels Correction channels are larger versions of the mini-channels discussed above. Mini-channels are a collection of bars, but don't contain any significant price swings. Correction channels do have swings, and while they can be seen and traded intra-day, usually these patterns are seen and traded on hourly, 4-hour and daily charts. The reason these appear on longer-term charts is because there must be a strong longer-term longer-term trend trend present. Corrections against the trend won't always be as simple as the mini-channels described above. The price may have multiple waves which move against the trend. This is where things get a bit more complicated; marking up the chart with trendlines and understanding the previous chapters will help. When there's an uptrend, it's possible to have a lower low, followed by a lower high, and then another lower low, but the uptrend still isn't over. Looking at overall price action we see that even though the price entered a short-term downtrend, given the overall longer-term picture, the trend is still up. Confused? Here's a chart showing this concept.
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Figure 5. GBPUSD Daily Daily - Correction Channel in in Larger Uptrend
During this uptrend we have a number of corrections which create lower lows and lower highs. In this case, the upward sloping green trendline shows the progress is still higher, despite a number of these more complex corrections/pullbacks. Let's focus on the channel correction which occurs between the white lines. From the high point there is a lower low then a lower high. Connecting the two high points allows us to draw the top line of the channel. When the price creates another lower low, we connect the two lows to form the bottom of the channel. From this point on, if the price continues to make price swings that are moving lower, this channel gives us an idea of the potential price trajectory. Based on this correction channel though, we're ultimately watching for a breakout higher because the overall trend is still up. up. If the price were to continue to drop and move below the long-term green trendline then we'd need to question that
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assumption, but while the price remains in that correction channel the overall ov erall trend is still up. The entry occurs when the price breaks above the correction channel, back in the trending direction. If the overall trend had been down, then the correction channel would be angled upwards, and we'd enter when the price breaks below the channel back in the trending direction. The chart below shows this. Our stop is placed 5 pips below a recent swing low; usually this is somewhere within the correction channel. Our profit is twice our risk, added to the breakout price. This ratio can be adjusted slightly based on market conditions. Ideally the target should be just beyond the former high when the price is in an uptrend, and just below the former low when trading an overall downtrend. Alternatively, take the width of the correction channel and add it to the breakout point of the channel. This is another an other way to establish a profit target, and can result in a very favorable reward:risk ratio when the risk on the trade is small (2:1 reward:risk ratio may leave leave a lot of profit on the table in this case). Adding the height of a pattern to the breakout point is a method you should be familiar with from the Chart Patterns chapter.
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Figure 6. Correction Channel Channel Strategy
In hindsight this looks very simple, but in real-time when the price moves lower for the first time (inside the white lines) you don't know if the price is going to plummet or form a correction channel like this. Therefore, on that first move lower, since the overall trend is up, you could buy using the mini-channel breakout strategy (when the price breaks above the mini-channel). The second time the price falls, the upper trendline of the channel is drawn. On the second decline another mini-channel breakout trade could have been taken. That one would've gotten you into the long-term trending move higher. There are mini-channels within correction channels; both are tradable. This correction channel in the GBPUSD actually presented three opportunities to get long, given the overall uptrend in the pair.
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Figure 7. Multiple Multiple Entry Points if Mini-Channel Mini-Channel and Correction Channel Channel Entries are Considered Considered
If trading a mini-channel breakout within a correction channel, you can base a profit target on the larger correction channel. If you took the second mini-channel entry, you would've gotten a better price than if you waited for a breakout above the correction channel (third potential long entry). If the price breaks out of the correction channel, then the target can be extended to what the target would be for the actual channel breakout. This would be near 1.70; the target shown in figure 6.
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Mi M i ni-C ni -Cha hann nne el and C or r ecti on C hann hanne el B r eakout kout Summ Summar y Markets move in a continual pattern of impulse, correction, impulse, and so on. Corrections against the trend can be simple or more complex. Simple onewave corrections are called mini-channels, and present an opportunity when the price breaks out of the mini-channel in the trending trending direction. A correction correction channel is more complex because there are multiple waves involved. With this pattern the key is to look at the bigger picture. Even though a correction may result in multiple waves moving against the trend, can that trend still be considered in effect? In the correction channel figures above, the answer is yes. When trends reverse, the impulse, correction, impulse pattern begins in the new direction. While the strategy appears simple in theory, in the real world it's more difficult to implement since you must constantly determine the direction of the trend. Draw the mini-channel lines on the corrections and attempt to profit from the impulse waves that follow. Mini-channels occur frequently on intra-day charts. Correction channels occur frequently on longer-term charts, and will often have mini-channels within them.
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18. Scalping Round Numbers There are price points which cause little pops or drops in currencies (and stocks, commodities, etc). These types of trades aren't based on fundamental or technically driven events; rather these quick “dashes” in price are due to order flow. Order flow is buy and sell orders coming into the market. Certain conditions create an imbalance in the order flow. Imbalances never actually exist, since for each buy someone must sell . An imbalance just means buyers or sellers become more aggressive, clearing out most opposing orders causing a quick move in price. Often this occurs due to stop s top or limit orders being triggered, at highly visible spots on the chart. If a price is reached which has a high concentration of sell stops, a flood of sell orders will hit the market as all those sell orders execute simultaneously. simultaneously. This causes a quick price move, which may or may not reverse just as quickly.
Scalping Round Numbers Numbers Round numbers have an almost gravitation pull to them. 1.3300 is an example of a round number, as is 98.00. Each currency pair has round numbers which often come into play each day, or every couple days, depending on volatility. The price often see-saws through these round numbers. If the USD/CAD is moving higher, approaching 0.99, it's likely it'll move above 0.99 by at least several pips. The same concept applies if the pair is moving lower, and approaching 0.98; it's likely the pair will move lower than 0.98, even if only slightly. This phenomenon provides a scalping opportunity for any currency pair that has intra-day volatility of greater than 80 pips (100+ pips recommended) per day.
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Trading this scalping strategy in pairs with less volatility than this usually isn't fruitful. As the price moves higher toward a round number, go long 10 pips before the round number and exit 5 pips after the round number. As the price moves lower toward a round number, go short 10 pips before the round number, and exit 5 pips below the round number. number. Your goal is to make 15 pips. This why you want to trade pairs which move at least 80 to 100+ pips intra-day; without that movement it's hard to attain 15 pips. These numbers can be adjusted slightly, but for liquid and moving currency pairs the 15 pip target should work fine. Since this is a day trading strategy, s trategy, use it during the Best Times to Day Trade (Chapter 7) for the pair you're trading. Trade with momentum. Buy as the price is moving up towards a round number. Short as the price is is moving down towards a round number.
Scalping is almost an art form. Since profits are small (in pips), risk must be controlled. This is mostly accomplished by waiting for price to begin moving in the direction you want before entering. If you always do this, you should only be showing a loss for several seconds and then immediately be in the money. If you're scalping and your trades are showing a loss, or your loss isn't diminishing within about thirty seconds, your timing is off or there wasn't enough momentum present. The key to scalping is to get in and out with a gain on a quick movement in price, while never really showing a loss on the screen (or only very briefly). Since gains are small, one big loss can be devastating. Get in quick with momentum and have an order already set to get out on the quick price surge. The easiest way w ay to do this is through market buy and sell orders. Some traders don't like these types of orders because they think their broker will rip them off. On the contrary, I use market orders all the time as I like knowing that I'll for sure get in and out. When you go through the broker selection process, choose a broker that gives you the tools to get in and out quickly, set up trades quickly and trade how you need to trade. The Resources section at the end of the book discusses a plug-in for MetaTrader4 which makes placing (and adjusting) orders, stops, targets and trade volume very easy. 234
Don't get greedy and try to make more than the scalping scalpin g strategy dictates. If you become greedy, you're changing the strategy mid-trade. If you wish to hold a trade for a bigger gain, plan the trade beforehand and have the method for doing so written down in your trading plan. If the trade is showing a profit, but doesn't reach your target, and your profit is evaporating, exit before it turns into a loss. Scalping is about quick profits; take any profit the market gives you. The USD/CAD 15 minute chart displays price action from September 13 to September 19, 2011. During this period there were many times the price see-sawed around 0.99, and also around 0.98. There were 22 occurrences where the price got within 10 pips of the round number (after being further away than 10 pips prior). 20 out of 22 times the price made it to the round number. Only twice did the rate move to within 10 pips and then not proceed to hit the round number. Those two instances are circled on the chart. All other trades would have at least resulted in a small profit.
USDCAD 15 Minute Chart
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Here are the main points of the strategy:
Buy within 10 pips of a round number as the price approaches, with momentum, from below. Short within 10 pips of a round number as the price approaches from above, with momentum. Target is 5 pips beyond the round number. Use a market order to get in. If the target isn't hit, use a market order to get out. Don't let a profit turn into a loss.
Enter as price is moving towards the round number — in in scalping you should never be showing a negative position for more than about 20 to 30 seconds. Exit if the position starts to move several pips against you (at any point). Place a worst case scenario stop loss on the position of 10 pips, but this should never be allowed to get hit, it's only a safety precaution.
This is a less structured strategy than some of the others mentioned in this book. Mainly, there's no particular stop (except the worst case scenario stop of 10 pips, but it should never get hit). Since you'll only ever enter this trade with momentum going in your favor , you should be showing a profit quickly. If you aren't, get out! If you are showing a profit, then it starts to disappear and you're about to go negative on the trade, get out! This may mean you make a couple pips, or lose a couple pips on a few trades, but I've generally found that as long as I only enter when the price is moving with momentum in the direction I want — according according to the strategy — 10 10 to 15 pips profit isn't uncommon.
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19. The "Good-Bye Kiss" Strategy The "good-bye kiss" is a great trade setup where risk can be kept quite minimal, there's a good probability of success and the pattern is fairly easy to spot. It takes a lot of patience but we avoid a plethora of bad trades. The good-bye kiss strategy is based on the premise that a legitimate breakout will often "re-test" the old breakout point. This provides an opportunity to get into a trade, and participate as the price likely moves back in the breakout direction. This strategy can be applied to any pattern from which a breakout occurs, such as ranges/rectangles, triangles, head and shoulders, wedges, etc. This strategy was briefly addressed when we discussed the head and shoulders pattern (pullback after the breakout).
1. I sola solatte a pr i ce r ange ng e ( or other her char char t pa patter n). n) . Price ranges/rectangles ranges/rectangles work quite well for strategy. Isolate a price range (or other chart pattern) on any time frame. The range should include several "price swings," meaning the price is oscillating back and forth within a contained area. The swings don't need to create the same highs or lows, although when this occurs the range is easier to spot. Figure 1 shows a daily chart price range in the AUDUSD.
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Figure 1. AUDUSD Daily Daily Range
2. 2. Wai Wai t fo f or the pr i ce to to br br eakout kout and and st stay outsid utside e the the pa patter n for for at at le lea ast 3 or 4 bar s. The real goal here is to make sure the price has actually broken out. In order for a breakout to be legitimate it needs to actually move out of the range a decent distance (this is subjective, and the actual pip amount it needs to breakout b reakout will vary by time frame and volatility) volatility) and stay outside for several bars. Figure 2 shows the type of move outside the range we're looking for.
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Figure 2. Likely Legitimate Legitimate Range Break
On false breakouts the price usually only moves out of a range by a small amount, and then retreats back into the range. In figure 2 there's a very strong breakout and the price moves well beyond the high of the range. This indicates the breakout is likley legitimate. legitimate. The price also stays outside the range for a number of bars before pulling pulling back toward toward the high of the the old range.
3. 3. Wai Wai t for for a pullb ullba ack to to the br eakout kout ar ea and ente nter a trade. In figure 2 the breakout was to the upside, therefore we're waiting for a pullback to the former resistance area of the range. This pullback pu llback is our "goodbye kiss," as the market is coming back to say goodbye to this area one last time. While occasionally the price will pull all the way back to the resistance area (or support in
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the case of a downside breakout), often it'll come up a bit shy (as in figure 2) — it it gives it a kiss from a small distance away. awa y. Place an order in advance near the breakout point, or watch for a manual entry using the consolidation breakout entry or the engulfing pattern entry. The manual entry is best; let the price pullback toward the former range, consolidate, and then trade a breakout of the consolidation back in the trending direction (entry method is outlined in the Truncated Price Swing Strategy) . If a consolidation doesn't form on the pullback, an engulfing pattern can also provide an entry signal. s ignal. Engulfing patterns were covered in Chapter 11. Figure 3 shows how you can use the consolidation breakout method for entering a good bye kiss trade. The price pulls back to our expected entry area and then stalls. The price then moves above the high of the small consolidation (white box), triggering triggering a long position position entry.
Figure 3. Upside Breakout in Expected Area 240
4. Place stops and targets. If you don't wait for the manual entry, and instead place an order just above the old resistance level (upside breakout), or just below the old support level (downside breakout), place a stop loss about 1/4 of the way into the old range. For example, if the range is 100 pips wide, your stop is placed about 25 pips from the breakout point. point. If using the consolidation breakout or the engulfing pattern to enter a good bye kiss trade, then you should already know where to t o place the stop (discussed in those chapters). If buying, place a stop below the consolidation or engulfing pattern low (1 pip below b elow if day trading, 5 pips below if swing trading). If shorting, place a stop loss above the consolidation c onsolidation or engulfing pattern pattern (1 pip above plus the spread if day trading, or 5 pips plus the spread if swing trading). The overall target is roughly equal to the range distance (reduce it slightly). If the range is 100 pips, look for a target between 75 and 100 pips above/below the breakout point of the range. This often results in a 3 or 4 to 1 reward to risk. If using this approach on a different type of chart pattern, calculate the profit target based on that pattern, pattern, as discussed in Trading Chart Patterns , chapter 9. If using a consolidation breakout or engulfing pattern entry you can also use a fixed reward to risk ratio for your target. If going long, choose a fixed reward to risk ratio which results in your target being placed just above the previous swing high. If going short, choose a fixed reward to risk ratio which results in your target being placed just below below the previous previous swing low. For this strategy we're using the same tools you learned before, but applying them to a different trade setup.
Good-Bye Kiss Considerations This strategy is most useful when a breakout has already occurred and you want to get in. Don't chase the price, let it come to you when it re-tests the old range/pattern.
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A potential pitfall is that the strategy can be subjective. How far the breakout must travel depends on factors such as how big the range is, the time frame and how much confirmation you want. Entries can be manual or set in advance near the breakout point. I prefer the manual approach as the stop, target and reward:risk can be fine-tuned when the trade is taken. Also, with a manual entry (consolidation breakout or engulfing) the price is already starting to move in the anticipated direction when we take the trade.
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20. Always Weigh the Probabilities This chapter is a break from strategy. There isn't much to learn, just a few things to remind yourself of while trading. As you've read through this book you've been exposed to trading strategies and a number of different methods for attempting to extract a profit from the market (and there are still more methods to learn). There's an endless number of trades to take, and near infinite ways to plan and execute a trading plan. But when it's all said and done, d one, each trade must be b e looked at and the following determination determination must be made: Are the odds in my favor? A well executed trading plan should put the odds in your favor, but spotcheck your trades to make sure the market hasn't changed, and that the potential reward from the trade outweighs the risk. Assume for a moment you wish to trade a triangle breakout. The triangle has formed inside of a larger range on a bigger time-frame. If a breakout from the triangle occurs, the range's support and resistance levels are close at hand. This may prevent the profit target from being hit, hit, if it rests outside support or resistance. How do you proceed? Assuming support/resistance will break just so our target can be reached is wishful thinking. It may happen, but what's the probability that it will happen? It's not like flipping a coin (I win or I lose) as many like to believe. That's That's like saying the lottery lottery gives you a 50% chance — I win or I lose. In trading there are many variables, and there's no way to calculate or even consider them all. This is why losing trades happen, and they also happen because there's a completely random element to the markets. So what do you do with that potential trade; take it or pass on it and look for better opportunities? opportunities? Consider the the following following example in the the AUD/USD. The daily chart shows an ascending triangle, highlighted by the box. The profit target for this pattern, based on the method described in Trading Chart Patterns (chapter 9), is 723 pips or a rate of 1.1113. If a breakout occurs to the 243
upside we can see two recent swing highs in price right near the 1.07095 area (look toward top of chart of the left). Since our breakout price is at 1.0390 this means that significant resistance will occur before we're half way to our target.
AUD/USD – Daily Daily Chart
The same occurs on a downside breakout. A longer-term trendline line crosses just under the triangle, indicating potential immediate support. How are questions like this handled? How likely is it our profit target will be hit? It's an important question to ask, and should be asked in order to avoid those trades that make you smack your palm against your forehead. Yet, there are always reasons not to take a trade. That's why we always try to make more on our winners than we lose on our losers. In this way we can lose about half the time and still make money; although if we're being selective with our trades and strategies then our win rate should be higher than this. Even pushing our win rate from 54% to 56% over a great many trades makes a huge difference. 244
A problem occurs when we're taking trades where there's almost no possibility that our target tar get will be hit. This is a common novice n ovice mistake. Consider C onsider someone who plays the lottery. In defining a strategy they stipulate that they'll gamble all their savings, $30,000, by buying lottery tickets. $30,000 is equivalent to a stop loss, and they're willing to risk it because if they win they get $1,000,000 — the the profit target. Based on pure numbers that's a fantastic risk/reward ratio. If they win they'll make more than 33 times their money back. Yet logically we know this isn't a good plan, as the odds of winning the $1,000,000 are staggeringly high. So we stand a much greater chance of losing everything than making any money...even though the risk/reward ratio theoretically is great. The odds of losing are much higher than the odds of winning. This is why I use rather small reward:risk ratios (1.5:1, 2:1, 3:1 etc) in my trades. Under certain conditions a trade may end up with a much larger reward:risk, but only if price action and the information within this book tells me it's feasible. I would rather take a trade that has a good chance of hitting my target, than place a much larger target which almost never gets hit. Traders make this mistake all this time. They create outlandish profit targets and expect, or simply want , the target to get hit. If the probability that a target is hit is miniscule it doesn't matter what the risk/reward ratio is, because you'll always lose and your capital will dry up long before a big score is made. Profit targets must be feasible and probable. That doesn't mean we need to make all sorts of calculations (because we can’t compute all the variables anyway) but it does mean we need to look at the market realistically. If the price is going to have to surge more than it has before, or “crash through the floor” to hit our target we're going to end up disappointed more often than not. Big moves do occur, yet it's better to use reasonable profit targets, and then re-enter if the market is offering lots of opportunity. There's always another trade; take profits when your realistic target is hit, as you can always re-enter to make more when the time is right. Based on this information, should the AUD/USD trade be taken? The following is a small check-list you'll want to run through when you first start
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placing trades. Eventually these will become second nature, but at the beginning it's a good idea to check your trading plan, and trades, for these criteria:
Is the target based on reasonable criteria? Did any abnormal events occur on this timeframe that aren't likely to occur again during the timeframe of my trade (such as a financial crisis, earthquake, economic news announcement etc)? If so, have I adjusted for this by basing my outlook on more “normal” market movements?
Is my risk under 1%?
Is my stop at a price that's reasonable and not just arbitrarily picked?
Does it seem feasible, that based on normal market movements (such as daily average pip movements) movements) my target will be hit before my stop? If there's a time limit on this trade (for example, the target needs to be hit before the US session ends), is it likely my target will be hit within that time frame based on the usual volatility of the pair? (See Chapter 14 on Statistics)
Based on these criteria, I'll take the trade. It may lose money, or it may make money — that's that's trading — but since the pattern seems reasonable and all the above questions check out, the trade can be taken. Assuming my trading plan indicates I can take the trade, and that the trade doesn't conflict with other strategies in my trading plan. Ultimately, you need to control risk, but you can't become gun-shy either. When there's a good set up, as long as your stops and profit targets are reasonable, take the trade. No matter what you do, you'll lose about half the time (maybe a bit less or a bit more). Trade good set ups when they come along. Just be sure to keep your risk on each trade to less than 1% of your total trading capital, and your winners bigger than your losers.
What are Realistic and Reasonable Criteria? With so much information being given and received by the market, traders often fall into the trap of making things very complicated. The checklist is meant to 246
keep things simple and reasonable. Avoiding impulsive trades keeps things much simpler than constantly having to figure out how to get out of ill-thought-out trades. Run through the checklist to see how reasonable a trade is. It only takes a few seconds and keeps your trading simple. It may just slow you down enough to stay out of the bad trade which isn't part of your trading plan. Eventually you won't need this checklist because everything on the list will become second nature. Later in the book there's a more advanced technical checklist which you'll use while trading. For now though, read over the checklist above several times so when you start trading you'll already be incorporating those reminders into your trading. Realistic and reasonable are subjective terms, and vary from trader to trader. We each see the markets in a slightly (or vastly) different way, yet this book has attempted to provide ways to trade based on how the market is actually moving, and not on illusions or wishful thinking. A realistic and probable trade takes everything into account that you've learned so far. For example, you may see a great trade set-up, but if you have to place the stop loss at such a distance that it exposes you to more than a 1% loss, you can't take the trade. You may see a great trade setup, but the potential on the trade isn't enough to warrant the risk — don't don't take the trade. You may see a day trade setup but it occurs at a very dull time of the day where day trading isn't recommended — don't don't take the trade. Each trade is a microcosm of your ultimate success. If you're diligent about your overall trading plan, and you're diligent in assessing each trade, then you'll eventually succeed. If you take random trades and aren't focused on every single trade you take, the failure at executing these details will result in an overall failure of not making money. Be precise, weigh the probabilities on every trade (based on what you've learned so far, and what you'll learn in the rest of the book), and execute each trade according to your trading plan with awareness and focus.
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21. Anticipating Chart Pattern Breakout Direction When I originally addressed chart patterns in Chapter 9, I told you not to anticipate the chart pattern breakout direction. Since you were just starting out your forex journey that was good advice. If you've gotten to this point though you know a lot more now than you did back then. Trading chart pattern breakouts is one of the first strategies I learned when I began trading nearly a decade ago. Always looking for ways to improve on trading methods, anticipating chart pattern breakout direction —I call it “front -running”— is an advanced technique for trading chart patterns. The next chapter on Velocity and Magnitude will help you determine trend strength, and assess whether you want to "front-run" breakouts. When the price is moving with velocity and magnitude in a particular direction, the conditions are more suitable to anticipate a breakout in that direction. Trends, trend channels and support and resistance levels will also help you determine in which direction a breakout is likely. likely.
What What i s F r ont-R nt-R unning unni ng a C har har t P atter n Br B r eakout? ut? While there are a number of chart patterns, there are only a few I consider good front-running candidates: triangles, ranges, head and shoulders patterns and consolidations. A flag or pennant is also fine, and for our purposes both these patterns are considered consolidations. Through the examples below you’ll get a good feel for how to trade triangles and head and shoulders in a traditional way, as well as “front-running” the breakouts. You can then use this knowledge for trading other chart patterns. Instead of waiting for a breakout — which which is the traditional approach for trading chart patterns (and is still a good method) — if if we're able to read the price
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action and come up with an expectation for the direction of the breakout, we can greatly reduce risk and increase potential profit by getting a better entry price. The method applies to all markets and time frames. I've included some stock examples, once again showing that many strategies have universal application.
Ant A ntii ci pati ng a C har har t P atter n B r eakout kout Figure 1 shows a triangle chart pattern in Apple (AAPL) stock, along with the traditional way to trade it.
Figure 1. Traditional Traditional Way to Trade Triangle Triangle in Apple Stock, Stock, Daily Chart
Once the pattern is drawn, the traditional method requires waiting for a breakout. In this case we enter when the price breaks below the lower band of the triangle. A stop is placed just outside the opposite side of the triangle, and a target is attained by taking the height of the triangle and subtracting it from the breakout price (add it in the case of an upside upside breakout).
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This method is fine — it it worked here —but we don’t always need to wait for the breakout. Figure 2 shows another triangle in Apple. The stock was in an uptrend, and the price was rallying aggressively prior to the triangle forming. We can anticipate the trend will continue, and that the breakout of the triangle will be to the upside.
Figure 2. Anticipating Anticipating Chart Pattern Pattern Breakout Direction Direction Strategy
Based on the prior rally, as soon as a support line can be drawn we have an approximate entry area. Since we're anticipating an upside breakout, and the price bottom of the triangle. Our stop is isn’t moving below support, we go long near the bottom placed just below the triangle – although although give a bit of a room. Using this method we get a better price than if we waited for the breakout. Our risk is reduced, because the stop is in the same spot as using the traditional method, and our profit potential has also increased because the target is still based on the breakout point. Less risk more profit. Good combination. In figure 2 the "front-running" entry price is about $10 better than the traditional
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breakout price. That's $10 less in risk, and $10 more in profit (per share). That's huge. Figure 3 shows a head and shoulders on a 1-minute EURUSD chart. Once again there's a strong price run leading into the head and shoulders pattern. The head and shoulders pattern is commonly considered a reversal pattern, but if you look closely, you'll often see small head and shoulder patterns that act as continuation patterns. Don't get trapped into conventional ways of thinking. The market is dynamic; read the price action, and use the various entry, stop and target methods outlined throughout this book to pounce on opportunities.
Figure 3. Anticipating Anticipating Upside Breakout on Head and Shoulders Shoulders Continuation Continuation Pattern, 1-Minute 1-Minute Chart 251
Given the prior move higher, the expectation is that the price will continue to rally. Although , we can’t be sure. O nce the right shoulder forms, and then makes a higher low (truncated price swing), it’s an indication that our expectation is correct. Following that higher low, we're looking for any opportunity to get long. The price drops a little again than starts to move higher –that’s the entry The entry is like the mini-channel entry discussed in chapter 17. Notice the downward channel which ends with yet another higher low — more more confirmation we want to go long. The price then breaks above the top of the channel signaling an entry. A stop is placed below the lows of the head and shoulders pattern, or below the recent low of the mini-channel. In this case, our entry is slightly better than waiting for an actual breakout higher, reducing risk and increasing profit potential. When trading a head and shoulders "continuation" pattern in this way, make sure it hasn't actually signaled a top is in place. Had the price dropped below the neckline or the second pullback of the pattern, this long trade would've been avoided. In this case, the head and shoulders started to form, but never broke lower. Instead, the price crept higher h igher (higher lows) — this this is why the long was taken in this case. Since this is a head and shoulders pattern, add the height of the pattern to the breakout point to get a price target. In this case, our entry point and the breakout point are different. Figure 3 shows the entry which occurs in the small rectangle. The breakout point of this pattern would be slightly higher, when the price breaks above a descending trendline connecting the top of the head to the top of the right shoulder. Another "pattern" front-running works well on is consolidations (could be a small range, flag, pennant, or really any pause following a trending move). After a strong trending move it' s common to see the price “drift ,” either sideways or slightly against the trend with little movement. The price is wiggling back and forth within a small area (relative to the trend) and most importantly the price isn’t showing any aggressive movement against the trend to indicate the trend is over.
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The oval in Figure 4 marks a consolidation. The trend is up, and then the price drifts sideways. In hindsight it's easy to spot the whole consolidation, but in real-time you wouldn’t be able to tell the price is moving sideways until several waves have formed and the price is no longer moving to the downside.
Figure 4. Good Consolidation Consolidation for Front-Running Front-Running – EURUSD EURUSD 1 Minute Chart
The consolidation is less than half the size of the last thrust higher; if the consolidation becomes bigger than this then it's not ideal for front-running. If the price is moving sideways, but making big swings, it could be a reversal pattern (double top or triple top), in which case the price is unlikely to break above the consolidation and keep running higher. Once you notice the consolidation, buy near the lows of the consolidation (for an uptrend like in Figure 4 and 5) and then hold it until an upside breakout actually occurs. Place a stop a bit below the consolidation. To establish a profit target, like other patterns, add the height of the consolidation to the breakout price. If the price ends up breaking lower, since you bought near the low of the consolidation (in an uptrend) your stop loss is nearby and your risk is extremely
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small. On the other hand, if the price breaks higher, which often it will, you have one of the best prices and will maximize your profit.
Figure 5. Front-Running Front-Running Consolidations: Consolidations: Entry and Stop
If the trend is down, watch for a similar looking consolidation and enter a short position near the top of the consolidation, expecting the price to trend lower once the consolidation is over. By front running chart patterns and consolidations, we get a much better price, which means our risk is smaller and profit potential larger, when compared to traditional chart pattern entries. By front running we can often make almost double what we would trading the traditional way, and our risk is also a fraction of the traditional way. With front-running, reward:risk ratios of 5:1 or even 10:1 aren't uncommon.
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Guidelines for Anticipating Chart Pattern Breakout Direction In order to anticipate chart pattern or consolidation breakout direction, there needs to be a strong move prior to the formation of the pattern. We expect that the breakout will occur in the direction d irection of that prior move. As a general rule , I want to see strong price movement prior to any chart pattern , whether I end up trading it in a traditional way, or front-running it. Without a strong move prior to the pattern there’s no evidence that traders care about the price, and therefore, breakouts are more likely to fail or not reach the target(s). For a front-running entry we want some confirmation of our expectation. In the event of an upside breakout, we want to see the price hold above the support of the pattern, as it did in the examples above. In the event of a downside breakout, we want the price to hold below resistance of the pattern. This sometimes means we won’t be able to front -run; the market simply opportunity. Refer back to figure 1. By the time w wee can actually doesn’t give us the opportunity. draw the triangle (we need at least two price swings) the price breaks lower before pulling back to the top of the triangle. Therefore, sometimes trading chart ch art patterns in the traditional way is the only option.
Pay attention to larger price structures. The price may be rallying higher in the short-term, but the longer-term trend is down. The most likely breakout direction isn't always the direction of the last price move. If the price rallied into a resistance area, front-running a breakout lower may be a better trade than frontrunning a breakout higher. Consider the micro and macro price action when deciding in which direction to front-run. The Crotch Strategy and Trend Channel Strategy discussed later provide more details on times when you will expect the breakout to occur occur in the opposite opposite direction of the recent price wave. wave.
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Ant A ntii ci pati ng C har har t P atter n B r eakout kout D i r ecti on – Final Considerations No matter what or or how we trade, losing trades trades occur. While some may may argue that waiting for a breakout is safer, breakouts can fail and result in losses as well. Anticipating the breakout direction reduces risk. Profit potential is also increased. Learning how to read the market, and account for all sorts of other factors — such such as near-by major support and resistance levels, tendencies and short and long-term trends — will will take time. If you find your expectations are wrong quite often, or you’re unable to capitalize on the opportunities that come along, you’ll likely do better by waiting for the actual breakout to occur. This is only a strategy, and like any strategy, must be combined in your overall trading plan and practiced (a lot!) for it to be successful. It’s your trading plan that' ll help you determine which trades to take, leave alone, front-run or trade in the traditional way .
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22. Interpreting Price Action: Velocity and Magnitude This chapter is what I call an "odds enhancer." You know a lot of strategies now (and there are more to come), and many of those strategies provide guidelines for when you should trade and when you shouldn't. This chapter, on two of the crucial elements you should analyze when determining when and how h ow to trade, will help you with implementing those guidelines. A trend following strategy has a better chance of success when the price is moving with both velocity and magnitude in the direction of the trend. When velocity and magnitude are both present in a trend, the odds the trend will continue are improved. With greater insight into the trend, decisions become clearer, such as deciding whether to front-run chart pattern breakouts.
Velocity and Magnitude: Why They’re Important Every price wave within a trend can be judged based on velocity and magnitude. Throughout the trend, assessments are made about the probability of trades in regards to that trend. If a trend is strong, based on velocity and magnitude, we know we want to take the next valid trade signal (based on our trading plan) that'll get us into that trend. If velocity and magnitude are weakening, the trend may be ending and the next trade signal may be filtered out, or our expectation/target for the trade lowered.
Ana A naly lyzzi ng P r i ce A cti on: Ma M agnit gni tude ude Magnitude, in regards to analyzing price action, refers to the length of price waves, relative to other price waves of consequence. If the price runs for a long way in one direction without a significant pullback, that run/wave has strong/large
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magnitude. During a trend we want to see waves of larger magnitude in the trending direction (called "impulses"). Short waves have small or weak magnitude. The price isn't moving aggressively. aggressively. During a trend, pullbacks should have weak magnitude relative to the impulse waves of the trend. When pullbacks become as strong as the impulse waves, the trend is in jeopardy of reversing (or has already).
Figure 1. Analyzing Price Price Action using Magnitude: Magnitude: GBPYJPY 1 Minute Minute Chart
Magnitude isn't measured in absolutes, it's always relative. Waves are measured against recent waves, as well as the overall outlook. In figure 1 the trend is down, as the impulse waves are larger than the smaller pullbacks. Toward the middle of the chart there are some stronger pullbacks, relative to recent down
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waves. While this may deter us from taking a short position for a period of time, looking at the overall outlook the pullback isn't big enough to rival the major down waves. Here are some basic guidelines for analyzing price action with magnitude:
The trend is confirmed by waves of large magnitude in the trending direction. A reversal has begun, or a deeper pullback is underway, when a wave of large magnitude (relative) (relative) occurs against the prior trend. A trend may be losing momentum if small waves start to occur in the trending direction. The trend isn’t over yet though, it's just weakening. I t’s possible to have several slow waves in the direction of the trend, only to be followed by wh y we w e don’t another strong wave renewing the strength of the trend —this is why assume the trend is over just because there are small waves in the trending direction. Pullbacks of small magnitude, relative to the larger impulse waves of the trend, confirm the trend.
Compare a pullback to other pullbacks, impulse waves and the overall trend. Do the same for impulse waves; comparing them to other recent impulse waves, recent pullbacks and the overall trend. View another time frame as well. If trading off a 1-minute chart (figure 1), view a 5 minute chart also. Doing so provides a broader perspective, and you may notice some relative strengths or weaknesses in waves that you hadn’t noticed o n the shorter time frame chart.
Ana A naly lyzzi ng P r i ce A cti on: Ve V eloc loci ty Velocity is how fast price covers distance. Use velocity in conjunction with magnitude. A very fast price move, that covers a significant distance (relative), shows greater conviction than a move that progresses very slowly.
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Figure 2 shows the same chart as above, yet we can also use velocity to analyze this chart in conjunction with magnitude. Moves down (trend direction) aren't only larger than pullbacks, but they occur faster than the pullbacks — the the impulse waves down cover more distance in less time. Having magnitude and velocity on the side of the market you're trading is ideal (ie. taking short positions when strong velocity and magnitude are to the downside).
Figure 2. Analyzing Price Price Action using Magnitude Magnitude and Velocity: Velocity: GBPYJPY 1 Minute Chart
Velocity is most applicable when combined with magnitude. A short burst of velocity isn’t particularly important, since it could j ust be one or two big orders
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being filled in the market. A move of large magnitude which also has velocity shows a lot of power and conviction, and may either confirm the trend (if in the trending direction) or indicate a reversal (if moving against the tr end). sub stantial velocity (relative (rela tive to recent price pric e Extremely large moves with substantial action) usually indicate a news announcement or unusual event. In such cases, technical analysis is generally useless, and it's recommended traders step aside until valid signals based on more stable s table market conditions emerge.
Ana A naly lyzzi ng P r i ce A cti on – H H ow to Use T his hi s I nfo nfor mati on Analyzing price action is the constant task of adjusting to new information. Develop some guidelines or rules about velocity and magnitude in your trading plan. While these concepts are relatively simple to understand in theory, I consider them advanced trading techniques. Analyzing velocity and magnitude requires strong focus to stay on top of changing market conditions. Agreeing that something works is very different than actually being able to use it in real time trading. Practice, practice, practice. Go through historical charts and analyze velocity and magnitude and how it impacted the trend, as well as how these factors could be used in conjunction with other strategies. Then proceed to marking up charts in real-time, noting changes in velocity and magnitude, and how those changes affect the price waves that follow. Note how velocity and magnitude could be used to find and filter trading opportunities. Velocity and magnitude are constantly in flux. Look at an overall picture of what's occurring, as well as note details about each wave. This is the study of current price waves relative to recent price waves. Even though studying velocity and magnitude gives us an edge, there's still an element of uncertainty. Everything can look great and you can still lose. By analyzing price action based velocity and magnitude — and and being able to effectively act on the information you interpret — hopefully those losing trades will happen slightly less often.
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23. "Strong" Support and Resistance Resistance and the Crotch Strategy Support and resistance are words that get tossed around a lot, and traders and analysts will mark up their charts with all sorts of supposed support and resistance levels. Most of these levels have minimal impact on the price. Understanding what a STRONG (important) support or resistance level is helps you isolate better trading opportunities and avoid likely losers.
Minor (inaccurate) Support and Resistance When most people mention support or resistance they're often looking at a recent swing high or swing low on the chart. Do these highs and lows provide any useful trading information at all? In Figure 1, an indicator has been added to the chart which marks short-term high and low points with red (resistance) and blue (support) lines.
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Figure 1. EUR/USD 1 Minute Minute Chart
The first thing to realize is support and resistance levels, especially these minor ones based on short-term highs and lows, are likely to be broken relatively easily. During an uptrend we expect the recent highs to be broken as the price moves to a higher high (definition of uptrend). During a downtrend we expect the the price to move below recent lows (definition (definition of downtrend). downtrend). While minor highs and lows may provide trend confirmation (per above), they do little to actually stop price from advancing or declining. Just because the price recently stopped s topped rising or falling at a t a certain point doesn't d oesn't mean that point is likely to stop the price from rising or falling in the future. For that we need more stringent criteria.
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STRONG Support and Resistance Resistance Certain levels are more likely to stop the price from rallying or falling — STRONG support and resistance levels. these are called ca lled important or STRONG While we expect these levels to also break at some point, they deserve more respect. Show these levels respect by:
Not taking a short short position when when the price is right right above STRONG support. Not taking a long position when the price is right below STRONG resistance. Going long very close to STRONG support (crotch strategy, discussed below). Going short very close to STRONG resistance (crotch strategy, discussed below).
Those are a few of the trading guidelines I follow when trading around an important support or resistance level. Important/strong support and resistance levels are price regions that changed the direction of the market in a significant way . In figure 2, regions that caused reversals are marked on the chart with white boxes.
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Figure 2. EURUSD 5 Minute Minute Chart with with Important Support Support and Resistance
As soon as the price significantly reverses direction the area is marked with a box (or lines), such as those in figure 2. The box is extended out to the right until broken (could be a very long or very short time). Learning to utilize this method will take time and practice. In order for a bounce off support to be important, the price must make at least two higher swing lows and two higher swing highs (on whichever timeframe is being traded). The move away from support shows the price reversed off the level. In order for a bounce off resistance to be important, the price must make at least two lower swing lows and two lower swing highs (on whichever timeframe is being traded). The move away from resistance shows the price reversed of the level.
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This guideline is subjective though. In order for an area to be strong it must reverse the price. Two waves in the opposite direction is just a rough guide. A very big one wave reversal (relative to surrounding price waves) is also fine. Look at figure 2. Each of those boxes changed the overall direction of the market...that's what we're looking for, and what we want to mark on our charts. Don't get too caught up in whether a reversal is one, two or three waves etc, just ask yourself if the trend reversed off a level. If it did, the level is strong. Moving from left to right on the chart, the price is moving higher and then witnesses a significant drop. Since this area caused a significant reversal it's marked on the chart (1). While there's no guarantee this area will stop the price from rising in the future, it's quite possible the price will struggle to get through the area. After the sharp drop the price bounces aggressively and makes two higher swing highs and two higher swing lows. The area that started that bounce is marked as strong (2). The price then drops again — which which you'll soon learn to use as an entry point — and then bounces aggressively. — and Before breaking through (1) the price moves lower and then rallies aggressively off (3). Level (3) also proves important toward the left of the chart as the price bounces off it again. (4) marks where an aggressive rally died and reversed (at least two lower swings highs and two lower swing lows). In the future, when the price approaches this area, it should be treated with respect. If a level is drawn and the price moves aggressively through it ("breaking" it), it can be deleted as it's no longer relevant. Resistance marked (1) was broken by an aggressive move higher; once that occurs it can be deleted. The exception is if the strong levels are marking a chart pattern, such as a range. In that case you may wish to leave the levels on the chart to remind you of the potential for a Good Bye Kiss Trade (chapter 19).
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How big a support or resistance area is depends on the size of the crotch — sounds bad, I know. The crotch is simply the bars/candlesticks which compose the reversal point.
Figure 3. AUDCAD Daily Daily Chart - Crotch Marking Marking Strong Resistance Area
On the left the price is trending higher, but as it reaches the 1.02420 area it stalls out and declines. We don't know this area is strong until we see the price fall, making two lower swing lows and two lower swing highs. As soon as we see that we can mark the area as strong with the two horizontal lines or a box. The spacing of these horizontal lines — showing showing how big the strong resistance area is — is is determined by the "crotch" size which caused the reversal. This area is highlighted blue. It doesn't need to be exact; you just need to encompass the highs and lows of several candles which were present at the turning point. Notice how the blue box encompasses the majority of the price action at the turning point? The box determines the size of the resistance area (or support area in the event the price was falling and then reversed higher). Sometimes this will be multiple price bars, as in this example, other times it may only encompass one price bar if the the price very quickly reversed off off the area. 267
Since this area caused a trend reversal (two lower highs and two lower lows on our time frame) when the price moves back to that area it's likely to struggle. We can see this occurring when the price rallies back into the strong resistance area in the following months. This information presents both a trade filter for other strategies, and also provides its own trading strategy (discussed below). be low). As a filter it helps you avoid taking short trades right above strong support, or taking long trades right below strong resistance. We know that the price is likely to struggle to get through these areas, therefore, buying near strong resistance or shorting near strong support isn't a high probability trade.
R evi ew of ST R ONG ON G Supp uppor t and R esist si sta ance These types of levels deserve respect, so alter your trading around them. Isolating strong support and resistance areas is much cleaner, and provides more relevant information, than drawing tons of unimportant high and lows on the chart. How big you draw the areas will depend on volatility and the timeframe you are trading on. Every strong support or resistance area will be different based on the "crotch" size that caused the reversal.
The Crotch Strategy You now know where strong support and resistance areas are; next you need to leverage that knowledge into a trading strategy. This strategy is simple, and highly effective. A nice thing about this strategy is that we can see strong support and resistance areas before the price comes back to "test" them. That means we can set our entry orders (along with stops and targets) near the strong support or resistance area and forget about them. It's a non-time-consuming -time-consuming strategy. The entry, stop loss and target rules are as follows:
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Mark strong support or resistance levels on the chart with a rectangle. The support/resistance support/resistance area is as wide w ide as the "crotch" which caused the reversal. For a strong resistance area, place an order to go short at the bottom of the strong resistance area (bottom of the crotch). Place a stop loss 5 pips above (plus the spread) the high of the strong resistance area. Place a target at 2x the risk. If the entry point is 1.2150 and stop is at 1.2250 (100 pips of risk) then the target is at 1.1950 (200 pips below entry point). For a strong support area, place an order to go long at the top of the strong resistance area (top of crotch). Place a stop loss 5 pips below the low of the strong support area. Place a target at 2x the risk. Once a strong resistance area has been established, and used for a short entry, the price must make a lower major swing low in order for the resistance area to be used again. For example, if you go short, and the price hits your target but doesn't make a new major swing low, if the price rallies back to the strong resistance area, don't enter another short trade at that area. If the price does make a new major low, and then rallies back to the strong resistance, you can use the same area and method described described earlier to make a second short trade at the strong resistance area. You can make a maximum of 2 trades at a strong resistance level; avoid taking a third. Once a strong support has been established, and used for a long entry, the price must make a higher major swing swing high in order for the support area to be used again. For example if you go long, and the price hits your target but doesn't make a new major swing high, if the price falls back to the strong support area, don't enter another long trade at that area. If the price does make a new major high, and then falls back to the strong support, you can use the same area and method described earlier to make a second long trade at the strong support area. You can make a maximum of 2 trades at a strong support level; avoid taking a third.
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Figure 4. EURNZD Daily Daily Chart - Crotch Strategy Strategy Entries and Stops Stops
In figure 4, the price is trending higher then falls. The initial decline sees a quick spike back into the strong resistance area. Since we hadn't had two lower swing highs and two lower swing lows at this point, this wouldn't have been a trade (the price hadn't fallen enough to even alert us that there's a strong resistance area there). But we still must make note of it, because it was a "test" of the strong area, even though we wouldn't have traded it. The price then continues lower, creating the lower lows and lower highs needed to confirm that this is indeed a strong resistance area which caused a reversal. With this information we then set our short entry order at the bottom of the crotch (red entry line) and our stop 5 pips, plus the spread, above the crotch high (red stop loss line). The price rallies into our order, but the price ultimately can't get through the strong resistance area. The price falls, hitting our target (shown on chart below). The price rallies again, but we don't put out any orders to go short again. The area has already been tested twice (even though we only took one trade off of it), and we don't assume a strong area will hold for more than two tests. It may, but all strong areas eventually break, and by the third re-test the odds on the trade are 270
reduced. When the price rallies to the strong resistance area a third time it blows right through it...that's why we don't trade a third test of a strong area.
Figure 5. Crotch Strategy Strategy with Entry, Stop Stop and Target
A 2:1 reward to risk ratio is used on this trade because that's what seems to be the most effective ratio in my experience. The 2:1 ratio will usually get you out of the trade before the price encounters another strong level. Don't take a trade if your target is beyond another strong level. Also, the 2:1 ratio gives us a profit, and if the price does continue to run, then we can always use one of the trending strategies in this book to capitalize on that. This strategy captures a bounce off strong support or resistance, warns us when trends may halt (filters trades), but isn't meant to capture major trends. That's what trend following strategies are for. In Figure 5, our target is near a potential strong support area. Off to the left there's an area that caused the price to reverse higher. So the target is in a good spot; we still capitalize on the short position, yet we're respecting the fact there's a potentially strong level near the target price. The price ultimately fell right through this strong support area, but at the time of the trade we couldn't have known that would happen. 271
Usually there's a directional bias that tells you in which direction to trade. When this snapshot of figure 5 was taken the pair was in an overall downtrend, so going short at resistance is more logical than going long at support. Whenever possible take trades that align you with the overall trend, if there is one. In this case, only the short trade was taken at strong resistance, and no longs were taken at strong support, yet you still need to respect that strong support area.
The Crotch Strategy and "Rangey" Pairs Currency pairs can be split into two broad groups — those those that contain the USD, and those that don’t. As the world’s reserve currency the USD has a tendency to trend, so pairs containing it also tend to trend. Even when a pair such as the EUR/USD enters a ranging environment, that range is unlikely to last for long. Time is better spent focusing on trends in USD pairs, than attempting to profit from ranges which may occur. Trying to range trade a pair that has a strong tendency to trend can be very frustrating. Moving to the opposite spectrum, pairs that don't contain the USD are generally more ranging in nature. This doesn't mean trends don't occur in such pairs, they will, but often you'll see the trends are within the context of a larger range, or the ranges will last a long time. Ultimately you want to put yourself in the highest probability trades. That means employing strategies in pairs which are more statistically suited to the strategies you're using. The crotch strategy is ideally suited to "rangey" pairs . Each currency pair has its own “personality.” Whether you're a swing trader or a day trader, it's important to look at how a pair acts on multiple timeframes. Even a day trader will benefit from seeing how a pair acts over a five or ten year period. Why? The trader trader can see where the tendencies tendencies lie. One pair may range over a 10 year period, but on a shorter time frame appears to trend. Another pair may appear to range on a short-time frame but is actually a trending currency most of the time.
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Ranges in Similar Economies Range trades and ranging strategies are more likely to work out in currency pairs that involve involve countries/economies countries/economies that are similar. similar. Australia and Canada for example have similar commodity-based economies. Pulling up a chart of the pair reveals that over the long term the currency rate between these these two countries countries is fluctuating fluctuating in a range. Trends do occur, but within a broader ranging context.
Figure 6. AUDCAD Monthly Monthly Chart
The EURGBP is another pair susceptible to ranging behaviour. Closely linked economies mean the price of the currency pair will bounce around in a
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choppy range, until such a time as either the EUR or GBP moves into favor based on fundamental conditions. A breakout and trend occurs, followed by another generally long-term range.
Figure 7. EUR/GBP Daily Daily Chart
If a trader can seamlessly move from a trending to ranging strategy, it won't matter what pairs they trade. Yet this is what many traders find frustrating about trading. They lose money when the market shifts, assuming what happened before, whether it's a trend or a range, will continue. If you struggle with this, refer back to the Trendlines, Horizontals and Shifting Markets chapter, which will help you to identify when markets are shifting. The "Crotch" trading strategy is especially effective in trading these types of "rangey" pairs — in in my experience the AUD/CAD and EUR/GBP have provided some of the best trades using it. The crotch strategy isn't as effective in trending pairs (trends that aren't within the context of a range).
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For trending pairs use the trending strategies, although you may find elements of the crotch strategy still useful in trend trading. Strong support and resistance areas still exist in trending pairs, and should be respected.
Time of Day
Note: All times in EST (may need to adjust for day light light savings)
While the EUR/GBP and AUD/CAD (as examples) are often ranging pairs overall, intra-day this tendency may not always be apparent. Depending on the time of the day the pair can be quite erractic, and at other times move more rythemically within a range. From the chart below, which shows two days of price action on a 5 minute chart (London session in yellow and US session in blue), you can see that typically the pair is quite calm and range bound during the US session, but can be more "trendy" or erratic during the early part of the London session (subject to change). One problem with the EUR/GBP is that typically these ranges that develop in the latter part of the London session and the US session are only 7 to 10 pips wide (subject to change). Unless you trade through an ECN broker with low commissions and very tight spreads, trying to trade such a range isn't worth the risk.
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Figure 8. EUR/GBP 5 Minute Minute Chart
Another alternative is the AUD/CAD. It typically has a more ranging environment throughout much of the 24 hour period, although I always recommend trading when a major market is open. From the 15 minute chart below, even when this pair is trending, the movement is typically choppy and confined to channels. While that dynamic isn't present all the time, and may change for periods of time, quite often this intra-day channeling can be found in the AUD/CAD which works well for the crotch strategy.
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Figure 9. AUD/CAD 15 Minute Minute Chart
Just because these pairs have more of a tendency to range, doesn't mean they don't experience trends or sharp price changes — they they do. Just probabilistically probabilistically pairs like these are more likely to experience ranging behaviour than a pair like the EURUSD, for example. This is why pairs that move like the EURGBP and AUDCAD typically work best with the Crotch strategy, and pairs that move like the EURUSD work better with the trending strategies strategies in the book. Remember that pairs which include the USD have a higher probability of trending, and pairs without the USD have a higher tendency to move in a more ranging fashion. fashion. Also, countries countries that have similar similar economies economies are also more likely likely to range (move between strong support and resistance). Unless something drastic occurs which changes the dynamic between countries, the rate between the two economies should stay within a band of activity reflecting the economic correlation. The time of day is also very important to short-term traders. If day trading the crotch strategy make sure there is enough movement to warrant taking a trade.
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At the time of writing, pairs which favor the crotch trading strategy include the EUR/GBP, AUDCAD, EURNZD, EURCHF, GBPCHF, AUDNZD, CHFJPY, GBPCAD and NZDCHF. Some of the time the GBPNZD, EURJPY, AUDCHF, GBPAUD and GBPJPY are also good for this strategy, but only if the price is moving within the context of a larger range or channel. If there's a longer-term direction bias, always favor trades that align with the directional bias.
F i nal nal Wo Wor d on the the C r otch Stra Str ategy The crotch strategy requires an understanding of strong support and resistance. A strong area is one which caused a significant price reversal. I've loosely described a trend reversal as two waves in the opposite direction of the prior trend. This is somewhat subjective since it's possible to get two waves without the price really reversing, or you could get a big one wave reversal. This is why you must practice this technique (and all other techniques in this book). Combined with what you have learned about trends, and with a bit study, you'll be able to apply this strategy quite effectively. Be more stringent than lenient with this strategy. Look for major reversals off price levels. The bigger the reversal, the stronger that level is, and the more likely it's going to hold next time it's tested. Figure 10 below shows an example of this. This is a "good look" for this strategy. When the chart looks like this, trade the strategy without hesitation. It'll be difficult to condition yourself to buy when the price is falling toward you, or sell when the price is rallying into you, but when you see how effective this strategy can be, those doubts should melt away. This is why you start out in a demo account, so you can condition your mind without risking real capital. Until you can effectively and consistently profit from this strategy in a demo account, don't trade it with real capital. This also allows you time to compile your own list of pairs which have the "rangey" movement we want for this strategy. Another trade entry option is to let the price enter the support or resistance zone, then wait for a consolidation and trade the breakout from the consolidation (only if the breakout occurs in the anticipated direction). This entry method
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incorporates elements of other strategies you've learned so far. This alternative is a fine approach, yet may result in missed trade signals since the price often spends very little time in the support or resistance zone (see figure 10) and doesn't have time to form a proper consolidation.
Figure 10. Big Reversals Reversals and Moves, Strong Level Still Still Holds
Don't become too attached to a strong level. Once it's been tested twice, don't use it anymore. Even if you didn't end up trading the tests, they still count. Once a level has been tested twice, the chances of that level breaking increase. increase. Once a level is broken, if another strong zone develops in that same area again, we can use it for another two tests. Since we're using rangey pairs for this strategy, strong support and resistance will often often develop in similar areas as before. The Crotch strategy is best used on the rangey pairs discussed in this chapter, and isn't ideal for trending pairs even though some of the elements from this strategy may help you with trading trends. Use the trend following strategies in this book for trading trending pairs.
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24. The Trend Channel Trading Strategy Earlier in the book mini-channels and corrections channels were discussed. There are also trend channels. You'll find that markets move in trend channels quite often. The trend channel trading strategy isn't complex, yet it'll draw on all you've learned so far and help you incorporate it. The simplicity of the strategy makes it highly effective. The key to a trend channel trade is isolating trend channels on the chart. Each night, I go through 1-hour and 4-hour charts (occasionally daily charts as well) of the pairs I trade and place trendlines wherever I can. This allows me to s ee where channels are. Some of these may be correction channels, and others may be trend channels. A trend channel is when the bulk of the trend on your screen is represented by angled parallel lines, either up or down. The trendlines don't need n eed to perfectly match the highs and lows in price, in fact, trying to draw trendlines this way is discouraged. Instead, the trendlines should be lines of best fit , running through the majority of the highs on the top of the channel and the majority of the lows near the bottom of the channel. The trendlines only act as a guide for — or or an approximation of — the the channel. In a downward trend channel, when the price is near the top of the trend channel, be on high alert for shorting opportunities. In an upward trend channel, when the price is near the low of the trend channel, be on high alert for buying opportunities. When the price is near the middle of the channel avoid trading. If the trend channel is down, avoid going long, even at the bottom of the channel. If the trend channel is up, avoid going short, even at the top of the channel.
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The trend channels acts as an excellent filter, helping you stay out of the market when probabilities don't favor a position. The trendlines also provide a rough guide for when it's time to act. You already know the basic entries for this strategy; it can be a number of the entry methods already discussed in this book: engulfing pattern, consolidation breakout, mini-channel breakout or even a correction channel breakout (if the correction channel occurs within a larger trend channel). The stop loss placement is also the same as most of the strategies addressed so far. If day trading a downward trend trend channel, place the stop loss 1 pip (plus the spread) above the recent high, which is near the top of the channel. If day trading an upward trend trend channel, place the stop loss 1 pip below the recent low, which is near the bottom of the trend channel. The same goes for swing trades, except the stop is placed 5 pips away from the recent high (plus the spread) and low. Targets vary based on the pattern, although typically 2:1 to 3:1 will end up being used. The target is placed p laced on the opposite side of the channel at the time the trade is made. If the risk is very small and channel large, reward to risk ratios can be up to 5:1 (or even slightly more), although most channels yield trades in the 2:1 region. This is not because we force that reward to risk ratio on the market, rather, the price movements which indicate where to place our entries, stops and targets yield this ratio. Here are a few examples of potential entries in a rising trend channel. The entries all occur near the lower trendline, and utilize engulfing patterns or consolidation breakouts.
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Figure 1. Trend Channel Channel Entries
It's quite possible that if you took the second trade, you wouldn't have taken the third, since you'd still be in a trade. The price didn't reach the top of the channel between the second and and third trade, so the target target wouldn't have been been reached on the second trade. It did reach it a short time later though. Figure 2 shows the second trade in more detail. The stop loss goes below b elow the recent low. The entry occurs as the price crosses above the high of the recent candle. The target is near the top of the channel — the the top of the channel at the time of entry that is.
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Figure 2. Trend Channel With With Entry, Stop and Target
This trade resulted in a more than 3:1 reward to risk. Notice how the target (thin blue box) is based on the high of the channel at the time of the trade. It isn't altered as the channel progresses. Remember, we draw channel trendlines as rough guidelines, not exact targets. If we keep adjusting the target to match the trendline it may never get hit. Leave it where it is. If the trade provides 2:1 to 5:1 reward to risk, that's more than sufficient. Greed usually results in ending up with nothing. Remember Figure 3 below from the mini-channel and correction channel chapter? It's the same chart, except now we can see the correction channel is within an even larger trend channel. The trend channel helps refine our entry. Where there were originally three entry points using mini-channel and correction channel breakouts, by only taking a
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long trade near the lower trendline of the trend channel, we're left with only one entry...the best one in this case.
Figure 3. Trading a Correction Channel Within Within a Trend Channel
The consolidation breakout works well for this trade, as the price forms a consolidation above the lower trend channel trendline and above the lower trendline of the correction channel. A stop is placed 5 pips below the consolidation low once the trader is triggered (breakout above the consolidation) and a target is placed at the top of the trend channel. The top of the channel at the time of the trade, that is. This trade resulted in a more than 3:1 reward to risk. Another nice thing about trading with trend channels is that they'll usually let you know when the overall trend is over. Look at the chart above. We assumed that the overall uptrend would remain in place, that's why we look for a long position in the corrective corrective channel near the bottom of the the longer-term trend channel. What if the price broke lower, instead of higher? That would alert us that the trend
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channel either needs to be adjusted, or it very well could be broken and no longer relevant. If the corrective channel just keeps dropping, in this case, below the trend channel, a new trend has likely emerged (down) or at minimum the trend is in question and we should step back and avoid trading.
T r end C hanne hannell Tr T r adi ng Str ateg y S umm ummar y This strategy combines many prior elements you've learnt about, and combines them. Using trend channels is a great way to eliminate a lot of confusion from trading, as it simplifies the process. Once a large trend channel has been found, only take long trades near the lower trendline if the trend channel is up, and only take short trades near the upper trendline if the channel is down. Use other techniques you've already learnt: place stops in the same place we've used for a number of strategies, and targets go on the opposite side of the channel at the time of the trade. The reward to risk on this trade should be at least 2:1, and typically that isn't difficult to attain if the entry is executed effectively and the stop placed in the proper location. location.
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25. Psychological Pitfalls You Need to Understand People can spend their entire life looking for something, not realizing the answer was looking back at them every morning in the mirror. All the work put in to understanding the market won't matter if you don’t understand yourself. Approaching trading with the right psychology is paramount to your success. Each trader must take a personal inventory and find a way to accommodate their personality, tendencies tendencies and habits habits and make it all fit with their trading. What follows are some key points on trading psychology. Psychology plays a huge role in trading success. You can have the best strategies in the world, but if you get fearful in trades, greedy, hopeful or angry, you're going to deviate from that strategy and it'll cost you. A great trading psychology book is Trading in the Zone by Mark Douglas (listed in the resources section at the end of the book). It covers more advanced psychological topics, and is a recommended read once you've been trading with real capital for several months. Trading real capital should be at least several months away if following the five step plan laid out at the beginning of the book, so you have time to absorb the content in this book before reading that one. Articles on specific trading psychology issues — such such as trading not to lose, loss aversion, biological factors, trading anxiety, availability bias, building the right mindset, etc — can can be found at: http://vantagepointtrading http://vantage pointtrading.com/tutorials/t .com/tutorials/trading-tutorials-tradi rading-tutorials-trading-psychologyng-psychologyarticles
How Not Losing Keeps You From Winning Losing is inseparable from trading. Losses do occur, and trying to avoid losses leads to ruin. Whether you're a day or swing trader, not accepting losses is a recipe for disaster. Great traders know losses occur, but they plan for losses and
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have an exit strategy. This exit plan is critical, and failing to have one is where most traders end up going wrong in their trading careers.
Avoiding Losses
Humans have a tendency to avoid loss. In terms of trading this often results in a delayed reaction to realizing a loss. Losses are allowed to "fester" and the trader shifts into “hope” mode. m ode. The “hope” mode results from the trader wanting to get back to breakeven on the losing trade. If you find yourself in this mode, where you're praying just to get back to breakeven, it's already too late. Get out now. At best you'll only breakeven, but you could lose your entire account trying to do so. It also shows a trading plan wasn't implemented or followed. In Beyond Greed and Fear, Hersh Shefrin discusses a study where people generally view a loss as having 2.5 times the impact of a gain of similar magnitude. In other words, a $1000 gain is one thing, but a $1000 loss in psychological terms feels more like a $2500 loss. Being wrong has an impact on the ego, not to mention, losing money means we have to forgo an opportunity to use it for something else. Profit is money you didn’t have any way, but money you lose is money you already had and no longer have. This stings, and is a psychological reason why traders don’t want to realize their losses when they should. Admit right now that losing is part of the game. Even if you become a great trader you'll probably lose 40% to 50% of the time. That's just trading. Plan now how you'll handle your losses, so you aren't faced with a "hope" situation. By following the five step plan laid out at the beginning of the book, you'll see that by making and following a trading plan even when you lose 50% of the time you can still make money.
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Losing Means Winning?
Successful traders don’t let losses get out of hand. They're not afraid to take a loss, and in fact they'll likely realize many losing trades because they have a low tolerance for trades that don’t react or move how they expect (more on this in upcoming chapters). In this way, taking losses actually means a trader is more likely to be profitable. “Realizing” a loss simply means the trader closes out the position and the loss (or profit) is booked in the account. Not realizing a loss or profit means the position remains remains open and is susceptible susceptible to further further movement. If a trader exits when they're supposed to, it shows the currency didn't react how they anticipated and there was no reason to remain in the position. A trader who allows losses to mount is no longer in control of their trading, they've entered a gambling mentality. The market has shown them they're wrong but they're not listening to the warnings. There are psychological reasons why this occurs, but regardless of the reasons, not accepting a loss and letting it mount will most certainly result in frustration and a lack of profits over the long run. Don't change your strategy mid-trade in an attempt to avoid a loss. I use many strategies that are only accurate a little more than 50% of the time. That means I KNOW I will lose about 50% of my trades with it, and that has to be okay; my profits are bigger than my losses so over a number of trades I'll still make a consistent profit.
A Psychological Psychological Trick Those who are struggling with their trading often have a hard time admitting that they're to blame...."It's the markets fault! ” There are endless endless excuses for why losing trades occur, but ultimately the blame lies with the person executing the trades. The faster you accept this the quicker you'll learn to minimize losses, and the more profitable trades you'll likely participate in.
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This is where a psychological trick comes in. Not only are losing trades losing you money, but the longer you hold onto those trades (and tie up capital) the more opportunities you give up to get into profitable trades. Thus losing trades deal you a double blow, and should be realized as quickly as possible so you can move onto other opportunities. Realize losses quickly by laying out in your trading plan how you'll exit losing trades, and then stick to that plan. Stock brokers, are often taught not to tell their clients to “Exit that losing position.” Rather, the broker is taught to tell their client something like “We need to transfer yo ur funds into something which has more opportunity.” Avoiding the “loss” discussion and instead using words like “transfer” and "opportunity" makes closing out an unprofitable trade much more palatable. You want to be in the best opportunity trades, and a trade that keeps going against you (losing) isn't a best opportunity trade. Just as a stock broker may convince a client to get out of a losing trade by changing their language, individual traders should also do this. Try not to think in terms of winning and losing on trades, because both will occur regardless of belief or trading system. Avoid win/loss thinking; instead, as a trader your job is to continually transfer money from one opportunity to the next ....and to execute your trading plan to the letter. This doesn't mean someone has to continually be trading (referred to as "over-trading"). "over-trading"). It simply means means that any time a trade is made you know when and how you'll exit. When a losing situation develops, the loss is booked and you can focus on moving funds into other opportunities. This transfer is what matters, getting out of a trade simply allows that transfer of capital to occur. Losing trades not only strip you of capital, but if a trade is held longer than needed other opportunities may be missed. Ultimately it's your responsibility to be in control of how you take profits and control risk. You can benefit by not thinking in terms of losses or profits, but rather in terms of “transferring” funds fr om one opportunity to another....and by viewing success as following your trading plan. If you think this way, consistent profits are more likely to be generated.
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Wanting to Be First In and Last Out You may feel that in order to make money you must be the first one into a move, and the last one out. In other words, you want to pick the exact top and bottom. Don't D on't attempt this; it's a suckers bet. When you try to be one of the first people into a move, normally there's very little evidence to confirm the trend reversal. Basing trades on little evidence, or a whim, is simply gambling, and good traders don't gamble. Instead, they take trades based on evidence and probabilities. — or — of Normally, Normally, capturing the bulk or even a chunk of a move will provide ample profit. There's no need to be first in. Be patient and wait for good trades. Wait for them to develop, instead of jumping the gun and assuming the market will turn right when you expect it to.
Exits are no different. Many people like to try to scrape every last bit of profit out of a trade. In doing so, they normally get greedy and end up giving all a ll the profits back because they wait too long to get out. Take your profits according to your trading plan. You won't get the exact top or bottom, so aim for capturing the bulk of the profit from the move (use the reward:risk ratios discussed). Besides, you don't need to make all your profit on one trade; there are countless other trades to profit from as well. If a trend is really moving, book your profit and then look for another entry.
Protecting the Ego Throughout life we do many things to protect our egos. One of the main things we do is fight for the idea that we' re “right,” or that someone else is “wrong.” Right and and wrong have have no place in trading; simply watch price movement, as it's the only thing that matters. If a currency plummets and you think it should go up, being “right” will bring you nothing but an empty trading account. When trading, forget about concepts such as right or wrong. By focusing on price (and not your ego) you'll pay pa y attention to what the market is saying. You'll identify and accept potential winning and losing trades. The markets aren't 290
personal. The price doesn't care what you think, nor what your entry price or stop level is. Don't become emotionally invested in your trades. As soon as you do, you lose your perspective and you'll likely deviate from your plan. Just as you can't let the ego creep in while you're losing, you can't let it creep in while you're winning. Traders often experience a bad week or month of trading after setting a new best day, or hitting a lofty goal. They become arrogant and begin to deviate from their their plan. They assume they have “trading “trading invincibility,” invincibility,” but forget what it was that actually got them to that point: following their their plan! Conditions in the market change and the successful trader must navigate these constantly shifting waters, both physically and mentally. After a string of losing or winning trades don't get trapped into thinking you'll always be right, or always be wrong. Rather, simply trade according to your plan, and ego never even enters into it.
On and Off Discipline Discipline can't be something you turn off and on; you must be disciplined every time you sit down in front of your trading screen(s). One slip up in your trading can cost more than you ever bargained for. At all times you must be vigilant and every trade must be thought of as a business decision. Successful traders are disciplined and stick to their trading plan. They shun any trading behaviour that isn't disciplined, such as trading at times that are unlikely to be profitable, or or taking a trade which which isn't outlined outlined in their trading trading plan. Lack of discipline in other areas of life is tolerable in small doses, in trading it isn't. In trading the full consequence of lacking discipline can be experienced immediately and fully. While someone on a diet can occasionally lack discipline (“cheat”) and not notice a difference (if it's infrequent), the trader can witness the full brunt of his lack of discipline very quickly in the form of a massive loss. Probabilities dictate that even making undisciplined decisions will work out sometimes, but in the long-run — like like the dieter who constantly cheats — the the full consequence of this lack of discipline becomes evident.
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If you struggle with discipline that doesn't mean you can't be a good trader, but you'll have to plan for your weaknesses. Keep detailed notes of your trades. At the end of the day analyze what you did, and write down your mistakes. Mistakes never have to do with making or losing money; mistakes are when you don't do what we were supposed to, or did something we weren't supposed to do. This exercise may be enough for some people; others may need even more discipline. If so, get yourself a trading referee. A trading referee is someone you trust who questions you on whether you're following your plan. Have them check in on you (periodically or regularly), or submit your trading journals to them. Take screenshots of the days you trade, and tell them exactly why you did or didn't take certain trades. This person may be another trader, just a friend or a partner. This person is there to make you feel more accountable for what you're doing. At trading firms, risk managers and other traders are always watching out for each other. Most stay-at-home traders don't have that luxury, so re-create it. Find a way to make yourself accountable to trading the way you are supposed to (your trading plan).
Don’t be Arrogant. Develop Confidence and Self control right!” attitude. attitude. Confidence Don't mistake confidence for an arrogant “I'm right!” comes from doing something difficult in spite of that difficulty, pushing through and sticking to your plan. By making a trading plan and sticking to it, you'll develop confidence and self-control. Confidence and self-control allow you to pull the trigger on a trade when you need to, and hold back when th e signals don’t quite line up.
Master traders make a plan and stick to it. This is how they make it look easy and effortless. Don't be fooled though into thinking it is easy and you can do whatever you want when you trade. This easy confidence and self-control comes from discipline and practice, and exercising these traits relentlessly.
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Losing Objectivity It's very easy to get distracted or caught up in the emotion of a trade. Successful traders find the discipline and mental focus to stay objective and not be swayed by their emotions. Find a healthy, constructive and positive way to deal with any emotions which could negatively impact your trading or reduce your objectivity. Take small breaks, go for a walk, exit a trade if you feel you can’t execute your plan, or don't trade at all if you're feeling particularity emotional (angry, fearful, agitated, nervous, etc) that day. One exercise very helpful for keeping emotions at bay, and staying focused on pertinent market movements, is to talk to yourself while you trade. Say out loud what's happening with the price action, and how it relates to your trading plan. The "checklist for while you're trading" provided later in the book gives you a list of things to watch for and focus on. Keeping your attention on what matters — price movement movement — and off of your emotions is a crucial skill to learn. — and
The “All In” Mentality/Revenge Anyone serious about making money from the markets over the long run must avoid the “all in mentality” and “revenge trading.” It may work once, but it's an impossible strategy to win with over the long run. Imagine entering a casino with $100. You play for a bit and get up to $150, but then you start to lose. Soon you're down to $50. You're upset that you didn't walk away with the $150 and now you only have $50 and it'll take a long time to get back to $150. What do you do? If you have a revenge/all in mentality you throw down the $50 and say "All I need to do is win a couple c ouple of times and I will be back to where I was." You gamble everything, in an attempt to gain quickly. Additionally, you may tell yourself "I will walk away if I get back to $150." But in trading you don't just walk away. There's always another trade. If you start going all in (revenge trading) eventually you WILL lose everything.
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This is losing behavior. Say you do win the money back, and you leave. Next time you go to the casino you'll do the same sa me thing, and the next time. Before you know it, everything is gone. When you continually risk everything, eventually you'll lose everything. Don’t put it all on the line on one trade, or even several trades. The maximum risk on a signal trade is 1% of account equity. Don't abandon your trading plan, or lose your discipline. The times when you want to get revenge on the market are the times you must fight these urges the most. By not yielding to it you strengthen your discipline, hone your mind and create a true trader mentality. The worst thing is that often these tendencies come up when we're already down or on a losing streak, hitting you right when you're already at your breaking point. Stay disciplined and realize profits are accumulated over many trades, and several losses (even in a row) are inconsequential if proper money management rules are used. If you're mad, get away from your trading screen. Drink some water, take a walk or even take the day off.
Random Reinforcement I introduced the topic of random reinforcement in an Investopedia article entitled Random Reinforcement: Why Most Traders Fail . Random Reinforcement is a term used us ed in psychology, but I've adapted the ideas of random reinforcement to trading, providing the following definitions: Random Reinforcement: Reinforcement: Using arbitrary events to qualify (or disqualify) a hypothesis or idea; attributing skill or lack of skill to an outcome which is unsystematic in nature; finding support for positive or negative behaviors from outcomes which which are inconsistent in in nature - like the financial financial markets.
That may sound rather complex, yet the idea is simple. Assume you like one of the strategies mentioned in this book. You see a trade setup based on the information information provided for the strategy s trategy and you make a trade — you you lose money. You
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tell yourself the strategy sucks and you go buy another book...repeating the same process over and over over again. You're succumbing to random reinforcement; you're forming an opinion that a strategy doesn't work simply because it failed you on a few occasions. In other words, you're basing your opinion on a very limited data sample and therefore the opinion has no substantial evidence backing it up. Another scenario may occur. You try out a strategy and the money starts piling in. You have several winners in a row and you feel on top of the world. You're a fantastic trader! This too is random reinforcement. You may actually be doing the wrong thing, and for a short time you get rewarded for it because randomness allows for even someone with no skill to have a winning streak. Randomness is present everywhere. You can have a long winning streak with almost no skill whatsoever, and you can have a long losing streak with great skill and an abundance of market knowledge and experience. If your strategy is sound, stick to it; even the best systems have losers, and even horrible trading habits can produce strings of profitable trades. Random reinforcement is a tricky trap and as the title of my article states, I do believe it's one of the main reasons traders fail. Judging a strategy or your trading skill based on very little data is a dangerous game to play, whether you're losing or winning. This is the why the five step plan outlined at the beginning of the book must be followed. It assures you're consistently successful with a strategy before you start trading it with real capital. You'll also have a large number of trades recorded, so you know how that strategy performs. Continually changing methods based on short-term results is a sure way to join the ranks of the massive group of traders that lose everything. everything. If you only risk 1% (or less) of your account per trade, even if you lose 10 trades in a row you'll still have most of your capital intact.
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26. Active Trade Management So far you've been presented with strategies that give you entry, stop loss and profit points. Whether it was stated or not, the inference was that once you take a trade you either let it hit your stop or your target. In other words, once you've placed the trade based on your strategy, you leave it alone and go look for other trades. Your trade will eventually hit your stop or target. This is a good option, and this is how you should trade when you're starting out. As you progress though, and your chart reading skills get better, you'll be able to interpret when your stop is likely to get hit. For example, your trade is onside (making money), but you can see a trend reversal is taking shape. Do you have to let the trade go all the way against you and stop you out for a losing trade? No, you don't have to let big winning trades turn into losing trades. Intervening in a trade once you've initiated it is called active management. It allows you to take profits, increase profit targets or cut losses by adapting to new information which may come available. Active management isn't required, but if done correctly c orrectly will improve overall profitability. profitability. Active management doesn't give you the right to throw your trading plan out the window. On the contrary, active management requires you to make your trading plan more extensive, as you'll now need to add an Active Management section to it. How and under what conditions are you allowed to move stops closer to the entry price (reducing risk), or when can you take profits before your target is reached? This is a personal decision, yet I suggest implementing a few simple to follow guidelines in your trading plan. For example, if you are long the EURUSD at 1.3550 and your target price is 1.3650, you have a 100 pip target. A simple guideline would be if the price is more than half way to the target (you're 50+ pips to good on the trade), drop down 1 time frame on your chart. If you took a trade based on your 4-hour chart, drop to a 1hour chart. Once on the 1-hour chart reduce your stop to 5 pips below the most
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recent low or consolidation. Sometimes this results in locking in a profit (stop loss above entry price) and other times it will simply reduce the risk on the trade (stop still below entry). If you're in a short trade, and the price is more than 50% of the way to target, drop down a time frame and move the stop loss to 5 pips (plus the spread) above any newly formed swing high or consolidation. Do the same for a day trade. If a trade was generated on the 5-minute chart, drop down to a 1-minute chart once the trade is 50% of the way to the target. Place the stop 1 pip below a recent low if long, or 1 pip (plus the spread) above a recent high if short. If already trading on a 1 minute chart, then go through the same process, but without without dropping down a time frame. frame. If the price is more than half way to your target there's no reason to take a full loss on the trade. That trade moved as anticipated, so just because it didn't reach our target doesn't mean we need to take a full 1% hit (or whatever our original risk was on the trade). Risk should be reduced if the price is more than half way to the target (move stop closer to entry point, according to methods described above and below). If the price is 75% of the way to target (target is 100 pips and you're 75 pips onside) on a short trade, draw a trendline on the declining price action. Move the stop loss to 5 pips (plus the spread) above the trendline and continue to trail the stop down with the trendline until you're stopped out (price breaks the trendline), or the target is reached. If you can't draw a trendline, continue to move the stop 5 pips (plus the spread) spread) above the high high of the most recently completed price bar . If the price is 75% of the way to the target on a long trade, draw a trendline on the rising price action. Place a stop st op loss 5 pips below the trendline and continue to trail the stop up with the trendline until you're stopped out, or the target is reached. If you can't draw a trendline, continue to move the stop 5 pips below the low of the most recently completed price bar.
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Once a trade is 75% of the way to the target we put a strangle hold on the position. The stop moves closer to the current price while the price gets closer to our target. It's emotionally rattling when the market misses your target by one or two pips, and then reverses course stopping you out for a loss. By actively managing positions positions in this way wa y that situation is avoided. As the price approaches your target your stop loss works to lock in profit, so even if the price reverses you still make a profit on the trade. Also, since that stop is moving closer to the target price, if the price is moving very strongly in your favor you can keep edging your profit target up. Eventually your stop will be where your original target was, locking in the originally anticipated anticipated gain. Here's my rule for expanding my profit target and trying to squeeze a bit more profit out of a trade. I only move it once the price is very close to the original target. For day trading I want the price to be within about 2 to 3 pips and for swing trades within about 6 or 7 pips. My stop needs to be protecting at least 90% of the gain. That means the price must really be moving and be expected to blow through my profit target if I'm going to adjust it. Re-read the chapter on velocity and magnitude (chapter 22) if you're not sure what strong momentum looks like. I keep adjusting my target about 3 or 4 pips higher on day trades, and about 10 pips higher on swing trades (may vary slightly base on pair-specific pair -specific volatility). volatility). I continue to do this until either my stop is hit, which is continually being moved as well (based on methods discussed earlier) or a price spike hits the target. As long as the price is ticking in our favor we hold the trade, but if at any point it starts to go back against us by about 3 pips on a day trade or about 7 pips on a swing trade, we exit. When expanding the profit target we become very active traders, trying to squeeze a few more pips out of our trade as it runs in our direction. An alternative to extending the target in this very active style is to just make one alteration. If you're long via the trend channel strategy and the price is surging toward your profit target, move it up slightly to allow for a bit more profit. How much you move it depends on the trend channel. For this strategy we placed our target based on the top of the channel at the time of the trade. Since the trend
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channel is sloping, you can adjust the target to where the top of the channel is currently. Make sure your stop locks in at least 75% of the original profit target though. Trail the stop behind recently completed bars, or use the short-term trendline approach. For a day trader, managing trades is fairly straightforward since they're sitting in front of their screens while their trades are on. For a swing trader managing trades may be a bit more difficult to do consistently. If you're trading off a 4-hour chart though, price swings take time to develop. Therefore, you can simply manage trades during your allotted time for swing trading each day. Ideally this is after the U.S. session and before the London session, when the market is quieter and you can reduce risk on trades that have moved in your favor. If the price is close to your target during this time, analyze the situation and assess whether moving your profit target is worthwhile. If you choose to expand your profit target, target, use trendlines and support support and resistance levels levels as a guide on where to put it. Then, if you do opt to expand the profit target, make sure your stop loss is locking in at least 75% of the profit target. Decide if you're going to actively manage trades. If you can't do it all the time, then don't do it any of the time. Choose the set-and-forget approach for all your trades or choose to actively manage all your trades, don't switch back and forth. Add a section into your trading which addresses precisely how you'll actively manage trades. You may wish to use the guidelines above, or develop your own. I use the guidelines above but I'm not a stickler for the exact percentage. If the trade is about half way to my target I reduce my risk, it doesn't have to be exactly 50%. My basic rule of thumb is this: if I am long/short and a trade is showing me a profit, I'll drop down one time frame and seek to reduce my risk by moving my stop to just below/above a recent swing low/high that formed. I continue to move my stop below/above recent swing lows/highs until either I'm stopped out or my target is hit. Adjusting my target is a rare occurrence.
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I have one other active management trading method which I share a bit later in False Breakouts Br eakouts - A GIFT to Active Traders (chapter 30). It's a more advanced technique and won't suit all traders, so I've opted to cover it separately.
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27. How to Incorporate All This Information There's been a lot of information provided in this book, possibly too much. The human mind loves the idea of having choices, but often becomes paralyzed by too much information and too many choices. It's called the paradox of choice. If you're a new trader you may be facing this problem now. You have lots of information, and while the strategies are defined, you realize you can't incorporate them all (and some strategies actually conflict, which I'll explain in a moment) and so you may be wondering what to do next. Here, once again, are the 5 steps to start incorporating what you've learned. learned. 1. Pick one or two strategies that you like or that you think you can implement effectively, effectively, based on reading this entire book. 2. Write a trading plan for how you'll trade these strategies. Define the strategy st rategy in your own words. How does the market have to behave in order for you to take the trade signals the strategy provides? When won't you take trade signals? What's your maximum percentage risk on each trade (1%, or less)? By reading the whole book you should have a good idea how to answer these questions, even though you're only going to use one or two strategies for now. 3. Practice trading the one or two strategies in a demo account, according to your trading plan. Don't deviate. If you make a trade that isn't based on your strategies then your profit/loss will be inaccurate. Your only goal in the demo account is to consistently implement those one or two strategies. That is it. Profits don't matter at this point. 4. Practice a strategy for at least a month in your demo account. After the one month period, if you notice a few small changes could be made to the trading plan, write them down as new guidelines, and proceed to practice
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implementing the strategy in the new way. Practice implementing this new method for another month. 5. If you're seeing a profit in the demo account, then you can consider opening a live account, but only trade those strategies you've been practicing. Don't attempt to incorporate more strategies until you're profitable in live trading with the one or two strategies you're already using. If you can't handle one or two, trying to juggle more strategies isn't going to help. If and when you're able to add new strategies to your trading plan, go through the same process as above — practice the new strategies in a demo account until they show you a consistent profit. Only then is the new strategy strategy used in your live trading account. account. We're all a bit different and "see" things a bit differently. When you read about some of these strategies it may have been like a light bulb went off in your head, and when you look at your charts you can see the strategy playing out, it makes sense to you. Other strategies may seem awkward to you, hard to implement and you just don't see it happening when you look at your charts. That's fine. You don't want to incorporate all these strategies at the same time. But maybe you take pieces you like, and incorporate it into you trading plan for another strategy. For example, in the next chapter I discuss how you can incorporate two of my favorite strategies into a swing trading plan. It provides an example of how you can combine elements and strategies into a cohesive plan that makes sense, and that works. No matter which strategies you choose, if you read the book carefully you may realize that certain strategies conflict with one another. As an example: assume a downward trend channel. Based on the strategy we are waiting for a rise to near the top of the channel and then a consolidation. If the rise happened quickly, this could very well look like a flag/pennant formation. formation. The targets for this thi s pattern are different different than what we use for the the trend channel strategy. strategy. The trend channel strategy is based on a larger price structure and more price information than just the flag/pennant pattern. If you decide on a particular
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strategy, don't be swayed by other strategies in the book. Don't allow yourself to become overloaded. Just focus on your one or two strategies, work on finding the setups and then implementing the strategy. Take small steps and practice a strategy before using it with real capital. Practice is rarely talked about in trading, yet it is a critical. A high school basketball player and an NBA player both know the mechanics of taking a shot, so why is the pro a pro if they both have the same information? Practice! Information isn't the key to success, practice is. In hindsight it looks easy to spot a trade signal, and tell yourself you would've traded it. Seeing a trade signal in real time, and having the reflexes and guts to act on it, is entirely different. Trading is tough; practice is the only thing that results in improvement. Start practicing in a demo account, just one or two strategies. strategies. Refine your approach approach with those, and when you're consistently profitable make the transition to a live account. From my experience, and the experience of hundreds of other traders I know and work with, it'll take at least 6 months until you start to see some consistent trading profits in your live account. Several months will be spent building your trading plan and practicing implementation in your demo account. Upon switching to a live account it'll likely be another few months before you develop consistency. Expect about a six month to one year time span between when you start this journey, as defined defined above, and when when you start to to generate some income. How much income you generate will depend on how many trades you make, how you're implementing the strategy (affecting reward-to-risk ratio and win rate) and how much capital you started with. Many traders become discouraged several months into their journey, quitting just before they're about to have a breakthrough. breakthrough. Don't be one of those people. Follow the process described in this book; starting with practicing in a demo account so you don't diminish your real capital during the learning phase. Then when you switch to a live account, risk 1% of your capital or less on each trade.
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That way even if you have a losing streak as you're get used to trading with a real account, it won't significantly drawdown your capital.
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28. Bringing Everything Together into Your First First Trading Plan Pl an A trading plan is a personal thing. I know guys who have a stack of paper representing their trading plan, and others, who have several bullet points on a page. Like a "while you are trading checklist" (next chapter) your trading plan can eventually be reduced to several bullet points, but when first writing it down, make sure to explain (to yourself, for later reference) exactly what you mean by those bullet points. points. Below is a sample trading plan, and is basically what I use most of the time when I'm swing trading. My two preferred strategies are the "crotch" and "trend channel" methods, and I use the two together to help filter or confirm trades. Even chart patterns, and front-running breakouts can be used in alignment with these strategies. If you construct a trading plan with these two strategies, then that's all you trade, just these two strategies, nothing else. With just these two strategies you'll always have lots of trades, so it should be enough to t o keep you busy. The point you really need to drive home to yourself is that you're only looking for the setups and conditions which are laid out in your plan. If the setup isn't there, or the conditions aren't right, don't start trading other strategies. You need to practice the plan you lay out for yourself down to the letter . The trading journey/career is a relentless pursuit of finding well defined trade setups, within a well defined context, trading them when they occur, and not being distracted by all the other price information which isn't relevant to the trading plan. My notes are in brackets explaining each point. This plan assumes that you know the basics of the strategies being employed, so reread the relevant chapters if needed. This is a sample plan. Alter it based on your circumstances and the strategies you wish to use.
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Swi Swi ng T r adi ng P lan lan Basics This plan applies to swing trades which occur based on 1-hour, 4-hour or daily charts (define which time frames you will trade, here). Ideally trades should last several days maximum. If a trade is going to last longer than a week, based on daily average volatility, then avoid the trade, or zoom in the time frame to reduce the risk and profit target so the trade can likely be completed within a week. (For example, if looking at a 4-hour chart, drop down to an hourly chart and see if that provides a similar trade setup, but with a shorter likely duration.) Trades are limited to pairs which are a mix of the following: USD, EUR, GBP, CAD, NZD, AUD, CHF, JPY (I monitor 28 pairs). "Actively manage" trades on a chart one timeframe lower than the trade setup timeframe. If the trade setup occurred on a 4-hour chart, active management is completed on a 1-hour chart. If the setup is based on a 1-hour chart, active management occurs on a 30-minute chart. Have the chart zoomed out to the maximum, but only enough that all bars are still clearly visible (high, low close, open). The daily time frame is the largest time frame looked at. Don't zoom out further than what's visible on the screen; scrolling back (or zooming) zooming) through years of of price data isn't relevant or or useful to us as swing traders. Don't factor anything that happened more than 15 months ago into your trading decisions. (It's easy to get information overload, and looking at very old data isn't likely to improve trading performance, and could very well harm it.) All swing trade orders are placed after the US session closes, and before London opens.
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Every order I place includes a stop and a target. Don't take swing trades within several hours of the close on Friday, or within the first couple hours of trading on Sunday night/Monday morning. Trades are only placed at the usual usual time — within within a few hours before the European open. Note tendencies in the pair. If you see that recent trades (based on the strategies below) in the pair would've been unprofitable, unprofitable, don't trade that pair until the pair begins performing in alignment with the strategy. If a pair has a history of poor performance (based (based on what you see or actual performance numbers), numbers), don't trade it and delete it from your watch list. TRADE ALL SIGNALS THAT MEET THE CONDITIONS LAID OUT BY THE STRATEGIES BELOW (considering all other guidelines). (If you try to guess which trades will be profitable, and skip trades you think will be unprofitable, you randomize your results results and will have no n o idea if the strategy actually works.) Record all swing trade results in a trade journal, noting the strategy used (1 or 2 below) for each trade. For actively managed trades (optional) be sure to note whether you exited the trade based on a trailing stop (note which type), or via the target.
Risk Management Never risk more than 1% 1 % of the account on a single trade. (If taking the smallest position size results in more than 1% risk based on the entry, stop and account balance, then don't don't take the trade.) trade.)
The 1% is calculated based on the current real-time account equity (the equity number fluctuates based on current positions). Never take more than 2 long or short trades trades in the same currency, at the same time. (This makes it easy, you never have to look at the correlation tables or worry about being overexposed. For example you can be long the EURAUD EURAU D and EURJPY, but 307
if another EURXXX long trade comes up, you can't take it. Same goes for being long USDJPY and short EURUSD, both are long USD, so if another trade comes up which requires you going long the USD, skip it.)
Entries with Stops and Targets Use pending orders whenever possible. If you miss an entry point, then you missed it, don't ever chase the price if you missed a trade. Instead, place a pending order at the original entry point and see if the market retraces to fill it. The pending orders mean the trade is entered when the price reaches the price of your order; there's no need to wait for bars to complete. Entry 1 - The Crotch
Can enter in the crotch of strong support or resistance. [Assume support or resistance will hold. In order for it to be a strong support area the price must have previously fallen into it, and then had a full trend reversal higher (two higher swing lows and two higher swing highs)]. Place a buy order in the crotch of strong support, with a stop loss 5 pips below the low of the strong support area. [In order for it to be a strong resistance area the price must have trended higher into it, then had a full trend reversal lower (two lower swing highs and two lower swing lows)]. Place a short-sell order in the crotch of the strong resistance, with a stop loss 5 pips (plus the spread) above the high of that strong resistance area. If the price bounces off strong support as anticipated, unless it makes a new major high (based on the time frame you're trading on) that level can't be used again. If the price makes a new high, the area is still considered strong and it can be used again (once more), using the most recent crotch as an entry point. If the price declines off strong resistance as anticipated, unless it makes a new major low (based on the time frame you're trading on) that level can't be 308
used again. If the price makes a new low, the area is still considered strong and it can be used again (once), using the most recent crotch as an entry point. The same price area can never be used for more than two crotch trades in a row in the same direction; two is ok, but don't take a third. Only takes trades in the direction of the longer-term directional bias (if there is a longer-term trend, trade in the direction of the trend. Place a target at a 2:1 reward-to-risk ratio. Entry 2 - Trend Channel
If a short trade develops using the Trend Channel method, but there's a long trade (or strong support) based on the Crotch method in close proximity to where the target would be, skip the Trend Channel trade. If a long trade develops using the Trend Channel method, but there's a short trade (or strong resistance) based on the Crotch method in close c lose proximity to where the target would be, skip the Trend Channel trade. Draw the channel, don't just envision it. Drawing it helps you with identifying the entry area and the target area. If a Trend Channel is down, wait for a consolidation of at least 3+ 4-hour bars (1-hour bars are also a lso fine) near the top of the channel. Enter an order to go short a pip below the low of the 3+ bar consolidation. Place a stop loss above the consolidation. Target goes near the prior low, near the bottom of the descending trend channel. (Placing it below the prior low is what I consider aggressive, and can be used when there's very strong overall momentum down; when momentum is "average" place the target just a tiny bit above the prior low).
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If a Channel is up, wait for a consolidation of at least 3+ 4-hour (1-hour also fine) bars near the bottom of the channel. Enter an order to go long a couple pips above the high of the 3+ bar consolidation. Place a stop loss below the consolidation. Target goes near the prior high, near the top of the ascending trend channel. (Placing it above the prior high is what I consider aggressive, and can be used when there's very strong overall momentum up; when momentum is "average" place the target just a tiny bit below the prior high). Never take a long long trade in a downward trend trend channel (even (even at the bottom), or or a short trade in an upward trend channel (even at the top)...unless it's because you're taking a Crotch trade. Target should be at least twice as big as the stop; typically these trades yield 2:1 reward to risk ratios, or more. When a consolidation forms near the top of a downward trend channel for a short trade, or near the bottom of an upward trend channel for a long trade, there's always the option to "front-run" the breakout and buy near the bottom of the consolidation of the long or sell near the top of the consolidation for a short. For this to occur, the consolidation needs to be "neat" and clearly defined so an entry can be made near the appropriate edge of the consolidation.
Active Management (This is an optional section based on how active you intend to be. If you only have 20 minutes a day, you may opt to include this, yet it is usually intended for traders who can monitor their positions throughout the day.) If a trade is more than half way to the target, then implement active management, not before. 310
If the price is more than half way to the target, drop down one time frame (from 4hour to 1-hour, from 1-hour to 30-minute, etc). If short and onside (currently making making money) move the stop loss to 5 pips (plus the spread) above any newly formed swing high, or 5 pips (plus the spread) above a consolidation from which the price has now broken below. If long and onside move the stop loss to 5 pips below any newly formed swing low, or 5 pips below a consolidation from which the price has now broken higher. If the price is more than half way to your target, never, ever, take a full loss on the trade. Risk must be reduced if the price is more than half to the target (move stop closer to entry point, according to methods described above and below). If the price is 75% (approximate) of the way to the target (target is 100 pips and you're 75 pips onside) on a short trade, draw a trendline on the declining price action. Place a stop 5 pips (plus the spread) above the trendline and continue to trail it down with the trendline until you're stopped out (price breaks the trendline) or the target is reached. If you can't draw a trendline, continue to move the stop 5 pips (plus the spread) spread) above the high high of the most most recently completed completed price bar. If the price is 75% of the way to the target on a long trade, draw a trendline on the rising price action. Place a stop loss 5 pips below the trendline and continue to trail it up with the trendline until you're stopped out or the target is reached. If you can't draw a trendline, continue to move the stop 5 pips below the low of the most recently completed price bar.
Spe Speci fic fi ci ty M atter s If you're going to follow a plan, it needs to be b e clear enough to follow. I think these two strategies are good to start with. There are a number of reasons for this. The main reason is that you'll get a lot of trade signals, in lots of pairs, and they
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don't take a long time to find, place orders in or analyze. This is especially true since I publish forex swing trading signals on VantagePointTrading.com at least once a week (usually) which provide you with a few examples of these trades. The two strategies also work in synergy with one another. One lets you know when the price is approaching a major resistance or support level. The other works to capitalize on trending moves when there isn't major support or resistance nearby. The Crotch strategy can also be used during the start of a ranging environment (for two swings). Therefore, you can capitalize on both ranges and trends. The plan also forces the market to come to us; we enter on our own terms, only under certain conditions. Nowhere does the plan say "If the setup doesn't occur, make a trade anyway." No, we ONLY trade if the market produces our setup. We trade those setups (the setups you include in your plan) every time they appear (unless the plan provides conditions under which we don't), and we never take trades which are based on setups not included in our plan. Create your own plan, but use this one as a base model if you like, if you're swing trading. If you're day trading you'll need to add in details like what hours you will trade certain pairs. Then begin trading a demo account with the plan. As you trade with the plan, note any questions you're asking of yourself while you trade. Then try to fill in those "holes" by inputting a guideline into your trading plan. For example, example, what if the market is in an uptrend on the daily chart and a downtrend on the hourly chart? If you're confused about which signals you should take under these conditions, create guidelines that tell you when you trade and when you don't, then test the guidelines in a demo account. It takes time to work out all the kinks; that's why you must follow the 5-step plan. Once you've read the book (multiple readings of some chapters may be required), build your plan. Then practice the plan, and tweak it as you notice issues. Eventually you'll end up with a plan that's perfect for you, and you'll begin to see consistent results. It's then, and only then, you can move on to live trading using that plan.
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Once you've been profitable with live trading for several months using your trading plan, add another strategy to it if you wish (not required). Be sure to practice using the new strategy in a demo account first. If it's profitable, profitable, work it into your live trading plan. Accommodate for your other strategies though...could the strategies conflict? Be sure to rectify this in your plan and account for contingencies before trading the new strategy with real capital.
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29. Checklist For While You Are Trading You have a lot to think about! It'll be impossible to attempt to implement all these strategies; ultimately you should choose one, two or a few and get very good at them. Practice them often and make a checklist to memorize which keeps you on track while you trade. In the psychology chapter, you learned that trading isn't as simple as it seems, and the mind can play tricks on us, even experienced traders. To keep the mind focused, compose a checklist that you'll run through during the day to monitor market conditions and assess which trades to take. Your checklist must be personal to you. Since I don't know which strategies you're going to use, I can't prescribe a checklist that'll work for you or your temperament. What I can do is give you an example so you can build your own. Your actual checklist should be about 4 to 7 statements or questions. Here's an example: What times are the economic news events scheduled at? What is the long-term and short-term trend? Is the market exhibiting exhibiting some sort of pattern? pattern? Is there strong support support or resistance anywhere? In which direction direction are the strong and weak moves? How volatile is is it? Would the strategy have worked already? Are there repeating tendencies? tendencies?
The above is a checklist that I continually run through my head throughout the day while day trading (for swing trading my checklist is slightly different, but the general idea is the same). While I only have the statements written down, each
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of those statements means something to me. How I answer each question gives me a definitive course of action for my next trade.
What times are the economic news events scheduled at? Avoid making any trades for about 5 minutes before, and a couple minutes after, news is released. What is the long-term and short-term trend? For me long-term, when day trading, is basically the overnight session, maybe a bit of the prior day and the current session. Short-term is the last 30 minutes to an hour or so. Ideally, I like trades where there's a shift in momentum on the short-term that aligns with the long-term. The question to ask is "What's the overall expectation, and what's the immediate expectation?" I take trades based on immediate expectations, but if that goes against the overall expectation then I am much quicker to bail on the trade at any sign of trouble. If I'm trading with the overall expectation, I am more inclined to "give the trade some room." Is the market exhibiting some sort of pattern? What may look like a trend may just be a piece of a larger wedge pattern or range. Drawing lines on the chart along highs and lows will highlight any patterns that are present. Pay attention to these. Is there strong support or resistance anywhere? These are areas that have caused the price to shift very strongly in the opposite direction. Be careful of strong bounces off these levels. These strong levels filter trades as well provide trading trading opportunities. opportunities. In which direction are the strong and weak moves? If all the really strong sharp moves are up, and all the weak moves are down, probably best to be trading on the long side until that changes.
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How volatile volatile is it? On a very slow day your profit expectations will be less than on a very volatile day. Base your targets and stops on the price action you've seen so far. You can only trade what the market is willing to give. Would the strategy have worked already? If a few signals already occurred before you started trading, would those have worked out? If the market doesn't seem to be respecting your strategy parameters, wait till it does. This may mean missing one trade, but it's better than trying to impose a strategy on a non-complying market. Are there repeating tendencies? This one takes quite a bit of focus because you need to realize it in real-time, but are there repeating price movements? For example, the price moves higher, stalls, and then makes three attempts to move higher before finally breaking out. Next time the price moves higher, the same thing starts occurring. Finding certain tendencies can give you a little extra confidence for a trade, but don't expect these patterns to always repeat. They may repeat 2, 3, maybe 4 times and then disappear. Use them for information while you can, but don't rely on them too heavily
When I look at each of those statements it lets me know what to look for, as described in the paragraphs above. The goal of the checklist is to keep me focused on the trading day and trades at hand, and not let my mind wander. When the mind wanders you may start to deviate from your trading plan, miss trades, or make impulsive unplanned trades. Create a checklist and check it continually while you trade. This is a very simple thing you can do to improve your results dramatically. While trading, talk to yourself. Repeat the checklist and describe what it means for the trades you're in, or the trade you're about to take.
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30. False Breakouts - A GIFT to Active Traders Think of this chapter as an addendum. You can read it now, but it's probably best to start implementing implementing these practices later on, after you have some actual trading experience. The technique also requires — and and is a form of — active active trade management. For many traders a false breakout is the most frustrating thing in the world. They find a great trade setup, set their stop loss according to the guidelines of a strategy, then watch in horror as the price touches their stop then proceeds in the intended direction without them. Read forums and you'll hear traders rage about how brokers stop hunt their order and how it's impossible to win because little traders always get stopped out before the big move. That's one way — the the wrong way — to to look at it. Another is to look at it as a MAJOR opportunity. Consider the consolidation breakout entry which can be implemented in many of the strategies in this book. You'll find that often a breakout will occur from the consolidation you've defined, but then the price proceeds right back into consolidation and out the other side, losing you money. It may do this a number of times, and other times the initial breakout is the legitimate one. So traders face a dilemma. How do you know which breakouts are likely to be fake, and which will be real? The answer is you don't, but you actually don't have to know. Having read this book so far, which emphasizes trading with the trend when a trade setup occurs, you should sh ould have a good idea of whether you want to be buying or selling when the consolidation forms. Assume the price is consolidating at the bottom of an upward trend channel. In this case, our bias is to go long. We want to buy, and you've learned a couple ways to do it:
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Buy when the price breaks above the small consolidation, with a stop just below the consolidation. consolidation. Buy near the low of the consolidation (front-running) with a stop just below the consolidation, because we're anticipating the price is going to proceed higher anyway.
If you're willing to sit in front of your computer (swing traders and day traders) and monitor the market when the price is around your entry points, then there's another option. If you notice that the price is constantly stopping you out just before it moves in the anticipated direction, then you're getting stopped out on false breakouts. Instead of playing the victim, accept it's happening and alter your entry approach. Don't increase your stop loss level, instead, wait for for the false breakout. In the scenario above, if the price drops below the consolidation at the bottom of the upward upward trend channel, let it happen. If the price then then rallies back into the consolidation, that's a false downside breakout; buy immediately. The quick drop below the consolidation that usually stops you out just became your new catalyst for entry, but only if the drop fails and the price moves back into the consolidation. You end up with a price similar to what you would get front running (near the bottom of the consolidation), but you avoided being stopped out on the false breakout lower. Also, since the price had a false breakout lower, as it heads back higher it's more likely to have a legitimate breakout to the upside. This method works great if you aren't front-running, or a break above the consolidation hasn't occurred yet. With those two approaches you're already long when the drop (false downside breakout) occurs, likely stopping you out. If you're anticipating the price to move higher, and you buy when the price breaks above a consolidation, but then the price quickly reverts back into consolidation, exit the trade (don't let it reach your original stop). You can always get back in if it starts rising again, but since you just got caught in a false upside breakout the price p rice is now likely to head back toward the low of the consolidation,
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putting your stop loss in jeopardy. Cut the loss quick. That way, you can watch w atch for an entry near the bottom of the consolidation, or wait to see if the price has a false breakout on on the downside, which presents presents another another buying opportunity. opportunity. If the price keeps falling you saved yourself some money. If there's a false breakout to the downside, then you get your long position back at a better price, which will probably offset the small loss you just took. If the price bobbles around in the consolidation, and then breaks higher again, you can go long again. This mindset is completely adaptive to what the market is doing, and completely detached from the outcome of the trade. Earlier in the book I warned about commissions and paying the spread, and many traders get scared away from actively managing trades because of this. Yet paying a 1 or 2 pip spread is much better than losing losing 20 or 30 pips pips when you don't don't have to. If you monitor your chart, you'll notice that pairs very frequently have a false move in the opposite direction before a big move in the other direction. This stops out a lot of traders, but it isn't a problem, it's an opportunity! opportunity! Switch out of victim thinking and capitalize on this tendency. If the price breaks out in the direction direction you expect, but then quickly fails fails and moves back inside the breakout point (give it a bit of room, so you aren't constantly punching in and out of trades) then get out. You can see the price is consolidating which means if it continues to consolidate your stop just outside the consolidation could easily be triggered. You were trading the breakout, but the breakout failed, so get out, now! The loss is a fraction of what it would be with the set-and-forget approach. The benefit of doing this is that you make more money. Your win ratio will likely creep up slightly. The main advantage though is that the dollar amount of your losing trades decreases. You may originally wager $100 dollars on a trade, but if conditions change and you cut losses early, you may only end up losing $20 or $30. Since you're actively managing trades, some of your winners may also end up the same way: you're expecting to make $300 but the price altered course so you take a $100 profit instead. You still end up with some big winners though, so you keep the upside, but reduce the downside.
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If you need to set-and-forget trades, that's fine. You don't need to actively trade in this manner all the time. The point is, if you're getting constantly stopped out right before a big move you've been anticipating, don't keep standing there and getting punched. Move your buy entry to below the consolidation (if the consolidation is at the bottom of an upward trend channel), and move your short entries to above the consolidation (if the consolidation is at the top of a downward trend channel). This way your entry occurs during the the false breakout that normally stops you out. Adapt to what the market gives you. Turn weakness into strength. If you feel like you're constantly "being tricked," ask yourself what the trickster is doing and mirror his actions. This type of trading brings together everything you've learned and takes it to the next level. You form expectations about what the market should do (which direction you want to trade in), and if it doesn't do it, you cut losses quickly. You notice market tendencies and act on them to get advantageous pricing. This often requires patience, but when the time comes there's no pause, immediate action is taken to either get into a position or get out of one.
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31. Create Your Own Trading Strategies There are many great strategies available to you, and even though they may work there may come a time when you wish to develop your own. Creating your own strategies is an important skill to have, and one which is rarely addressed. Creating your own strategy takes time and patience, but the rewards are significant. While rewards may come in the form of monetary gain, there are other substantial advantages of going through through the process to create your own strategies. Mainly, building a strategy from scratch will give you a much greater understanding of price movements, the markets and yourself. You'll also truly understand how the strategy works, and what could make it stop working. When you use someone else’s strategy you may rely on it without really understanding how it works. On the other hand, if you build it and understand it you're more likely to be able to implement it properly and at the right times.
Creating Strategies To create a strategy, look at your charts — historical historical and in real-time — to to find points where there was profit potential. Usually this means seeing a trend, a range which could be traded multiple times or finding turning points. Glance through your charts and make note of the obvious "profit potential" times, and then note any commonalities between the different scenarios. Wherever you see profit that you think you can extract is where you want to focus your attention. Once you've found a pattern or movement that could have made you money, it needs to be scrutinized for tradability.
What initiated the Move?
Profits are great, but sometimes a profit is hard to capture. While it's tempting to think we could have captured a big move, it's not always possible and
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quite often there's no reliable way of getting into every move (big or otherwise) which occurs. By looking at the move(s) you've isolated, was there anything that signaled the move, or indicated it may occur? Was there a chart pattern or a candlestick pattern that initiated the move? A breakout through resistance or support? A consolidation breakout? A bounce off a trendline? Did a news event trigger it, and or did it occur at a certain time of day? Is there a correlation to the global sessions (such as the European, Australian, Tokyo or US session) opening or closing? Consider adding an indicator (these are technical analysis tools which I rarely use but some traders find helpful): did the indicator(s) give any signal of what was about to happen? Be careful with this one. Indicators often act like "Chicken Little;" they spot turning points, but how many times did they signal a turning point that didn't occur? Is there an overall trend present, or is the market in a range? This is relevant as it may provide a context for the strategy. For instance, the strategy is only implemented implemented during trends, or is only implemented when a range is present. Next, consider where you could have entered the move? If the move was very fast it may not be possible to get in, and thus is an unreasonable trade to assume you could make. As you ponder where you could enter the trade, consider any factors you mentioned prior that could have initiated the move. Ultimately, you must define something tangible, so that if the specific move occurs again you can isolate it and then trade it. This is called your "trade trigger" and is a required element for any strategy. Knowing you want to buy (or short) is only one part of the entry puzzle. You also need a precise event that tells you to enter the trade. Many of the trade triggers in this book have revolved around the price breaking above another price bar or out of a small pattern. That's the trigger. The moment the breakout occurs you know it's time to act.
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Look For an Exit
Every entry requires an exit at some point, in order to take profits or losses. Find something that signals your exit from the trade. It may come from an indicator, a price moving above/below resistance/support, breaking a trendline or your entry criteria disappearing. By "entry criteria disappearing" you're watching for what got you in the trade no longer being there. For example, if you got into a long trade because of a price break coupled with a rising indicator, when that rising indicator levels off or starts to decline that could signal your exit. What kept you in the trade — the the rising — is indicator is no longer rising, so your reason for the trade is no longer there and you can exit. This is the logic behind chapter 30, False Breakouts - A GIFT to Active Traders. If a breakout occurs but then immediately fails, the reason for the trade is gone, so exit the trade. You want to capture as much of the move as possible, but at the same time you don’t want to give back all your profits when the market reverses. Ask yourself how this can be accomplished? Just as you looked for a trigger to get into the trade, you need to find a trigger for your exit that lets you know it's time to get out. Consider whether a trailing stop would be effective, or if stops could be raised manually as the trade moves in your favor. Would a fixed reward:risk ratio work? Would Would a fixed target work, such as 40 pips or 100 pips? This requires requires some knowledge of of how far the pair moves in a day (or week, etc.) but is an effective statistical method for exiting trades. After going through the chapters of this book, you should have a grasp of how to come up with reasonable profit targets.
Money Management – What’s – What’s the Risk?
So far, on your chart you've found a price move, or series of price moves, that would've produced a profit had you captured it. In order to extract a profit you
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need to first find a way to enter the trade based on a signal you can identify and trade, and then you must also find a way to exit the trade at a profit using an identifiable signal. Not every trade goes our way. While you may find a pattern that often precedes a big move, it won't always work out. Determine where to place a stop loss. Look at the moves again. You know where to enter and also know how you're going to exit with a profit. In order to control the risk, where does your stop loss go? The stop should be at a price, which if triggered, signals the trade setup isn't going to work out. Now consider what wha t your risk/reward looks like. Is the profit potential worth the risk? If the profit is too small, is there any way to get into the move earlier, or make a larger profit by exiting at a slightly different time or with a different signal? If the risk is too large, is there a way to reduce the risk, possibly by actively managing the trade, like discussed in chapter 30 (False Breakouts - A GIFT...)?
See if it's Reliable
So far you've completed the easy part. You've looked at price moves and considered them for money making purposes. Then, you thought about different ways you could enter into the move, exit that move at a profit and control your risk. Unfortunately, only looking at a few price moves isn't going to provide a reliable trading strategy. You now need to go back and see how your strategy faired in the past, and also watch in real-time to see if you can actually implement your plan in the heat of the moment when the market is moving. First, make sure you have your strategy ideas written down...precise and well defined . This includes what initiated the move and how you'll enter and exit it.
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Scroll back your charts and see if you can find your entry trigger in the past. If you can’t, your strategy may still be b e valid but the signals will be infrequent, thus it'll be hard to gauge if it's actually effective or not until more signals come along and you can test your theory. When you do find an entry trigger, see if your entry, profit extraction and risk control methods produced a profit or loss on the subsequent price moves. Continue to move back through charts testing every signal you see against your criteria. Write down how many signals you find, along with what your profit or loss would've been. Include both losing and winning trades. Just because there are losing trades doesn't mean it's a bad strategy, every strategy will have losses. Once you have found at least 10 setups, tally up your results. 10 signals isn't and won't indicate whether your strategy is likely to win or lose over the long a lot and run, but it's a start. Ideally, find about 50 signals and tally up the results. If the strategy is profitable on historical data, then watch for new signals in real-time. When the price is moving, and you can’t see the future (like we can when we are looking through historical charts), can you still implement the strategy? If you can’t, something has gone wrong and you need to adjust your criteria so they are objective and tradable, or you may need to start all over again.
If your strategy is indicator based and involves nothing subjective (it's rule based), you may be able to run it through back-testing software. This will provide you with a much longer history of how the strategy has performed, and give you some inkling of how it may perform in the future. Some strategies are hard to run through back testing software as the signals are based on a price pattern or chart pattern which the back testing software may have a hard time recognizing, and thus won't provide accurate results. Most of the strategies in this book fall in this "hard to test" category, because they rely on hand drawn trendlines and consolidations (for example) which are subject to interpretation interpretation and may vary slightly from trader to trader. Ultimately, if you've gone through the charts and found many examples of the signal you're looking for, the risk is controlled and more often than not you can
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exit at a profit (or at least profits outweigh losses) then you have a strategy which you'll want to start monitoring in real-time. Open a demo account and trade the strategy without risking any real money. If it works on the demo and you have a track record of positive results, only then move to trading real money with your new found strategy. You created your strategy so you should be aware of how it works. Make sure the strategy is formalized and simple to implement. Then incorporate the strategy into your complete trading plan so that it fits within the context of your other strategies and overall risk tolerance. t olerance.
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32. Meditation for Traders Meditation, visualization and hypnosis have been used by athletes and in many other professions to improve performance and reach goals, but can meditation help traders? The short answer is, yes. There are many misconceptions about what meditation actually is, and this chapter will discuss that as well as how it can help your trading. We've all visualized a scene playing out perfectly in our mind, which means you've already practiced a form of meditation. If you learn to focus this attention, you can harness its power and apply it to your trading.
What Meditation Is, and How it Relates to Trading Meditation is focusing your attention on a specific idea, thought, picture, sound, etc, or even focusing on nothing at all. Our minds are constantly accepting data, interpreting it, reacting to it or filtering it out. When we slow down and meditate we can start to make profound changes within ourselves because our energy is focused on a limited number of things. The world is widdled down and we can work with precision on one thing, instead of being bombarded by loads of everyday trivialities. Meditation helps you progress; it helps you get used to taking larger positions as your account grows, implementing implementing an alternative form of trading, or overcoming obstacles such as exiting earlier than a trading plan dictates.
Using Meditation For Improved Trading Within the trading field there are many potential uses for meditation. Almost every problem we face as traders can be aided by meditation. Adapt the meditation, which is just a visualization exercise, to address other issues, but for the purposes of this book we'll look strictly at how to improve performance in general.
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Just as learning to trade effectively isn't going to happen overnight — even even with the strategies outlined in this book — meditation meditation isn't instantly going to change your life. It changes your habits slowly, and takes work. You need to meditate regularly if you want to see the positive aspects of the practice. This chapter is just a start. If you're interested in this area I suggest picking up a book on the subject or doing more research. Your mind is the main tool you need to trade, and meditation improves it, and that's a big trading advantage. The following exercise can be done anywhere and requires no prep work. While going through this exercise in the evening and spending 15-20 minutes will be of great benefit, it can also be done quite quickly. Use a quick version before the trading day begins, taking 5 minutes before the first trade is placed. Run through the exercise to get yourself in the right frame of mind to start trading. The following method is very adaptable. Use it to become more selective about trades, focused on price instead of internal thoughts, increase trading volume or move up the pecking order in an institutional environment. For the meditation we'll use the following situational context: a trader is struggling to meet his/her potential. He has created a trading plan and has several strategies that he wants to implement. When he goes to do it, he has a hard time pulling the trigger on trades, and when he does he often deviates from the plan, exiting too early or letting losses get out of hand. This is just a context. If you deal with a different issue, read through the meditation a few times to get the general idea, and then alter it to suit your individual situation. The words in the dialogue below don't matter; they're just used to create a visual scene in the mind. Once you're familiar with the general concept, go sit somewhere quiet, close your eyes and visualize what I'm describing below. Create the scene in your mind. The object isn't to focus on profits. The object is to focus on you and how you handle yourself when you trade.
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Improving Performance Meditation Close your eyes and find yourself outside a downtown skyscraper (or whatever tall structure you prefer). Straining to see the top, you can’t, as it disappears into the clouds. Walking towards the front entrance of the building, you see that it's your name above the door. This is your building, and it represents your life and your success. You enter the building and see yourself in a familiar trading environment (your home office most likely), doing what you have always done. If you make a couple trades a day, you see yourself executing those trades as you have been doing with the same results you have always gotten. This first floor represents w here you are as a trader right now. As you look around the room you notice an elevator. If you're going to be successful in your trading you know that you need to step up your trading and to do so you must go into that elevator. As you get into the elevator, you notice there are hundreds of buttons representing each floor of the building, but right now only the second floor is lit up, so you press it and feel yourself moving higher. You're leaving behind your old behavioural patterns and moving towards a more successful you. As you get out of the elevator you once o nce again see your trading environment, but this time your trading post is empty. As you take your place at the helm you feel empowered. You see yourself taking advantage of more trading opportunities opportunities as dictated by your plan. Everything seems clearer. You see a trade setup based on one your strategies. You wait for the trigger, and then execute the trade. No hesitation, no fear, just calm, assertive action. You've done all the prep work, and even if the trade doesn't work out, you will only lose 1% of your capital — an an easy amount to make back on another trade. You realize that one trade will never make or break you; so you set a stop and profit target and let the trade play out according to the plan. You sit back satisfied, knowing that no matter what happens the market will either
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hit your stop or profit target, and there's nothing you can do about it. So you relax. You let the trade play out. You don't care if you win or lose, because i t doesn't matter. If you're using a good strategy profits will come, and you know you don't need to force it. You're satisfied that you followed your plan and let your profit or stop be hit. Regardless of the result, by doing this you know you're becoming a better trader. You stay at this level in the building until you're comfortable and until you are actually implementing this action in your real-life trading. You know that once you are comfortable at this level the elevator will allow you to move to the next floor, where once again you'll be able to take your trading to the next level. At each level you hone in on a particular issue and work though it. See yourself doing what you need to do to to be successful. Repeat this process several times. Picture yourself y ourself executing trades, maybe one you know you have difficulty executing, multiple times. Each time, you're calm and composed and follow the exact strategy your plan has ha s laid out. The result of the trade doesn't matter to you anymore. One trade never matters, because you know great traders are built over many trades, and you are going to be one. You're going to bring this confidence and calm state of mind to your real-life trading. Bring your thoughts back to the current moment, remembering you're about to start trading for the day. You feel refreshed and confident that it'll be a good day — you'll follow your trading plan, control your risk, and by doing so, over the long-run you're you're very likely to to be successful.
Altering the the Meditation With all the potential pitfalls traders face, maybe the context used above doesn't fit your situation. The method can still be used. As you move up floors within the exercise, see yourself doing what it is you want to do in the real world. Maybe you overtrade, so in the visualization see yourself allowing trades to pass by that don’t fit your trade criteria. Feel the urge you have to trade, then subdue it.
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Use your meditation to come up with solutions or ways to curb your behaviour. In your visualization, feel satisfied satisfied and happy ha ppy that you overcame this issue. Maybe you take too much risk on your trades. In this case see yourself setting a stop and profit target and letting the trade ride out. You risk no more than 1% of your capital on the trade. Within the mediation you feel happy because you know that these are traits of profitable traders and if you follow them you can also be successful. The potentials uses are virtually endless, so use the exercise to help with your individual struggles. As you improve, keep moving up floors. Push yourself and see yourself improving at each new level.
F i nal nal Tho T houg ught htss on on Me M edi tati on Meditative visualization is a powerful catalyst for change. Contrary to popular belief, this process requires no strange postures and is no different than daydreaming except you're directing that daydream in a certain direction to give you a tangible result. Just like an actor rehearsing for a play, or a golfer visualizing a shot before they hit it, you're mentally rehearsing what you'll do in trading situations. Adapt the above mediation to suit your individual needs; change the focus of the exercise to help you with a particular problem. Do the meditation in your down time, or before you begin your day, to condition yourself to be disciplined and implement proper trading practices. The more you do the exercise the more anchored the beneficial aspects of the exercise will become in your mind. Meditation is only useful though if you bring the feelings and traits back into the real world — such such as confidence, calmness, assertiveness, patience and discipline. When you're sitting at your computer ready to trade, bring back the sense of confidence you had during the meditation, and then follow-through; do in the real world exactly what you visualized in the mediation. At first you may have to pretend you're confident, happy, calm, etc. Do it anyway. Recreate how you felt in the visualization, in the real world. You can't control the market. You may lose 331
on this trade, but it doesn't matter. You do control yourself, and by acting with the same disciplined confidence you did in your meditation, you're working on becoming a better better trader overall. overall.
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33. Trading Resources
Forex Session Highlighter (MetaTrader 4) - A tool that marks the different global trading sessions: http://vantagepoin http://vantagepointtrading.com/ ttrading.com/archives/8072 archives/8072 Forex statistics and tools: http://vantagepoi http://vantagepointtrading.com/ nttrading.com/daily-forex-stats daily-forex-stats and https://www.mataf.net/en/tools/home (only really need forex correlation and forex volatility stats). Hook up your account and analyze your trading stats: http://www.myfxbook.com/ . This site also has volatility and correlation stats, as well as an economic calendar. Customizable Customizable economic calendar: http://www.dailyfx.com/calendar See when major markets open and convert time zones: http://www.forexmarke http://www.fo rexmarkethours.com/mar thours.com/markethours.php kethours.php.. Best Book on Trading Psychology: Trading in the Zone by Mark Douglas A palatable introduction to statistics: A Drunkards Walk — How Randomness Rules Our Lives by Leonard Mlodinow. An ECN/STP trading tool that makes it easy to get in and out of positions. Set stop losses, targets and limits orders, as well as change position size with ease: https://www.fxopen.com/en/traders-tools/ https://www.fxopen.com/en/traders-tools/..
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Best Wishes.
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